FATCA: A shake-up in the World of Finance and Banking Secrecy?

A new American tax law has the potential to shake-up not just the U.S. tax reporting system, but also the way financial institutions do business globally.

Since the U.S. income tax system was created in 1913, the U.S. government has essentially relied on taxpayer honesty in reporting their income and assets, particularly with regard to assets and income that were earned or held “offshore” i.e. outside of the U.S. Although there have always been both civil and criminal penalties for failing to disclose offshore assets, it was difficult for the U.S. government to “find” offshore assets and trace them back to their beneficial owners without taxpayer cooperation. This system of “self reporting” was revealed to be inadequate when the recent “Swiss banking scandals” erupted; it was revealed that, allegedly, foreign bankers had been helping thousands of wealthy American citizens conceal billions of dollars of offshore income and assets from the U.S. tax collectors.

That all started to change in March 2010, when President Obama signed into law the Foreign Account Tax Compliance Act (FATCA). The Act is intended to force foreign financial institutions into coughing up the information that the US Internal Revenue Service previously relied upon taxpayers to provide voluntarily. FATCA introduces a new tax regime that is designed to compel foreign financial institutions to comply by imposing, beginning 1 January 2013, a 30 percent withholding tax on financial institutions that that do not comply with reporting and enhanced Know Your Client (KYC) requirements.

The impact of FATCA is likely to be significant in the financial centre that is Hong Kong, as it will in other ‘offshore’ banking locations. The implications of FATCA, and its compliance and reporting requirements, are wide-ranging for financial institutions, investment entities, and many other global organisations. Due to the delayed implementation date, FATCA hasn’t yet arrived in Hong Kong, but it will shake up the financial sector when it does arrive.

Who is impacted by FATCA?
The level of impact varies based on the type of entity, but will be focused on entities that are determined to be “foreign financial institutions” as defined by the Act. These institutions, which would include Hong Kong financial institutions as well as the Hong Kong branches of international financial institutions - Chinese, American, European and overall Asian - are directly targeted by the regulation.

FATCA defines “Foreign financial institutions” or “FFIs” to include:
• Banks
• Private equity funds
• Hedge funds
• Institutional investment funds
• Retirement funds & trusts
• Insurance companies
• Securities brokers and dealers.

In essence, any non-U.S. organisation that holds or manages customers’ or affiliates money is considered an FFI subject to FATCA.

Who is targeted?
Before going any further in the explanation, let us clarify what FATCA requires.
Under FATCA, complying FFIs are tasked with identifying and reporting all account holders, customers or investors who are U.S. citizens or residents (i.e. the “green card” holders).

Included in this “U.S. group” are people possessing dual citizenship, Hong Kong residents who have U.S. green cards, and non-listed companies with 10 percent U.S. shareholders. Starting in 2013, FFIs will be required to report all these “U.S. persons” to the U.S. Tax Authority, the Internal Revenue Service (“IRS”).

What effect will FATCA have on your business?
Organisations in Hong Kong and elsewhere will need to rapidly determine the potential business implications of FATCA and define their compliance strategy accordingly.

Although the deadline of 1st of January 2013 may seem to be a long time from now, FFIs will need to consider the overall complexity induced by addressing the elements required by FATCA.

Many organisations will have to significantly revamp their Know Your Customer (KYC) & Anti Money Laundering (AML) procedures; they will also need to adjust their underlying IT infrastructure in accordance with those changes, which is a potentially difficult and expensive process.

Some organisations are considering the possibility of entering into negotiations with the IRS in order to receive an exemption, in case where the business model of the organisation would clearly have nothing to do with U.S. customers or possible tax evasion (e.g. non-life insurance companies, mandatory provident funds). Another potentially thorny issue may be the question of whether the FATCA requirements would be considered illegal in countries where an organisation operates (e.g. infringement of data privacy issues, non-compliance with local KYC rules), creating a situation where the FFI may arguably be legally unable to fully comply.

Is FATCA likely to just disappear?

Not likely. It appears that the legislation will be implemented as planned due to the strong consensus of Main Street and Capitol Hill to fight international tax evasion. For that reason alone, FATCA will, most likely, remain intact.

Will FATCA set the standard in the fight against banking secrecy and tax evasion?

Very possibly. Several international tax and banking experts have already declared that FATCA will lead to the end of banking secrecy as we know it. This trend seems to have the quiet support of most major nations behind it, all of whom have tax evasion problems similar to that of the U.S., and it may well evolve into a set of global FATCA-like standards.

Next steps

FFIs should immediately attempt to determine, understand and communicate the full implications of FATCA to all the organisational stakeholders. FATCA is still often erroneously perceived as a “tax issue” which supposedly only tax departments need to be cognisant of. In reality, FATCA has horizontal implications across tax, finance, operations, business units, risk, compliance and internal audit departments. Developing a “FATCA policy” will require that fundamental C-level decisions be made.

Subsequently, FFIs should identify which departments would need to have changes taking place, communicate the business implications and develop a FATCA implementation plan.

The organisation may wish to seek advice and support from firms, such as KPMG, that possess multi-disciplinary FATCA teams to assist analysing the overall implications, the cost of compliance, and in developing an optimal response to FATCA.