FATCA Enlists Other Countries in the Fight Against U.S. Tax Cheats

The taxman has gone global.

The release earlier this month of final regulations for the Foreign Account Tax Compliance Act kick-started a crackdown, in the works since 2010, on those who use foreign jurisdictions to skirt U.S. tax laws.

The Internal Revenue Service and the Treasury Department will forcefully deputize foreign financial firms as tax investigators. It isn't mere cooperation U.S. tax authorities want, as much as observance of a complex, costly, and—according to some tax experts—overly ambitious compliance regime.

The final regulations build upon many of the items found in an earlier proposal. Among these changes, are aligning the timelines for due diligence, reporting and withholding with intergovernmental agreements; and extending the time needed for financial institutions to comply. They also expand the use of alternative forms of documentation that participating FFIs may require. The use of government-issued identification is permitted and third-party credit agency information may also be utilized for identifying an individual or entity's FATCA status.

The definition of “investment entity” in the final version includes individual or collective portfolio managers, and others who investing or manage assets on behalf of a client. Investment managers who receive fees for their services are considered financial institutions under the final regulations. They also clarify, however, that solely accepting deposits as collateral or security pursuant to a lease, loan, or similar financing agreement does not mean an entity is a depository institution.

It is estimated that tax evasion keeps about $100 billion a year out of national coffers; FATCA is expected to reclaim about $7.6 billion of that money over the next decade. The crux of the plan is that foreign financial institutions (FFIs)—such as banks, investment funds, and insurance companies—will register through an online portal the IRS is expected to launch by June 15, pledging to collect and share data on the offshore accounts of their U.S. clients. Institutions must register by Oct. 25, 2013, to be designated as compliant institutions by the IRS.

If it sounds like a tough sell, well, it was. Other countries initially balked at the new responsibilities asked of them.

“FATCA was designed because the U.S. can't possibly audit everybody and be everywhere in the world, but what we could do is encourage foreign financial institutions to do our work for us,” says Jim Mastracchio, co-chair of the law firm BakerHostetler's tax controversy practice. “Well, there are a lot of problems with that. Those overseas financial institutions are just not familiar with our system. Local laws often preclude them from even asking about the true owner or beneficial owner. And even if they could ask those questions, there are privacy laws in place that don't allow them to release that information to any person outside of maybe their banking regulatory group.”

The intended solution, and a cornerstone of FATCA, was to forge “intergovernmental agreements (IGAs)” that establish frameworks for how information can be shared. So far, the United Kingdom, Ireland, Norway, Switzerland, Spain, and Denmark have signed off on one of two types of arrangements. Foreign institutions either provide information directly to the United States, or, to resolve privacy concerns and conflicting regulations, they report to their own governments, which then coordinate with their U.S. counterparts.

“Up until about a year ago, nobody thought that the IRS would even consider this alternative approach,” says Mike Laveman of EisnerAmper, a consulting and accounting firm. “Then, people started to realize that the IRS bit off a little bit more than they could chew by forcing the international community to be their police officers ... Overseas governments hated FATCA as it was originally written and their opposition would have made enforcement much more difficult.”

The IGAs are designed to “channel countries into compliance in a more digestible way,” says Thomas Humphreys, head of the Federal Tax Practice Group at the law firm Morrison & Foerster. “This is particularly true if you look at the IGAs where an FFI reports to their own government. Institutions are more comfortable doing that.”

“There is always a fine line between enforcing the rules and over enforcing the rules to the point of non-compliance. They are trying to find that line right now.”

—Thomas Humphreys,

Head of Federal Tax Practice Group,

Morrison & Foerster

A Two-Way Street

A concession to sweeten the deal for foreign governments is allowing reciprocity. While the current focus is on the U.S. demanding account information, other countries may soon demand quid pro quo as they escalate their own hunt for more information on the overseas accounts held by their citizens.

“FATCA acknowledges that tax evasion and transparency is a worldwide issue, not just a U.S. issue and a lot of foreign governments were struggling with it,” Laveman says. “A lot of the IGA agreements, like the one with the United Kingdom, say that not only will they provide information to us on U.S. citizens, we are going to be required to provide information to them on their citizens. I don't think a lot of U.S. financial institutions have focused on that issue yet, and it could be a huge burden on them.”

Dominick Dell'Imperio, co-leader of PricewaterhouseCoopers' global information reporting practice, expects that FATCA will also lead to more foreign-country-to-foreign-country agreements. “You'll get the economies of the world signing off on that,” he says.

Still FATCA raises the thorny issue of enforcement outside the U.S. government's jurisdiction.  One lingering question is what will happen if financial institutions and their host countries resist IGAs and fail to become registered and compliant FFIs by 2014. Humphreys says that in the Middle East—including such countries as Egypt, Lebanon, and Turkey—“there hasn't been a lot of activity around FATCA.” “It is an enormous global undertaking and it will take a long time for people to see if it can work,” he says.

