Fatca IGAs causing concern in US

The signing of the first reciprocal IGA under Fatca is causing concern among US banks

The US Foreign Account Tax Compliance ACT (Fatca) continues to make waves. With the signing in September of the first of the reciprocal intergovernmental agreements (IGAs) covering compliance with Fatca - between the UK and the US - the industry is starting to ask exactly what these IGAs mean. In the US in particular domestic institutions will now find themselves on the receiving end of Fatca's more onerous provisions. The potential for complications for US institutions trying to comply with potentially tens, if not hundreds, of intergovernmental agreements means that US institutions are starting to make serious noise about this all-encompassing tax law.

The IGAs, which have also been termed reciprocal agreements, have been brought in to try and make Fatca less complicated and less one-sided. The intention is that jurisdictions around the globe that enter into an IGA with the US will relieve the burden of compliance on their financial institutions. This is because the IGA models that have been put forward thus far involve exchanges of information between governments on non-citizen account holders - who could potentially be hiding their income from their home governments - rather than each individual foreign financial institution (FFI) having to enter into an agreement with the US Internal Revenue Service (IRS), which was the original intention under Fatca.

These reciprocal agreements are also intended to give Fatca a less one-sided complexion. Jurisdictions outside the US have been keen to get a quid pro quo from the IRS where Fatca is concerned. There have been rumblings that without this there could be a lack of commitment from the rest of the world to the controversial US tax law. Concerns have been voiced that Germany, for example, may be hesitant to commit fully to Fatca without assurances of a reciprocal arrangement.

When the IRS released draft Fatca regulations in February this year, a joint statement was released alongside them detailing the intention of an IGA between the US and five European jurisdictions - France, Germany, Italy, Spain and the UK. Since then model agreements have been signed with Japan and Switzerland and various other countries have also expressed their interest in an IGA with the US.

The agreements with Switzerland and Japan detail a different IGA model to the one proposed by the five EU countries. The Swiss and Japanese model - referred to as Model II by the IRS - will still see FFIs sign up to an agreement with the IRS, but the information reported under this agreement will be supplemented by information exchange between the Swiss or Japanese and the US government upon request. When this model was signed in June this year, concerns were raised about the impact it might have on Fatca's timeline - and about what it meant for FFIs in other jurisdictions.

"This presents a planning dilemma for FFIs in countries that might conclude agreements with the US," Jay Bakst, a New York-based partner in the tax practice of US accounting firm EisnerAmper, told Operational Risk & Regulation at the time. "A significant consideration in this regard is that many of the countries that are contemplating Fatca agreements require new legislation to do so and such legislative processes can take a significant amount of time. So should an FFI that is organised in a country contemplating an agreement with the IRS proceed to register in 2013, or wait for its country to conclude the agreement with the IRS?"

This question remains, and as such it complicates matters further for US financial institutions. In the face of the first IGA being signed, it is only natural to question whether the US is facing a potentially endless stream of IGAs.

"I suspect that lots of people will try to say we'll have what the UK's got," says Aileen Barry, London-based director of national tax investigations at law firm DLA Piper. "The question is, will this defer the effective start of Fatca because I know that even jurisdictions like Jersey and Guernsey will be radically looking at their own legislation to enable them to gather the information and pass it on."

Dying to comply

US institutions fear that this potential cascade of IGAs may signal the beginning of a compliance nightmare. They already face a full roster of post-crisis regulation that needs to be complied with, plus their role as withholding agents for non-complying FFIs; throw in the reporting reciprocity of Fatca IGAs and US institutions complain that they will be carrying a considerable load.

"The compliance life for a US institution is already very complicated and very costly," says David Schwartz, executive director of the Florida International Bankers Association (Fiba). "When you're looking at smaller institutions - the level of community banks - whose assets aren't that large, the costs at a certain point lead them to question whether they can afford this. It's difficult coming out of the crisis as it is and looking for ways to make money today, so if your costs are going to increase on one side but you're unable to compensate on the other, how long are you going to stay in existence?"

Larger institutions also fall victim to burdensome compliance, Schwartz says. The size of the institutions, the number of customers and the number of transactions they process only adds to the burden of compliance, he points out.

The fact that IGAs from different jurisdictions may well have differences means that a US bank dealing with clients from all over the world may also find itself having to put different requirements in place for each jurisdiction with which it does business.

Martin Schulte, head of capital markets at the Association of Foreign Banks (AFB) in Germany, expresses concern about this. "You have to consider that the US banks will have to identify people from various countries," he says. "They'll be thinking how do I find an Italian? How do I find a German? Whereas we outside the US just have to look for US people."

