What is FATCA?
The Foreign Account Tax Compliance Act (FATCA) is a US law designed to prevent tax evasion by US citizens using offshore banking facilities. FATCA creates a new tax information and reporting and withholding regime, designed to gain information about US persons rather than to raise revenue.
FATCA is a controversial piece of legislation because it is wide-ranging and applies to non-US financial institutions. It is extremely complex and this guide provides only a general introduction to how FATCA applies to UK financial institutions.
FATCA imposes a 30% withholding tax on payments of US source income made to non-US financial institutions unless they enter into an agreement with the US Internal Revenue Service (IRS) and disclose information about their US account holders.
FATCA will require information to be provided in respect of certain accounts in existence from 1 January 2013. More details of FATCA deadlines can be found in Announcement 2012-42 issued by the IRS and the US Treasury.
FATCA compliance presents a number of problems for UK financial institutions because their information disclosure requirements under FATCA will not necessarily be permitted under data protection, confidentiality and bank secrecy laws. In addition, the burden of each institution entering into an agreement with the IRS about its compliance with FATCA is significant. To counter some of these issues, the UK government, along with those of Germany, Spain, France and Italy (the G5 countries), agreed to enter into bilateral arrangements with the US to allow FATCA compliance to take place at national level. These were based on a model agreement.
The UK and the US have now entered into an inter–governmental agreement (IGA) which will mean that UK financial institutions will be able to meet their FATCA obligations without having to enter into an agreement with the IRS, by reporting information to HM Revenue & Customs (HMRC). HMRC will supply the information received to the US. This agreement has not yet been ratified by the UK parliament and HMRC has been consulting on how it should be implemented into UK law.
What does FATCA do?
FATCA requires all Foreign Financial Institutions (FFIs) to provide information about their customers to the IRS in accordance with the terms of an agreement (FFI Agreement) entered into between the FFI and the IRS. If an FFI does not enter into an FFI Agreement with the IRS it will be deemed to be a non-FATCA compliant FFI and a 30% withholding tax charge will be applied to certain payments made to it.
FATCA also imposes withholding obligations when US source income is paid to certain foreign non-financial institutions but this aspect is not considered in this guide.
What is an FFI?
FFIs are non-US entities that accept deposits in the ordinary course of a banking or similar business, hold financial assets for the account of others as a substantial portion of their business, engage primarily in the business of investing, reinvesting, or trading in securities, partnership interests or commodities, or conduct certain business as insurance companies.
This will include not only banks, insurance companies and broker-dealers but will extend to clearing organisations, trust companies, hedge funds, private equity funds, property funds and pension funds. It will also include securitisation vehicles and other investment vehicles.
There are very few exemptions from the FFI definition. Exemptions are available for certain institutions which are perceived to present a low risk of tax evasion such as institutions based solely in a single jurisdiction which do not accept or maintain accounts opened by foreign customers. There is also an exemption for FFIs that have only low value accounts (such as credit unions).
What information must a FATCA compliant FFI provide?
The basic obligation is to disclose details of all "financial accounts" maintained by an FFI for US persons. This includes any individual who is a citizen or resident of the US. The disclosure is required not only in relation to direct account holders but also to any substantial US owners of account holders, such as US shareholders in a UK corporate. Financial accounts include any depositary or custodial accounts maintained by an FFI, any shareholding or debt holdings in the FFI (although this does not include shares or debt regularly traded on an established securities market) and cash value insurance contracts.
There are some exemptions from this definition including certain retirement savings accounts and general insurance products. The reporting to the IRS will take the form of an annual report on each US account and includes an obligation to provide any further information about those accounts which the IRS may request.
The information that must be provided includes the name, address and US taxpayer identification number of each account holder who is a specified US person, the year end account balance or value and the gross receipts and gross withdrawals or payments from the account.
The withholding obligations
If an FFI does not comply with the disclosure obligations imposed by FATCA, a withholding tax is applied to payments made to the FFI by US-based entities and also to payments made to it from other FFIs that are FATCA compliant.
If a US account holder refuses consent for an FFI to pass its information to the IRS, it will be a "recalcitrant account holder" and payments made by it, and accounts held by it, will be subject to a 30% withholding tax.
"Grandfathering" provisions mean that some "obligations" issued before January 1, 2013 will not be subject to any FATCA withholding as long as they are not substantially modified after that date.
The withholding tax applies to all payments that are "withholdable payments". This is a very wide definition and includes a variety of US source income, such as interest and dividends. It also includes gross proceeds of sale from assets that produce US source dividends and interest. For example, interest earned on a US Treasury bond is a withholdable payment.
There is an exemption from the withholding tax for payments made in the ordinary course of business for non-financial services, including payments for wages, lease payments, licence payments etc..
