Offshore: The FATCA question

The past few years, following the economic crisis in the U.S. and Europe, have seen offshore financial centres being forced to adjust to a new environment of increased regulation, challenging fundraising and in-depth scrutiny of investors. Among the new and complex issues they must deal with is the U.S.  Foreign Account Tax Compliance Act (FATCA), enacted in March 2010, which seeks to identify assets held and income earned by U.S. citizens from offshore sources to ensure that the relevant taxes have been assessed and paid; foreign financial institutions which do not comply with the new rules are subject to withholding tax of 30 percent on U.S. sourced income.

Offshore financial centres, among the world's most popular destinations for investment funds to organise for tax purposes and frequently labeled as “tax havens” by critics, have reacted by signing inter-governmental agreements (IGAs) with the U.S. and the UK to allow smooth implementation of anti-tax-evasion regulations. By the end of 2013, Guernsey, Jersey, the Isle of Man and the Cayman Islands had signed Model 1 inter-governmental agreements (IGAs) with both the United States and the United Kingdom, while the British Virgin Islands has signed a FATCA- type IGA with the UK and was negotiating a Model 1 IGA with the U.S. that is set to be signed in the “very near future.”

Under a Model 1 IGA, foreign financial institutions (FFIs) in partner jurisdictions will be able to report information on U.S. account holders directly to their national tax authorities, who in turn will report to the IRS. This is widely regarded as one of the key benefits of the Model 1 IGA, as there will be no direct reporting by foreign financial institutions directly to the United States government.

“Once the IGAs are fully in force, this will greatly simplify FATCA compliance for Cayman and BVI financial institutions, including for hedge funds, private equity funds, structured finance and aircraft finance vehicles, banks, trust companies and insurance vehicles,” says Michael Gagie, global head of the BVI law practice of Maples and Calder. “For example, there will be no need for each Cayman or BVI FI to enter into an FFI agreement directly with the IRS, or be concerned about confidentiality issues once the enabling legislation is in place.”

Jonathan Culshaw, Asia managing partner at Harneys also notes that under the terms of the Model 1 IGA and the relevant regulations, a FATCA withholding tax will not be imposed on U.S.-source withholdable payments made to a typical fund if it becomes a registered and reporting fund, or on payments made by such a fund to investors which are sourced from such amounts, subject to the certain exceptions. “In addition, the Model 1 IGA provides a qualified ability to rely on investor self-certification of FATCA status which is an important benefit in terms of reducing the verification compliance burden,” he says.

Increased certainty

Gagie says that having an IGA in place is critical for financial centres outside of the U.S. “Financial institutions, investment funds and their investors using Cayman or BVI will now benefit from increased certainty in preparing for any potential registration or reporting obligations under FATCA,” he adds. “In agreeing to IGAs, Cayman and BVI have once again demonstrated their willingness to work with the major economies to enhance the global financial framework.”

Robert Briant, partner and BVI office head at Conyers Dill & Pearman, says he anticipates that these agreements, as implemented by local legislation, will have minimal impact on businesses in the BVI and the Cayman Islands.  “Specifically, the legislation targets tax evasion under U.S. and UK law,” he adds. “In our experience, very few, if any, BVI and Cayman companies are used for tax evasion. To the extent FATCA is a tool to root out any such criminality, its use is welcome.” He says he does not anticipate that FATCA will have any significant impact on the vast majority of BVI, “particularly if they do not engage in business caught by the definition of a foreign financial institution under U.S. law, such as accepting deposits, holding assets for the account of others or engaging in the business of investing or trading in securities.”

Culshaw says that one effect will be increased costs for offshore funds. “The BVI and Cayman Islands governments are not driving these requirements and have done what they can to put in place arrangements which mitigate the reporting burden on offshore entities, and so I don’t see any particular negative publicity or loss of material business for the jurisdictions,” he says. “There will be some increased cost for many offshore funds. The most material of these will be increased administrative costs as administrators and other service providers review and verify investor categories for FATCA purposes, and put in place procedures for categorising new investors and tracking changes to investors.  Secondly, additional legal costs will be incurred as fund offering documents and subscription agreements are updated to address FATCA issues and the potential for further governments to require this type of reporting. For many Asia-based funds which do not offer securities to U.S. investors, complying with FATCA should not be onerous or costly.”

Marcus Hinkley, group partner and head of the Singapore office of Collas Crill, which has offices in Guernsey and Jersey, cautions against drawing too much from the implementation of the IGA. “Whilst politically it may be convenient for the UK to implement such an agreement, the reality is that there are numerous studies which demonstrate that tax leakage in the UK as a consequence of the Crown Dependencies is very small,” he says. “As a practitioner in offshore private client work, I see little uptick in clients intending to take advantage of the disclosure provisions in the IGA, as it [is?]well understood that most clients who use the Crown Dependencies are doing so in a tax-compliant fashion currently.”

Grey areas

Gagie says that there are some areas, particularly in relation to definitions and the scope of exemptions, which may need further clarification. “We understand that the U.S. Treasury is working on revised drafts of the U.S. Regulations, Rules and certain forms,” he says. “Certain jurisdictions are similarly revising their Guidance Notes. Cayman and the BVI will benefit from these developments as they prepare their own enabling legislation.” He adds that his firm is looking forward to receiving greater clarity from the U.S. Treasury in the next few weeks on certain definitions and the implementation of exemptions.  “We also look forward to finalising the Cayman enabling legislation, Regulations and Guidance and following the same approach in the BVI.”