Others agree that this could lead to a complicated situation. "What if the information they have to provide on British and French and German people and so forth is different from what they have to supply for Norwegians, Swedes and Portuguese and who knows who else?" asks Jim Jatras, principal of Squire Sanders Public Advocacy, a Washington, DC-based lobbying firm. "That could get very complicated."

He also argues that the IGAs put the US in a worse position than FFIs. "I guess the foreign institutions are in a somewhat better position because they do have those helpful 380 pages [of draft regulations]," he says. "The American institutions, they're way behind the curve in terms of knowing what they would have to comply with - not only with regard to this reciprocal model but how many permutations there could be on a country-by-country basis."

DLA Piper's Barry points out that financial institutions in the US probably won't have a system in place to have flags and identifiers in order to extract the relevant data. They will need to have the correct software in place to enable them to identify UK citizens. And it doesn't end there.

"They'll have all the same problems that FFIs in the UK for example have got: is it a mailing address, is it a residence, do they need to know a passport number, and does the passport mean nationality or residence? All those sorts of questions they're going to have to worry about," she explains. On top of this they will then have to consider how to report the information, she adds.

Institutions in the US are certainly aware of the complications IGAs may bring, according to the American Bankers Association (ABA). Fran Mordi, senior tax counsel at the ABA says while she is well aware of the complications IGAs may bring, the IRS has indicated it's going to tailor IGAs so that the differences are not substantive. But the new legislation is still going to add to the complication for US banks.

"A question to ask is, are these IGAs going to be different from the regulations or are they going to mimic the regulations, because we have to deal with the regulations and then we have to deal with the different IGAs. We're looking at different documents and we've got to get it right. If we're looking at a billion things it's going to be difficult for us to get it right."

Some are less concerned about the introduction of the first IGA under Fatca. Laurie Hatten-Boyd, a Washington-based corporate tax expert at KPMG, says US withholding agents have already prepared the additional reporting requirements under Fatca so the only change is that they will need to begin obtaining the date of birth for any UK individual residents that maintain accounts that will be reportable under Fatca.

However, she adds: "US withholding agents understand that, under the IGA, the Treasury is committed to adopting future rules that would result in the collection of reciprocal data. These agents will obviously be monitoring any future law changes very closely."

Reality check

There is also the question of how aware financial institutions in the US have been of Fatca up until the point when IGAs started to appear. Jatras argues that before the IGAs were on the table, the concerns surrounding Fatca were not a pressing issue for financial institutions or government in the US. While institutions outside the US have been trying to tackle the Fatca compliance for some time, he says institutions in the US are just beginning to do so.

"I think that they had always felt that bank income and interest was sacrosanct," Barry says.

But not everyone agrees. The ABA's Mordi says US banks were "up in arms" about Fatca before it was put into legislation. She says various meetings took place with the US Treasury and the IRS and describes the withholding element of Fatca - which US banks have been aware about since Fatca's inception - as "the untold, huge burden on the banks". To this end she says they are on top of Fatca and have been since long before the IGA conversation began.

Denise Hintzke, tax director at Deloitte in New York, says most of the larger US financial institutions have been working on their Fatca compliance projects for a while because of reporting requirements on any offshore entities and the withholding requirements on US-based entities. She points out that this is obviously not as big an effort as the FFIs will have to make, but work has started on these modifications.

"I wouldn't say they're just starting to wake up to it," she says. "I think that they've been focusing on it for a while. They may be more concerned now as to what this means but they've been looking at it for a while."

KPMG's Hatten-Boyd agrees that US institutions have been preparing for Fatca for some time, although she points out that preparation has been limited. "Most US withholding agents have been very aware of Fatca and have been monitoring the development of the regime very closely," she says. "Of course, because the regime is a work in progress they, like the FFIs, were limited in what they could do to prepare. I don't think from a US perspective the IGAs have changed this."

She says US withholding agents are anxiously awaiting the definitive regulations and the finalisation of the new forms for reporting so they can move into the implementation phase of their Fatca projects.

The content of the IGA with the UK has also raised some questions. While it has clarified some points, there are also areas that Hintzke points out may add to the confusion for US institutions. "Instead of coming out and saying things directly, in some places they talk about following the recommendations of the Financial Action Task Force - for example when they talk about ‘controlling persons'. That means you've got to look and see what that means."

The section in the IGA Hintzke refers to states that the term ‘controlling person' "means the natural persons who exercise control over an entity...and that is a specified US person" and that "the term ‘controlling persons' shall be interpreted in a manner consistent with the recommendations of the Financial Action Task Force".

Wording such as this confuses matters, Hintzke says. "People will have to ask, ‘what were those recommendations? What does that specifically mean?' I think there are places where it's going to take more analysis to understand what they're saying."

