Buy-side firms outside the US will see a sizeable reduction in the costs of compliance with the US Foreign Account Tax Compliance Act (FATCA) as a result of the proposed regulations for implementation released by the Internal Revenue Service (IRS) and US Treasury on 8 February.
According to KPMG, the latest measures could reduce FATCA implementation costs by more than US$10 billion. Adrian Harkin, global FATCA leader at KPMG, suggests these savings will primarily benefit the insurance sector. However, he notes, “our internal model shows that the European investment management industry stands to save US$1 billion from the changes announced.”
Signed into law on 18 March 2010, FATCA aims to ensure US tax payers with offshore accounts meet their obligations to the IRS. It places particular reporting and withholding obligations on foreign financial intermediaries with US assets or clients.
The FATCA provisions, which will be phased in from July 2013, envisage agreements between foreign financial institutions and the IRS to report information on these client accounts. Without such agreement, dividends and interest paid by US corporations will be subject to a 30% withholding tax, as will the gross proceeds from the sale of relevant US property.
Among the new proposals that may be viewed as lightening the regulatory burden are: an extension to the categories of foreign financial institutions (FFIs) that qualify as ‘deemed compliant’; a limitation of the due diligence for pre-existing accounts to electronic review and Know Your Customer (KYC) and anti-money laundering documentation; a narrower definition of ‘financial accounts’; and extensions to the transition period for reporting requirements on income and gross proceeds and the timeframe for the withholding requirements on pass-through payments. At the same time, the US Treasury issued a joint statement from the governments of the US, UK, France, Germany, Italy and Spain, promoting an inter-governmental approach to regulatory implementation.
The upfront effort required to achieve timely compliance will, however, remain considerable. “It’s a complex system of changes for firms not currently withholding US tax,” says Nick Matthews, member, Kinetic Partners, a global professional services firm focused on the asset management, investment banking and broking industries. According to Matthews, some firms are distinguishing between the upfront costs and the on-going regulatory compliance requirements. “They're saying, ‘We'll have to go through the due diligence to get where we need to be by 2013', but will then only interact with other qualified or participating FFIs,” he says.
Matthews supports a coordinated approach among national revenue authorities but believes it will only help to a limited extent. “It's a good step forward and the concept makes sense: you're reporting domestically, not internationally and you may already have information flows with your domestic authority,” he says. “The caveat is it will still require the IRS to approve that the information you're reporting locally is the information they need. You’re still going to have to collect most of the information; you're just reporting it to a different body.”
Widening the net
The proposed approach would also see ‘FATCA Partner’ countries enacting quasi-FATCA legislation of their own to require financial institutions to collect and report information to their domestic tax authority for onward transmission to the IRS. This would require extensive industry consultation at the very least. And Ireland and Luxembourg – two major European fund hubs – are not yet among the governments preparing for FATCA partnership, says Matthews, “I suspect they may see it as a good idea to sign up.”
The offer from the IRS of reciprocal information exchange could be a significant attraction for most revenue authorities. Meanwhile, individual firms are likely to bite the bullet, at least on the initial compliance requirements. “People just have to get used to the idea that it's probably preferable to do it than not,” he says. Even a fund that invests in emerging market stocks and only has non-US investors will probably find it easier to comply than, for example, be prevented from working with certain custodians. “There will be some on-going compliance requirements, but essentially all they’ll be doing is putting in a nil report every year,” says Matthews. “They'll still have to do it, but that’s less onerous than the consequences of not registering. That's what the IRS is trying to encourage.”
While recognising the beneficial impact of the latest proposals, KPMG’s Harkin argues that FATCA will cost the industry far more than it is likely to raise for the IRS. “The bottom line is FATCA continues to present a major challenge to the industry at a difficult time and any efforts to further reduce its impact would be welcome,” he says.
Harkin’s sentiments have been echoed by Peter De Proft, director general of the European Fund and Asset Management Association. “Although the proposed regulations address many of the difficulties faced by the funds industry, we hope that they will be further refined as the US Treasury and IRS continue the process of moving toward final regulations,” he says.
By Richard Schwartz, editor of Philanthropy Management, an Asset International publication.