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Implications Of FATCA For Non-US Financial Institutions « Back
Matt Atkins, October 2012
Enacted in March 2010, the Foreign Account Tax Compliance Act (FATCA) provides a complex US anti-avoidance tax law aimed at stopping US citizens and taxpayers from ‘hiding’ income offshore. The application of the act has considerable extra-territorial scope, and will impact significantly upon the operations of foreign financial institutions (FFIs). Non-US jurisdictions have, in recent months, entered into discussions with the US in an effort to shield their FFIs from some aspects of FATCA. However, financial institutions, wherever they reside, must inform themselves about the implications of FATCA, monitor developments, and, if necessary, review the investment strategies of affected funds.

Obligations and exemptions

FATCA aims to counter tax evasion by requiring FFIs to disclose details of their US account holders. In order to achieve this, the act will, from 1 January 2014, impose a 30 percent withholding tax on all ‘withholdable payments’ out of the US to FFIs and, from 1 January 2015, impose the same tax on the gross proceeds of sale by FFIs of shares and debt issued by US persons. “To escape FATCA withholding, an FFI can enter into an agreement with the US which will oblige it to disclose certain information about its US account holders, becoming a ‘participating FFI’,” clarifies Stephen E. Fiamma, a partner at Allen & Overy LLP. “The agreement will also oblige an FFI to withhold up to 30 percent of any ‘passthru payment’ it makes to another FFI from 1 January 2017, unless the latter FFI is also participating.”

Under FATCA, the definition of a financial institution is extremely broad, encompassing banks and many institutions not ordinarily thought of as financial institutions. FATCA defines a ‘financial institution’ as any entity that accepts deposits in the ordinary course of a banking or similar business, that holds financial assets for the account of others as a substantial part of its business, or that is engaged primarily in the business of investing, reinvesting or trading in securities, partnership interests, commodities or any interest in such securities, partnership interests or commodities. Banks, insurance companies, brokerage houses, private equity funds, hedge funds, securitisation vehicles and most other financial intermediaries all fall under the FFI umbrella.

Some institutions will be exempt from FATCA enforcement. “Under the proposed regulations, certain entities are excluded from FFI treatment, are treated as being participating FFIs, or are exempt from withholding because they pose a low risk of tax evasion,” says Carolina Perez Lopez, US counsel at Clifford Chance. “As examples of those, it is worth mentioning certain non-financial holding companies and start-up companies as well as certain hedging or financing centres of a non-financial group. But there are many other exceptions.”

Although the burden of FATCA will be felt mainly by financial institutions, most non-financial entities will also be affected. Foreign entities that are not financial entities are known under FATCA as non-financial foreign entities (NFFEs). An NFFE will be subject to a 30 percent withholding tax on ‘withholdable payments’ made to it unless it provides a certificate that it does not have any substantial US owners, or the name, address and tax identification number of each such owner.

The ‘Model Agreement’ and global compliance

The application of FATCA has caused considerable consternation among non-US institutions. Of particular concern is the possibility of becoming subject to the withholding tax, both when they have direct dealings with the US and even when they are facing non-US FFIs, for example in the case of ‘passthru payment’ withholding – potentially quite onerous because of the ‘expanded affiliated group’ rule which means that, from 2016, an FFI is only able to be participating if every member of its expanded affiliated group is also participating. The nature and scope of passthru withholding has raised questions over whether it is workable, and in a number of cases it is unclear whether historic terms of business and other contracts will properly allocate the risk of passthru withholding.

Withholding tax is not the only concern. Many institutions are also anxious about the compliance burden they will assume if they become participating FFIs. “The compliance costs on FFIs are very significant, even for FFIs with no US account holders,” says Ms Perez Lopez. “Disclosing account holder details to the IRS may be contrary to the data protection, confidentiality and bank secrecy laws in many jurisdictions, as well as to many financial institutions’ terms of business and other contracts with clients as counterparties.” In this case, any bank with operations in a jurisdiction where FATCA compliance is unlawful would have to dispose of those operations or accept that it would be non-compliant worldwide.

FFIs, it seems, are caught between a rock and a hard place. However, in order to avoid the potential conflict of US and domestic laws, a number of jurisdictions have issued joint statements with the US, setting out plans to pursue an intergovernmental approach to FATCA implementation. On 26 July, the US published a Model Intergovernmental Agreement (IGA), developed in consultation with France, Germany, Italy, Spain and the UK. Coming in two forms, a reciprocal version and a non-reciprocal version, the IGA eliminates the need for local FFIs to become ‘participating FFIs’. Thus, FFIs within an IGA jurisdiction will not be liable to FATCA withholding, and will be able to provide information on their US account holders to their local tax authorities rather than directly to the US. Such FFIs may also not be required to impose 'passthru withholding' on payments they make to other FFIs, although the IGA holds out the prospect of some form of passthru withholding being imposed by mutual agreement at a later stage. “Both the reciprocal and non-reciprocal versions of the IGA establish a framework for reporting by FFIs of certain financial account information to their respective tax authorities, followed by automatic exchange of such information under existing bilateral tax treaties or tax information exchange agreements,” explains Mr Fiamma.
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2 comments | Sort by: Newest | Oldest | Most Recommendations
Arthur Heale
13 March 2014 14:39 GMT 
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Great summary! What are the implications for the USA and its citizens should many FFIs simply refuse US clients, and tell those they have to take their business elsewhere in order to avoid the complaince burden? I'm not sure who will end up isolated here...but it may not be the small, non-compliant jurisdictions and FFIs.
Ian J Sutherland
London, UK
25 September 2012 07:57 GMT 
Reveal full post
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I think that this is one of the best summaries of FATCA, its implications and challenges, that I have seen. It should be mandatory executive reading.

It is certainly a lot more than a "tax" change!

There is scope for synergy and conflict with many other business and regulatory changes that are running parallel with this. In particular changes in the OTC derivative

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