If the IGAs are the “carrot,” the “stick” is a withholding penalty FATCA imposes. An FFI that fails to comply will be required to withhold 30 percent of any incoming assets from U.S. clients, effective Jan. 1, 2014.

“This is what really grabs the attention of a foreign financial institution,” Humphreys says. “They know that once the withholding tax kicks in, if they are not a compliant financial institution, then they are really not going to be able to hold U.S. securities.

This concern, according to Jeff Trent, a partner in PwC's financial services assurance practice, runs contrary to persistent threats that overseas institutions will decide to just stop dealing with U.S. clients. “The reality won't be as strong as that messaging sounds,” he says. “At the end of the day, people will realize that the global marketplace demands certain things and there are various challenges you just have to assume in operating in that environment.”

FINAL FATCA REGULATIONS

The Following is from a joint statement issued by the Treasury Department and Internal Revenue Service on final regulations implementing the Foreign Account Tax Compliance Act (FATCA):

The final regulations:

Build on intergovernmental agreements that foster international cooperation. The Treasury Department has collaborated with foreign governments to develop and sign intergovernmental agreements that facilitate the effective and efficient implementation of FATCA by eliminating legal barriers to participation, reducing administrative burdens, and ensuring the participation of all non-exempt financial institutions in a partner jurisdiction. In order to reduce administrative burdens for financial institutions with operations in multiple jurisdictions, the final regulations coordinate the obligations for financial institutions under the regulations and the intergovernmental agreements.

Phase in the timelines for due diligence, reporting and withholding and align them with the intergovernmental agreements. The final regulations phase in over an extended transition period to provide sufficient time for financial institutions to develop necessary systems. In addition, to avoid confusion and unnecessary duplicative procedures, the final regulations align the regulatory timelines with the timelines prescribed in the intergovernmental agreements.

Expand and clarify the scope of payments not subject to withholding. To limit market disruption, reduce administrative burdens, and establish certainty, the final regulations provide relief from withholding with respect to certain grandfathered obligations and certain payments made by non-financial entities.

Refine and clarify the treatment of investment entities. To better align the obligations under FATCA with the risks posed by certain entities, the final regulations: (1) expand and clarify the treatment of certain categories of low-risk institutions, such as governmental entities and retirement funds; (2) provide that certain investment entities may be subject to being reported on by the Foreign Financial Institutions (FFIs) with which they hold accounts rather than being required to register as FFIs and report to the IRS; and (3) clarify the types of passive investment entities that must be identified and reported by financial institutions.

Clarify the compliance and verification obligations of FFIs. The final regulations provide more streamlined registration and compliance procedures for groups of financial institutions, including commonly managed investment funds, and provide additional detail regarding FFIs' obligations to verify their compliance under FATCA.

Sources: Treasury Department; Internal Revenue Service.

Laveman praised the IRS and Treasury Department for incorporating many of the comments it received into its final proposal, and making an effort to streamline the process. It isn't as bad as everyone expected, he says, offering examples of how the IRS bent on some of the most contentious points to accommodate both industry groups and other governments.

The first reporting period on U.S. accounts has been pushed back to March 31, 2015, from September of 2014. Gathering information for account holders, as well as the timing for doing this, has been made a bit easier, especially on what documentation can be used in the near term. This will help the accounting industry “catch up,” Laveman says.

Also, given new timelines, most investment funds won't need to deal with FATCA in the next two to three months as they focus on getting audited financials out and tax information out. “That is going to be a big help to accountants working with funds to actually comply with the torrent of rules coming from various regulatory bodies around the world,” he adds. Obligations outstanding prior to Jan. 1, 2014, pre-existing accounts such as derivatives contracts entered into this year, will not be subject to FATCA withholding. FFIs must account for high value accounts (more than $1 million) by Jan. 1, 2015, with due diligence for all other accounts by Jan. 1, 2016.

Dell'Imperio says the IRS allowance of a transition period for “limited FFIs” will help many, in particular multi-national banks with operations throughout the world that have difficulty meeting compliance demands. “Then, the question is what happens next,” he says, explaining that the IRS sought to balance the need for more time while keeping up the pressure of a deadline.

A difficulty, Trent says, is that FATCA mandates the identification of a responsibility officer to serve as an IRS liaison and oversee the entire compliance regime. Given the complexity of this position, the level of accountability and the disciplines it touches (taxes, operations, technology, data privacy, electronic searches), banks may have trouble finding people to fill these roles. He says institutions are looking at ways to ensure there is a point person who, even if they can't touch upon all the relevant areas at a level of detail that would be required, can at least adequately oversee controls.

Humphreys stresses that, even with various concessions, FATCA is “still a very demanding compliance regime.”

 “Making it a little less onerous does not change the fact that it will be, for many foreign financial institutions, a real burden,” he says. “There is always a fine line between enforcing the rules and over enforcing the rules to the point of non-compliance. They are trying to find that line right now.”