FATCA requires ‘foreign financial institutions’ (FFIs) to report information on US account holders to the US Internal Revenue Service (IRS). FFIs are expected to identify the direct and sometimes indirect owners of their accounts to determine whether they are ‘US accounts’. To the extent they are, the FFI is required to disclose them to the IRS. FFIs that do not agree to do this would suffer a 30 percent withholding tax on all US withholdable payments. To avoid the withholding requirement, the FFI must enter into an agreement with the IRS to identify all US accounts held by it or its affiliates and report annually on each account.
Major concerns were raised by the insurance industry over the practical and administrative burden that FATCA would impose; and also in many jurisdictions on its apparent conflict with local privacy and data protection legislation which would prevent the release of such information. In many cases, too, companies argued that they simply did not possess the necessary information to comply with the law. Reflecting these concerns, the governments of the UK, France, Germany, Italy and Spain (the G5) approached the US, with the support of the European Commission, to explore ways to address the legal difficulties presented by FATCA.
The outcome was the development of an intergovernmental approach, in which financial institutions will report the necessary information to their own tax authorities, who will then exchange information with the US under existing double taxation and information exchange agreements. In July 2012, the US Treasury published two versions of a Model Intergovernmental Agreement to Improve Tax Compliance and to Implement FATCA as a basis for implementing this approach. The G5 governments are currently in the process of drafting Intergovernmental Agreements (IGAs); although the UK is furthest ahead, having signed the agreement and issued a consultation document on the intended implementation into UK law in September 2012. The other four governments are in detailed discussion with the US.
IGAs: G5 progress
France and Italy are in the process of negotiating annex II to their IGAs. In France, the IGA will have to be presented to the French parliament, which will have to enact implementing legislation. The situation is more complicated in Italy, where both the foreign ministry and the finance ministry must sign off on the IGA, which then must be ratified by the legislature.
Spanish officials have said that implementation of the IGA should not require too many changes to domestic law. The government is currently drafting non-compliance penalties and anti-avoidance measures, and is hoping that the IGA will be agreed by parliament using an expedited process, in time for January 2013.
Germany is currently negotiating Annex II with the United States. Ratification of the IGA is expected before the end of 2012, with domestic implementing legislation following. Officials expect the IGA to become effective before mid-2013.
The UK-US IGA
In the UK, HMRC have said that the UK-US IGA sets out a framework within which:
- legal barriers to compliance, such as those related to data protection, have been addressed
- withholding tax will not be imposed on income received by UK financial institutions
- UK financial institutions will not be required to withhold tax on payments they make
- due diligence requirements are more closely aligned to the requirements under the existing anti-money laundering rules
- a significant range of institutions and products are effectively exempt from the FATCA requirements.
Some relief for insurers
Although earlier hopes that insurers – at least non-life insurers – might be exempted entirely from FATCA have not been fulfilled, the IGA, including the exemptions in Annex II, does bring some significant relief:
- ‘custodial accounts’ expressly do not include insurance or annuity contracts
- ‘cash value insurance contracts’ are expressly defined to exclude indemnity reinsurance
- reportable cash value insurance contracts are subject to a 50,000 US dollar (USD) de minimis threshold
- all ‘Registered Pension Schemes’ are exempt financial accounts
- tax-favored savings products such as Individual Savings Accounts (ISAs) and Child Trust Funds are exempt products
- certain other pension arrangements may also be exempt financial accounts, although there are conditions that have to be met.
Uncertainty remains, however, regarding the exemption of products such as certain pension income paying contracts from the definition of a Financial Account, which could hinge on whether such contracts are ‘authorized payments’. The guidance is eagerly anticipated.
One of the major original concerns raised by insurers was the likely difficulty of collecting the required information from pre-existing accounts. The position has been eased significantly: back book due diligence should now only be required for ‘Financial Accounts’ held by individuals where balances exceed $250,000 on which no reporting is done to HMRC, for example under the qualifying policy or chargeable events regime. The effect of this is that due diligence on preexisting accounts should be focused on overseas life assurance business. For ‘Financial Accounts’ held by entities, reliance can be placed on the ‘know-your-customer’ and anti-money laundering procedures.
Annex II also exempts ‘local financial institutions’, that is, institutions located solely within the UK that serve a local customer base. A number of conditions need to be met to be able to take advantage of this exemption:
- the institution must be located solely in the UK
- be regulated in the UK
- be required to report information or withhold tax on accounts held by UK residents
- ninety-eight percent of accounts must be held by residents of the UK or another member state of the EU
- accounts must not be provided to US persons (who are not UK residents) or any entity which has beneficial owners who are US persons (who are not UK residents), and all related entities must meet the same requirements.
To demonstrate compliance, local financial institutions need to implement procedures by 1 January 2014 to identify any new customers that breach these provisions and complete appropriate due diligence investigation of pre-existing accounts.
Despite these developments, which go a significant way towards resolving the FATCA issues raised by the industry and by insurers especially, major uncertainties still remain. In particular, Annex II of each IGA will be specific to the US government partner in question. Any institution with operations more extensive than that of a ‘local financial institution’ is likely to face inconsistent, and potentially conflicting requirements for information gathering and reporting in different jurisdictions. Many multinational groups will have operations in countries both with and without IGAs, creating major challenges in developing a compliance framework.
A further complication for multinational groups is that there are two models of IGA and one of those has two variations. Helpfully, a recent announcement by the IRS has almost wholly aligned the timelines for entities in IGA countries, non-IGA countries and the US. The opportunity for consistency in core definitions, however, will have to wait until the final regulations are released later this year.
For UK companies specifically, uncertainties remain over the interpretation of a number of technical and definitional details; although the consultation period for the current draft closes at the end of November, it is unlikely that all outstanding issues will be resolved by the January 2013 implementation date. Similar -- but different -- inconsistencies and uncertainties can be expected in each IGA negotiated by the US government.
Despite the uncertainties, time is short, notwithstanding the recent announcement. The priorities of affected institutions now should be to review and catalogue legal entity organization, insurance products, and all on-boarding procedures (including those of distributors) to prepare the organization to act as the rule become more settled. Notwithstanding the concessions made under the IGA approach, FATCA is still going to represent a significant burden.
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1frontiers in tax, November 2011 and February 2012 editions, kpmg.com/frontiersintax