The Effect of the Foreign Account Tax Compliance Act on Financial Institutions - Research Paper Example

The Effect of the Foreign Account Tax Compliance Act on Financial Institutions Table of Contents Introduction 2 Application of FATCA 2 Broad application 2 Specific application 3 A Group of Companies with FFIs 3 Company as payor 4 Company as payee 4 Implications of FATCA 4 Cost of Non-compliance 4 Cost of Compliance and Administration 5 Relationship with American Clients 6 Bank Secrecy 6 Conclusion and Recommendation 7 Categorize foreign entities 7 Analyze global payment flows 8 Educate business stakeholders 8 Evaluate the need for training 8 Examine related processes 9 Works Cited 10 Appendices 11 Appendix 1: FATCA Timelines (2014-2015, Taken from the FATCA Library) 11 Appendix 2: Recommended action plan for compliance 20 Introduction Congress endorsed FATCA, the Foreign Account Tax Compliance Act, in 2010 to detect and prevent offshore tax evasion [Gri12]. The Act was first applied in January 2013. Based on its name, FATCA appears to be targeted at financial institutions only. Thus, many global organizations operating outside the US financial services market have mistakenly assumed that the law does not affect them. However, upon closely scrutinizing their business portfolios, many foreign companies are surprised to discover that one or more of their divisions are under the FATCA net or make or receive payments that are subject to FATCA. Currently, organizations that are withholding agents are already required to report, document payees and withhold on payments [Hei12]. FATCA pushes these requirements a notch higher. In essence, for financial institutions, FATCA requires these institutions to identify Americans with offshore accounts worth $50,000 or more and report them to the Internal Revenue Service (IRS). This paper analyzes the impact of FATCA on businesses, both financial and otherwise, and recommends a way forward for the purpose of compliance with the law. Application of FATCA Broad application The US Congress passed FATCA to ensure that US citizens with offshore accounts and investments pay taxes on those accounts and investments [Hei12]. In order to achieve this goal, the Act requires foreign financial institutions (FFIs) to identity their American customers and furnish the Internal Revenue Service (IRS) with the particulars of those Americans for purposes of taxation. The Act mandates the Treasury and IRS with its implementation. In order to operationalize the Act, the Treasury and IRS issued a series of notices and proposed and final regulation January 2013, soon after the Act came into force. In order to overcome identified foreign legal setbacks to the successful implementation of FATCA, the Treasury has entered a number of intergovernmental agreements (IGAs), with more come [Dha14]. For most of the IGAs signed so far, IRS will share information directly with foreign governments. The implication is that business organizations operating within the jurisdiction of a government that has signed an IGAwill now be required submit to the respective government information that was hitherto either not required or permitted to be shared. In order to solicit compliance, FATCA slaps a 30% withholding tax on FFIs that fail to withhold the 30% FATCA tax where it is due. Specific application The application of FATCA is not limited to the financial services industry alone [Gri12]. The Act will affect many activities of nonfinancial organizations and require compliance. Following is an inexhaustive outline of the situations under which FATCA may apply to a company. A Group of Companies with FFIs FATCA imposes the heaviest burden of compliance on FFIs [Gri12]. While many nonfinancial businesses may believe that few or none of their businesses constitute an FFI, FATCA’s definition of the term is so broad that it nets in a conglomeration of business. Certainly, this is bad news for companies that were not prepared for the Act. Even though the regulations provide a number of exceptions, these are some of the activities that FATCA defines as FFIs: non-US foundations and retirement funds; treasury centres, captive finance companies and holding companies; bank-like subsidiaries and special-purpose entities and captive insurance companies. Company as payor FATCA applies when a multinational business, whether based in the US or elsewhere, makes a withholdable payment [Hei12]. Virtually, any multinational business that makes a payment that the Act defines as withholdable will be impacted by FATCA. Again, under FATCA, the definition of “withholdable payment” has been greatly expanded to include the gross proceeds from the sale specified property, for instance. Company as payee The entities within a group that receive withholdable payments could be subject to the 30% FATCA withholding. In addition, an entity that passes as an FFI will also be subject to FATCA withholding if it fails to prove timely, by providing valid documentation, that it is FATCA compliant [Hei12]. For instance, a treasury center must evaluate whether it is classified as an FFI in order to ensure that the right documents are furnished to requesting banks. The long and short of it that all foreign businesses that receive withholdable payments must ascertain their classification under FATCA. Implications of FATCA Cost