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What is FATCA and why is it being implemented?
The US Congress estimates that the US loses around $100bn a year as a result of what it calls offshore tax abuses, The US government is therefore intending to introduce the "Foreign Account Tax Compliant Act", (FATCA), a measure, which, in simple terms, will require foreign financial institutions to become an instrument of its Inland Revenue Service.
Since the sign-off of the Hiring Incentives to Restore Employment Act by Barack Obama, which includes the FATCA provisions, it became more and more obvious that FATCA will have a tremendous impact on the worldwide financial industry over the next few years. The consequences are multiple:
1. Political: The EU Commission has now taken up the dialogue with the US legislator to discuss how they can cooperate.
2. Regulatory: At some point the EU Regulators will need to provide advice, as it would be difficult to adhere to US law without local regulatory advice.
3. Procedural: We will need to change the way we work in order to follow the FATCA rules, should the final decision be that we need to go ahead. If the decision is not to conform to FATCA, there might be a trend to redeem from the US market for non-US investment vehicles, as this currently seems to be the only way to avoid FATCA.
4. Cost: FATCA as detailed today will bring huge implementation & processing costs and effort. This cost might have to be borne by investors & account holders. Industry members estimated increase of cost per account around USD 20-50, which is still to be proven, but does not seem unrealistic.
What seems certain today is that we will not be able to just ignore FATCA or assume we will not be concerned. The latest guidance provided by the IRS made it very clear that big international financial industry players are not going to be able to avoid FATCA at all and need to start to plan their project immediately.
At Societe Generale we started to plan the project at a corporate level from the beginning of the year - with a top-down approach including all business lines, entities and branches. This project also includes our clients, as we need to understand their intentions and needs and cooperate within the project.
SGSS has held individual meetings with our clients and in early May we invited clients to a FATCA breakfast seminar in Luxembourg which was very well received. At this event we presented the background and current status on FATCA and discussed different options and implications.
What will it cost and who will pay?
A FATCA will bring huge implementation & processing costs and effort. This cost might have to be borne by investors & account holders. Industry members have estimated an increase in cost per account of around USD 20-50, an amount which is still to be proven, but does not seem unrealistic.
If a fund does not want to follow FATCA, can they just decide not to participate?
A Should a fund decide not to participate, it will be considered a non-participating FFI (NPFFI) and be subject to 30% gross tax for all withholdable payments (US sourced income) - e.g. when selling US securities or receiving dividends on them. This 30% will be withheld by all participating FFIs it is dealing with.
If a prospectus states that the fund does not accept US investors - will the fund be out of scope for FATCA and not need to do anything?
According to the current notices, all funds need to become participating FFIs not to be charged the withholding tax as a whole entity. With this agreement, they need to comply with all requirements of the agreement, including the identification of their US investors.
The US tax definition of a US investor includes US citizen and residents, or companies where more than 10% is held by a US specified person. FATCA follows the negative presumption rule - this means that all account holders are considered to be US unless it is proved otherwise. The fund's prospectus will not be sufficient as such; verification procedures will need to be implemented and contracts agreed with distributors to ensure and prove that there are no US investors.
The compliance officer will have to certify this and there will still be need for an agreement with the IRS.
How will it be possible for Transfer Agents or Administrators to be compliant with FATCA in the context of funds?
Given investment funds are sometimes in a situation in which they don't know who their final investors are, Transfer Agents and administrators will have to do part of the job by identifying the funds' investors (on the level known). If necessary, they will need to apply FATCA withholding tax to recalcitrant clients and NPFFIs on the basis of technical information (such as the PPP, the “FATCA-TIS/TID”) that has to be provided by investment funds, so a similar process to today’s European Savings Tax Directive but not limited to European retail investors.
The question remains as to what can be done within Europe to minimize the effort required to follow US tax law. What are the main efforts of the lobbying by ALFI and EFAMA and discussions with the IRS?
ALFI is principally lobbying through EFAMA. Several meetings at the EFAMA level have been held in Washington with the Treasury and IRS. EFAMA is trying to suggest a simplified regime that would reduce the burden of reporting and withholding for funds which do not allow US investors.
The discussions were, however, very difficult. EFAMA has also submitted a number of explanatory letters and even suggested specific wording for FATCA treasury regulations on investment fund topics.
What is the EU Commission’s and Regulator's opinion and involvement in the lobbying?
