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Ross McGill

Corporate Actions Automation

Ross McGill - TConsult Ltd

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Innovation in Financial Services

Innovation in Financial Services

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Draft FATCA regulations

14 February 2012  |  4606 views  |  0

Better late than never, I guess, but on the way to Dubai for a FATCA conference, where all the speaker's presentations were based on guidance notices, the IRS finally issued draft regulation on FATCA, the Foreign Account Tax Compliance Act.

This piece of regulation, has long been heralded as the largest piece of extra-territorial tax since the British tried to put a tax on Tea in America (hence the Boston Tea Party).  FATCA, actually Title V of the US HIRE Act,  seeks to force all non US financial institutions to go looking in their accounts for US tax payers that may be evading taxes by hiding their assets outside the US.

The effects of this push have been a bit like the days preceding a volcanic eruption, low level seismic shocks, growing in intensity, as people figure out the consequences of each piece of guidance (and now draft regulation) that has been issued.

In the prior guidance there were 3 or 4 big issues.  First, because the US wants to force disclosure and reporting of US Persons, it widended the definition of who gets caught in the net of the regulations.  'Foreign Financial Institutions' or FFIs include not only the traditional banks, brokers and clearing houses, but now, almost any entity involved in investment management.  Under the prior rules (IRC Chapter 3), there were around 6,500 firms that contracted with the IRS to 'qualified intermediaries' leaving an estimated 35,000 to be non-qualified.  Under the new definition, the number of firms caugfht by the regulations is estimated to top a million with ease.  The US government wants all of these firms to sign up to a contract - an FFI Agreement, under which the firm obligates itself to document (including pirecing the corpoare veil) all their customers and report those who are US or penalise those that refuse to be responsive (so called recalcitrance).

Second, the rules lay down complex procedures for documenting investors and piercing any vehicle in which an American could hide assets.  The rules vary depending on what the account balance is, whether the account was pre-existing or not on January 1st 2013 (the date the regulations come into force) and the nature of the account and investment vehicle used.  While the draft regulations do water down some of the complexity, through carve-outs and increases in de-minimus limits on account values, these will still be highly complex and costly for traditional financial institutions to implement and extremely challenging for the hundred of thousands of firms that, today, don't think of themselves as financial institutions. 

The third and most important impact of FATCA are the outputs.  There are only three, but thats where the good news ends.  Output one is that a US investor is found.  In that case, the new 'Participating FFI' will report the investor's global income to the IRS once a year, starting in 2014.  Output 2 is that investors are found to be definitively non-US, in which case, nothing happens (second piece of good news).  Output 3 is that the investor refuses to provide documents or information required, in which case they will be 'recalcitrant'.  Any FFI that does not sign an agreement with the IRS will, by definition, non-participating and, from a practical perspective, they will suffer the same problem that a recalcitrant investor will.  That problem is (i) a 30% tax on FDAP income, typically dividends and interest AND a 30% tax on gross proceeds and (ii) account closure for long term recalcitrance.  The formula for applying this penalty is complex and so, in the draft regulations, some aspects have been pushed back to 2017, due to industry lobbying, but for the most part, penalties will start to be applied from 2014.

The impact of these regulations cannot be understated.  They pretty much affect every collective investment vehicle and traditional financial institution on the planet.

Thats not the full impact though.  One of the problems being dealt with at present is that the second output, reporting customer's global income to the IRS may be illegal in some countries.  So to avoid conflicts of law, the IRS has started out on a campaign to convince certain countries to allow the reporting to go via a domestic regulator, then to the IRS under exchange of information agreements.  Five countries have so far indicated a willingness to participate.  They key thing about the US Treasury Statement on this subject is that they expect this exhcnage to be reciprocal.  In other words, the US would be willing to receive infiormation reports from US banks about the accounts held in the US by non-US taxpayers in these 'FATCA Partner' markets.  This essentially would mean, if it goes ahead, that the FATCA Partner countries would be in a perfect position to implement their own FATCA system...and so, FATCA would blossom round the world.

The message?  if you're trying to get compliant to US FATCA, its time to start thinking about this as a global phenomenon not just a US one.



TagsPaymentsRisk & regulation

Comments: (1)

Ross McGill
Ross McGill - TConsult Ltd - Yateley 09 March, 2012, 10:37 Just to add further flavour, the IRS also just issued Notice 2012-20. This highlights the implications of the HIRE Act on the bond industry. Most people are currently focussing on the documentation issues. This notice reminds us that the HIRE Act is complex and affects many different areas of our industry.
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Founder and CEO of TConsult - a firm specialising in promoting, mentoring, training and advising financial intermediaries on best practice in corporate actions automation and global regulatory complia...

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