of Non-compliance A business that fails to comply with FATCA will attract a number of consequences. Perhaps the most significant one is the risk of losing 30% of the value of a specific payment in withholding tax [Dha14]. As is the case other American regimes of information reporting, a payor who does not deduct and remit FATCA withholding where required will be charged the full amount they failed to withhold plus related interest and penalties. FATCA is also likely to impact financial statements. Businesses may be forced to set up reserves for tax liabilities should they occur. These may be especially necessary if there exists substantial risk of assessment by a tax authority. For a group of companies, a payee may receive a payment that is less than what they expect due to FATCA withholding. Therefore, it would be necessary that organizations communicate among themselves and clarify with units are FATCA compliant. If measures to ensure FATCA compliance are not well-coordinated, the wastage of time and resources is likely to occur. A 30% withholding tax is certainly harsh. However, Section 1471(b) of FATCA provides FFIs with a way out of the tax – compliance with the legislation [Dha14]. The section outlines the steps an FFI can take to comply with the law and- therefore, avoid the 30% withholding tax. The steps include (1) identifying the accounts held their US customers (2) reporting information about those accounts annually to IRS (3) withholding the 30% FATCA tax for payments that pass through them and (4) furnishing IRS with any additional informational it may request in relation to a US account. While these and other steps to compliance may appear an incentive for FFIs to comply and avoid paying the 30% withholding tax, there are enormous costs involved. Cost of Compliance and Administration One of the main criticisms leveled against FATCA is that passes the cost of apprehending American tax evaders to FFIs while America rips all the benefits [Hei12]. According to the Institute of International of International Bankers, it would cost a major bank approximately $250 million to fully comply with FATCA, a figure that is well beyond smaller banks [Hei12]. This figure is only a rough estimate. In arriving at the figure, the Institute simply reported that a number of large institutions conservatively estimated that, on average, it would cost them $10 to properly identify and document each customer's account. The Institute did not disclose (1) the institutions that gave the $10-an-acccount estimate, (2) the accuracy of that estimate and (3) the extent to which that estimate is conservative. Thus, the figure is not verifiable [Dha14]. Still, some businesses have put the annual cost of compliance at billions of dollars. Besides, the reporting procedures will impose on businesses administrative burdens. Relationship with American Clients To avoid the elevatedoutlay of complying with FATCA, some FFIs are avoiding US account holders [Dha14]. For this reason, FATCA has elicited an outcry from overseas Americans. As the fear of FATCA spreads, more Americans living abroad could see their bank accounts closed especially of their banks are too small to be able to comply with FATCA yet large enough to attract a considerable number of American investments. In the end, these Americans may be forced to open and maintain accounts with small foreign accounts with no major American accounts. Some critics such Marylouise Serrato of American Citizens Abroad, predict that sooner than later, FATCA will render it difficult for Americans living abroad to buy foreign insurance policies and invest in pension fund. In a bid to avoid the tentacles of FATCA, some American citizens living abroad have opted to renounce their citizenship, even though renunciation too comes at a cost of $450. Moreover, there is an additional expense for those renouncing their citizenship and are worth at least $2 million or earn at least $150,000 a year: they must pay a special “exit tax” [Dha14]. Bank Secrecy Many countries prohibit their banks and other financial institution from divulging information about their customers to foreign governments. For this reason, FATCA raises concerns over its contravention of local bank secrecy laws. Historically, Swiss banks are known for their strict observance of secrecy laws [Coh13]. However, recent commitments by Switzerland, Austria and Luxembourg through the signing of GIAs with the US could mark the end of bank secrecy in Europe and usher in the era of automatic information reporting. Moreover, FATCA requires foreign banks and other FFIs to deny accounts to US citizens if they are unwilling to comply with the bank’s or FFI’s reporting requirements. Conclusion and Recommendation Given the far-reaching and potentially destructive implications of FATCA, multinational businesses, both those in the financial services industries and others, should put in place compliance measures to avoid the 30% withholding tax [Dha14]. This section presents an action plan that a multinational business could follow to help it comply with the Act. It is important that this process be well-managed to avoid the wastage of resources and duplication of effort. Whereas the cost of implementing this action plan may be high, the cost of non-compliance may be even higher. The action plan is summarized in