U.S. Foreign Account Tax Compliance Act in Full Swing
By Dezan Shira & Associates
Posted: 11th March 2013 08:41
The Foreign Account Tax Compliance Act (also known as FATCA), was enacted in 2010 by the U.S. Congress to target non-compliance by U.S. taxpayers using foreign accounts. It requires foreign financial institutions (FFIs) to report to the Internal Revenue Service (IRS) information about financial accounts held by U.S. taxpayers worth more than US$50,000, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest.
The most notable feature of FATCA is that it allows a 30 percent withholding tax on the gross amounts of “withholdable payments” made to FFIs and non-financial foreign entities (NFFEs), unless such organizations satisfy certain FATCA requirements.
To meet such requirements, an FFI generally must enter into an FFI Agreement with the IRS by registering online through the “FATCA Registration Portal” and agreeing to carry out certain due diligence, reporting and withholding responsibilities (withholding responsibility occurs where an account holder fails to provide the required information to the financial institution). An NFFE must either certify it does not have any “substantial” U.S. owners, or report the name, address, and tax ID number of each substantial U.S. owner.
“Withholdable payments” under FATCA include:
- U.S.-sourced interest, dividends, rent, salaries, wages and similar fixed or determinable, annual or periodical (FDAP) payments.
- Gross proceeds from the disposition of property that can generate U.S-sourced FDAP income.
- “Foreign pass-thru payments,” the IRS is still considering rules for defining a foreign pass-thru payment.
Impact on Overseas U.S. Residents
The United States is the world’s only industrialized country that taxes on the basis of citizenship rather than on residence or source of income. For Americans living overseas, if the aggregate value of their foreign financial accounts exceeds US$10,000 at any point in time during the tax calendar year, they need to report their personal accounts through the Report of Foreign Bank and Financial Accounts (FBAR).
In addition to the long-standing FBAR form, FATCA has brought in a new IRS filing requirement, called Form 8938. The new form requires taxpayers to provide detailed information on their overseas financial accounts to the IRS, along with their annual income tax returns. U.S. citizens who have foreign financial assets in excess of US$50,000 are obliged to report through Form 8938, while Americans residing overseas only need to report if they:
- File a return other than a joint return and the total value of the specified foreign assets is more than US$200,000 on the last day of the tax year, or more than US$300,000 at any time during the year.
- File a joint return and the value of the specified foreign asset is more than US$400,000 on the last day of the tax year or more than US$600,000 at any time during the year.
Failing to report could result in a penalty of US$10,000, and up to US$50,000 (for continued failure after IRS notification). Furthermore, underpayments of taxes attributable to non-disclosed foreign financial assets will be subject to an additional understatement penalty of 40 percent.
“As FATCA begins to be implemented, more taxpayers who have not been compliant will be under pressure to disclose their non-U.S. bank accounts,” comments Philip Stein, president of Philip L. Stein & Associates. “Also of note is that as soon at the foreign banks identify their U.S. customers and pass that information on to the IRS, U.S. taxpayers will no longer have the option of participating in an ‘Overseas Voluntary Disclosure Program.’”
Final Regulations on FATCA
On January 17, 2013, the U.S. Treasury and the IRS issued final regulations under the FATCA (hereinafter referred to as “Final Regulations”), which made a number of important changes to the proposed regulations of FATCA published in February 2012 (hereinafter referred to as ‘Proposed Regulations’).
Under the FATCA regime, certain obligations are grandfathered and no withholding is required on such obligations. The Proposed Regulations provide that withholding is not required on any payments relating to an obligation outstanding on January 1, 2013. This applicable date has been extended by one year to January 1, 2014 under the Final Regulations.
The Final Regulations have rendered some changes to the “investment entity” – one of the broadest categories of financial institution. These changes are as follows:
- Providing that certain investment entities may be subject to being reported on by the FFIs with which they hold accounts, rather than being required to register as FFIs and report to the IRS themselves
- Clarifying the types of passive investment entities that must be identified and reported by FFIs
The Final Regulation defines the “preexisting accounts” as accounts maintained by an FFI prior to January 1, 2014, and such accounts must be reviewed by December 31, 2013. However, the preexisting accounts with a balance or value of US$50,000 or less held by individuals and accounts with a balance or value of US$250,000 or less held by entities are exempted from review.
Gross proceeds withholding
The Final Regulation extends the effective date for withholding on the gross proceeds of sales of assets that produce U.S.-sourced income from 2015 to 2017, but it does not extend the effective date for withholding on U.S.-sourced income that does not constitute gross proceeds, which begins on January 1, 2014.
