WHAT IS FATCA?
From 1 January 2013, FATCA will require foreign financial institutions (or "FFIs") to enter into an agreement with the US Internal Revenue Service (the "IRS") whereby they agree to:
- identify their US account holders;
- report certain information of such account holders annually to the IRS; and
- withhold tax on payments to recalcitrant US taxpayers and to non-participating FFIs and close accounts belonging to recalcitrant account holders.
If FFIs do not comply, they will suffer a 30% withholding tax on payments of US source income or capital into their institution, irrespective of whether payments are made to the institution itself or on behalf of its clients.
FATCA is designed to detect and discourage offshore tax evasion by US citizens, rather than raise tax revenue in itself. However, it is expected to have an impact that extends far beyond tax and reporting obligations, requiring major changes in technology, operations and customer contact. It is anticipated that compliance will be complex and costly, with some estimates putting the likely costs above US$100m. It is essential that finance businesses in the Channel Islands are fully aware of the impact of FATCA and the ways in which they can ensure that they are compliant.
WHY IS FATCA RELEVANT TO THE CHANNEL ISLANDS?
FATCA applies on a global basis, regardless of jurisdiction. It therefore applies to any Channel Islands institution which falls within the definition of FFI - this definition is very broad, covering any foreign financial institution that accepts deposits from US persons or primarily engages in the business of investing or trading in US securities. This will therefore include banks, custodians, brokers, many investment funds, hedge funds and private equity funds, trust companies, family offices and insurance companies and will clearly impact on many, if not all, financial businesses operating in the Channel Islands.
WHICH CLIENTS ARE CAUGHT BY FATCA?
FATCA requires the collection of certain information relating to US account holders or persons who have indicia of US status. The IRS has listed seven indicia of US status:
- US citizenship or permanent residence (i.e. a green card)
- US birth place
- US residence address or US correspondence address
- US Telephone number
- Standing instructions to transfer funds to an account maintained in the US
- A Power of Attorney or signatory authority granted to a person with a US address
- An 'in care of' address or 'hold mail' address in the US
The key will be the ability to identify US account holders. For a small organisation a manual search may suffice, but for larger organisations a manual search would be difficult. For many, IT systems will need to be upgraded to look for these indicia in order to establish whether the information required by FATCA must be collected and reported. Given the scope of the indicia, existing AML, due diligence and client take-on procedures will in the majority of cases need to be improved and updated to reflect these increased identification requirements - it will be essential that a business is able to identify whether it is dealing with US account holders in order to go on to assess the additional information which must be collected in respect of such persons.
WHAT INFORMATION MUST BE COLLECTED?
The information which must be collected on US account holders is:
- the name, address, account number and taxpayer identification number of each account holder
- that person's account balance or value at year end
- the gross dividends, interest or other income paid or credited to that account
FFIs will also be required to report the aggregate number and value of accounts held by recalcitrant account holders at the end of the calendar year grouped as those that have US indicia, those that do not and those that are dormant.
FFIs may also need to collect either a form W-9 or W-8BEN, which are US tax forms. Finally, there are annual reporting requirements in respect of US clients.
Most finance businesses don't currently collect this sort of information. Nor do the GFSC or the JFSC require this information. Given the draconian and over-arching provisions of FATCA, businesses will therefore need to ensure that they have adequate systems in place to identify and collect this additional information, and to ensure that the reporting requirements are complied with on an ongoing basis - this is likely to include developing enhanced client acceptance forms and business risk assessment procedures, together with increased reporting awareness.
DO THE RULES APPLY TO EXISTING ACCOUNTS AS WELL AS NEW BUSINESS?
It is important to note that FATCA does not only apply to business take-one going forward - in order to comply, businesses will be required to review their existing accounts to establish whether any clients have US status, according to the indicia published by the IRS. This is, on the face of it, a huge undertaking.
However, the IRS has recently issued a raft of new regulations regarding the proposed implementation of FATCA. Included in these regulations were provisions for "deemed compliant" FFIs. Essentially, these set de minimis thresholds whereby pre-existing individual accounts with a balance of US$50,000 or less, and entity accounts with a balance of US$250,000 or less, will be excluded from the requirements.