Appendix 2. Categorize foreign entities As noted, FATCA has more far-reaching implications than it appears on the surface: the Act applies not only to FFIs, but also any business that makes or receives withholdable payments. Therefore, an international business should first take the time to understand “withholdable payments” in the broadest sense of the term as defined by the Act [Gri12]. Next, the business must scrutinize its operating units to see if any qualifies for an FFI. The Act defines an FFI in the broadest sense possible. Throughout this process, the legal department should play a key role. Analyze global payment flows The company should closely analyze its payments and receipts in order to determine which components qualify for withholdable payments as defined by FATCA [Hei12]. The importance of this exercise cannot be overemphasized given the Act’s wide-sweeping definition of withholdable payments; a component that, under the old regime, did not qualify as a withholdable payment could easily qualify under FATCA. Having identified the withholdable payments, the information should be communicated to all the units of the organization that are likely to receive less-than-expected payments due to FATCA withholding. It may also be necessary to set up a contingency fund to cater for any liabilities that may arise due to the misinterpretation of the law. Educate business stakeholders The company may need to create awareness among its stakeholders on the new law and the effect it may have on the business in the present and the future [Dha14]. For instance, it would helpful for suppliers to know whether the new law is likely to affect their ongoing currents and if yes, in what ways. Existing and future contracts may need to be modified. The suppliers will also need to know if by virtue of doing business with the affected multinational corporation, they too will be affected and have to comply. Evaluate the need for training FATCA creates much liability for the company and may need certified compliance [Dha14]. Therefore, there is need to train staff, particularly those in the finance department on the requirements of the law and what they need to do to comply with it. The business may need to hire the services of a firm with expert knowledge on the law rather than depend on its in-house training team. Examine related processes The should examine the current procedures used to identify payees and document them accordingly under Chapters 3 and 61 then compare them with the new rules under FATCA. Special attention should be paid to any procedures that may need to be overhauled or updated. This process is important as it will help the business avoid unnecessary costs of compliance by changing only the affected area as opposed to overhauling whole systems when there is no need for an overhaul [Gri12]. Works Cited Gri12: , (Grinberg 30), Hei12: , (Heiberg 1692), Hei12: , (Heiberg 1689), Dha14: , (Dhanawade 141), Gri12: , (Grinberg 33), Gri12: , (Grinberg 51), Hei12: , (Heiberg 1698), Hei12: , (Heiberg 1701), Dha14: , (Dhanawade 154), Dha14: , (Dhanawade 147), Hei12: , (Heiberg 1705), Dha14: , (Dhanawade 151), Dha14: , (Dhanawade 148), Dha14: , (Dhanawade 149), Coh13: , (Cohen 3), Dha14: , (Dhanawade 158), Gri12: , (Grinberg 50), Hei12: , (Heiberg 1702), Dha14: , (Dhanawade 162), Dha14: , (Dhanawade 142), Gri12: , (Grinberg 60), Appendices Appendix 1: FATCA Timelines (2014-2015, Taken from the FATCA Library) Date Issued Topic Title Country March 2015 IDES FATCA Reports ICMM Notifications User Guide  All March 2015 IDES FATCA Reports ICMM Notification XML Schema v1.4 User Guide  All March 2015 IGA Agreement between the Government of the United States of America and the Government of the Republic of Croatia to Improve International Tax Compliance and to Implement FATCA  Croatia, US March 2015 IGA Agreement between the Government of the United States of America and the Government of the Republic of Belarus to Improve International Tax Compliance and to Implement FATCA  Belarus, US February 2015 IDES Publication 5190, FATCA International Data Exchange Services (IDES) User Guide  All February 2015 IGA Agreement between the Government of the United States of America and the Government of the Republic of Kosovo to Improve International Tax Compliance and to Implement FATCA  Kosovo, US January 2015 IGA Agreement between the Government of the United States of America and the Government of the State of Qatar to Improve International Tax Compliance and to Implement FATCA  Qatar, US December 2014 IGA Agreement between the United States of America and the Kingdom of the Netherlands, in Respect of Curaçao, to Improve International Tax Compliance and to Implement FATCA  Curaçao, US December 2014 IGA Agreement between the Government of the United States of America and the Government of the Republic of Singapore to Improve International Tax Compliance and to Implement FATCA  Singapore, US December 2014 IGA Agreement between the Government of the United States of America and the Government of the Republic of Bulgaria to Improve International Tax Compliance and to Implement FATCA  Bulgaria, US December 2014 IGA Agreement between the Government of the United States of America and the Government of the Republic of Cyprus to Improve International Tax Compliance and to Implement FATCA  Cyprus, US December 