Banks prepare to handle challenges of Fatca and its offspring

The US Fatca tax-evasion law has triggered new tax compliance efforts around the world. Banks must now deal with new regulatory demands in almost every jurisdiction, while still keeping an eye on the uncertainties surrounding how Fatca reporting will work in practice

Fatca's children: banks are dealing with a slew of anti-tax evasion rules

Times are getting tough for tax evaders. Tax enforcement has risen steadily higher up the list of priorities for financial regulators, governments and international bodies, ever since the 2010 passage of the US Foreign Account Tax Compliance Act (Fatca) and the 2012 decision by the international Financial Action Task Force to make tax evasion one of the "predicate offences" for money laundering.

The result has been a dramatic increase in know-your-customer (KYC) requirements at banks around the world. "AML has had compliance obligations for some time, and we've seen anti-bribery and corruption concerns also move into that space. But I think the newest thing that is happening is tax evasion compliance," says Chrisol Correia, director of anti-money laundering global at LexisNexis Risk Solutions. "And that's pretty interesting because it means banks now have to ask more questions about the source of wealth, or the tax legitimacy of funds."

The change has not been the result of Fatca alone; in the years since it was passed, other nations have implemented a spate of bilateral agreements that facilitate the sharing of client tax information. Several of the bilateral tax agreements that exist today were firmed up following the increased focus on global tax transparency and cross-border information sharing from 2009's G20 summit of leading economic powers. Switzerland, for instance, has signed up to such agreements with the US, the UK and France.

The Organisation for Economic Co-operation and Development (OECD) has also released its Common Reporting Standards (CRS) for the automatic exchange of cross-border client tax information. But teething issues still remain for Fatca.

Incentives for information

Collection of client information has become a more central part of doing business, says Chris Collins, global director for regulatory response at Sapient Global Markets, as he points to the culture change going on in the industry. "It's interesting because Fatca fits around the wider concept of know your customer, and these days KYC means everything, from client on-boarding, to anti-money laundering, to risk appetite, to records management and client portals," he says. "It's another operational challenge you need to comply with while doing your day-to-day business."

This is true not least because the Fatca model of banks reporting the tax information of their customers to relevant authorities has been mirrored elsewhere.

The UK government, for instance, introduced its own version of Fatca whereby firms in overseas territories and dependencies including Guernsey, Isle of Man and Bermuda need to provide the UK tax authorities with information relating to the financial affairs of UK resident clients. Reporting is due to begin next year, and then the regime will fold into the OECD's CRS – a system that is being dubbed 'global Fatca' as it takes a similar approach but is significantly broader, covering the tracking of tax residents, not just US citizens, of all signatory countries.

"I don't think anyone envisioned that five years after its introduction, [Fatca] would end up with 80-plus countries signed up to a multilateral tax reporting regime," says Laurence Kiddle, managing director of tax and accounting at Thomson Reuters. "I think it points to the fact that there's a lot of pressure on government revenue to crack down on tax evasion and tax fraud. And this is a good way to combat it."

The road to Fatca implementation has been a rocky one, and many obstacles remain, including for some firms a lack of decent client data or inadequate control frameworks related to IT infrastructure.

Know your customer, keep your customer

With thousands of retail customers opening new bank accounts, the challenge for firms lies in training and educating their customer-facing staff about the requirements of Fatca and other tax compliance rules, says Laurie Gentz, head of North American compliance at BAE Systems Applied Intelligence. "Besides the technical requirements of data retention, these employees also need to have the skills to confidently inform customers of why the bank needs to put their details under significant scrutiny."

Often, client relationships may be strained as bankers repeatedly go back to their customers to ensure their information is correct and current. Banks need to strike the balance between meeting high compliance standards and interrupting client relationships as little as possible, according to Richard Kando, director at Navigant's global investigations and compliance practice.

"It's the daily minutiae, the nuts and bolts of the necessities of Fatca and other KYC requirements that can affect the client relationship if an institution isn't organised," he says. Even apparently simple issues like the registration of multiple addresses or the formats of telephone numbers can cause problems for large-scale data collection.

And costs can add up quickly when screening and reporting client information. When reviewing existing clients, holes can appear across different sources and applications, for instance. Customers that were off-boarded in one business unit may pop up again in other data sets, and mistakes can also occur due to weak back- or front-office filing systems.


"[Reporting is] an unglamorous subject, but it's an important one," Thomson Reuters' Kiddle says. "Because you can be 90% through your Fatca programme, you've got all your accounts, everything you need and you've validated everything – but if you can't submit that means you're non-compliant. And that's a difficult place to be."

The procedural requirements vary from country to country, so financial institutions operating in several jurisdictions often need to tailor and abide by multiple compliance programmes simultaneously. They will also need to do this for 2017 deadlines for the CRS, which has often been referred to as "Fatca on steroids".

The result has been a massive overhaul of internal processes and systems at most banks during the past few years, particularly regarding on-boarding procedures and data governance.

And the pressure to continually track the activity of countless tax authorities for announcements regarding technical requirements has not alleviated – whether regarding the launch of reporting portals, the confirmation of the intergovernmental agreements (IGAs) themselves, or updated guidance that they then need to factor into their processes.

