Background of FATCA

washingtondc-hedgethink Background of FATCA

The US Foreign Account Tax Compliance Act (FATCA) was enacted on 18 March 2010 and will be effective as from 1 July 2014. FATCA requires Foreign Financial Institutions (FFI) to enter into legal agreements with the IRS according to which they would have to comply with due-diligence, information reporting and tax withholding obligations with respect to their US accounts.

Reasons for FATCA

  • Financial Scandals
  • Curb US Tax Abuse: US investors using offshore accounts to evade US taxation

– Evasion of US withholding tax system
– Failure to pay tax on income/gains
– Failure to comply with US tax/reporting disclosure rules

  • Enactment occurred at same time as:

– G20 promoting tax transparency and exchange of information
– Financial crisis
– Need for revenues

What does FATCA require?

FATCA requires Foreign Financial Institutions (FFIs) and Non-Financial Foreign Entities (NFFEs) to report information with respect to US account holders or members or suffer or suffer a 30% US withholding tax on US on certain payments relating to US investments.

FFI obligations under IRS agreement

Enter into IRS agreement to: identify US accounts, report certain information to IRS regarding US accounts, verify its compliance with its obligations pursuant to agreement and US withholding on certain payments.

NFFE obligations

Provide information with respect to US members or certify no US members.

EU Dimension

Since the adoption of FATCA many EU financial institutions and their representatives have been in contact with the European Commission and the tax administrations of the Member States to express their concerns about the high compliance costs that the FATCA legislation would involve for them. FATCA is a US centric law that imposes expansive obligations on FFIs and NFFEs. A number of these US obligations may conflict with local law prohibitions with respect to privacy, disclosure, anti-discrimination, consumer protection and withholding ‘foreign’ taxes if the local law doesn’t permit an FFI or NFFE to undertake the required FATCA obligation or if the account holder or member doesn’t otherwise consent to the actions. It will be necessary to resolve these conflicts prior to the effective implementation of FATCA.

Therefore the US has considered an alternative intergovernmental approach to implement FATCA and improve international tax compliance. The US has developed a ‘model agreement’ to be used by countries which are interested in adopting such an intergovernmental approach. The intergovernmental approach would simplify practical implementation of FATCA and reduce FFI costs. Note also the willingness of the US to reciprocate in collecting and exchanging on automatic basis information on accounts held in the US financial institutions by residents of FATCA partners.

Intergovernmental Agreement (IGA)

The IGA approach to implement FATCA will be structured to avoid local law conflicts with FATCA. The US and a partner country (FATCA partner) would enter into an agreement pursuant to which, which subject to certain terms and conditions, the FATCA partner would agree:

1) To pursue necessary implementing legislation to require FFIs in its jurisdiction to collect and report FATCA required information to the authorities of the FATCA partner.
2) The FATCA partner, in turn, would transfer to the US, on an automatic basis, the information received by the FFIs.
3) FFIs in a FATCA partnership wouldn’t be required to enter into an FFI Agreement with the IRS but rather would be subject to an IRS registration requirement. FFIs in a FATCA partnership would be treated as compliant with FATCA.

IGAs are intended to establish a partnership between the US and foreign countries to:

  • counter offshore tax evasion;
  • improve international tax compliance;
  • establish uniform reporting standards and an automatic information exchange;
  • eliminate local legal obstacles to FATCA compliance; and
  • implement FATCA in a manner that will reduce compliance burdens and costs on FFIs.

Model 1

In July 2012, the US Treasury Department issued the first model for an IGA which makes it easier for partner countries to comply with the provisions of FATCA. Under this agreement, FFIs in partner jurisdictions will be able to report information on US account holders directly to their national tax authorities, who in turn will report to the IRS.

Model 2

In November 2012, the US Treasury Department issued the second model of the IGA for complying with the FATCA provisions. Model 2 IGA was designed to address potential conflicts of national and local laws that would make it difficult, for Financial Institutions in some jurisdictions, to comply with FATCA.

FATCA type provisions

Any country that has some sort of power can implement FATCA type provisions. For example: a large country with a growing economy and a fast growing market (such as for example India) could consider imposing FATCA type requirements, and permits foreign individuals or companies access to the Indian market only if the governments in which those foreign individuals and companies are resident/incorporated comply with a FATCA type provision. It is merely a question of power. Power reflected by the importance of a financial market (such as the US) or power reflected by a large consumer market.

Conclusion

When FATCA was being designed it was clearly understood that a US tax evader could avoid FATCA reporting by investing with a non-US bank that is not part of the FATCA regime. However, the hope was that such banks would not be that well respected within the international community and therefore US tax cheats would be hesitant to risk their money with such banks. Nevertheless, it is safe to assume some tax evaders will be prepared to take such a risk. However, the amount of capital at risk is extraordinarily small when one views US capital flows in total. In theory, the EU could take unilateral measures (such as FATCA) as well, but because the EU is composed of many different countries, the risk of a watered down approach is significant.

The two IGA models differ significantly in their approaches to FATCA implementation. Choosing between the two will require a potential FATCA partner to consider its own priorities with the benefits and burdens of each model.