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US Focus - FATCA

By Lowtax Editorial
12 November, 2014

Described by the US Government as a "major milestone" on the path to eradicating offshore tax evasion, but derided by its critics as a substantial step by the US authorities towards Big Brotherdom, the Foreign Account Tax Compliance Act (FATCA) went into force on July 1, 2014 after a long period of preparation by the Internal Revenue Service (IRS), foreign revenue agencies and foreign financial institutions (FFIs).

FATCA: The Basics

FATCA is designed to tackle the non-disclosure by US citizens of taxable income and assets held in foreign accounts. It was signed into law by President Barack Obama on March 18, 2010 as a revenue provision of the Hiring Incentives to Restore Employment Act.

The law is intended to ensure that the US obtains information on accounts held abroad at FFIs by US persons. Failure by an FFI to disclose information on its US clients, including account ownership, balances and amounts moving in and out of the accounts, will result in a requirement on US financial institutions to withhold 30 percent tax on US-source income.

To address situations where foreign law would prevent an FFI from complying with the terms of an FFI agreement, the United States Treasury Department has developed three model intergovernmental agreements (IGAs).

The Model 1IGA requires FFIs in the foreign jurisdiction to report tax information about US account holders directly to the government, which will in turn relay that information to the IRS.

The Model 1A IGA is essentially the same, except that the IRS will reciprocate with similar information about account holders from the signatory country with the partner government.

The Model 2 IGA requires FFIs to report specified information about their US accounts directly to the IRS, to the extent that the account holder consents or such reporting is otherwise legally permitted, and such direct reporting is supplemented by information exchange between governments with respect to non-consenting accounts. FFIs also report to the IRS aggregate information with respect to holders of pre-existing accounts who do not consent to have their account information reported, on the basis of which the IRS may make a "group request" to the partner jurisdiction for more specific information.

At the time of writing, just over 100 jurisdictions have either signed a FATCA IGA, or are treated by the US Treasury as having reached an agreement in substance with a view to signing an IGA at a later date. The vast majority of these agreements are Model 1 or 1A IGAs.


US citizens, US individual residents, and certain non-resident individuals who own specified foreign financial accounts or other offshore assets (specified foreign financial assets) must report those assets on new Form 8938 'Statement of Specified Foreign Financial Assets,' which must be attached to the annual US income tax return (Form 1040).

Individuals who do not have to file an income tax return for the tax year do not need to file Form 8938, even if the value of their specified foreign assets is more than the appropriate reporting threshold (specified below). Those required to file Form 8938 do not have to report financial accounts maintained by: a US payer (such as a US domestic financial institution); the foreign branch of a US financial institution; or the US branch of a foreign financial institution.

For individuals who are resident in the United States, if the total value of the specified foreign assets is at or below USD50,000 at the end of the tax year, there is no reporting requirement for the year, unless the total value was more than USD75,000 at any time during the tax year.

Higher asset thresholds apply to US taxpayers who file a joint tax return or who reside abroad. Married taxpayers filing a joint income tax return and living in the US must report if the total value of their specified foreign financial assets is more than USD100,000 on the last day of the tax year or more than USD150,000 at any time during the tax year. Married taxpayers filing separate income tax returns and living in the US must report if the total value of their specified foreign financial assets is more than USD50,000 on the last day of the tax year or more than USD75,000 at any time during the tax year.

US taxpayers living abroad must file Form 8938 if they file a return other than a joint return and the total value of specified foreign assets in the foreign account is more than USD200,000 on the last day of the tax year or more than USD300,000 at any time during the year. Non-resident taxpayers filing a joint return and with specified foreign assets of more than USD400,000 on the last day of the tax year or more than USD600,000 at any time during the year must also file Form 8938.

The IRS currently defines a taxpayer living abroad as: a US citizen whose tax home is in a foreign country and who is either a bona fide resident of a foreign country or countries for an uninterrupted period that includes the entire tax year; or a US citizen or resident, who during a period of 12 consecutive months ending in the tax year is physically present in a foreign country or countries at least 330 days.