Out of 112 countries, 62 are fully signed up to an IGA, while the remaining 50 agreements have only been signed "in substance". As it is presumed that the "in substance" IGAs will be finalised at some point this year, the financial institutions operating in those countries have been advised to act as if an IGA is already complete. But if any of these agreements fall through at short notice, financial institutions need to be ready to change their systems to report to the IRS directly.

If a particular country and the US cannot finalise an IGA, the onus on financial institutions that have already registered – and thus need to report – becomes much more significant.

Requirements will arise that countries and financial institutions may not have thought about, says Denise Hintzke, director of Fatca at Deloitte, such as dealing with the IRS-specific reporting format, which involves registering and receiving an encryption certificate. Or, sending out legal declarations to all affected clients of the intention to send their details to the IRS – something which IGAs were designed to prevent, as the sharing of private information with other countries becomes protected by national law.

"They've underestimated what that could mean," Hintzke says. It may not necessarily be the case that banks have misunderstood requirements, she continues, but that the country realises it's too difficult to build a national-level reporting system, and tells the firms at the last minute that they need to handle it on their own. "I think there will be a lot more countries that do that, particularly the smaller ones."

Ian Comisky, a partner at US law firm Blank Rome, says that the IGA completion process is proving slower than expected. "There are rumours the US thought it would have IGAs with certain countries but it has not been able to reach agreement. I don't know what the US or the IRS are going to do about that."

In the face of radically different filing formats across countries, falling into non-compliance could be easier than most firms believe.

And although it's not particularly clear how much the IRS is going to dedicate itself to enforcing Fatca requirements among the numerous other tax rules it deals with, firms will play it safe, says John Staples, a partner at US law firm Burt, Staples and Maner. "In practical terms, when institutions look at the risks here, they're going to self-police very aggressively because they're not going to want to chance it."

Non-compliance never too far away

"Some institutions are further along than others," says Navigant's Kando, adding that reporting will only be as good as the due diligence conducted.

In the UK, for instance, there has been a relatively high level of preparedness. Lexis Nexis's Carreia says that the UK has the second highest number of foreign financial institutions that have registered with the IRS, totalling 22,000. This is probably because the UK is well connected and is often quick to adopt international measures by transposing them in to national law.

"The next big economy after that is Brazil with 5,000. France has got 4,400 and Germany has 4,000," he points out. "We recently polled our customers in the compliance and tax department in Asia, and despite the relative lack of domestic regulatory pressure ... Fatca was actually the third-highest area of client spend" behind transaction reporting and KYC, he says. "It's really established itself there. So I think that demonstrates the extent to which institutions have responded."

Learning from Fatca

The US government significantly increased the financial sector's role in preventing tax evasion in 2010 when it introduced the Foreign Account Tax Compliance Act (Fatca) – a law aimed at identifying US persons with offshore accounts and investments, but which puts the burden of reporting this information on foreign financial institutions (FFIs) and tax authorities.

Financial institutions – defined as depository institutions, custodial institutions, investment entities, insurance companies and certain holding companies – must identify all US citizens on their books during the previous tax year, and report the name, address and taxpayer identification number of the account holder, as well as the account number and balance to either the IRS or their national tax authority, depending on the intergovernmental agreement (IGA) signed with the US Treasury.

The IRS came up with two different "models" that the signatory country then adds to its own laws: Model 1 IGA – whereby the FFIs operating in that country need to report their US client information to the respective national tax authority, such as the HMRC in the UK, who then fields the information to the IRS; or Model 2 IGA – which involves FFIs reporting directly to the IRS.

Model 1 IGAs are reciprocal – meaning that the US will facilitate an exchange of information on foreign accounts held in US banks. Model 2 IGAs can be supplemented by an exchange of information upon request.

First reporting deadlines: The IRS lists two deadlines for reporting in 2015, one of which has already passed: March 31 for firms operating in countries without an IGA or an IGA Model 2, and September 30 for firms with an IGA Model 1. Individual nations’ deadlines may vary within these timelines. Firms in the UK, for example – an IGA Model 1 country – needed to file with HMRC by May 31, 2015.

Non-compliance: The IRS enforces compliance with the threat of a 30% withholding tax on payments of US source income, but this only affects firms operating in the US or in countries without an IGA. IGAs remove this penalty because the country has put Fatca requirements into its own laws, under which non-compliance penalties are aligned with existing tax regimes.


CRS: a new standard

The Common Reporting Standards (CRS) are the standards for the automatic exchange of financial account information, developed by the OECD. Usually in tax treaties the sharing of information is upon request, but the idea behind the CRS is that information on residents' assets and incomes will automatically be transferred cross-border. Its focus is on tax residency, compared to Fatca’s emphasis on citizenship.

Banks, custodians and other financial institutions, such as brokers and insurance companies, operating in signatory countries will need to report the accounts on their books held by individuals and entities including all types of investment income (i.e. interest, dividends and income from certain insurance contracts), as well as account balances and sales proceeds from financial assets. By late-April 2015, 51 jurisdictions had signed up for "early adopter" status and more than 40 others have committed to a later roll-out.

Deadlines: For early adopters the CRS are due to come into force in January 2016, with client on-boarding and self-certification on tax residency expected to be in place. The first reporting deadline is May 2017. Deadlines for later adopters will be a year later.

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