WHO WILL BE RESPONSIBLE FOR POLICING COMPLIANCE?
FATCA requires each FFI to identify a responsible officer, who will be required to certify that the FFI has completed the requisite reviews of its pre-existing accounts and, going forward to provider periodic compliance confirmations to the IRS.
WHAT IS THE ALTERNATIVE?
If a business decides that the obligations of FATCA, and the associated costs of implementing new systems and processes which are FATCA compliant, are too onerous, there is one simple solution - to exclude themselves from having any US taxpayers as clients, and from receiving any payments from the US, unless they are prepared to accept a 30% withholding tax on such payments. For some businesses with limited exposure to US markets this may in fact be the most sensible option, but for many the commercial opportunities which US clients bring will be too big to ignore and they will be faced with no option but to comply with the requirements of FATCA in full.
HOW DO WE REGISTER?
Registration will be open from 1 January 2013 and FFIs must enter into an agreement with the IRS before 30 June 2013 to avoid withholding from 1 January 2014. However, it should be noted that the US, the UK, France, Germany, Italy and Spain, have issued a joint statement pursuant to which they have agreed to explore an intergovernmental 'Partner' system whereby FFIs report to their domestic authority, which then shares the relevant information with the IRS provided they receive reciprocal information about US accounts relating to that partner's domestic taxpayers. It is anticipated that being a FATCA Partner will being a range of benefits which will reduce the burden on individual FFIs and, in particular, will remove the need for each FFI to enter into a separate FATCA agreement with the IRS. However, it is notable that major finance jurisdictions such as Canada, Switzerland and the Netherlands have not been included as initial FATCA Partners and it remains to be seen whether the Channel Islands will be included in such a scheme given the USA's previous vocal criticism of offshore jurisdictions.
From a Channel Islands point of view, three key issues immediately come to mind. The first is what additional information you will be required to collect from your client over and above the requirements of our AML legislation. The second is whether a financial institution will be permitted, under existing data protection law, to disclose personal information to the IRS. The third is the extent to which FATCA conflicts with existing Jersey law in general.
The straight answer is that we do not know the answer to any of these questions yet. The latest set of implementation regulations were issued by the IRS on 8 February 2012 and the impact of these regulations is still being assessed. National governments, including Jersey and Guernsey, are working on proposals designed to address conflicts and facilitate the exchange of information in accordance with national law. However, it is important that the issues are understood and considered now to enable Jersey businesses to plan ahead.
IMPACT OF FATCA ON JERSEY AML PROCEDURES
The impact of FATCA on current AML procedures is a cause for concern. Channel Islands AML compliance procedures are onerous enough, but they are limited at present by applicable exceptions. For example, our regimes currently allow a business to rely in certain circumstances upon an introducer's certificate given by a regulated entity, or to disregard the requirement to collect identification information on beneficial owners who hold less than a 25% interest in a given entity. These exceptions are largely pushed aside by the requirements of FATCA where US clients are concerned.
There may perhaps be a silver lining to all of this. Jersey and Guernsey have in the past been criticized for being more highly regulated than some of our competitors and the perception has been that the amount of AML information that we must collect is more onerous. This may level the playing field, at least as it relates to Americans or people that have US interests.
JERSEY DATA PROTECTION LAW
Data protection law in the Channel Islands is made up of a number of principles. All relate to the protection of confidential information. Two principles are particularly relevant.
Principle 1 requires a data controller to process data fairly and lawfully. Fairness essentially requires a person to know what the data is to be collected for and to whom it will be disclosed.
There are a number of exceptions to this principle, including where you obtain client consent to disclosure. Because of this, it will be necessary for Channel Islands businesses to ensure that their standard terms and conditions are wide enough, and specific enough, to constitute client consent to FATCA disclosures. Even with amended terms and conditions, there is still an issue with those individuals who are not required to sign terms and conditions - beneficiaries under a trust, for example. What gives a business the right to disclose information relating to such people under our law?
There is a further exception where the processing is necessary for compliance with any legal obligation to which the data controller is subject. However, this does not apply where the obligations are imposed by a contract and it is unclear whether compliance with FATCA is required by virtue of law, or by virtue of the FFI agreement (which constitutes a contract).
