28 May 2012

FATCA attack

Christopher Alkan outlines why the Foreign Account Tax Compliance Act is turning financial companies into US tax collectors – and turning them against the US government

Bankers may have thought things couldn’t get any worse. After the 2008 financial crisis, vilification by the press and public and tighter regulation, financial professionals have been hoping to get back to business as usual. Instead another storm is heading their way.

Over the coming year financial institutions across the globe will have to adjust to the Foreign Account Tax Compliance Act (FATCA), a rule passed by the US Congress that will cost billions of dollars to implement. The law was passed in March 2010 to snare Americans dodging tax by concealing funds in foreign accounts. But it is only relatively recently that financial firms have become aware of the burdens this legislation will impose.

If you fail, you can get shut out of US capital markets, so the incentives are high to get this right

John Staples, managing partner of the US office of Burt

At the heart of the law is a requirement that financial companies around the world hand over information to US tax authorities on accounts held by Americans and containing more than $50,000. Those unwilling to do so face a 30% withholding tax on any funds transferred from the US – a draconian fee that would effectively shut off all financial dealings with the world’s largest economy.

The US has made various efforts to ease the burdens of the act. Its implementation was put back a year, until January 2013, to give banks more time to prepare. In February five European nations struck a deal allowing financial firms to turn over information to their own governments rather than directly to the US. But even after such concessions, the scale of the problem is imposing. KPMG believes it will cost financial firms about $30bn to implement worldwide over the next five years. To add insult to injury, the measure is expected to collect just $8bn in tax revenue over a decade.

"This law is kicking financial firms when they’re already down," says Adrian Harkin, global FATCA leader at KPMG in a unit aimed at helping clients cope with the new rules. "Being enlisted as unpaid US tax collectors is the last thing they need." Even financial businesses in the five-nation deal – comprising the UK, France, Italy, Germany and Spain – will still have to collect far more information than before.

About seven million Americans live abroad, a quarter of a million of them in the UK, according to the US’s National Taxpayer Advocate. Many more have at one stage lived abroad or had access to foreign financial firms. There are also countless accounts to be scanned around the world. Japan’s banking association, for example, has estimated that about 800 million accounts need to be examined.

Detective work

Conducting this huge piece of financial detective work will be especially tricky for firms with a large global footprint, says Neil Bromberg, a principal at Ernst & Young on the FATCA team. "For firms that have dozens of different businesses in many countries, complying with FATCA is a major undertaking," he says.

It is not just high-street banks that need to go through this. Mutual funds, broker dealers, insurance firms, investment banks, custodian banks and hedge funds will also be compelled to comply with FATCA. The first task firms will face is to look through all existing customer accounts for signs of American citizenship, everything from a US address or phone prefix to powers of attorney or linked bank accounts. This is not as easy as it sounds. "Aside from US citizens, you will be looking for those holding green cards," says Harkin.

Adding to the difficulty, financial firms will not just be searching for accounts held directly by Americans but also trusts and shareholdings in corporations. "Drilling down into different layers of ownership can be tricky," says Harkin. In some cases, he adds, an asset needs to be declared to US tax authorities even if an American owns a stake as small as 10%.

Reaching out to these customers once they have been identified may be another headache. Clients don’t always respond to letters, so they may need to be called – a time-consuming activity. Once this has been done, the financial institution may need to start deducting tax on payments into the accounts of customers deemed recalcitrant – those who have refused to confirm if they’re eligible to pay US tax. They will need to set up payment and withholding systems, a big investment in information technology.

A further challenge is on-boarding – a banking term for setting up new accounts. A slow on-boarding system is considered a competitive disadvantage. "Asking a couple of extra questions [about US links] may seem a small thing but there’s intense competition between firms on how quickly they can open up accounts," explains Harkin. Firms may be wise to devise systems that can embrace new rules quickly. Now that the US has insisted on such information, it is more likely that others, including China, may follow suit.

Financial firms will also need to give someone the unenviable task of personally certifying that the new rules have been followed. The US requirement is in the spirit of Sarbanes-Oxley, the law enacted after the collapse of Enron, which requires corporate chiefs to attest to the accuracy of financial statements.

In the case of FATCA, US law does not specify which officer must be responsible. Convincing someone to step up may not be easy. "This individual will have to guarantee that everything is spot on and that the firm has complied with the spirit and letter of the law," says Harkin. "If it later turns out this is not the case, this individual will be in legal trouble. Given extradition requirements, I don’t think anyone will rush to sign this document."

However, there may be positive side effects from FATCA. David Treitel, tax director at US Tax & Financial Services, believes firms need to get used to a world where data flows more freely across borders. "One benefit is that firms will know their customers better," he says. "This means you can manage risk better."

If a firm is unaware that a customer is a US taxpayer, Treitel explains, they may sell them an inappropriate product, such as a UK ISA on which an American would be liable for a tax rate of up to 100%. "Not only would this be bad for the customer, it could also expose the firm to legal action from their aggrieved client," he says.

Treitel does however agree that FATCA will be a "huge management consulting exercise" that will cost financial firms dearly in terms of money and time.

Mixed blessing

For accountants FATCA is a mixed blessing. Many companies – already weary of implementing new regulations – are hiring accounting firms to help ensure compliance with FATCA. This will mean extra fees.

"A mini compliance industry has sprung up," says John Staples, managing partner of the US office of Burt, Staples & Maner, a Washington DC-based firm with a strong FATCA practice. "This is one of the most significant overhauls in over a decade in this area. If you fail you can get shut out of US capital markets, so the incentives are high to get this right."

Each of the major accounting firms has a large team working on the issue. Ernst & Young has trained 2,500 people to deal with FATCA. Law firms are also likely to get extra business over coming years as they help clients cope with the rules. Still, accountants and lawyers are reluctant to raise their glasses to the US Congress over FATCA. Some worry that clients will resent spending money complying with the new rules. There’s also a risk clients will cut down on other consultancy projects to free up cash to spend on FATCA.

Much of the frustration over the new rules is being directed at the US authorities. Tax collection was not the only goal of FATCA. Even so, it was a leading motive according to Senator Max Baucus, who sponsored the bill. Speaking in support of the act in 2009, he warned that "tax evaders cost our country tens of billions of dollars every year in unpaid taxes," money that, he said, "could be used in any number of other important areas, such as reducing our fiscal deficit."

Yet the US has been neglecting easier ways of raising revenue. The Internal Revenue Service had its budget cut by 2.5% for 2012, forcing it to lay off more than 5,000 tax collection staff. Given that each tax collector generates three times their salary in extra revenue, it seems like a bad time to be downsizing the IRS. In contrast, the FATCA rules may generate only $1 for each $4 that global firms spend in implementing the rules – a terrible deal for financial businesses.

Finding people to speak in favour of the new rules is hard. FATCA will hurt the finance industry while providing little benefit to the US.