FATCA and the real cost of compliance
Foreign account tax Compliance Act (FATCA) was introduced by the US government in the year 2010. The main focus of FATCA act is to reduce tax evasion by foreign finance institutions through offshore Accounts and shell companies. Apart from Foreign Financial institutions FATCA also covers US based Financial Institutions and individuals as well. US government estimates that the losses from tax evasion to the extent of US $100 billion can be avoided after implementation of FATCA.
FATCA on a broad sense is a compliance act that requires all foreign financial institutions, US Financial Institutions with foreign business interests and US individuals with foreign assets to ensure strict compliance so as to reduce tax evasion. FATCA also covers all Not for profit organizations which involve dealing with foreign clients.
This act requires a withholding of 30% of any financial proceeds paid to foreign clients that are not FATCA compliant. ‘Withholding 30% of the tax may not be required if the US government agencies feel that all compliance as per FATCA Act is met. This act is more focused towards non US entities which receive US based income or proceeds from interests, dividends, royalties, license fees or property sale based on US. FATCA covers almost all financial institutions including banks, insurance companies, stock brokerage firms, investment banks, asset management companies, etc.
All foreign financial institutions and US Financial Institutions with foreign Business interests are required to get registered and enter a FFI agreement with Internal Revenue service’s (IRS) in US. After successful registration they receive a Global Intermediary Identification Number (GIIN) from the IRS.
Entering into an FFI agreement by Financial Institutes will mean that there will be complete cooperation with all US government agencies and complying with their rules. As per the FFI agreement it will be required that all information such as name, address, tax identification number, source of income, account number, account balance and global assets be provided to the US government agencies.
Before FATCA was introduced, Qualified Intermediary (QI) guidelines were in place. FATCA differs from the earlier guidelines by the fact that it covers a very broad base and suggests punitive measures for non compliance. It is very difficult to escape from FATCA rules unless you have no US citizens involved and no US based income involved. After the new FATCA guidelines, it would be riskier to do business with clients that are not FATCA compliant.
FATCA requires the reporting of not just US based income but also income from all over the world for which global monitoring and global compliance systems are required. US government enters into different types of Inter governmental agreements such IGA model 1, IGA model 2, etc with different countries across the globe. These agreements between US and other countries add to the complexity involved in implementing FATCA across financial Institutions. Implementation of FATCA requires complete cooperation from all the Jurisdictions across the globe. FATCA is already recognized by more than 100 jurisdictions across the globe.
The cost of implementing FATCA act by financial institutions can vary from case to case. This cost can depend on number of factors. As a result of FATCA act, the most visible cost is the 30 % withholding on payment of proceeds in case of non compliance. In order to avoid 30 % withholding on proceeds, other costs are bound to occur for maintaining FATCA act compliance environment. Many financial Institutions agree that majority of cost would incur in account identification followed by documentation requirements.
Financial institutions will need new infrastructure for monitoring data of their clients and to comply with strict diligence norms put in place by the FATCA act. Implementing FATCA would require all Financial Institutions to revamp their processing systems, Know Your Customer (KYC) procedures, Anti Money Laundering (AML) norms and compliance frameworks. New employee training will be required with improved IT structure for deep forensic tax analysis. Revamping of various departments such as legal, compliance, IT, operations and tax would also be required.
Crossbridge, an investment bank based in London estimated that a medium size bank would spend between $150-200 million in order to meet the FATCA compliance. The Banking Federation and the Institute of International Bankers estimate that top 30 foreign banks alone in US would have spent more than $ 7.5 Billion for FATCA compliance. Cost of implementing FATCA act will impact profit margins of financial institutes. There are also chances of losing customers due to non compliance. At a time when financial Institutions are still facing the heat of 2008 financial crisis, FATCA can have a significant effect on financial Institutions in the short term.
The initial deadline for implementing FATCA was 1 Jan, 2013. However, with many firms failing to register within the deadline, final date for implementation has been postponed to 30 June, 2014. FATCA is a very complex process to be implemented and many feel that at least 12-18 months would be required to fully implement FATCA. Nevertheless, there is still lack of clarity on many issues for which guidelines are expected from IRS. Many experts feel that FATCA might be fully implemented across all Financial Institutions only after 2015.
FATCA act imposes costs not only on Foreign Financial Institutions but also on US Internal Revenue Service (IRS) which has a huge job of monitoring compliance internationally. Internal Revenue Service (IRS) has to bear the cost of collecting data from financial institutions then verify the data for compliance. Many feel that the cost incurred by IRS for FATCA act may exceed the benefits derived from tax evasion avoidance.