A letter was sent by the EU to the US Treasury at the beginning of April of this year. The letter underlines the burden FATCA represents for the European financial industry and suggests expanding the EU Savings Directive to US Persons. However, the EU of course supports the idea of the US Treasury being able to implement measures to support US taxpayers and motivate them to declare their taxes properly. But the effort required should be proportional to the expected benefit.
There are of course big banking groups and companies like corporate banks or funds with multiple subfunds and compartments - it is important to understand how they would be impacted if one part of such a group signs an FFI agreement. What about expanded affiliated groups - what about subsidiaries and branches if there is a FFI agreement signed with the IRS?
A If an agreement is signed with the IRS, each branch and office will be automatically included in the Participating FFI's scope. Furthermore, each subsidiary where more than 50 % is directly or indirectly held (by voting power or by value) by the Participating FFI itself, or any other company that is a member of the Expanded Affiliated Group, will also be in FATCA's scope regardless of whether the company concerned has a financial activity or not. This means that nearly all the hundreds of companies that are normally held by International Banking Groups will be in FATCA's scope and this is why the Group parent company will normally play the "lead FFI" role to act on behalf of all these subsidiaries when signing the contract with the IRS.
This sounds very complex and theoretical. What should we really expect from a practical point of view? How can this be implemented practically and what would be the effort required? Which players are impacted by FATCA with regard to Funds Processing and how?
For the investor side, each account holder needs to provide sufficient documentation to categorize them as US, non-US / PFFI or recalcitrant / NPFFI. On the fund side, each fund would calculate, on top of the EUSD TIS/TID , a "FATCA-TIS/TID" specifying the value of the US-securities within the NAV; this rate would then be used to calculate the tax to be withheld for all recalcitrant account holders, and at the end of the year the fund transfers the tax withheld and the reporting on the US accounts to the IRS. The implementation effort and procedures required can, to some extent, be compared to those needed for the EUSD.
From what we’ve seen, it is clear that implementing FATCA would be very expensive and burdensome for the entire financial industry. Is there any chance that the implementation date will be postponed?
Difficult to say; however, not very realistic as the start date is written explicitly in FATCA law: January 1, 2013. In the QI regime however, back in 2001, the 1st year was considered a "test year" with no consequences for the banks. So there might be some sort of penalty-free grandfathering period. Nevertheless, we are not counting on it.
But how can the US authorities force people to apply FATCA? What controls can the IRS impose afterwards to ensure the FFIs follow the requirements?
Payments from US securities always have their origin in the US. The payment chain starts in the US and US payers have to make sure that the recipient of their payment is playing the game (and is FATCA-compliant), otherwise they will apply the 30% penal withholding tax.
But if institutions do have to abide by FATCA, what will they actually need to do? What information will have to be reported to the IRS and how often?
A Participating FFI has to report two things to the IRS:
1. annual reporting about US clients and, according to the new IRS Notice, this includes dividends, interest, other income and also gross proceeds
2. reporting, that is more statistical, to help the IRS identify whether a Participating FFI is FATCA compliant or not: this includes the number of recalcitrant account holders, the number of Non Participating FFIs that are clients and the aggregate value held by each of them.
How often does the collected Withholding tax have to be paid to the US Administration?
There are no details yet about the payment frequency but it could be monthly or weekly for Participating FFIs which are also QIs, which have a Primary Withholding Agent status and have a direct connection with the US administration according to which they already pay QI withholding tax weekly.
Thus they could have the same payment frequency for FATCA and QI.
Looking at the directive, it requires accounts to be closed if they are considered recalcitrant for an "unreasonable period". Closing the accounts of holders who don't provide a waiver could become an investment decision. Who decides when to close an account?
If the position of an investor in an investment fund is closed, this can be considered a financial decision, as the shares will be redeemed normally at current NAV creating a gain or loss for the investor. Investors who entered into the fund prior to FATCA did not have to provide waivers, so it is questionable whether they can be forced to do so as a result of a US law as long as this is not confirmed by a local European or Luxembourg law. For this the local regulator's advice may be required.
What happens if US persons are identified during the client identification process?
If an investor refuses to provide the necessary documentation to prove whether he is US or not, 30% on all withholdable payments to him will have to be withheld. If he provides all relevant documentation and a waiver to disclose, his data will have to be reported to the IRS. If there is sufficient documentation to prove that he is US and does not provide a waiver, or he wants to be withheld, his account will have to be closed - provided that this is in line with local law.