The Final Regulation also streamlines FFI registration and compliance procedures, and relaxes certain documentation requirements.
Given the fact that there may be certain privacy or banking secrecy requirements under foreign laws that prevent FFIs from reporting to the IRS, the U.S. Treasury has developed two models of inter-governmental agreements (IGAs) to facilitate the implementation of FATCA in a manner that avoids foreign legal impediments – namely the Model 1 Agreement and the Model 2 Agreement.
Under a Model 1 Agreement, FFIs should report information directly to their own governments, and such information will be automatically channeled to the IRS. It should be pointed out, though, that there is a reciprocal and non-reciprocal version of the Model 1 Agreement. The reciprocal version is available only to jurisdictions with which the United States has an income tax treaty or information exchange agreement, and it requires the U.S. government to report account information to foreign jurisdictions. The non-reciprocal version only requires the foreign jurisdiction to provide information to the U.S. government.
Under a Model 2 Agreement, FFIs must register with the IRS and report information regarding their U.S. accounts directly to the IRS, this will require the foreign government to enact a local law that permits the exchange of information with the United States.
IGA with Switzerland
On February 14 this year, the U.S. government scored a big win in its pursuit of American tax evaders as Switzerland has agreed to reveal the information of U.S. account-holders to Washington, although such agreement still needs to be approved by the Swiss Parliament.
The agreement with Switzerland is of particular significance as the IRS and the Justice Department have long been demanding information from Swiss banks (including UBS, Credit Suisse and Wegelin) on U.S. taxpayers with hidden accounts, and it is also the first Model 2 Agreement that has been signed thus far.
Since the United States will start to implement FATCA in January of 2014, Swiss financial institutions will be forced to implement FATCA from this date. Failing to comply could result in exclusion from the U.S. capital market.
“We are pleased that Switzerland has signed a bilateral agreement with us, and we look forward to quickly concluding agreements based on this model with other jurisdictions,” said Acting Secretary of the Treasury Neal S. Wolin in a statement.
So far, the United States has concluded IGAs with seven countries, including Denmark, Ireland, Mexico, Norway, Spain and the United Kingdom. The U.S. Treasury has also noted that besides Switzerland, Japan is also working on a Model 2 Agreement, and is in the midst of IGA negotiations with over 50 additional jurisdictions including the Cayman Islands. Negotiations with China have begun, but have not made any progress.
Key FATCA Dates
Below is a list of certain key dates for FATCA implementation:
October 25, 2013
- It is expected that the IRS will open FATCA registration for FFIs by July 15, 2013 and for FFIs hoping to avoid becoming subject to FATCA withholding, they must register through the “FATCA Registration Portal” by October 25, 2013
January 1, 2014
- Withholding on U.S.-sourced FDAP commences
- Newly-opened accounts will no longer be considered as preexisting accounts
- New obligations issued after January 1, 2014 will no longer be treated as grandfathered obligations
March 31, 2015
- Filing of FATCA Information Reports begins. The first deadline for “participating FFIs” to file information reports with the IRS is March 31, 2015
January 1, 2017
- Gross proceeds withholding begins
- Earliest date that the withholding on “foreign pass-thru payments” may begin
Controversy Surrounding FATCA
Critics of FATCA point to several problems with the legislation that may eliminate its estimated US$8 billion increase in government revenue. Central to these concerns is the costs on the part of FFIs, as they have to provide extensive documentation to the IRS about their American subjects.
The European Commission has estimated that compliance would cost EU institutions alone US$100 million, and James Broderick, the head of JP Morgan’s European, Middle Eastern and African asset management business, has suggested overall implementation costs could equal the roughly US$8 billion FATCA is expected to raise over the next 10 years.
A report by American Citizens Abroad (ACA) warns that the large cost of observing the legislation could lead many foreign financial institutions to choose to close the accounts of U.S. citizens and sell off U.S. holdings rather than complying. A 2011 survey by KPMG of leading fund promoters found that 6 percent of respondents were intending to do so. Some have suggested that this could cause a larger impact on U.S. government revenue than the money raised by FATCA, as disinvestment deteriorates the state of the overall economy.
The Final Regulations do, however, appear to have taken into account some of these concerns, as efforts to simplify the act have led to what analysts call “favorable changes” in time allotted for reviewing existing accounts, use of existing documentation and the application of FATCA on certain existing obligations.
This article was first published on China Briefing.
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