Foreign Banks, Others Struggle to Prepare FATCA Compliance

Companies, including foreign banks and other institutions, continue to fret over compliance with the reporting requirements of the Foreign Account Tax Compliance Act, also known as FATCA. Now,  a delay in the release of the proposed rules by the U.S. Department of the Treasury and the Internal Revenue Service has  left tax experts and large foreign banks behind on their compliance efforts.

FATCA, which was enacted in 2010, is aimed at foreign financial institutions and other financial intermediaries to prevent tax evasion by U.S. citizens and residents through use of offshore accounts. It requires foreign banks to report information to the IRS on foreign accounts held by U.S. taxpayers or by foreign entities that are substantially owned by U.S. taxpayers.

Implementation guidance gives foreign banks until June 30, 2013, to reach agreements with the IRS to comply with the information reporting in order to avoid withholding penalties on certain types of payments beginning in 2014. The IRS has promised it will require the withholding on U.S. source interest and dividends, gross proceeds from certain U.S. securities, and pass-through payments, beginning in 2014 for foreign banks that do not cooperate. The withholding in 2014 is for fixed or determinable annual or periodical (FDAP) payments. Withholding on proceeds begins in 2015 and the earliest it will be required on pass thru payments is 2015—meaning the IRS may delay that further.

The IRS is most focused on high-risk accounts, those with balances greater than $500,000. Under the information reporting agreements, banks will be required to identify U.S. accounts and report certain information about those accounts to the IRS that will be helpful to the IRS is pursuing any U.S. tax due on those accounts.

Still, though, many questions remain on how the law will be implemented and what kinds of exemptions the IRS will allow. Last July, the Treasury and the IRS said they expected to issue the proposed regulations incorporating all previous FATCA notices with further guidance on implementation by the end of 2011. Meanwhile, the draft and final versions of the foreign financial institute Agreement and withholding agents' reporting forms are expected to be issued this summer. The time has lapsed on the proposed regulations release date, leaving many companies and non-profits wondering if the complex law will apply to them.

Denise Hintzke, global tax leader of foreign account tax compliance initiative at Deloitte, is hopeful that more definitive guidance will be issued by the end of the month. “What we're hearing is that the regulations will provide more clarity around exemptions for certain types of clients, such as pensions and charities,” she says.

According to Hintzke, the IRS could provide more details around the deemed compliant option that includes documentation requirements for new accounts, detailed guidance on the remediation of pre-existing accounts, and other reporting requirements

Laurie Hatten-Boyd, principal at accounting firm KPMG's Washington national tax practice, anticipates many significant items to be included in the proposed regulations, such as a broadening of exemptions for some institutions. On deemed compliant foreign financial institutions—entities that can be exempted from having to enter into the formal FFI agreement—she says, “The listed requirements to ascertain such status were so restrictive that few, if any, entities could actually take advantage of this status.” She expects the proposed regulations to offer some relief with respect to this.

Another significant item relates to the requisite reporting. Hatten-Boyd says initially, everyone anticipated that FATCA reporting would be limited to just U.S. accounts. However, more recently there are indications that it is possible that all withholdable payments made by U.S. financial institutions would need to be reported and that participating foreign financial Institutions, in turn, would need to report all of the payments that it makes (similar to what is described above for 1042-S reporting under the current regime). “If this occurs, I think this would take a lot of people by surprise,” she says.

Hatten-Boyd doesn't expect the proposed regulations, whenever they are issued to answer all the looming questions effected organizations  have on the rules. “I think it (the proposed regulations) is not going to be an easy read. One thing that is likely to disappoint [foreign financial institutions] that are not familiar with U.S. tax rules is that the proposed regulations will not provide them with all the information they need,” she says.

She expects most of the actionable information for FFI to be included in the FFI agreement itself, which will be published in draft from sometime after the proposed regulations are issued.

What we will not see in the upcoming guidance, says Terence Cardew tax partner at Ernst & Young, are rules on pass thru payments and processes on how to implement the withholding on pass through payments. "The implementation timeline on withholding on pass thru payments has been postponed by Notice 2011-53 to 2015. I do not expect to see rules on the requirement in the upcoming guidance,” he says.

