When the Foreign Account Tax Compliance Act (FATCA) was first talked about over three years ago, most of the financial world simply laughed at the concept and viewed it as being both unenforceable and unworkable.
Personally I lost count of how many times I heard people quote the decision ‘Government of India v Taylor 1955’ as a defence against FATCA when it was first talked about. This case essentially set a precedent for one country’s tax laws not being enforceable in another.
However, times change, countries go broke and three years down the line and many hundreds of millions of pounds spent on system and procedural development later, most financial institutions around the world are ready to comply.
Such is the success of US FATCA that the UK has successfully concluded similar agreements between its Crown Dependencies and British Overseas Territories and to top it all, the OECD’s concept of a multilateral exchange of information agreement hatched at the last G20 meeting has so far attracted over 60 countries, all willing to take part in the pilot scheme.
An offer you can’t refuse
One question I get asked quite a lot is ‘why is everyone so willing to sign up to these things’?
The answer in respect of the US agreement is pretty straightforward. It’s a choice of comply or suffer 30% withholding tax on anything you receive from – or through – the US, together with the risk that other financial institutions around the world will refuse to deal with you post-implementation.
With the UK agreement, essentially the Crown Dependencies and British Overseas Territories had to conclude that agreement before they could progress with that of the US.
However, there is also the bigger picture to consider.
For example, if country A wants an agreement with country B, but country B refuses, then it is not unreasonable to assume that country A will think that country B has something to hide, call it a tax haven, put it on a blacklist, possibly restrict its residents from transferring any capital to country B and heavily taxing anything received from it.
This clearly wouldn’t be good for economic growth and could result in trade sanctions, for example.
Necessary evils
Of course, there are some countries that are big enough and, more importantly, that matter enough, to be able to negotiate their own agreements.
As I understand it, China and Russia fall into the latter category in that while they are OK with the principles of US FATCA, they are making sure that it is on their terms and are keen not to be forced down the draft agreement route like the majority of the world.
So, while the additional compliance requirements that invariably follow these types of agreements are always unwelcome, we have now arrived at the stage where information exchange agreements are almost perceived as being necessary to ensure fair treatment of business transacted between countries and the individuals or organisations resident in them.
As such, irrespective of where any business is located, its success is really going to depend on how quickly it can embrace, adapt and work with new legislation rather than doing an impression of an ostrich and hoping it will all go away. Even now, just six months prior to the introduction of FATCA, there are still significant numbers of organisations who simply aren’t geared up to deal with it and are clearly at risk of not being able to comply going forward. Ironically, those making the loudest noises are actually in the US!
In addition, quite a few well known international organisations around the world have already made it quite clear they want to limit their exposure to US FATCA by refusing to do business with US citizens or are in the process of trying to run off their existing book. However, while this may have been a reasonable strategy six months ago, the OECD’s pilot scheme, if successful, will see such organisations having to change their approach or heavily restrict their future business.
Practical considerations
So what does all of this really mean in practice for advisers and their clients?
First of all, it’s important to make it clear that from an adviser’s point of view, none of these agreements require you to do any reporting.
All reporting requirements are undertaken by the financial institution. Clearly it makes sense to put clients on notice that their information may find its way back to the tax authority in their country of residence (and the US if they are a US specified person) but providing all their tax affairs are up to date, there really isn’t anything for them to worry about. They will have to provide slightly more information about themselves when opening an account to enable the financial institution to correctly categorise them as reportable or not, but that really is it.
It’s also important to stress that with the exception of the USA and Eritrea who tax on a citizenship basis, most other countries around the world only tax their residents or income on gains derived from that country.
Therefore, providing a client is certain that they have met the non-residency rules of their ‘home country’, they are unlikely to suffer any tax on foreign income they earn while non-resident (unless its source was the country they have left). Clearly they will have to adhere to tax principles applicable to them in their present country of residence, but there shouldn’t be any double taxation.
Keeping it local
So, what does it mean for product providers? With the US FATCA, the Isle of Man, Jersey and Guernsey have agreed to sign a Model 1 agreement. Under this agreement, the jurisdiction agrees to introduce local laws requiring the reporting of information with respect to US accounts in compliance with the reporting required by FATCA.
Under a Model 1 agreement, financial institutions are not required to report directly to the IRS, as all reporting is done directly to the local tax authority which then passes this information on.
The UK agreement will function on a similar basis with financial institutions adhering to local laws again providing the information to their local tax authority rather than directly to HMRC. The inter-governmental route is attractive for a number of reasons but namely:
1. Information only has to be provided to a central source.
2. There is no risk of breaking data protection laws.
3. There cannot be a direct enquiry into accounts held by you by a foreign revenue authority.
While under both the US and UK inter-governmental agreements, financial institutions are required to provide details on US and UK specified persons respectively. The definition as to what constitutes such a person is quite different and as a result, advisers will see the declaration sections in product applications being significantly expanded.
Twisted logic
Both agreements also work to the same deminimus account values for reporting new and existing business and, bizarrely, the deminimus limits for the UK are in dollars rather than sterling which, in my view, is quite ridiculous, as most accounts held for UK residents will be in sterling.
As a result, financial institutions will have to build in exchange rates to the search parameters to find the dollar threshold and once the sterling equivalent is found, it then has to be reported in dollars. HMRC’s logic behind this thinking is that as we would be reporting in dollars for US FATCA, it would be easier to do the same under the UK agreement.
The reality is that the US and UK agreements are very different indeed, not only in respect of what has to be searched for and reported, but also the exemptions. For example, under the US agreement there is a back book exemption for the typical offshore bond products (known as cash value insurance contracts under the US and UK regulations) as the US view them as being very low risk in respect of being used for tax evasion.
However, the UK haven’t seen fit to extend the same exemption even though offshore bond providers already provide information to HMRC in respect of certain chargeable events on policies held by UK residents each year. The apparent rationale for the UK approach is that they want to be able to see flows of capital, so one can only assume this is to catch out UK taxpayers who are under-declaring their income and assets held offshore.
The UK will therefore end up getting information on actual tax events on which they should receive revenue through the chargeable event reporting requirements, plus details of account balances and flows of capital under the inter-governmental agreements it has concluded. The latter only yields an income following an investigation which could incur significant costs, so you have to ask as to whether it really was necessary at all.
A fair exchange
The OECD’s model will essentially require financial institutions to ascertain a client’s country of residence for tax purposes. Upon the completion of an agreement between two countries, information will be shared on each other’s residents.
At this point in time, it’s anticipated there will be a standard agreement and that it will be entered into on request only. By that I mean even though the intention is for it to be multilateral and form the basis of a global model, just because country A has an agreement with country B who has an agreement with country C, doesn’t mean that B will be able to pass on A’s information to C.
Furthermore, while over 60 countries have so far given a commitment or indicated they will take part, a great deal of cherry picking will take place initially before it starts to gather momentum and spreads to all those agreeing to be a part of it.
US FATCA has already been delayed and, as a result, the first reports to be provided by financial institutions will be generated in Q1 2015 for the year 2014. The significance of the US FATCA delay is that the UK’s version works on a timeline of FATCA plus one year, therefore should US FATCA be delayed again; this really will put a spanner in the works for those using it as a benchmark.
Whatever the outcome in the US, we are now too far down the line to expect other countries to wait around for too much longer and therefore, the sooner you deal with it the better.
