The Foreign Account Tax Compliance Act (FATCA) is a United Stated (US) Federal law which was introduced as a part of a Hiring Incentives to Restore Employment (HIRE) Act in 2010 to increase tax transparency and tax revenues. The regulation requires all Financial Institutions (FI) (banks, funds, brokers, custodians, asset managers, insurers, etc.,) outside of the US to search their records for any listed US persons and report their assets and identities to the US Treasury.
There are thousands of US citizens with non-US assets, such as astute investors, dual citizens, or legal immigrants. FATCA is aimed at obtaining information about them and bringing them in the US tax net. During a discussion at the US Congress, it was revealed that approximately $100 billion is lost by the US annually due to tax evasion and avoidance of citizens residing outside of the US.
As per the regulations, all FIs are required to comply with FATCA requirements or they will be subject to 30% penal withholding on specific type of incomes received from US sources.
Implementation of FATCA has evolved since the enactment of the statute, but it is clear that the implications surrounding this new regime are wide-ranging for foreign FIs.
There are several practical implications which FIs face or are currently facing in implementing FATCA. These implications are divided into two board categories i.e. (a) implications on business model / operations and (b) implications on Information Technology (IT) System.
(a) The implication of FATCA on business model
FATCA will have an impact on several aspects of operations of any FI. It will entail the FI to assess impact on their operations, register with Internal Revenue Services (IRS) i.e. tax authority of US and devise a detailed implementation framework. Foremost is change in account opening documents (account opening form, AML / KYC Form, Terms & Conditions etc.) to on-board new customer in accordance with FATCA regulations.
FIs will have to conduct a detailed impact assessment to identify the implications of FATCA and prepare adequate strategies in response.
As FATCA targets information disclosure from FIs, it will also compel changes in existing data privacy and disclosure legislation of relevant jurisdiction.
(I) FATCA affects Financial Institution?
Under FATCA, different FIs will have varying requirements, and these requirements will be identified by appropriate entity classification of the FI. In order to be compliant with FATCA requirements, FI will need to perform its legal entity analysis to understand what obligations it will have under FATCA. FI will have to assess the applicability of FATCA on them as per guidelines issued by relevant Government authority and FATCA regulations.
On a practical note, this can be a very challenging task for any FI as all the subsequent requirements for particular financial institution varies according to their entity classification. Giving an example of such difficulties, ‘Piraeus Bank’ in Greece had to perform entity classification analysis for its 250 entities in 7 countries for FATCA classification.
(ii) To comply, Financial Institutions need to register with IRS
After entity classification, FI will need to register with the IRS to commence FATCA implementation. Once, an FI is registered with IRS, its obligations under FATCA begins officially.
Not all FIs are required to register with IRS. FI’s classified as exempt FI’s under FATCA regulations will not be required to register themselves with the IRS, however, they will have to submit and claim their exemption from FATCA regulations.
With regards to FI’s which are neither exempt nor complying with FATCA regulations, they will be classified as Non-Participating Financial Institution by IRS and will be subject to penal withholding of 30%.
(iii) Smooth Implementation or Chaos?
Implementation of FATCA necessitates an appropriately defined framework or it may result in a chaos. It requires FIs to set up a FATCA implementation landscape to ensure smooth implementation across the board. Relevant Government Authority may develop and provide procedural guidelines to facilitate the management of FIs in their efforts towards FATCA implementation.
(iv) FATCA, a burden?
FATCA will definitely result in increased compliance, operating and technological cost. FIs may require enhancement to their documentation / record keeping procedures to keep record of all documents obtained to determine the US and Non US Persons status of clients.
Obtaining the initial information does not conclude financial institution’s obligation for compliance, a continuous monitoring of client/payee’s information for FATCA status is required which may well be seen by the entity as additional cost.
(v) Launching New Products will be harder than ever
In order to avoid inconvenience or additional cost FIs may require strategic shifts regarding their targeted client segments, product and investment options to offer. Product and services analysis needs to be performed to take into account different products and services offered by the FIs.
FATCA regulations impact certain types of financial accounts maintained by FIs and product analysis should be performed to evaluate whether the FI’s products and services fall under the prescribed ambit.