In addition to withholding tax payable on withholdable payments, a withholding tax will also be applied to "passthru" payments made by an FFI to non-FATCA compliant FFIs and to recalcitrant account holders. Passthru payments are withholdable payments (essentially US source income); and payments that are indirectly attributable to a withholdable payment.
The second limb of this definition gives FATCA a very wide scope. Rather than trying to trace through individual withholdable payments to determine where the withholding applies, the withholding will apply to all payments made by a FATCA-compliant FFI to any non-FATCA compliant FFI or any recalcitrant account holder.
The IRS has indicated that the withholding amount will be based on a very broad calculation of the percentage of US assets held by the relevant compliant FFI. This calculation is known as the passthru payment percentage and will be used by the FATCA compliant FFI to determine the percentage of any payment made to a non-FATCA compliant FFI or recalcitrant account holder that is subject to the withholding tax. This percentage will be applied to all payments made to a non-FATCA compliant FFI, whether or not they are directly or indirectly attributable to any US income.
What is the effect of the UK's IGA?
The US/UK IGA means that UK financial institutions will be able to meet their FATCA obligations without having to enter into an agreement with the IRS, by reporting information to HMRC. HMRC will supply the information received to the US under the existing exchange of information provisions in the UK/US double tax treaty.
Although UK financial institutions will not have to enter into an agreement with the IRS they will have to register with the IRS. It is not yet clear how this registration will work.
The IGA has not yet been ratified and HMRC has been consulting on how it will be implemented into UK law so the position is not yet certain. Draft legislation is due to be published by the end of 2012 and included in the Finance Act 2013, but HMRC have stated that the detailed rules may be set out in regulations rather than in the Finance Act.
Putting the provisions into UK law will remove many of the confidentiality and data protection concerns.
The IGA will apply to financial institutions resident in the UK (excluding any branches that are located outside the UK) and to UK branches of non-UK financial institutions.
UK financial institutions that comply with the requirements of the UK provisions enacting the IGA will not have FATCA withholding made on payments they receive. This applies whether the payments come from a US source payer or another FFI.
UK financial institutions complying with the UK provisions should not have to impose passthru withholding on US-source payments or on payments of gross proceeds they make to other FFIs, although the position on passthru payments is not entirely clear. If a transaction involves payments with a US source, normal US withholding rules will apply. Where there are no US-source payments involved in a transaction, UK FFIs should not be required to impose any withholding, or receive any payments subject to withholding under FATCA.
UK financial institutions that do not comply with the provisions will not be subject to withholding unless they are specifically identified by the IRS as a "Nonparticipating Financial Institution". This is much more favourable than the position under FATCA itself.
The US/UK IGA is closely based on the model IGA. It sets out the obligations of the US and the UK to obtain and exchange information, the application of FATCA to financial institutions in the UK, and the procedures for collaborating on compliance and enforcement.
The IGA sets out in detail the due diligence requirements for identifying and reporting on specific types of accounts under FATCA. It also sets out a list of UK financial institutions that are FATCA non-reporting entities treated as "exempt beneficial owners".
Exempt beneficial owners do not have to comply with the FATCA requirements and include UK governmental organisations (such as local authorities) and the Bank of England. UK pension schemes or other retirement arrangements "described in article 3 of the UK/US double tax treaty" will also be exempt beneficial owners.
The IGA also lists the "deemed-compliant FFIs", another category of financial institutions which do not have to comply with FATCA. They include UK charities and "financial institutions with a local client base". These include credit unions, industrial and provident societies, friendly societies, building societies, mutual societies, investment trust companies and venture capital trusts. These financial institutions will only qualify if they have at least a 98% UK or EU client base, they have no fixed place of business outside the UK and they do not solicit account holders outside the UK.
The IGA contains a list of the types of UK accounts and financial products that a US person may hold for which UK financial institutions need not provide information under FATCA. These "exempt products" include registered pension schemes, ISAs, child trust funds, premium bonds, National Savings and Investments products, tax exempt savings plans, save as you earn share option plans, share incentive plans and company share option plans.
When will UK FFIs have to comply with FATCA?
FATCA will require information to be provided in respect of accounts in existence on or after 1 January 2013. Normally this information will need to be given to the US within 9 months after the end of the relevant calendar year. However, the reports in respect of the 2013 year will not need to be given to the US until 30 September 2015, but it is proposed that the information will be required by HMRC by 31 March 2015.
In order to comply with the information requirements financial institutions will need to obtain further information from individuals when accounts are opened such as the US taxpayer identification number of US taxpayers. This information will need to be obtained in respect of new accounts opened form 1 January 2014.