The US's Foreign Account Tax Compliance Act, or Fatca, was widely criticised when it was enacted by Congress in 2010. Newly proposed regulations have brought with them some concessions, as well as an intent among some European countries to share this approach, meaning that the act is here to stay.
What is it?
The newly proposed regulations from the US Treasury Department and the Inland Revenue Service (IRS) for information reporting by foreign financial institutions (FFIs) and withholding on certain payments to FFIs and other foreign entities, related to the US's Foreign Account Tax Compliance Act (Fatca).
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What is Fatca?
Fatca was enacted by Congress in 2010 and targets non-compliance by US taxpayers paying tax on income which is offshore. It requires FFIs to report information about financial accounts held by US taxpayers, or by foreign entities in which the US taxpayers hold a substantial ownership interest, to the IRS. The proposed regulations affect anyone making some US-related payments to FFIs and other foreign entities and payments by FFIs to other people.
It has been roundly criticised for the costly burden it imposes on foreign firms in terms of identifying US account holders, for potentially breaching local data protection and privacy laws, and for the cost, complexity and commercial issues surrounding the requirement to withhold on so-called 'passthru payments' (see Reg Rage, May 2011).
What's the latest?
Having first argued that investment banks and private banks bought this upon themselves by helping US citizens to avoid tax, the authorities’ stance in the US has softened somewhat in the face of a barrage of criticism highlighting how Fatca will affect a wide range of foreign institutions. The 388 pages of proposed regulations attempt to address some of the biggest issues raised by affected institutions and trade bodies.
Alongside the regulations, a joint statement was issued in February by the governments of the US, France, Germany, Italy, Spain and the UK, stating that they are “exploring” a common approach to Fatca implementation through reporting to a domestic authority, which will then share relevant information with the IRS. “At least this brings hope that we [banks] will not be turned into a branch of the IRS,” says one banker. “I would rather report to my own regulator than have to make a formal agreement with the IRS.”
What are the main concessions?
- An extension of the categories of FFIs that will be automatically 'deemed compliant'; this is of particular interest to the funds industry because it includes funds that restrict access to non-US investors.
- Modification of due-diligence procedures so that for pre-existing accounts this is limited to electronic review and an extended reliance on know your customer documentation. The thresholds beyond which a review of pre-existing accounts is required has also been raised.
- Extension of the transition period for reporting requirements.
- Confirmation that no external audit is required and that FFIs which comply with the obligations of their FFI agreement will not be held liable for the failure to identify a US account.
What does the industry say?
Most are thankful that some concessions have been offered. However, they argue these do not go far enough, and Fatca is still going to be a massive, expensive headache for an already beleaguered financial sector.
Nick Matthews, member at financial advisory firm Kinetic Partners, says a lot of work still lies ahead. “Firms may breathe a small sigh of relief at [this] update, but should not pause for long given the substantial compliance task that still faces them…the deadline for entering into agreements with the IRS itself has not changed.”
Many are still worried by the cost. US concessions are expected to save European fund managers up to $1bn in costs, for example. However, managers will each still have to face between $15m and $150m of Fatca compliance costs over the next five years. International managers in particular could face high costs.
“There have been valuable concessions around insurance, tax-free savings and not for profit. However, many financial institutions will still see Fatca as overly burdensome,” says Julian Skingley, partner at Ernst & Young. “With the new rules around what counts as [proof] that a client is from the US, [there is] still a strong likelihood that firms will have to invest in their operating systems. As a result, firms will be pressing the US for further changes before these regulations are finalised in the summer.”
Will it go away?
No. If people hoped that industry lobbying would kill Fatca, they were wrong. The six-government negotiations show that some kind of domestic, quasi-Fatca legislation is getting more and more likely in each jurisdiction.
