The overhaul of US withholding tax legislation will have a dramatic impact on how US corporations raise funds abroad, as well as the way foreign investors invest in US securities. Writer Charlie Corbett

What is it?

The US Foreign Account Tax Compliance Act (FATCA).

A revamp of the US withholding tax system designed to clamp down on tax evasion and improper tax compliance. It will slap a new 30% withholding tax on foreign financial and non-financial institutions that refuse to identify US account holders and investors. It will apply even if US citizens hold only non-US bank and securities accounts.

Who dreamed it up?

The US federal government. President Barrack Obama signed the Hiring Incentives to Restore Employment Act in March 2010, of which FATCA is a part. It will become fully effective on January 1, 2013.

What are the main provisions?

To avoid the withholding tax, foreign financial institutions must enter into an agreement with the US to:

- Reveal all account holders who are US citizens.

- Comply with all verification and due diligence procedures the US authorities demand.

- Report annually to the Internal Revenue Service (IRS) the name, address and taxpayer identification number of each US account owner, the account number, the account balance or value and the gross receipts and withdrawals from the account.

- Comply with IRS requests for additional information.

What is in the small print?

The small print revolves around the IRS and US government's definition of a 'foreign financial institution'. FATCA requirements could extend to every type of foreign investment entity used in the investment management industry. This will include: any fund invested in US capital markets; any fund using an intermediary that has exposure to US capital markets; and any fund that might have a US taxpayer as an investor. It also incorporates the alternative investment industry.

What does the industry say?

It is very hard to argue against a government that says it wants to create a fairer, more transparent tax framework. However, the sheer scope of the legislation has left money managers across the world deeply uneasy. "The current tax legislation in the US is onerous enough - this demand for complete transparency will make it far more onerous," says David Aldrich, head of alternative investment services, EMEA, at BNY Mellon in London. "It will catch everyone involved in managing money in the US and the alternative investment industry."

How much will it cost?

A 30% withholding tax will be applied to interest, dividends and securities sales proceeds made to non-US banks and brokers, unless they comply with the regulations. "You are going to have to operate on a much larger scale to justify the costs of the due diligence involved in complying to FATCA," says Mr Aldrich. "It will play into the hands of larger funds."

What do the regulators say?

Too many US citizens avoided paying tax using methods that were not transparent and which were partly to blame for causing the financial crisis. The US Joint Committee on Taxation estimates that FATCA would prevent the evasion of $8.5bn of taxes over the next 10 years.

The law of unintended consequences

FATCA will change the way US corporations raise funds abroad as well as the way foreign investors invest in US securities. "If enacted, FATCA will have a considerable effect on the operations of US and foreign hedge funds, private equity funds and venture capital funds, as well as their investors," says US law firm Pepper Hamilton. "It seems likely to result in over-withholding of tax and thus investors would have to file tax returns to obtain refunds." FATCA could also eliminate the ability of corporations to raise funds through the issuance of bearer bonds.

Could we live without it?

A resounding 'yes!' from the investment management community. It says this is yet another regulatory burden the industry does not need. US regulators will argue that FATCA is critical in avoiding future financial crises and for creating a fairer, more transparent system.

 

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