FATCA: are you up to date?

Although forming part of the Hiring Incentives to Restore Employment (HIRE) act, the impact of FATCA has been felt far more widely than the US and its territories.

As is now commonly understood, the US tax system for citizens and green card holders is global, irrespective of where the taxpayer actually lives. As such, it was necessary to introduce a system of enforcing US tax compliance, which is the sole purpose of FATCA, that itself is global.

In the five years that have passed, there have been many changes to the way in which FATCA is intended to be implemented. Many of these changes have occurred as a result of the reaction from taxpayers, financial institutions and governments.

How does FATCA work?

FATCA is intended to enforce full tax compliance by all US persons in respect of their foreign (i.e. non-US) income and financial assets. Penalties and sanctions previously in place to ensure all taxpayers comply with their self-assessment obligations were not considered to be sufficient.

FATCA instead aims to enlist non-US 'entities' to provide information to the US government, regarding US persons for whom they are considered to hold an account for. The substantial stick the Internal Revenue Service (IRS) will wield to ensure compliance is a 30 per cent withholding regime on US source income received at the entity level.

The intention is that information provided to the IRS under FATCA will be cross-referenced with reporting provided by the taxpayer. Any under-reporting, or full non-compliance can then be followed up on using information that, pre-FATCA, the IRS would never have been aware of. This can include knowledge of the actual existence of a US person.

Originally, the implementation of FATCA was governed by the US Internal Revenue Code and related regulations and would have been applicable for all, which for many reasons including local laws, was not an appropriate approach.

Therefore, probably the single biggest change to FATCA in the last five years is the introduction of Intergovernmental Agreements (IGAs), between the US and other countries to improve the manner in which FATCA can be complied with for those individual countries.

IGAs

IGAs can essentially be broken down into two types:

• Model 1 - These are generally reciprocal agreements where information should flow between each country about their taxpayers.

• Model 2 - These are not reciprocal but in many cases were introduced in order to avoid problems with local bank secrecy laws.

The concept of FATCA and any opportunity to obtain information about resident taxpayers has been very appealing to many other countries and there are currently over 80 IGAs in place.

For entities resident in an IGA country, with residency generally being determined under local principles, their exposure to FATCA is governed by the IGA in place. If resident in a non-IGA country, then FATCA is implemented by reference to the Internal Revenue Code and related regulations.

It is probably fair to say that most of the entities that we deal with as private client advisers will be resident in a country that has an IGA, and as such, the code and regulations are somewhat obsolete.

Focus on the US/UK IGA

The US and UK entered into the first Model 1 reciprocal IGA in 2012, and provide definitions and guidance regarding the FATCA obligations facing UK resident entities.

For the purpose of this definition, an entity encompasses a UK tax resident company, partnership and/or trust.

The most important definition set out within the IGA is that of a Foreign Financial Institution (FFI), which is broken down into four types:

• Custodial FFI

• Depository FFI

• Specified Insurance FFI

• Investment Entity FFI

Both Custodial and Depository FFIs generally include any entity that holds funds on behalf of a customer in the ordinary course of business (banks, building societies etc).

Specified Insurance FFIs, as the name suggests, relate to insurance providers and do not require any further discussion in this article.

The Investment Entity FFI is the 'catch all' definition and is itself broken down into two parts:

Entities that provide a customer service

• The FFI definition is based on the type of services provided;

• If the majority of gross income generated relates to services provided in respect of the management of financial assets, that entity can be considered an investment entity FFI;

• This can include corporate trustees and investment managers; and

• An entity that generates passive income and employs the services of a corporate trustee or investment manager may be an Investment Entity FFI.

Entities that do not provide a service to customers

An entity can still be an FFI if both the following are applicable on an annual basis:

• Greater than 50 per cent of income is derived from passive sources (i.e. investment income/gains but excluding rents); and

• The entity is in some way managed by another FFI.

It is therefore essential to determine the FFI status of all UK resident entities. FFIs have the most obligations under FATCA, including possible requirements to register with the IRS and make annual disclosures regarding certain US persons.

For a corporate/partnership FFI, reportable persons would include US persons who are shareholders/partners. For a Trust FFI, US settlors and beneficiaries may be required to be disclosed.

Non-compliance by the FFI can be met with the enhanced US tax withholding penalty and HM Revenue & Customs (HMRC) issued penalties.

Non-Financial Foreign Entities (NFFEs)

If an entity is not a FFI then it is, by default, a Non-Financial Foreign Entity. This creates the somewhat bizarre result that every entity in the world has a FATCA status, either as an FFI or NFFE.