The following types of foreign assets must be reported on Form 8938:

  • Financial (deposit and custodial) accounts held at foreign financial institutions
  • Foreign stock or securities not held in a financial account
  • Foreign partnership interests
  • Foreign mutual funds
  • Foreign accounts and foreign non-account investment assets held by foreign or domestic grantor trusts
  • Foreign-issued life insurance or annuity contracts with a cash-value
  • Foreign hedge funds and foreign private equity funds

In addition to accounts held at foreign branches of US financial institutions and US branches of foreign institutions, the following assets are not reportable under FATCA:

  • Domestic mutual fund investing in foreign stocks and securities
  • Indirect interests in foreign financial assets through an entity
  • Foreign real estate held directly
  • Foreign real estate held through a foreign entity (although the foreign entity itself is a specified foreign financial asset and its maximum value includes the value of the real estate)
  • Foreign currency held directly
  • Precious Metals held directly
  • Personal property held directly such as art, antiques, jewellery, cars and other collectibles
  • Social Security-type program benefits provided by a foreign government

It is important for those potentially affected by FATCA that the legislation merely supplements, rather than replaces, existing reporting obligations required of US taxpayers, notably the Report of Foreign Bank and Financial Accounts, or FBAR. And penalties for failure to report foreign financial assets on Form 8938 when required under the legislation are harsh.Non-disclosure may result in a penalty of USD10,000, and an additional fine of up to USD50,000 for continued failure after IRS notification. Furthermore, underpayments of tax attributable to non-disclosed foreign financial assets will be subject to an additional substantial understatement penalty of 40 percent.

Financial Institutions

Final regulations for the implementation of FATCA were issued by the US Treasury and IRS on January 1, 2013. From August 2013, FFIs have been permitted to use an on-line portal for FATCA registration. Under current timelines, FFIs must have fulfilled their due diligence and withholding requirements to comply with FATCA by July 1, 2014 (extended from the original January 1, 2014 deadline) ready for the first reports to reach the IRS by March 31, 2015, regarding accounts maintained during 2014.

However, in recognition of the administrative difficulties faced by FFIs to ready for FATCA reporting, the IRS announced in May 2014 that it is regarding calendar years 2014 and 2015 as an enforcement and administration "transitional period" with respect to the implementation and enforcement. In practice, this means that they will refrain from "rigorously enforcing" many of FATCA's requirements this year and next, as long as FFIs are making "a good-faith effort" to achieve compliance.

On October 10, 2014, the IRS and the US Treasury, in Notice 2014-59, announced their intention to amend certain provisions of the temporary regulations concerning the Foreign Account Tax Compliance Act to expand administrative relief provisions set out in Notice 2014-33.

However, while only ball park estimates exist of the total cost to the world's financial institutions of building new systems to comply with FATCA, it is widely accepted that the figure is pushing USD10bn or more.

Recently, both the Securities Industry and Financial Markets Association (SIFMA) and Mindtree, a global technology services company, have pointed out the immense global compliance costs and issues posed by FATCA to the financial services industry.

SIFMA recently conducted a survey and found that financial firms had to spend over USD1bn in an effort to comply with FATCA in 2013 and 2014 alone. However, SIFMA President Ken Bentsen has said that this represents "only a small fraction" of the global compliance costs of FATCA, as the IRS has estimated that there could be as many as 600,000 FFIs required to comply with FATCA and the vast majority of these banks are not included in this cost estimate.

Bentsen added: "Let's not forget that FATCA also impacts millions of individuals and entities outside the financial services sector. It would not surprise me if the total cost of FATCA will be in the tens of billions – a number that comes close to eclipsing the IRS's USD11bn annual budget."

Added to this total are the additional data gathering and reporting systems needed by the world's tax authorities, and all for a predicted revenue gain of around USD800m a year for the US Treasury, although the reciprocal nature of many of the IGAs means additional revenue will be collected in other countries too. Just how much remains to be seen.

How Safe Is Your Data?

What is certain is that there will be a huge rise in the volume of individual personal information sent from one place to another. But just how secure this information is going to be, both in storage and in transmission, is another worry.

