Unpopular FATCA could be a blueprint for Europe


In my July entry, I took a broad look at regulations in the finance market and how they are hindering the sector’s ability to innovate. In this and the next entry, I plan to concentrate on two developments complicating matters further for financial institutions. Today’s topic is FATCA. This will be followed up with an exposition on SEPA.

Dirk Elsner – Business Consultant and Banking Blogger
Dirk Elsner – Business Consultant and Banking Blogger

When I composed my first blog entry on the “Foreign Account Tax Compliance Act” (FATCA) two and a half years ago, I gave it the headline: FATCA expected to make finance sector see red. At that time, almost nobody had heard anything about this US law, which was adopted in March of 2010. But our in-house compliance and tax specialists already had an inkling that it could mean trouble for the credit and insurance industries. This terrible feeling was less a result of knowing that the USA could more efficiently lock down on tax evaders, and more a reaction to the impending complexity and effort involved in implementing the new regulations – despite them yielding minimal added value for the credit industry itself.

So what exactly is the issue with FATCA?

Under FATCA, financial institutions outside of the USA (referred to as foreign financial institutions, or FFIs) are required to do the following:

  • Provide (existing and new), customer identification and classification information on US-Americans
  • Monitor revenue-related data, plus report this information directly to the US Internal Revenue Service (IRS) on a yearly basis
  • Impose a tax when these individuals refuse to cooperate

This identification also applies to customers outside of the USA insofar as they receive payments from American sources or have American investments. Financial service providers, such as banks, asset managers, trusts and insurance companies who do not comply run the risk of paying a 30% penalty tax on all payments linked to US assets (withholdable payments). This will not just affect non-US customers, but also any proprietary trading investments held by banks. With this mechanism, non-US financial institutions are obligated de-facto to comply.

Worldwide implementation of the act is expected to cost roughly $500 billion according to Big Four auditor KPMG. And that’s a conservative estimate. Experts also forecast a budgetary surplus of $7 billion in the US treasury over the next decade. Whether this will pan out is anybody’s guess. In any case, the regulation (See original here, page 27) and its final, 543-page executive order adds unbelievable complexity to the equation while yielding almost no benefits for tax-paying banks and individuals. Moreover, the provisions of the act call for bilateral contracts between banks and the IRS.

Image: fotolia.com
Image: fotolia.com

Since FATCA requirements can hardly be fulfilled, not to mention enter a grey zone in terms of data protection, the US has initiated bilateral treaties with countries around the world. These serve as a mechanism for placing FATCA objectives at an inter-governmental level. According to the bilateral agreement with Germany, German financial institutions no longer need a separate bilateral contract with the IRS. And instead of having to report directly to the IRS, they report to an intermediary national tax authority. Yearly balances and capital yields, in particular, will still be reported. FATCA partner countries, however, are exempt from the penalty tax.

Most banks are already taking the necessary steps to accommodate the regulation and have begun analysing its strategic impact on their business areas while taking into account customer structure and personal investments. The result: many institutions see non-compliance as disadvantageous. It’s not worth it to sever contacts with US customers, for example. And avoiding the penalty tax would essentially mean banks, as well as their customers, forgoing all business involving US payments – simply impossible in our networked global economy.

FATCA will be implemented in different stages (see the timeline here ). As of 1 January 2014, new identification of customers will begin. Of course, the bilateral treaty is taking some of the edge off of the act’s severity. But the new requirements are having a massive impact on overall product and customer data, as well as reporting policies at financial institutions. In our opinion, this act will be more costly than the withholding tax introduced in the US at the turn of the millennium. Depending on business and customer structure, financial intuitions can plan on preparation lasting anywhere from 18 to 30 months.

In 2011, I speculated that FATCA could become a blueprint for similar regulations in other countries. In this case, it makes sense to consider this accordingly during project planning, and design processes and IT changes for scalability. Since it came out that European banks had also played their role in massive, “tax-optimised” transfers to offshore accounts, the cry for regulation has only grown louder. The EU Commission already presented a corresponding paper at a European Council congress on 22 May 2013. With reference to the US FATCA regulations, recommendations were made to expand the planned, automatic information exchange regarding interest revenue in the EU to include all sources of investment yields.

A corresponding legislation process will probably take a while to emerge. But I expect experts will be able to get their hands on a European version before the time to implement US FATCA guidelines runs out in 2017. And if FATCA is taken as the standard, the EU version will also have to answer thousands of questions regarding implementation.