Comply with FATCA now – but think to the future!

By Chris McAuely, Director of Fraud & Financial Crime, SAS

Tax evasion is a hot topic. Not least because virtually every advanced economy in the world is being held back by a mountain of public debt. Governments want to close tax loopholes, while national electorates want to see wealthy individuals and multi-national companies pay their fair share into public coffers.

According to The Economist, around $20 trillion of unpaid personal and company tax is stashed away in tax havens. The EU claims that around €1 trillion in revenues is lost annually to tax evasion and avoidance in its member states.

In 2010, legislators on Capitol Hill estimated that the U.S. Treasury loses as much as $100 billion annually to offshore tax non-compliance. Their response was to pass the Foreign Account Tax Compliance Act (FATCA). The objective is to stop US citizens from hiding income and assets overseas by forcing foreign financial institutions (FFIs) to disclose information about their American clients. To comply, FFIs will need to be able to identify US-tax liable individuals and entities at the point of on-boarding. They will also be required to carry out periodic sweeps of their account base and provide information about any clients that are potentially US-tax liable.

Governments have a very strong motivation to worktogether to close tax loopholes.

The IRS has a big stick

As of July 2014, financial institutions that fail to comply with FATCA will face two major sanctions. The first is a direct one from the US authorities: the United States will withhold at source 30 percent of any income originated from US domiciled assets (for example, US Treasury Bonds) owned by the bank. The second is indirect but is compelling for smaller financial institutions: because all of the Tier 1 banks trading in US dollars require their correspondents to be FATCA-compliant, an institution that does not participate in FATCA will effectively be placing itself outside the international banking network. It will no longer be able to work with the big boys.

Moreover, the IRS will deem recalcitrant any account holders who fail to provide the FFIs with documentation required under FATCA. The FFI would then also be obligated to deduct a 30 percent withholding tax on any payment credited to their accounts. 

Who is affected?

FATCA is more extensive in scope than many realize. Any FFI with American clients will need to comply with FATCA. This includes banks (savings banks, commercial banks, savings and loans associations, thrifts, credit unions, building societies and cooperative banks); the investment and insurance industry (broker dealers, clearing organizations, trust companies, custodial banks, retirement plan custodians, annuity contracts, cash value insurance contracts); and the asset management and fund industry (mutual funds, funds of funds, private equity, venture  capital and investment vehicles).

What specifically do you need to do now?

 FFIs need to put systems and processes in place covering three broad areas:

  • Documentation: capturing process changes and analyzing the customer base
  • Withholding: building functionality for withholding on recalcitrant account holders
  • Reporting: building and sustaining a reporting model for all US individuals to cover account balances and gross payments

Inter-governmental agreements

However, it isn’t quite that simple. While some institutions are well advanced in their efforts to comply with FATCA, others are waiting for guidance and specific instructions from their local regulators. In some cases, Inter-Governmental Agreements (IGAs) have been concluded for the provision of data to the United States only; other agreements have been reached for reciprocal sharing. In many other countries IGA negotiations have not yet been concluded, which means regulatory guidance is limited or entirely absent. All of this means that multi-national FFIs face an unclear regulatory reporting environment, one which will depend on the specific nature of, or absence of, the IGAs within specific tax jurisdictions.

The broader picture

But it doesn’t stop there. Tax evasion is also high on the agenda internationally. The problem for FFIs, however, is that they simply don’t know how the compliance landscape will look in years to come. No one does.

While the United States has taken the lead on cross-border tax evasion with the introduction of FATCA, financial institutions also need to keep an eye on the broader international dimension. The issue was on the agenda at both the G8 and G20 summits and it is only a matter of time before FFIs face new client identification regulations.

An enterprise case management approach

Given that it will be some time before an international consensus is reached on cross-border tax evasion, we advise FFIs to put in place a reporting framework that is flexible, scalable and extensible enough to cope with whatever new requirements may arise. 

This will require some up-front investment, because the robustness of current and future risk and compliance applications depends above all on having high quality data that is integrated across the organization.  But once these solid foundations are in place, you have the flexibility to build applications to deal with whatever the regulator can throw at you in terms of know-your-customer and financial crimes management.

Financial institutions have been through a similar scenario with anti-money laundering (AML) regulations. In the case of AML, it took a few years before an international consensus grew around the kind of national legislation needed to address the challenge, but countries have learned from each other and the regulatory environment is much the same in all advanced economies. The same will hold true of ATE – but the process will probably be faster for two reasons: first, there are international bodies such as the OECD driving international agreements; and second, with most of the world’s leading economies suffocating under the debt burden, governments have a very strong motivation to work together to close tax loopholes.


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