The US's Foreign Account Tax Compliance Act puts onerous burdens on foreign institutions to capture data about US clients, and any clients with ownership of US assets, and to report related tax information to the country's tax authorities. For banks, it is a huge task, but they had better do it well, as this is likely to be the first of many such schemes.

What is it? 

The Foreign Account Tax Compliance Act (FATCA) was signed into law by president Barack Obama as part of the Hiring Incentives to Restore Employment Act in March 2010. Although it does not take effect until January 2013, the magnitude of changes means the financial community must start preparing for it now.

What’s behind it? 

Tax evasion. The US wants to prevent offshore tax abuses by 'US persons', by requiring foreign financial institutions (FFIs) to determine the direct and indirect ownership by US individuals of assets in foreign accounts, and to provide the related tax information to the US tax authority.

Essentially, FFIs will form part of a global information exchange on US persons and their tax liabilities with the US’s Inland Revenue Service (IRS).

What are the main provisions? 

The act requires affected foreign entities and FFIs to disclose US account holder information to the IRS annually or be subject to a 30% withholding tax on US-based investment-type income.

All FFIs will be subject to the withholding tax unless they make an agreement with the IRS and assume hefty obligations to identify and report information with respect to their 'US accounts'.

The definition of what constitutes an FFI is extremely broad, taking in entities that manage investments, which in turn includes alternative investment entities and insurance companies. Most global firms, in fact, house legal entities that can be considered FFIs; for FACTA purposes, the foreign subsidiaries of US financial institutions are also FFIs.

Moreover, non-financial foreign entities (NFFEs) will have to disclose whether they have any 10% US owners, and NFFEs that fail to 'document' the existence or non-existence of US owners may also be subject to the 30% withholding tax.

What's in the small print? 

The implications of FATCA go far beyond an understanding of technical tax requirements: it impacts right across the business, taking in compliance, operations and technology. Identifying the relevant data from existing clients (and putting in processes to do so for new clients) will be a huge challenge.

“It is unlikely that many firms are currently able to confidently and consistently identify and validate the citizenships of their clients, regardless of the countries in which they reside,” says Steve Beattie, principal, financial services at Ernst & Young. “Further, there remain open questions about exactly how the FATCA rules are to be applied in a variety of common situations, such as indirect ownership through foreign entities, trust relationships, insurance products, fund products, etc."

The work it will require is mind-boggling: existing client relationships will have to be checked, validated and documented to identify the nationality of every client; internal operations and governance have to be changed so that firms can identify US residents or citizens as they become clients of the institution; data systems will need to be able to separate US from other clients, and to report US resident and citizen relationships.

Internally, someone will have to ensure that all of this is being done, so existing compliance functions will need to be beefed up.

What does the industry say? 

This is going to be expensive and difficult. To comply, institutions must adapt operating models – from identification of customers and documentation, to product portfolios and IT systems – and internal processes. Any changes have to be group wide. An agreement with the IRS in one part of the group, means the rest of it must comply with FACTA provisions.

“This is a major project. It requires a complete review of the client base and the ability by 2013 to be able to report to the IRS,” says Paul Symons, head of compliance, UK, at Handelsbanken. “The onus is on us as an organisation to actively identify any of our clients who qualify as a ‘US person’ under the act. It will hugely increase client on-boarding requirements going forward.”

Financial institutions will not be able to avoid compliance by simply exiting US business. Even institutions that stop doing business involving US securities, but still have customers who qualify as US persons or have dual citizenship, will have to get to grips with the rules.

Could we live without it? 

Government treasuries say no. Financial institutions say yes. But it is likely we will have to live with more of it, because other national and supranational committees are discussing similar moves.

Reg Rage


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