Are we witnessing the beginning of the end for bank secrecy laws?
Regulators in the United States and Europe have been chipping away at bank secrecy for some time now. But two recent developments suggest that efforts are not only intensifying but also becoming more globally coordinated. In early February, the U.S. Treasury Department and Internal Revenue Service released proposed regulations to implement the next major phase of the Foreign Account Tax Compliance Act, known as FATCA, a law enacted by Congress in 2010 to provide U.S. authorities with more tools to detect and deter abuses involving offshore assets of U.S. taxpayers.
At the same time, the United States, France, Germany, Italy, Spain, and the U.K. issued a joint statement (PDF) announcing agreements to develop an intergovernmental framework for the implementation of FATCA. Once the framework is fully developed, wealth management providers and pertinent financial institutions in each of those European jurisdictions will only need to provide information required under FATCA to their local jurisdictions’ tax authorities instead of directly to the IRS, along with reciprocal information access privileges. Most importantly, the joint action shows how key hurdles for FATCA implementation — for example, compatibility with local bank secrecy laws and infringement of foreign government sovereignty — can be overcome.
Efforts to curb offshore tax abuse, of course, are not new. The European Savings Directive implemented a few years ago contains some of the same elements as FATCA to combat offshore tax abuses, but the rules are limited to European Union jurisdictions and a number of exceptions and loopholes curtail its effectiveness. At the same time, piecemeal efforts to curb tax abuses have advanced in Australia, Germany, the U.K., Switzerland, and other jurisdictions, along with initiatives undertaken by the OECD (Organization for Economic Cooperation and Development) and the multilateral framework known as the Global Forum on Transparency and Exchange of Information for Tax Purposes.
Nonetheless, the far-reaching scale and scope of the new FATCA measures — as well as the accompanying multilateral agreement between the United States and its key European allies — bestow real clout on an emerging framework that could well evolve into a global tax compliance model. Although governments in the Asia Pacific do not have as much experience as their European counterparts with new approaches to tax compliance enforcement, they face equally serious, if not more serious problems with tax evasion involving offshore assets. Some observers speculate that China and other Asia-Pacific countries, enticed by the reciprocal privilege of tax information access, will join the “club” and sign cooperative agreements with the IRS and tax authorities elsewhere.
All of which suggests that the global wealth management landscape is likely to be reshaped by the pervasive impact of the new FATCA regulations, which are expected to be finalized this summer.
Key Provisions of FATCA
Central to FATCA regulations is the requirement to withhold 30% of “withholdable payments” to:
- Foreign financial institutions (FFIs) that have not become participating foreign financial institutions (PFFIs) by entering into an FFI agreement with the IRS to provide information regularly regarding U.S. accounts, together with other prescribed responsibilities; and
- Certain nonfinancial foreign entities (NFFE’s) that are not in compliance with prescribed information reporting requirements regarding their substantial U.S. owners.
This FATCA payment withholding requirement is designed to motivate FFIs and NFFEs to report information relating to offshore accounts and investments beneficially owned, directly or indirectly, by U.S. persons. FATCA provisions were eventually incorporated into Chapter 4 of the Internal Revenue Code. As the title to Chapter 4 — “Taxes to Enforce Reporting on Certain Foreign Accounts” — suggests, the government’s ultimate goal is deterring tax evasion rather than collecting those 30% payment withholdings. To understand this better consider the following definitions:
- An FFI is any entity that:
- is engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests, certain commodities, or any beneficial interest (including forward, options, futures, or other derivatives) in the above;
- holds financial assets for the account of others as a substantial portion of its business;
- accepts deposits in the ordinary course of a banking or similar business.
An FFI is thus broadly defined to include non-U.S. banks, private banks, investment banks, trust companies, securities brokerage firms, investment funds, trusts, certain insurance companies and products, and other types of investment vehicles.
- NFFEs are any non-U.S. entities that are not FFIs, including any other classes of persons identified by the Treasury Secretary as posing a low risk of tax evasion.