2014 IGA Agreement between the Government of the United States of America and the Government of the Turks and Caicos Islands to Improve International Tax Compliance and to Implement FATCA  Turks and Caicos Islands, US November 2014 IGA Agreement between the Government of the United States of America and the Government of the Republic of Moldova for Cooperation to Facilitate the Implementation of FATCA  Moldova, US November 2014 IGA Agreement between the Government of the United States of America and the Government of Barbados to Improve International Tax Compliance and to Implement FATCA  Barbados, US November 2014 IGA Agreement between the Government of the United States of America and the Government of the Hong Kong Special Administrative Region of the People’s Republic of China for Cooperation to Facilitate the Implementation of FATCA  Hong Kong, US November 2014 IGA Agreement between the Government of the United States of America and the Government of the Commonwealth of The Bahamas to Implement FATCA  Bahamas, US October 2014 IGA Agreement between the Government of the United States of America and the Government of the Republic of Poland to Improve International Tax Compliance and to Implement FATCA  Poland, US September 2014 IGA Agreement between the Government of the United States of America and the Government of the Federative Republic of Brazil to Improve International Tax Compliance and to Implement FATCA  Brazil, US August 2014 IGA Agreement between the Government of the United States of America and the Government of Sweden to Improve International Tax Compliance and to Implement FATCA  Sweden, US August 2014 IGA Agreement between the Government of the United States of America and the Government of Republic of Lithuania to Improve International Tax Compliance and to Implement Foreign Account Tax Compliance Act  Lithuania, US August 2014 IGA Agreement between the United States of America and the Czech Republic to Improve International Tax Compliance and with Respect to the United States Information and Reporting Provisions Commonly Known as the Foreign Account Tax Compliance Act  Czech Republic, US July 2014 Forms and Instructions FINAL Form W-8BEN-E, Certificate of Entities Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities)  All July 2014 Forms and Instructions FINAL Form W-8IMY, Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain U.S. Branches for United States Tax Withholding and Reporting  All July 2014 Forms and Instructions FINAL Form W-8EXP, Certificate of Foreign Government or Other Foreign Organization for United States Tax Withholding and Reporting  All July 2014 Forms and Instructions FINAL Form W-8ECI, Certificate of Foreign Person's Claim That Income Is Effectively Connected With the Conduct of a Trade or Business in the United States  All June 2014 IGA Agreement between the Government of the United States of America and the Government of the British Virgin Islands to Improve Tax Compliance and to Implement FATCA  British Virgin Islands, US June 2014 IGA Agreement between the Government of the United States of America and the Government of the State of Israel to Improve International Tax Compliance and to Implement FATCA  Israel, US June 2014 IGA Agreement between the Government of the United States of America and the Government of the Republic of Latvia to Improve International Tax Compliance and to Implement FATCA  Latvia, US June 2014 Forms and Instructions Instructions for Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding   All June 2014 Forms and Instructions Publication 5118-A, FATCA Online Registration User Guide Addendum   All June 2014 Forms and Instructions Instructions for Form W-8BEN(E), Certificate of Entities Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities)   All June 2014 Forms and Instructions Instructions for Form 8966, Foreign Asset Tax Compliance Act (FATCA) Report   All June 2014 Forms and Instructions Instructions for Form W-8IMY, Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain U.S. Branches for United States Tax Withholding   All June 2014 IGA Agreement between the Government of the United States of America and the Government of New Zealand to Improve International Tax Compliance and to Implement FATCA  New Zealand, US June 2014 Forms and Instructions Publication 5124, FATCA XML v1.1 User Guide  All June 2014 IGA Agreement between the Government of the United States of America and the Government of the Republic of South Africa to Improve International Tax Compliance and to Implement FATCA  South Africa, US June 2014 IGA Agreement between the Government of the United States of America and the Government of the Republic of Slovenia to Improve International Tax Compliance and to Implement FATCA  Slovenia, US May 2014 Forms and Instructions Instructions for Form W-8EXP, Certificate of Foreign Government or Other Foreign Organization for United States Tax Withholding and Reporting  All May 2014 IGA ABBL Guidance notes on the implementation of FATCA in Luxembourg  Luxembourg May 2014 IGA Slides - Conference on the ABBL Guidance notes on FATCA  Luxembourg May 2014 IGA Agreement between the Government of the United States of America and the Government of the Principality of Liechtenstein to Improve International Tax Compliance and to Implement FATCA  Liechtenstein, US May 2014 IGA Agreement between the