The current delay on the proposed regulations is squeezing the timeframe foreign banks will have in order to comply with the rules.  Previously, those affected by the rule have already stated that they need at least 18 to 24 months to get their system upgraded to comply with all of FATCA's requirements.

“Until companies really pull up their sleeves and take a hard look at all the necessary changes, they won't realize the impact.”

—Laurie Hatten-Boyd,

Principal,

KPMG

The penalty for not entering into the agreement with the IRS by the June 30, 2013 deadline is high. If a foreign financial institution chooses to look the other way, a 30 percent tax withholding will be imposed on all relevant U.S.- sourced payments including dividends and interest paid by U.S. corporations beginning Jan 1, 2014. The high withholding threshold will also apply to gross sale proceeds from sale of all relevant U.S. property. The notice further warns that because the IRS requires time to process the applications and the U.S. withholding agents need time to verify the status of the foreign financial institutions, those who choose to sign the agreement after the June 30 deadline but before the beginning of 2014 could be considered to be “non-participating and be subjected to the withholding penalty as non-participating FFIs.

Foreign banks that do cooperate with the IRS will be required to put in place account opening procedures to identify U.S. accounts opened on or after the effective date of the agreement. Within a year of the effective date of the agreement, participating institutions will also be required to complete the pre-existing account due diligence procedures for all accounts opened before the effective date of its agreement associated with a private banking relationship on individual or entity account with a balance of at least half a million.

Challenges in FATCA Compliance

FATCA FACTS

The following charts are from KPMG's recent FATCA poll. The survey polled companies in the funds industry.

In the first chart below respondents were asked: Do you expect to change your distribution model further to FATCA?

The second chart polled companies on their preferred method for complying with FATCA obligations.

In the following graph, KPMG asked respondents: How realistic is it to ask all your distributors to become participating Foreign Financial Institutions, i.e., to sign an FFI agreement with the IRS.

Source: KPMG.

According to tax experts, large institutions are conducting impact assessments, to analyze which business entities, business units, and income streams within their groups will be potentially affected by the implementation of the new regulations.

Based on a survey conducted by KPMG last year, 55 percent of the 70 banking executives surveyed said compliance costs will increase significantly as a result of FATCA. “It is imperative that the large institutions conduct this impact assessment now so that they can formulate a budget and ensure their budget is approved by senior management,” says Hatten-Boyd. Without an approved budget for the necessary resources required to meet the FATCA reporting requirements, they risk non-compliance and withholding penalty.

One of the most difficult aspects of FATCA is that it is still not clear what organizations and related businesses will be affected. According to Hatten-Boyd the process of trying to determine which entities within the expanded affiliated group must enter into the disclosure agreements is a challenge in itself. “Many have special purpose vehicles—entities that were established for a specific purpose and generally operate for a limited time period,” she says. The task of classifying these entities into foreign financial institutionss or excepted non-financial foreign entities is difficult, she says. Cardew adds that some industries will face more complications when trying to comply with FATCA. For example, insurance products that have in-built investment features or the more tricky funds of funds investment products available within the hedge funds industry will increase the compliance difficulties for them to comply.

Misconceptions About FATCA

The biggest misconception about FATCA, according to Cardew, is that many think it is all about tax withholding, “It is not about withholding. FATCA is about understanding your on-boarding processes, customer profiles, and data that is available to you.” Many domestic financial institutions assume that the rules will only apply to foreign firms. That is not true,he says, U.S. financial firms will need to know who their customers are. In addition, many domestic financial institutions have foreign subsidiaries that are foreign financial institutions.

Another popular misconception among foreign institutions is that they will not be affected by FATCA so long they do not have U.S. accounts. “If you receive a withholdable payment, or are given the pass thru payment provisions as currently contemplated, or receive any payment from a participating foreign financial institution, you will have to comply or suffer the penal withholding,” says Hatten-Boyd. “Until companies really pull up their sleeves and take a hard look at all the necessary changes, they won't realize the impact.”