The IRS has already had to issue an assurance to taxpayers following reports of FATCA-linked identity theft attempts.

These reports, confirmed by the IRS, reveal that FFIs directly registered to comply with FATCA, and those in jurisdictions that are treated as having in effect agreements to implement FATCA through intergovernmental cooperation, have been approached by persons claiming to represent the IRS.

The IRS has reports of such "phishing" incidents from multiple countries and continents, and the scams are typically carried out through the use of unsolicited emails and/or websites that pose as legitimate contacts. The agency has asked FFIs that suspect they are the subject of a scam to report the matter to the Treasury Inspector General for Tax Administration (TIGTA).

Furthermore, concerns have been raised about the reliability of the IT systems the IRS has put in place to facilitate FATCA reporting.

A review of the FATCA Financial Institution Registration System (FRS) by the TIGTA found that the IRS has not yet: approved and implemented FRS business performance measures; completely ensured security requirements were fully tested prior to deployment; fully evaluated the risks of using electronic signatures for registration forms; or documented FRS system access controls in sufficient detail to permit analysis and testing.

The FATCA Effect

It seems that there are few avenues of escape open to those caught in FATCA's web, aside from renouncing US citizenship completely. And there has been a notable rise in the number of Americans handing back their passports as awareness of FATCA has gown.

According to Treasury Department statistics published in the Federal Register in August 2014, a record number of 1,577 United States taxpayers gave up their passports or their green cards in the first half of the year, up from 576 in the first quarter. The fact that this was the six month period immediately preceding the start of FATCA can't be dismissed as mere coincidence. Indeed, the Treasury's latest set of figures show the trend continuing as FATCA begins to bite, with 776 US taxpayers giving up their passports or their green cards in the third quarter of 2014, up from 560 in the same period last year.

What's more, fearful of the legal consequences of falling short of the complex FATCA regulations, some financial institutions are attempting to sidestep the reporting obligations by having nothing to do with US clients, old and new. This has created a serious problem for a substantial number of the 8m US citizens residing abroad.

In actual fact, this so-called "lock-out" effect for US banking customers has been on the increase for a number of years, commensurate with the spread of US anti-money laundering, anti-terror financing and anti-tax evasion laws, especially 'know your customer' provisions in the Patriot Act, and FBAR.

There are no official estimates of how many US citizens are being deprived of even basic banking services whilst abroad, but there is plenty of anecdotal evidence to suggest that the lock-out is prevalent and global.

"All these reporting requirements, and the threat of penalties if the reporting is not complete and accurate, are causing some foreign banks and other financial institutions to cut off access by Americans overseas to foreign financial tools, such as mortgages, bank accounts, insurance policies, and pension funds, all of which are essential financial tools for survival overseas,"merican Citizens Abroada pressure group for US expats, confirms.

And the lock-out isn't just affecting US citizens with foreign bank accounts. The Patriot Act's know-your-client guidance is leading US banks to close domestic US accounts held by Americans who no longer can provide a mailing address in the United States.

FATCA – Here To Stay?

There is a small but growing movement in Washington for the repeal of the law. At the last winter meeting of the Republican Party's National Committee in January 2014, a resolution was adopted calling for FATCA's repeal, and last year, Senator Rand Paul, a Kentucky Republican, introduced a bill that would repeal FATCA's anti-privacy provisions, thereby rendering the law effectively redundant. Bill Posey, another Republican Congressman, has also taken issue with the Treasury's legal authority to conclude IGAs as under the US Constitution only the Senate has the right to authorize foreign treaties.

The Republicans' recent mid-term election success, which saw them regain a majority in the Senate, heightens the chances of a legislative challenge to FATCA. But, in reality, repealing FATCA is currently low down Washington's agenda and even if a repeal landed on President Obama's desk, he would very likely veto it.

Furthermore, by developing the FATCA IGAs, the US Treasury and participating Governments have unwittingly (or perhaps by design) created the template for a system of global automatic exchange of information between national tax authorities which is rapidly coming to fruition, and which is strongly supported by most developed nations.

So, for the foreseeable future at least, the world is stuck with FATCA.


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