The FATCA (Foreign Account Tax Compliance Act) legislation was enacted into US law on 18 March 2010 as part of the HIRE Act (Hiring Incentives to Restore Employment). It comes into force after 30 June 2013. Initial reports indicated that FATCA would create some 1,000 jobs in the US treasury and bring in some much-needed currency to help to manage US budget deficits. Figures between US$100b and US$350b have been quoted as the amount of money that the Inland Revenue Service (IRS) can expect to raise from FATCA.
For a start, let’s clear one misconception – no one is forced to comply with FATCA. FATCA works by “inviting” foreign financial institutions (FFIs) to enter into an agreement with the IRS. Under that agreement, the FFI agrees to identify persons whom the IRS defines as US persons and to report their investment income to the IRS. Thereafter, the IRS can collect from these persons the US taxes they are due to pay.
But can a FFI choose not to accept the invitation? The answer is yes, but there are “penalties”. The IRS will effectively have 30% withholding taxes deducted from US investment income, which includes interest and dividends, that are paid to such “non-cooperative financial institutions”. And, the sting in the tail? The IRS will effectively also have 30% in withholding taxes deducted from the gross sale proceeds of instruments that yield US investment income, regardless of whether a profit or loss was made on the sale.
So how can a financial institution waste money on FATCA? There are two key scenarios:
1. Not accepting the invitation. Except in rare cases, most FFIs seem to expect to have to enter into the agreement with the IRS. If not, they may waste money by suffering withholding taxes on US investment income and sales proceeds, which could put them at a serious competitive disadvantage compared to financial institutions which have entered into the agreement.
2. Doing more than you need to. The IRS has provided some clarity about what it expects FFIs to do, but financial institutions are wasting money by planning to do too much. For example, by attempting to become detectives to find out which existing clients should pay US taxes and by including entities that could be excluded from FATCA.
And how can a financial institution avoid wasting money on FATCA?
1. Plan, plan and plan. Careful planning is essential. Identify which parts of the business can be excluded from FATCA. Identify which products are outside the scope of FATCA, such as pure insurance protection. Use technology as a facilitator. For example, Ernst & Young uses several technological tools to help organizations identify out-of-scope entities and clients who are deemed to be US taxpayers. Don’t reinvent the wheel – use professionals who are familiar with FATCA and have done it before, to reduce the scope and costs.
2. Don’t delay. FATCA is a major piece of legislation that cuts across all aspects of the business of a financial institution. These include legal, compliance, tax, operations and information technology. Any projects that are required to become FATCA-compliant will be major ones. As such, these projects can expect to take 12 to18 months to complete. Financial institutions that delay may end up having to rush to complete their FATCA-compliance by the deadline, incur more costs and increase the risk of errors.
After taking out public holidays, in reality it is only about 18 months to the FATCA “go-live” date. Consequently, financial institutions don’t really have that long for their preparation. Some organizations may want to wait for the final draft legislation, due in January 2012, in the hope that this will provide further clarifications. It certainly will, but significant areas of doubt will remain, as the final regulations are not expected until about 30 June 2012. That would leave only 12 months before FATCA “goes live”. As with any new regulations, the final legislation will still require rounds of clarification and interpretation.
So what can financial institutions do now to avoid wasting money on FATCA? Start planning now. Appoint a FATCA project manager. Plan carefully and do not delay. Have a robust plan in place, preferably before the year end, so that the organization can execute it swiftly and effectively.
Duncan Edwards, Executive Director, Global Financial Services, at Ernst & Young LLP.
The views expressed in this column are the author's own and do not necessarily reflect this publication's view, and this article is not edited by Asian Banking & Finance. The author was not remunerated for this article.
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Duncan Edwards is Executive Director of Global Financial Services at Ernst & Young. Duncan leads the support and development of EY's financial services internal audit practice across Asean. He has a wealth of experience in risk management and regulatory compliance, having specialised in financial services for the past 19 years, working in Asia and Europe.