(vi) Legal aspects of FATCA
Legal consultants of the FI will be required to mend/update/modify terms and conditions of various service offering of the FI to include specific terms which allow the FI to disclose their information to IRS.
Many countries have already amended their local laws to cater FATCA requirements including Republic of Azerbaijan which has already amended its Banking Law, Tax Code, Law on Personal Data and Insurance Regulations to embed necessary FATCA requirements in its legislation.
(vii) Not just implement but train yourself as well
Training of client representative/ compliance/ risk management and other relevant members of the institution will be required on immediate as well as on continuous basis. Training will be required to ensure technical advice on FATCA and subsequent developments are understood and disseminated appropriately across the entity / group.
FIs will be required to develop awareness programs and implement procedures to ensure that training is provided to all requisite staff across the entity / group. In addition, the nominated responsible officer will need to ensure that training sessions are held regularly, as appropriate, and for all relevant new staff.
(b) IT Systems will be under FATCA Clouds
As mentioned earlier, FATCA will impact almost every activity/ function of FI and IT is no exception to this. FATCA will have a significant impact on IT system of the FIs. As the basic data capturing documents will evolve (account opening form, AML /KYC Form), the IT systems need to be modified to capture FATCA related information of customers.
Databases will need modification to store FATCA related data and produce reports as per the requirements of relevant forms and relevant Government Authority.
The FIs will have to assess and address the FATCA implications on IT systems keeping in view the following abilities of the system to:
– comprehend new information requirements and on-boarding requirements
– withhold withholdable payments when required
– report certain information to IRS and local authority
– accommodate changes necessitated by other global tax regulations
(I) Collect the Information of your Customers
The elementary implication will be on the Front End IT systems of FIs. Front end IT System will require significant modification to include US indicia (indicators to identify US account) and FATCA fields for new customer on-boarding. FIs will be required to obtain and store static data on account holders that is not required today.
Oracle and many other Enterprise Resource Planning (ERP) software providers have already launched their FATCA compliant system interface for FIs.
(ii) Store the Information & Generate Reports
Changes in account opening and other documents are likely to require changes to underlying customer systems and databases to store additional data items. The FIs will be required to update their system database to store and recreate information captured by front-end IT system.
MIS generating system modules of the FI will require modification to generate reports pertaining to FATCA related customer and relevant customer details.
(iii) Penal Withholding – A Cost of Non-Compliance
A most common misunderstanding under FATCA is with regards to penal withholding of 30%. It should be duly noted that this is not the regular withholding, it is just to penalize the non-compliant FIs and customers.
However, new withholding responsibilities are required in this regulation and therefore additional systems capabilities and infrastructure will need to be developed to track for transactions producing withholdable payments to ensure that necessary business rules for withholding are applied.
(iv) Consistency at all times
All the front-end and back office systems will require integration to cater FATCA requirements. FIs shall have to ensure that all information captured via front office system is adequately transferred to the back office system and maintained properly in the database management system.
FIs with branches in multiple jurisdiction may face great difficulties in this regard as they will need to ensure that front end system across all the branches in world capture the same (required) information.
Conclusion – Impacts of FATCA are Far Reaching
FATCA has emerged as one of the most far reaching tax legislation of recent time which has impacted large number of financial institutions across the globe. As elaborated above, FATCA compliance is complex, may involve additional cost, time consuming and require co-ordination of several business units of the organization.
Nevertheless, FIs opting to comply with FATCA requirements in full, should consider the above mentioned implications of FATCA for their impact assessment and FATCA readiness.
Lastly, while implementing FATCA, FIs will need to ensure readiness for another tax transparency regulation i.e. Automatic Exchange of Information (AEOI) commonly known as Global Account Tax Compliance Act (GATCA) which may come into force in the span of next few years.
This article has been written based on months of research on FATCA regulations, IRS Circulars and hands on experience of implementing FATCA on various Banks, Investment Companies, Securities and Funds.
Operational and system challenges mentioned herein are practical experiences faced by financial institutions while implementing new tax regime.