Data and transparency
Central to FATCA is data and transparency. A key issue will be validating the data, making sure you are compliant and ensuring you don’t having holding costs. It is also essential that firms have a single view of the data; this also reduces cost burdens and builds Know Your Customer (KYC) offerings.
From the US perspective, things come down to the transparency of U.S companies with foreign ties and offices – that are tax compliant of any foreign subsidiaries. Ergo FATCA will place onerous operational and cost requirements on a wide range of Foreign Financial Institutions (FFIs). Under FATCA, FFIs will have to report their financial information and data to the U.S government. In non-compliance cases, FFIs will also need to withhold 30 percent tax on their U.S sourced income and gross proceeds of sale. Full implementation is expected by the end of 2017.
FATCA - the reality
In reality, the desired result of FATCA in the U.S is to generate reporting to the IRS and reduce the chances of tax evasion. Firms will likely face key challenges in detecting and reporting to the IRS in existing and new accounts. There is also a likelihood of smaller companies disinvesting from the US due to the regulation and the required reporting.
Recent announcements have lessened the required due diligence FFIs must conduct for their pre-existing accounts and analysis of electronic records. KYC and anti-money laundering documentation remain the key challenge for new clients. Systems and processes will need to be in place to detect US clients, using indicia defined by the IRS, to provide the information required and to deduct 30 percent withheld tax in the role of Withholding Agent, where applicable.
FFIs will need to make a strategic decision to either establish a business model that is compliant with FATCA or exit the market for US clients. This is a classic example of Darwin’s evolution theory, as FATCA turns FFIs who want to invest in the US into the survival of the fittest. In order to invest, you must adapt your company to the regulations of FATCA, or face extinction in investing in the U.S. There is already evidence of American wealth management clients who want to bank offshore and are being redirected to conduct their business within the US private banking sector.
Recent concessions have reduced the reporting burden from an asset manager’s perspective, with lighter reporting requirements and a five year time period before withholding is required. Fund scheme documentation (prospectus and offering memorandums) will need to be amended and gain regulatory approval to accommodate FATCA. Regulatory bodies will need resources available in order to approve these documents. US paving the way
There is a global desire to reduce tax evasion. The governments of the US, France, Germany, Italy, Spain and the UK have all agreed to become FATCA Partners in order to create a common approach to FATCA implementation. Having all of these governments behind FATCA provides numerous benefits for the financial industry and gives them a strong level of confidence that the regulations will succeed. The concern, however, is whether the FATCA partners will reach an agreement in accordance with the implementation timetable. There is an ongoing debate as to how the FATCA partners will impact the introduction of the legislation. They could introduce an additional up front administrative burden to FFIs, as the work done to become FATCA compliant may have to be replicated for each FATCA Partner.
It is expected that other countries will introduce the same requirements as FATCA in the future. The U.S has already indicated that it will reciprocate data sharing, by automatically collecting and exchanging information on accounts held in US Financial Institutions via residents of the FATCA partners. By sharing the data it collects, the IRS is practicing what it is preaching; offering transparency.
Working with a middleman
Since it’s easier to aggregate data and create a new industry standard in one location, instead of implementing it in five different places, the Intergovernmental Agreement (IGA) was created to simplify FATCA for FFIs. This prevents an entrance institutional barrier for lower funds that are held, which would actually be more expensive to regulate.
The Intergovernmental Agreement was created for FATCA to allow the U.S, UK, and other European nations in other countries to work together and have a standard in which to conduct their business under FATCA. The IGA allows FFIs to send their monies and pertinent information to their national tax authorities, which will forward this data to UK for consolidation. Once that is completed, the UK can provide everything over to the U.S via the IRS. The United States will then supply all of the information they receive to the tax governors associated with FATCA.
How Data Comes Into Play
Under FATCA, U.S firms that have foreign entities will be looking to find a way to best manage the implementation of the regulation. One of the easiest ways firms can do this will be centrally aggregating their data, giving them the ability to accurately report the withholding information and account balances and positions.
The use of data in FATCA is reliant on the assessment of two main factors. Firstly, the cost of the implementation is paramount to look at. FFIs will face issues validating the data, making sure they are being compliant, and ensuring they don’t have holding costs. Secondly, it is important for them to become transparent by obtaining a single view of the data. FFIs have to ensure they will be thorough throughout the process from accounting to aggregating the information. By being transparent and complete with their data, companies will meet their KYC offering and also ensure they meet FATCA’s requirements and objectives.
Benefit or costly burden?
Currently, FATCA will only benefit the IRS, to the detriment of the investor, and it will also be a costly burden on the financial services industry. Additionally, high administration costs are likely to end up being passed onto investors.
Two of the more challenging implications of FATCA for asset managers will be coping with changing requirements for clients on boarding and classifications. As a consequence, these will potentially generate the higher implementation costs. Although these costs will vary, they still could be significant.
The recommendation for FFIs is to not just build a FATCA solution, but build a global solution instead. As more countries follow the lead of the US, a genuine concern is that if more countries join, will this become even harder to regulate and enforce? What can be done to ensure that doesn’t happen? Nobody knows at present time. The key to success lies in adequate global scenario testing and planning, so that FFIs are readily prepared, if and when, other countries come on board.
Each FFI is required to nominate a Responsible Officer, which is fundamental to the successful implementation of FATCA. The generation of the Responsible Officer position creates specific ownership and responsibility to this regulation, which is seen as providing no benefit to financial institutions. Before a hire is made, it is necessary that a formal project structure already needs to be in place, with a detailed project plan, owners and timelines.
FATCA becomes effective on January 1, 2014, with a continually phased implementation concluding in 2017; and FATCA will not be going away. Sitting back and waiting for further clarification of the requirements is not an option - FATCA cannot be ignored. Rick McCarthy, managing director, Americas, joined DST Global Solutions in 2010. His primary role is to lead new business development activities for the company’s investment management solutions. Previously, Rick focused on financial risk, energy risk and business process management in particular and acted as SunGard’s 26th employee. In addition, he held senior sales and marketing management roles within several blue chip and Fortune 1000 companies. Rick earned a Master’s degree from Thunderbird School of Global Management and a Bachelor’s degree from the University of Kansas.