- Withholdable payments include all U.S.-source revenues, including interest, dividends, rents, royalties, service fees, and gross proceeds from the sale or disposal of U.S. securities.
- Under the FFI Agreement, the FFI is to:
- determine if it has U.S. accounts (i.e., financial accounts held by one or more “specified U.S. persons” which include U.S. citizens or resident aliens, privately owned U.S. corporations, or U.S.-owned foreign entities);
- comply with verification and due diligence procedures in identifying U.S. accounts, including the mining of client data for evidence of U.S. indicia situations;
- annually file information on U.S. accounts with the IRS;
- collect the 30% withholding tax as prescribed;
- attempt to obtain a waiver in any situation where the law of the jurisdiction would prevent the reporting of information as required under FATCA, and if a waiver is not obtained within a reasonable period, close the account; and
- comply with additional IRS information requests regarding U.S. accounts.
There are more details and technical concepts contained in the draft regulations, including provisions on “recalcitrant accounts,” pass-through payments, deemed compliance, and reclaims, to name just a few.
For more information, consult Chapter 4 of the Internal Revenue Code (or Subtitle A of the HIRE Act of 2011, which incorporated the FATCA provisions). Many law and accounting firms have also published extensively on FATCA — see, for example, publications from Baker McKenzie (PDF), Dechert, Ernst & Young, Deloitte, KPMG, and PricewaterhouseCoopers.
While a number of “guidance” documents have previously been published by the IRS, the 388-page proposed regulations released on 8 February 2012 (PDF) affirm the U.S. government’s resolve to implement the key provisions and suggest that lobbying efforts to repeal or significantly water down FATCA are fading out. The proposed regulations incorporate measures to relieve the compliance burden after extensive worldwide consultations and are open for comment until 30 April 2012, with a public hearing scheduled for 15 May 2012.
Here are some key take-aways:
- The first report filing date was extended to September 2014 and the phase-in period will extend to 2017. FFIs would have additional time to make adjustments to their systems for reporting U.S. source income and sale proceeds. However, in most cases, the report to be filed in 2014 will need to cover the 2013 calendar year.
- The “grandfathered” period for certain debt securities and other obligations that would be exempt from the FATCA withholding tax requirement has been extended to 1 January 2013. (Previously, the cutoff date was March 18, 2012.)
- A three-year transition period is introduced to provide additional time for affiliates that are in restricted countries to enter into agreements with the IRS to become PFFIs. (The rules previously required that each FFI in an expanded affiliate group sign up either as a participating or deemed compliant FFI in order for the “parent” FFI to be in compliance and qualify as a PFFI.) However, these FFIs will still have to go through due diligence requirements with respect to their accounts. And if they are to receive withholdable payments, then they will be subject to withholding during this transition period.
- Due diligence procedures around preexisting accounts were made less onerous. In many situations FFIs would be able to rely on existing procedures for anti-money-laundering (AML) and know-your-customer (KYC). Searches are not required for accounts of individuals of less than $50,000 or entity accounts of less than $250,000. FFIs can rely on electronic searches for accounts ranging from $50,000 to $1 million. (For accounts with a balance of more than $1 million, FFIs would also be required to question any relationship managers associated with these accounts to confirm that they do not have any knowledge or reason to believe that the client is a U.S. person.)
As Itai Grinberg of the Georgetown University Law Center puts it in his recent paper, “Beyond FATCA: An Evolutionary Moment for the International Tax System,” the global tax regime “is in the midst of a novel contest between information reporting and anonymous withholding models for ensuring that states have the ability to tax offshore accounts.” Professor Grinberg’s paper explores in greater detail emerging models for automatic residence-based tax information exchange and models for anonymous payment withholdings as well as the development and outlook of a global tax compliance regime.
For more information on FATCA, register for a free webinar hosted by CFA Institute at 8:00 a.m. ET on 26 April 2012 featuring a panel of experts on FATCA from the Asia Pacific and Europe.
Bank photo from Shutterstock.