FATCA Simplified - the Good, the Bad & the Ugly

July 19th, 2012
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Contributed by: Shane Brett, Global Perspectives
FATCA (the Foreign Account Tax Compliance Act) is US tax legislation enacted in 2010 and due to come into force on Jan first 2013. Put simply FATCA require all foreign financial institutions to report US account holders to the IRS.

The US, unlike virtually every other country in the world taxes its citizens on their worldwide income. Its citizens are made to report their income on a global basis.

FATCA is effectively the IRS extending its long reach internationally into every country on the globe and forcing its financial companies to report to it, to disclosure to it and to withhold tax on its behalf. Essentially FATCA is the IRS ordering foreign institutions to do its dirty work - by making non-US companies act as unpaid tax collectors!

FATCA compels all Foreign Financial Institutions (known as FFI’s) to identify all U.S. account holders and report this information to the IRS. The FFI must then impose a 30% tax on payments/transfers to all account holders who refuse to identify themselves and their country of origin.

FATCA has a very broad definition of a foreign financial institution (the “FFI”). This has been designed specifically to bring as many financial type institutions into the IRS’s reporting net (Hedge Funds, Mutual Fund Managers, Private Equity etc, as well as traditional banks and Prime Brokers).

If your organization does not enter into an agreement with the IRS and agree to the required reporting, disclosure and withholding of tax on your client’s money/assets, then your own organization will be subjected to a 30% Withholding Tax on all your and your client's US sourced income. This also applies to US Dividends and proceeds from the sales of US assets.

To avoid this 30% withholding Tax FATCA compels every Foreign Financial Institution worldwide to enter an agreement directly with the IRS.

This agreement will detail the processes your organisation must follow to identify all US accounts, the on-going reporting required on those accounts and finally that you agree to withhold 30% tax on any payments to FFI’s & their Accounts holders worldwide, that do not also have a similar agreement with the IRS.

Currently FACTA legislation is in near final form. The IRS issued a substantial expansion and clarification of the rules in February (all 400 pages of them - which we will discuss further below) and the final hearings in Washington took place in May. The legislation will be finalized during summer 2012

Below we’ll examine the Good, the Bad and the downright Ugly regarding FATCA.

This will include outlining what this legislation means for the wider Financial Services Industry, Fund Managers in particular, and what your organisation needs to do next to comply.

The Bad

With less than a year to go many companies in the financial services industry are starting to examine their reporting, withholding and disclosure obligations as required under FATCA. With all the attention on Dodd Frank, Form PF and the AIFM Directive over the last couple of years, FATCA has to date not been a priority for many Fund Managers.

This is about to change.

Organizations right across the global financial services industry need to start planning in detail how they will address the disclosure and reporting requirements contained within FATCA.

One point we have heard repeatedly is that the more organizations examine the amount of work involved to become FATCA compliant, the more management are surprised at the level of effort and cost to make themselves compliant.

The initial worldwide costs of complying with this legislation have been conservatively estimated at $10 billion dollars, with the cost to the average large Global bank (e.g. HSBC, Morgan Stanley) estimated at a massive $100 million per bank. The IRS itself estimates FATCA will bring in less than a billion dollars in revenue.

Given the huge internal cost (with no obvious benefit whatsoever) for all FFI’s involved, it is very surprising that financial lobbyists in Washington did not kill off or substantially dilute this legislation at the outset. We understand many companies and countries presumed FATCA would die off or be postponed indefinitely. This hasn’t happened.

Instead in February this year 5 other European countries announced they had signed an agreement with the US to share this taxation information (The UK, France, Germany, Italy and Spain - with Ireland and Luxembourg expected to do the same soon). This is a significant development and essentially means FATCA is here to stay.

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