Government of the United States of America and the Government of Gibraltar to Improve International Tax Compliance and to Implement FATCA  Gibraltar, US May 2014 IGA Agreement between the Government of the United States of America and the Government of Jamaica to Improve International Tax Compliance and to Implement FATCA  Jamaica, US May 2014 IGA Agreement between the Government of the United States of America and the Government of the Republic of Estonia to Improve International Tax Compliance and to Implement FATCA  Estonia, US May 2014 IGA Guidance Notes on the International Tax Compliance Requirements of the Intergovernmental Agreements Between the Cayman Islands and the United States of America and The United Kingdom  The Cayman Islands, U.S. & U.K. May 2014 Notice Notice 2014-33: Further Guidance on the Implementation of FATCA and Related Withholding Provisions  All April 2014 IGA Agreement between the United States of America and the Republic of Austria for Cooperation to Facilitate the Implementation of FATCA  Austria, US April 2014 IGA Agreement between the Government of the United States of America and the Government of Australia to Improve International Tax Compliance and to Implement FATCA  Australia, US April 2014 IGA Agreement between the Government of the Kingdom of Belgium and the Government of the United States of America to Improve International Tax Compliance and to Implement FATCA  Belgium, US April 2014 IGA Australia - Memorandum of Understanding  Australia, US April 2014 IGA Australia - Explanatory Memorandum  Australia, US April 2014 IGA Australia - Exposure Draft   Australia, US April 2014 Forms and Instructions FINAL Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding  All April 2014 Announcement Announcement 2014-17 Update on Jurisdictions Treated as Having an IGA in Effect and on FATCA Financial Institution Registration  All March 2014 Forms and Instructions Instructions for Form W-8ECI, Certificate of Foreign Person's Claim That Income Is Effectively Connected With the Conduct of a Trade or Business in the United States  All March 2014 Forms and Instructions FINAL Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons  All March 2014 Forms and Instructions FINAL Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding (Individuals)  All March 2014 Forms and Instructions Instructions for Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding  All March 2014 IGA Agreement between the Government of the United States of America and the Government of the Republic of Honduras to Improve International Tax Compliance and to Implement FATCA  Honduras, US March 2014 IGA Agreement between the Government of the United States of America and the Government of the Grand Duchy of Luxembourg to Improve International Tax Compliance and with respect to The United States information reporting provisions commonly known as the Foreign Account Tax Compliance Act  Luxembourg, US March 2014 IGA Agreement between the Government of the United States of America and the Government of the Republic of Finland to Improve International Tax Compliance and to Implement FATCA  Finland, US March 2014 IGA Agreement between the Government of the United States of America and the Government of Chile to facilitate the Implementation of FATCA  Chile, US March 2014 IGA Agreement between the Government of the United States of America and the Government of the Republic of Finland to Improve International Tax Compliance and to Implement FATCA  Finland, US February 2014 IGA Agreement between the Government of the United States of America and the Government of Canada to Improve International Tax Compliance through Enhanced Exchange of Information under the Convention Between the United States of America and Canada with Respect to Taxes on Income and Capital  Canada, US February 2014 IGA Agreement between the Government of the United States of America and the Government of Hungary to Improve International Tax Compliance and to Implement FATCA  Hungary, US February 2014 Regulations Coordination Regulations: Revision of Regulations Regarding Withholding of Tax on Certain U.S. Source Income Paid to Foreign Persons, Information Reporting and Backup Withholding on Payments Made to Certain U.S. Persons, and Portfolio Interest Treatment  All February 2014 Regulations Final and temporary regulations: Regulations Relating to Information Reporting by Foreign Financial Institutions and Withholding on Certain Payments to Foreign Financial Institutions and Other Foreign Entities  All February 2014 Announcement U.S. Treasury Department Office of Public Affairs Fact Sheet: FATCA Amendments and Coordination Regulations  All January 2014 IGA Agreement between the Government of the United States of America and the Government of the Republic of Italy to Improve International Tax Compliance and to Implement FATCA  Italy, US January 2014 FFI Agreement Revenue Procedure 2014-13, FFI Agreement for Participating FFI and Reporting Model 2 FFI All Appendix 2: Recommended action plan for compliance Action Plan Actor Duration Categorize foreign entities Analyze global payment flows Examine related processes Operations Department Finance Department Finance Department 3 months Educate business stakeholders Public relations Department 2 weeks Evaluate the need for training Human Resource Department 3 months Read More