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The US Foreign Account Tax Compliance Act (FATCA) has just come into force – and is threatening to turn the world of international tax management upside down

This article was first published in the February 2013 International edition of Accounting and Business magazine.

It is a testimony to the continuing power of the US marketplace, even in today’s multi-polar world, that the controversial US Foreign Account Tax Compliance Act (FATCA) has so much influence. Indeed, with key US trade partners adopting many FATCA provisions themselves, the act is going global and giving the US taxman the power to nullify the advantage of offshore for tax evaders.

The act was approved in 2010 and came into force on 1 January 2013. From the start of 2014 participating foreign financial institutions (FFIs) will have to report to the US Internal Revenue Service (IRS) the balances, receipts and withdrawals pertaining to the accounts of US citizens or be hit by a 30% withholding tax on income from US financial assets.

EUG5 buys in

And if that scope was not international enough, the UK, France, Germany, Italy and Spain (the EUG5) last year joined with the US to set up a new model international tax agreement based on FATCA compliance. Japan and Switzerland quickly followed suit. At the end of last year, Washington announced it was in negotiation with over 50 countries to sign up to FATCA.

FATCA sets up a system for automatic information exchange between governments. Taxpayers who use foreign bank and brokerage accounts and the like to hide deposits and transactions from their own tax authorities should take note: the world is about to get much smaller.
Some aspects of this development are surprising. For years governments have tried to stamp out tax evasion and bank secrecy either by acting from the top down – through multinational bodies such as the European Union – or by pressuring target countries individually with sanctions. Both approaches have had mixed fortunes.

FATCA breaks new ground because it started off as a purely US initiative but has gained clout through its adoption by the five European powers, which has set off a chain reaction. This has been widely interpreted as a victory for the US Treasury at a time when FATCA had run into a wall of hostile comment from US expat taxpayer groups, financial institutions and business media.

A lot has still to be decided but there should be no doubt that FATCA is legislation that goes straight to the very crux of the matter.

Richard Murphy, founder of the Tax Justice Network, says: ‘FATCA does something that we’ve been demanding for a long time, which is automatic information exchange between governments. The only problem with FATCA is that it only applies between the US and the rest of the world and not between the rest of the world and the rest of the world.’

World to follow suit

That may come, of course. Chris Tragheim, partner in financial services with responsibility for FATCA at Deloitte, says: ‘People are thinking there’s a possibility that these FATCA-type models will be used by countries for exchanges of information between them. I’d put it this way: there’s an increasing desire to have information exchange between regulatory authorities and this is a significant step towards it. We expect continuing moves forwards. It’s not necessarily that FATCA is the absolute model but it would be a step towards that.’

Central to the US-EUG5 model is an intergovernmental agreement between the signatories, which will be developed by the Organisation for Economic Cooperation and Development (OECD). Pascal Saint-Amans, director of the Centre for Tax Policy and Administration at the OECD, says that privacy is a key question. ‘If your laws, your domestic legislation, protects or organises secrecy to protect the customer of your financial institutions, how can you allow them to report directly to the IRS?’ he asks.

The intergovernmental agreements  provide for this by allowing the FFI to pass the data to its own national tax authority, which will then send it to Washington under certain conditions. Saint-Amans explains: ‘The automatic exchange of information includes a number of safeguards in terms of the protection of the information which must remain within the tax administration and cannot be used for other purposes.’

For Europe’s bankers FATCA nevertheless raises a host of questions. In a letter to the US Treasury in April 2012 the European Banking Federation (EBF) said the FATCA changes would ‘need to be prepared and organised at group level with multiple cross-border implications. Such a process will require 18 to 24 months to implement.’

A major problem is that the legal framework for the intergovernmental approach is provided by bilateral tax treaties. Unpicking and rewriting these will demand an often protracted period of ratification. The EBF is not alone in believing it ‘unrealistic’ to expect such ratification by FATCA’s initial effective date of 1 January.

Not so fast

The EBF letter went on: ‘The negotiations with the EUG5 countries on legal conflicts and sovereignty-related issues may further defer the release of guidelines applicable to FFIs located in partnership countries.’

The EBF called on the US for a transitional period during which all FFIs in affected jurisdictions could adapt their systems while the full FATCA requirements were waived. The EBF wants such a waiver to extend beyond the EUG5 and the transitional arrangements to include FFIs in territories engaged in active discussions about achieving FATCA partner status.

Clearly the position of FFIs in partnership countries appears to need clarification. The EBF pointed out: ‘Those FFI groups operating in partnership countries which have limited affiliates in jurisdictions not covered by partnership agreements will face an untenable and substantial risk of non-compliance if the legal challenges in these jurisdictions are not resolved. If this is not addressed by the end of 2015, this would pose a major risk to the compliance of the entire FFI group and would jeopardise the FATCA status of all the partnership territories.’

The EBF called on the US to consider further transitional relief arrangements for the envisaged withholding requirements to give FFIs operating in these jurisdictions the necessary level of certainty.

Other organisations representing FFIs have also protested to Washington about aspects of FATCA. Many are unhappy about the timetable, which Tragheim calls ‘aggressive’. These and other questions will be covered at a special FATCA conference in Rome this month organised by the EBF, which US Treasury officials will attend.

What effect is the automatic exchange of information between governments likely to have on tax evasion? Murphy thinks it could be dramatic: ‘When there’s automatic information exchange, when people know that the details of their income, the details of their assets, are going to be declared to their domestic tax authority, then this information gets on a tax return. In the US the evidence is that when a source of income is automatically notified to the IRS, there’s an over 90% probability that it’ll turn up on a tax return. When there’s a source of income that’s not automatically notified, there’s a 50% chance that it will be incorrectly declared – in the wrong amount or not at all.’

Secrets exposed

Murphy adds: ‘In the UK about half of all the tax returns of self-employed people understate their income. What FATCA is saying is the US taxman is going to get that information from the source, so you might as well put it on your tax return. This is already creating waves around the world where people will say if you can give this data to the US, you can give it to us. This really will shatter the secrecy of tax havens.’

There have been some moves by the US Treasury to limit the impact of FATCA following a wave of furious protest by US taxpayers. Thresholds have been raised so as to exclude pre-existing accounts of US$50,000 or less for individuals and US$250,000 or less for pre-existing entity accounts, and other reporting requirements have been moderated. But the model agreement by the EUG5 may have set FATCA off on a global momentum that could prove unstoppable.

FATCA

A new model international tax agreement designed to improve cross-border tax compliance and boost transparency was agreed in July 2012 by the US and the so-called EUG5 countries – the UK, France, Germany, Italy and Spain. The model will allow implementation of FATCA through automatic exchange of data between governments, reduce compliance costs for financial institutions and provide for reciprocity.

FATCA is designed to prevent US citizens hiding assets from the Internal Revenue Service by holding them in offshore accounts with foreign financial institutions (FFIs). FATCA requires FFIs to identify such account holders and to disclose their balances, receipts and withdrawals to the US.

For more on FATCA, see Accounting and Business, May 2012, page 42.

Alan Osborn, journalist

Last updated: 8 Apr 2014