NFFE FATCA obligations are nowhere near as complicated as those facing an FFI, but there are still potential reporting obligations and identification requirements to consider:

• If requested by a US withholding agent or other financial institution looking to satisfy their own FATCA obligations, an NFFE will be required to confirm Passive or Active status.

Passive status

Passive NFFE status is applicable if the majority of the entity's income is from passive source (investment income /gains including rents). Alternatively, an NFFE will be passive if greater than 50 per cent of assets on an annual basis are held for the generation of passive income.

A Passive NFFE, if requested, will need to confirm details of 'substantial US owners'. For a corporate/partnership NFFE, shareholders and partners with a greater than 10 per cent interest should be disclosed. For a trust, US settlors and beneficiaries (in receipt of benefit) should be reported.

As with a non-compliant FFI, a Passive NFFE that does not disclose substantial US owners would also be subject to the FATCA penalty withholding.

Active status

If not passive, an entity will be deemed an Active NFFE. Upon request, the simple status as an Active NFFE will be disclosed.

Confirmation of FATCA status is provided through the W-8 series of IRS forms (i.e. W-8BENE/W-8IMY).

As well as providing the relevant definitions, the US/UK IGA also provides confirmation of certain entities that are considered to be deemed compliant (including certain investment managers) and those entities that are exempt (UK charities etc).

Registration requirements

It should be noted that a UK FFI has to comply with FATCA through application of the IGA. There is no option to choose for the US FATCA regulations to apply.

As such, if a UK entity is an FFI, then it must register with the IRS in some fashion. That can either be through a direct registration with the IRS (obtaining a Global Intermediary Identification Number (GIIN)) or reliance on the registration of a sponsoring FFI.

Under the US/UK IGA, an FFI must disclose any US reportable persons to HMRC, who in turn will provide that information to the IRS. Given the reciprocal nature of the agreement, US financial institutions will provide information about UK taxpayers to the IRS, who will then pass onto HMRC.

Where a UK FFI reports US persons, the FFI will need to register with HMRC to make the required disclosure. HMRC recently confirmed FFIs with no US reportable persons do not need to submit a 'nil return' or register with HMRC.

There are no registration obligations facing an NFFE.

Where are we now?

FATCA reporting to HMRC has already begun and in fact, the first reporting date for 2014 information has already passed (31 May 2015). As such it is essential to review all entities to determine FFI status and potential registration and reporting obligations.

The immediate exposure would be for those currently non-compliant FFIs that are in receipt of US source income. Without a GIIN or sponsoring arrangement, the FATCA tax withholding will be applied to US source income and, from 2017, gross proceeds on the sale of US source financial investment assets.

If a UK FFI has no US source income, but does have US reportable persons, then disclosure must be made to HMRC as soon as possible.

Final thoughts

Despite all the angst and anger (and in many cases denial) over FATCA and its complex reporting requirements, it is here and will remain. Along with the introduction of Common Reporting Standards, information sharing between countries to enforce their tax requirements will become the standard approach globally.

There will certainly be many problems over the next few years with the implementation of FATCA:

• Simply determining the relevant US status of all potentially reportable persons will be a large task;

• The W-8 series of forms, where FATCA status of an entity will be confirmed, have been redrafted;

• As these forms are not submitted to the IRS, each requesting institution will have their own house rules as to how these will be completed, which can significantly vary from firm to firm; and

• It also remains to be seen how information will flow from the US under the reciprocal IGA.

The purpose of FATCA is to ensure full compliance. However the implementation and impact pays little regard to the majority of US persons that are, and have always been compliant. In addition to greater levels of reporting requirements placed upon international US taxpayers on what seems an annual basis, the possibility of FATCA reporting not 'tying' to the disclosure made by the taxpayer is a significant reality. Anything that could create IRS scrutiny would certainly be unwelcome.

What is clear is that for the IRS, FATCA must already be considered a success. Understanding of the unique US tax system throughout the professional and financial world is greater than ever.

It is now extremely difficult for a non-compliant US person to continue or open relationships with non-US financial institutions without much scrutiny. Even for compliant US persons, certain institutions no longer want to work with Americans.

All this has led to many previously non-compliant persons taking steps to rectify the sins of the past. These non-compliance cases range from the wilful to the completely unaware, with the IRS offering compliance programmes to suit many situations.

It is likely that with FATCA reporting now in force, the opportunity to take advantage of any IRS programme may be limited. When this time passes, the IRS may look to impose the full weight of their penalty regime to any cases of continued non-filing.

With the global reach of FATCA, going forward it will certainly be hard for anyone to argue that they simply didn't know… 

Iain Younger is a private client
tax director at Frank Hirth