Caught in the act: FATCA - what can be done now?

appeared in JEP Investment Review, June 2011

Ben Gilbert, senior tax manager, PwC, examines the implications for the Island's finance industry practitioners of the Financial Account Tax Compliance Act

The predicted dramatic reshaping of the tax and regulatory landscape in the post Financial Crisis world continues apace; including from the US, in the form of Dodd-Frank and FATCA legislation.

With FATCA, the US is essentially using the big stick threat of a withholding tax penalty to encourage entities to comply with a new raft of disclosure requirements.

The impact of FATCA is wide; so if you have not thought about them already, these are the questions you should be considering:

What is FATCA and how does it impact the financial services industry here in Jersey?

FATCA is the Financial Account Tax Compliance Act, which forms part of the United States’ Hiring Incentives to Restore Employment Act (‘HIRE’).

FATCA is effectively a way of seeking to reduce tax evasion by US citizens, by increasing the tax reporting and compliance obligations in respect of US persons who invest through non-US entities.

Withholding tax under FATCA applies where certain US source income and the gross proceeds from the sale of US investments (‘withholdable payments’), is received by a Foreign Financial Institution (‘FFI’) or Non Financial Foreign Entity (‘NFFE’).

Where an FFI fails to comply with the reporting, disclosure and related requirements imposed under the FATCA regime, US withholding tax (‘WHT’) at 30% on any withholdable payment is deducted and remitted to the IRS.

The withholding obligation is not imposed where the FFI enters into an agreement with the US Government to comply with FATCA documentation requirements, due diligence procedures and reporting obligations.

FATCA takes effect for payments made after 31 December 2012 and is anticipated to have a significant impact in Jersey, as the regime will impact custodians, banks, funds and trusts, to varying degrees.

Who is impacted?

Those caught by the regime and who would be subject to the 30% WHT if non-compliant are any FFI’s or NFFE’s with US source income.

The definition of an FFI captures banks, funds, trusts and insurers amongst others. Broadly, those non-US institutions who accept deposits, hold financial assets for the account of others and those involved in trading in securities, partnerships and commodities.

The definition of an NFFE is basically any foreign entity which doesn’t meet the definition of an FFI.

If impacted, what do you need to do?

If you meet the definition of an FFI and have US source income there are two options available. The first is to comply with the provisions of the regime and become a ‘Participating FFI’. The second is not to comply and accept a 30% WHT on certain US source income and gross proceeds, however this latter option may have both reputational and practical consequences.

It is envisaged that less onerous requirements will apply to entities that pose a lower threat of US tax evasion and are entitled to apply for ‘deemed compliant’ status.

Compliance with FATCA means entering into an agreement to provide the IRS with certain details on US account holders and transactions. It also means applying the 30% withholding on ‘passthru’ payments to non-compliant FFI’s or NFFE’s and returning this to the IRS.

In order to meet the reporting requirements it is first necessary to have identified all account holders/ investors who are US persons or US entities.

The IRS have issued guidance on what constitutes indicia of US status and this includes, amongst others, documentation suggesting that account holders are US Residents or US citizens, a US address associated with the holder of the account and a US place of birth for the account holder of the account.

There are currently no transitional provisions legislated for, and this means that with effect from 1 January 2013 your client on-boarding procedures and IT systems must be sufficient to identify and report on all US persons, if you want to be a participating FFI.

For existing account holders there is a two year window, ie until January 2015, for identifying US persons.

What preparation can be done now?

Although the final FATCA regulations have yet to be released, sufficient information has been made available by the IRS to enable preparation for the new regime to commence.

Familiarisation with IRS withholding, reporting and compliance obligations

Although further detail is to follow, the IRS have released IRS Notices 2010-60 and 2011-34, which provide guidance on the documentation, reporting and withholding requirements of FATCA. Time should be taken to become familiar with the legislation and guidance to date.

Education of stakeholders

The business’s key stakeholders impacted by FATCA can be identified and tailored training provided to them, based upon the degree of their likely involvement in implementing and monitoring FATCA compliance. The key stakeholders are likely to be the IT and Compliance Functions.

Preliminary Business Risk Assessment

Businesses can start assessing the probable FATCA impact, by, for example:

entity assessment, to identify FFIs and NFFEs
liaising with service providers as part of information gathering exercise
creation of FATCA working party and allocation of roles within the business, to ensure key responsibilities under FATCA regime are owned.

Identification of US account holders
Based on existing guidelines, businesses can begin initial high level searches for specific investor attributes (ie ‘Indicia of US status’) within their electronically searchable information repositories and assign tentative FATCA relevant classifications.

Gap Analysis in client information collected

Businesses can review the information collected as part of their client take on procedures, ie Anti Money Laundering processes, to identify what additional information would need to be collected with effect from 1 January 2013 to meet FATCA requirements.

Reviewing IT systems to identify areas for development

A review of existing IT system capabilities and infrastructure can be commenced now, to identify where development work is needed to ensure new withholding and reporting responsibilities can be met, ie to ensure transactions producing withholdable or passthru payments can be tracked.

Further guidance on FATCA is expected to be released by the IRS in Autumn 2011, however, it is recommended that preparation for FATCA starts now.