If this was the end of it, it would seem fairly straightforward. However, Principle 8 of our law sets out when it is acceptable to transfer clients' personal information outside the borders of Jersey or Guernsey. These limitations are in addition to Principle 1 and the exemptions that relate to Principle 1 do not apply to Principle 8. Principle 8 provides that transfers are only permitted to countries that are deemed to have adequate protection of confidential information. US data protection law is much weaker than that of Jersey and the United States is not a country which is listed as one having adequate data protection - the de facto position in Jersey and Guernsey is therefore that an FFI can't lawfully transfer information to the US without that person's permission. Again, whilst client consent is an exception to this principle, compliance with another country's laws is not. On the face of it, it will therefore be unlawful for a Jersey or Guernsey institution to transfer information pursuant to, or indeed register for, FATCA.
There is an additional exemption under our law where the processing is necessary for the conclusion or performance of a contract between the data controller and a person other than the data subject, being a contract which is in the interests of the data subject. Whether this exemption extends to, for example, a trust, is far from clear.
There are mechanisms whereby a business can obtain consent from the Data Protection Commissioner to make disclosures to the US government, but again this process will be time consuming and costly and currently requires the identification of specific circumstances on a case by case basis, rather than allowing for a blanket approval.
What all this comes down to is fairly simple. Financial Institutions must comply with FATCA if they handle US investments or have US taxpayers as their ultimate clients. FATCA compliance will require FFIs to breach Jersey data protection law unless they have made adequate preparations, by adopting client verification procedures which clearly identify whether each and every client is a US taxpayer (by reference to the seven indicia), gaining the consent of all relevant clients to pass their personal data to the IRS (this may be through amended terms and conditions), and registering this data collection and processing with the relevant Data Protection Commissioner. In making their annual reports to the IRS, FFIs will also need to be able to report all payments made to each US client, while avoiding reporting on any payments or personal data about non-US clients.
In addition to the more obvious data protection issues, there is also the question of payment processing - where an FFI passes information to a third party financial institution (a "passthru" payment under FATCA), that FFI will need to supply information relating to the source and purpose of that payment to the third party institution to allow them to assess their own obligations under FATCA. This will require institutions to collect, process and supply data which they have never previously needed and for which their systems are not equipped, meaning that most businesses will need to enhance or replace their transaction handling systems to achieve FATCA compliance.
Finally, there remains a question mark over whether, in the future, it will be necessary to gain permission from non-US clients to pass their information to the IRS in order to evidence that funds received from US institutions are not being paid to US taxpayers.
This is an area of specific concern which requires further analysis before FATCA comes into force next year.
IMPACT OF FATCA ON LOCAL LAW MORE GENERALLY
There has been a large amount of commentary regarding the over-arching effect of FATCA, even in the face of conflicting local laws. One area which FATCA does not yet address in any detail is that of trusts law. For example, where a trust has US taxpayer beneficiaries which do not provide the requisite information, it will be very difficult for the trustees to simply exit the relationship - it is unlikely that a new trustee will be identified (as they would have the same FATCA compliance issues), yet FATCA would require the relationship to be ended. In addition, it is a feature of trusts law that beneficiaries are often difficult to ascertain, may be minors or may not even be aware in some cases that they are beneficiaries under a trust. In these cases compliance with FATCA will be complicated. Finally, the provisions of FATCA cut across any professional secrecy or confidentiality provisions and it remains to been seen how this will operate in practice.
It is clear that the implementation of FATCA will have far reaching implications for financial services businesses in Jersey and Guernsey. Not only will client take-on and verification procedures need to be updated and enhanced, but existing client details will need to be reviewed to ensure that all US taxpayer clients have been identified. Businesses will need to implement adequate reporting processes and will need to take advice on any conflicts between their obligations under FATCA and their obligations under data protection and other laws. Finally, it is essential that local businesses and professional advisers engage with the local regulators, the relevant Data Protection Commissioner and local government now in order to identify and address any key issues, whether legal or practical, as a result of the implementation of FATCA.
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