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Foreign Account Tax Compliance Act (FATCA)

This guide was last updated in March 2014

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 on or after 30 June 2014.

FATCA compliance presents a number of problems for UK financial institutions because the information disclosure requirements under FATCA are not necessarily permitted under data protection, confidentiality and bank secrecy laws. In addition, the burden of each UK financial 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 many others in the world have entered, or have agreed to enter, into bilateral arrangements with the US to allow FATCA compliance to take place at national level.

The UK and the US entered into an inter–governmental agreement (IGA) in September 2012 which 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 HM Revenue & Customs (HMRC). HMRC will supply the information received to the US. This agreement has been implemented into UK law via the International Tax Compliance (United States of America) Regulations 2013 (SI 2013/1962) which came into effect on 1 September 2013. HMRC has also produced detailed Guidance on the Regulations (the latest version being published on 28 February 2014).

What does FATCA do?

FATCA requires all Foreign Financial Institutions (FFIs) to provide information about their US customers to the IRS in accordance with the terms of an agreement (FFI Agreement) entered into between the FFI and the IRS. If it does enter into an FFI Agreement, the FFI is known as a 'participating FFI' and if it does not, it will be deemed to be a 'non-participating 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 non-financial foreign entities (NFFEs) but this aspect is not considered in this guide.

What is an FFI?

FFI is defined very widely and includes: an entity that accepts deposits in the ordinary course of a banking or similar business (Depository Institution); holds financial assets for the account of others as a substantial portion of its business (Custodial Institution); engages primarily in the business of trading in financial instruments, managing portfolios or otherwise administering or managing funds or money (Investment Entity); or conducts certain business as an insurance company (Specified Insurance Company).

The definition of FFI, therefore, includes not only banks, insurance companies and broker-dealers but extends to clearing organisations, trust companies, hedge funds, private equity 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 'Reportable Accounts'. 'Reportable Accounts' are 'financial accounts' maintained by the FFI where the 'account holder' is either a Specified US Person (which includes any individual who is a citizen or resident of the US) or is a non-US entity the 'controlling persons' of which include one or more Specified US Persons. 'Controlling persons' are individuals who exercise control over an entity. In the case of a trust, this will mean the settlor, the trustees, the protector (if any), the beneficiaries or class of beneficiaries, and any other individual exercising ultimate effective control over the trust.

Financial accounts include any depositary or custodial accounts maintained by an FFI, any equity 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 reportable 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 Specified US Person that is an account holder (and, in the case of a non-US entity that is identified as having one or more controlling persons that is a Specified US Person, the name, address and US taxpayer reference of such entity and each such Specified US Person), the year end account balance or value, the total gross amount of interest credited to the account (in the context of a Custodial or Depository Account) and the total gross amount paid or credited to the account holder in the case of any other 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 1 July 2014 will not be subject to any FATCA withholding as long as they are not substantially modified after that date.

'Withholdable' payments

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.

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. 

'Passthru' payments

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. It is not yet clear exactly what constitutes passthru payments as the IRS has not yet any published regulations defining the scope.

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 FFIs 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.

The IGA has been implemented into UK law via the Regulations together with detailed guidance published on 28 February 2014 setting out HMRC's interpretation of the Regulations. Putting the provisions into UK law has removed many of the confidentiality and data protection concerns.

Although UK FFIs do not need to enter into an agreement with the IRS as a result of the US/UK IGA, they are still required to register with the IRS. The IRS has opened its registration portal and FFIs will have to register by 25 April 2014 to be included on the first list to be published by the IRS on 2 June 2014. The IRS will update the list on a monthly basis thereafter.

The IGA will apply to FFIs resident in the UK (excluding any branches that are located outside the UK) and to UK branches of non-UK financial institutions.

Assuming that all UK FFI's comply with the Regulations as a matter of law, FATCA has become less of an issue for UK based FFIs as under the terms of the IGA, the FFIs will not have FATCA withholding applied on payments they receive. This is the case whether the payments come from a US source payer or another FFI.

UK FFIs complying with the Regulations 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 foreign passthru payments is not entirely clear (see Article 6 of the IGA). 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.

The US/UK IGA 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 treated as non-reporting UK financial institutions (which includes 'exempt beneficial owners' and 'deemed compliant financial institutions').

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'. 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 30 June 2014. This information will be exchanged between HMRC and the IRS within 9 months after the end of the relevant calendar year. The reports in respect of the 2014 year will not need to be given to the US until 30 September 2015, but the information will be required by HMRC by 31 May 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 from 30 June 2014.

Contact – Jason Collins

Recent Financial Services Experience

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