The ABA's Mordi thinks the agreement has brought some clarity, but there remain unanswered questions. She says the ABA is waiting to see what the IRS signs with other governments and that it's unclear as to whether the UK-US IGA is complete because "according to the US and the UK they will continue to have discussions about amending or changing it, so we don't know how complete it is or if an addendum is going out".

This is also a problem for US institutions as withholding agents because constant amendments mean that financial institutions need to keep up with those as well, Mordi says. US banks are waiting to see the next IGA and the regulation itself, which Mordi says is the biggest thing for the ABA. "The agreements are important but the regulations are the most important for us," she points out.

It is also worth noting that financial institutions in the US are not strangers to reporting on non-US citizens. In April this year legislation entered into law in the US requiring financial institutions to report on bank deposit interest of non-resident aliens (NRAs). This regulation comes into force on January 1, 2013 and means that US withholding agents are already preparing for some level of reporting.

According to the IRS, this regulation was brought in mainly to enhance information exchange for tax purposes and also to improve voluntary compliance by US taxpayers by making false claims of foreign status less appealing.

The NRA agreement requires a US withholding agent to report NRA accounts that receive more than $10 in deposit interest or any other payment that is currently subject to withholding and reporting. As the rules for bank deposit interest were finalised last year and the reporting for that income commences in 2013, withholding agents in the US have already prepared for this additional reporting requirement, Hatten-Boyd says.

The AFB's Schulte agrees. "The good news for the US is that what they have to do under the Fatca reciprocal model agreement is something they have to do anyway. How difficult it's going to be in the end, I'm not sure."

Some argue it will become more difficult and that the IGAs are going to complicate matters further for US institutions. The difference between the NRA deposit-interest regulation and Fatca is that the former calls for the possible exchange of information with the home country of foreign US account holders and the UK-USA IGA under Fatca is an automatic reciprocal agreement. Fiba's Schwartz describes this as "a kind of inconsistency" which, he says, is troubling for US banks.

And the NRA regulation has not passed off easily in the US. In March this year, a month before the regulation was passed into law, Congressman Bill Posey, along with 24 other members of Congress, wrote a letter to President Barack Obama demanding the withdrawal of the regulation because it may "drive job-creating capital out of America".

Schartz says capital flight as a result of the NRA regulation has already started, and this could be made worse by Fatca's IGAs. "There is a risk of capital flight [as a result of the IGAs] and we did see some within the first couple of months of the passage of the first NRA reporting rule in April. Florida banks in particular saw an outflow of capital directly related to the rule."

Capital concerns

DLA Piper's Barry agrees there is genuine concern about capital flight from the US in light of Fatca's IGAs. She says that individuals who have been used to having anonymity will suddenly find that they don't under Fatca. "Although the IRS has tried to give assurances that they won't exchange information unless they're certain that the governmental body that has signed up is going to treat that information for tax purposes only, there will be concerns by US banks where IGAs are concerned," she says. "If they've got a number of South American clients, for example, information the IRS holds on them under the NRA deposit-interest regulation may only be currently seen by the IRS in many cases. Under an IGA with Fatca this information may have to be passed over to the reciprocating government. The implication of this may be that people become open to bribes, which can lead to dangers like kidnappings, for example," she explains.

She says there will be serious concern by the banks in relation to their significant clients that the information may be used for non-tax purposes.

However, Deloitte's Hintzke is not sure this applies where Fatca's IGAs are concerned. "It's hard to estimate that," she says. "Fatca is now rolling out the concern that you're going to have people start to pull their assets out of the US. That's always a risk I guess, but again something we can't predict whether or not it ultimately will happen or how extensive it would be, if it did."

The ABA's Mordi remains unconvinced by the capital flight argument in relation to both foreign citizens in the US and US citizens overseas: "I can't see that happening because the US is going to be withholding on any bank that is not part of Fatca so capital flight is going to be circular. The US is reporting and all the foreign countries are reporting so where are you going to go?"

There is also the question of compliance and enforcement now that IGAs have been added to the mix. As things stand, institutions in the US are not facing any kind of withholding tax if they don't comply with the IGA that has been signed with the UK. And this is an important consideration, according to Schulte of the AFB.

"If you assume there's no room for non-compliance because enforcement will be fierce, then it's kind of balanced, but US institutions are definitely not facing the same amount of risk for non-compliance...this is definitely more burdensome for [FFIs] than for the US foreign institutions," he says.

Fiba's Schwartz does not rule out a withholding tax on US institutions being introduced as a result of IGAs under Fatca. "I'd be surprised, but then these things always start here in the US and then as they reach around the world each government is free to implement it how they wish. So they could decide 30% withholding sounds like a good idea."

However, he points out that with a reciprocal IGA he doesn't think jurisdictions outside the US would be that concerned about the withholding tax because they would already have a government-to-government exchange in place.