FATCA – The Act that compels local financial institutions to comply with US federal law

Misperceived as an Act that only affects US citizens and entities, it could be costly for Malaysian financial institutions

KUALA LUMPUR, 10 December 2014 - Malaysian entities which qualify as a Financial Institution under the Foreign Account Tax Compliance Act (FATCA) (or Malaysian Financial Institutions) will be obliged to comply with this US federal law, come end 2014 when Malaysia’s Inland Revenue Board (IRB) is expected to enter into an intergovernmental agreement with the US. This includes identifying and reporting on their customers - both individuals and entities - who are considered to be US persons under FATCA.

“I’d venture an educated guess that there are more than 1,000 financial institutions in Malaysia which fall under the FATCA scope, some of which may not even realise they do so. The cost and effort to comply with this Act could be high, ranging anywhere from RM100,000 to several million. Financial institutions shouldn’t misperceive this as an Act that only impacts US banks, or traditional financial-related entities,” said Ong Ching Chuan, PwC Malaysia Partner and Assurance Financial Services Leader.

FATCA which has been in effect since July 2014 is a US federal law intended to detect and deter the evasion of US tax by US persons who hide money outside the US. In Malaysia, the level of awareness on FATCA and who or which entity falls under its scope is low. There is a common misconception among businesses, individuals and even financial institutions (FIs) that FATCA only affects US citizens.

In reality, FIs which fall under the FATCA scope include:

• Those in the banking business
• Those who perform custodial services e.g. nominee companies, trustees
• Investment entities e.g. unit trust companies, private equity companies
• Life insurance companies
• Holding companies or treasury centres

Any FI which doesn’t comply with FATCA (or chooses to simply ignore the Act) will be subject to 30% withholding tax by the US on any of their US-sourced income. For example, dividends receivable from stocks of US-based companies.

The IRB reached an agreement in substance on 30 June 2014, and has announced their plans to enter into an intergovernmental agreement with the US by 31 Dec 2014. Local laws and policy are expected to change to accommodate FATCA compliance - for example laws governing privacy protection to enable local FIs to report on their relevant customers’ status.

There are four areas which FIs will have to address in order to comply with FATCA:

• Determining if they qualify as Foreign Financial Institutions under FATCA
• performing due diligence procedures on customers to determine their FATCA status, covering both individual and entity customers
• reporting on financial account balances and income paid on these financial accounts held by reportable persons
• withholding obligations on entities which do not comply - FIs are subjected to a 30% withholding tax on US sourced income. For customers of FIs who refuse to reveal their FATCA status (referred to as “recalcitrant” account holders), the FIs are obligated to withhold 30% on US sourced income paid to them

Taking these elements into account, financial institutions need to grapple with additional costs of compliance in the area of IT implementation and other operational processes. For the customers, the additional due diligence means additional forms to complete as part of the self-declaration process.

“The success of any reporting system to promote financial transparency must first begin on the right footing by being transparent with the financial institutions’ stakeholders including its customers, front office staff, investors and the tax authorities. Customer education will be key in smoothing out the kinks related to account holder declaration and other aspects of customer on-boarding related to the implementation of this Act,” adds PwC Malaysia Executive Director Foong Mei Lin.

Calendar years 2014 and 2015 will be regarded as a transition period for purposes of US IRS enforcement and administration. IRB will be the competent authority under the proposed Malaysia IGA: this means that all Malaysian FIs which fall under the FACTCA scope will have to perform annual reporting on affected customers’ financial account balances to the IRB. The IRB has yet to announce the reporting timeline by Malaysian FIs to them, however, as the competent authority, IRB’s first reporting timeline to the US IRS is on 30 September 2015.

As at 21 November 2014, 498 FIs in Malaysia have registered with the US IRS. The next two years will be a critical period for all financial institutions as they embark on a change management exercise impacting multiple stakeholders and processes, in transitioning to FATCA.

“Our local financial institutions need to take a hard look at their systems implementation processes and assess the impact of the Act on their organisation – this includes resources needed to support the implementation and monitoring processes,” said Ching Chuan.

A new wave of “FATCA-like” compliance is expected to take place in several years. The Organisation for Economic Cooperation and Development (OECD) is working to establish Common Reporting Standards (CRS) to enable global automatic exchange of tax information. This will require due diligence on customers and reporting of financial account information based on customers’ tax residency. Malaysia is expected to be a party to the CRS Agreement by 2018.

ENDS