Culshaw says that there is a little uncertainty as to the precise role and responsibilities of a FATCA Reporting Officer under the Cayman Model 1 IGA at the moment.  “Such an officer is required to be referenced on the FATCA IRS registration portal, but the scope of the role is not addressed in the Cayman Model 1 IGA,” he says. “Such a role is expressly contemplated in non-IGA countries and Model 2 IGA countries where a fund will need to enter into an agreement directly with the IRS and appoint an officer to maintain its compliance programme and certify as to its adequacy on a periodic basis. I’d expect that the Cayman domestic legislation will similarly require an officer to take responsibility for FATCA compliance but the domestic legislation will need to make this explicit, clarify to what extent reliance can be placed on information received from service providers and contain penalties for default.”

Nevertheless, firms are updating clients on the evolving situation. “With respect to clients which are FFIs, and, as such, will be resident financial institutions in our respective jurisdictions, notably hedge funds, we are recommending that the client obtain global intermediary identification numbers (GIINs) from the IRS portal,” says Briant. It will be necessary to obtain an IRS GIIN in order to register on the BVI and Cayman portals.” According to Gagie of Maples and Calder, financial institutions will have until the end of 2014 to determine if they need to register and obtain a GIIN, and withholding agents do not need to verify GIINs until after Jan. 1, 2015.

Gagie adds that he is currently advising clients on the scope and application of the Cayman IGAs, although they will only come into force with the enactment of local enabling legislation, expected in April 2014. “We are working with the Cayman Islands government on the drafting of the enabling legislation,” he says. “Our affiliate Maples FS is also working with our clients to assist with the classification, validation and remediation of their accounts, as well as IRS registration and ultimately reporting.”

Culshaw of Harneys says that as fund counsel, his firm is currently involved in updating fund offering and subscription documents to address FATCA issues and advising as to registration mechanics and related FATCA issues. Meanwhile, Hinkley says that for “our institutional clients based in the Channel Islands, we are offering template letters to be sent to clients outlining the contents and effects of the IGA, including setting out both their clients and the institution's obligations for disclosure of information.”

Real value

Hinkley says that the IGAs reflect a new approach that onshore jurisdictions are taking to fight tax crimes – automatic exchange of tax information. “It has been an agenda of the OECD for the last 10 years to achieve automatic disclosure, and the approach taken in FATCA is the catalyst for change,” he says. “The pace at which there has been a move from disclosure of information between governments on request, to automatic exchange of information is unprecedented and is a profound change in approach. So too is the almost universal acceptance among leading financial centres that the facilitation of tax evasion is a money laundering offence in the jurisdiction assisting the evader.”

Culshaw notes that there are conflicting views as to what the real value of FATCA will be in terms of preventing tax evasion, whether it is overreaching in terms of extraterritoriality and whether the compliance cost and burden being imposed both in the U.S. and participating jurisdictions is reasonable in the context of the regulatory benefit provided. “To some degree though, these are now academic arguments; FATCA isn’t going away and in my view, the BVI and Cayman Islands governments have acted in a responsible, rapid and effective manner in dealing with FATCA, underlining their respective commitments to collaborate with onshore authorities to combat tax evasion.”

Briant at Conyers Dill & Pearman echoes Culshaw’s sentiments. “To the extent FATCA is a tool to root out criminality, it is a welcome development,” he says. “We do wonder whether FATCA will bring the benefits anticipated, but as the U.S. and UK decision makers have determined to implement FATCA, we as jurisdictions are happy to implement the necessary steps required to comply with FATCA.”

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‘Global version of FATCA could be a reality in a few years’

By Ajay Shamdasani of Compliance Complete

The U.S. Foreign Account Tax Compliance Act (FATCA) could eventually be displaced by a global tax information sharing agreement between countries, industry officials say.

Such an internationalised FATCA, putatively called the Global Account Tax Compliance Act (GATCA) could soon be a reality for many international banks, but doubts remain over whether the U.S. – having set the process in motion with FATCA – would be likely to sign up.

Jim Calvin, a partner with Deloitte in Singapore, told Compliance Complete that the progression towards GATCA has been brewing for several years. "This has been in the works since 2009. The U.S. was the only jurisdiction with a single capital market that could force FATCA to work. Once the U.S. effort was underway, it became apparent in 2012 with the release of the proposed regulations and the simultaneous announcement by the UK, France, Germany, Spain, and Italy to enter into inter-governmental agreements (IGAs) that this was not just the U.S. acting alone," Calvin says.

FATCA was enacted in 2010 and is set to take effect this July. It will require foreign financial institutions to notify the U.S. Treasury Department's collection arm — the Internal Revenue Service (IRS) — about U.S. citizens' offshore accounts worth more than $50,000 or face a withholding tax on their U.S. assets. Entities that have registered with the IRS by April 25, 2014 will not be subject to withholding taxes.

There is a growing movement towards global tax information exchange, driven by the gradual global acceptance of what was initially deemed as intrusive information demands by the U.S. Laura Charkin, a partner at King & Wood Mallesons, said in a recent briefing that "the introduction of the … FATCA regime originally caused consternation for [financial institutions] across the world; however for foreign governments, it planted the seed of an idea — the thought that perhaps they could have a similar regime themselves.”

Several Asian countries came closer to signing up for FATCA in 2013, with Japan agreeing to a model 2 IGA with the U.S., Australia in ongoing negotiations about a model 1A IGA and Singapore expressing its intention to sign a model 1A IGA. Beijing has also announced its commitment to entering into an IGA with the U.S. on FATCA's implementation.

Furthermore, there has been a growing political focus globally over the past 18 months on eradicating tax evasion. "There have been numerous announcements in this area … with more and more countries announcing their support for these proposals. This has culminated in a report by the Organisation for Economic Cooperation and Development (OECD): ‘A Step Change in Tax Transparency,’ proposing a model for global automatic tax information exchange, or, as it is becoming commonly known, 'GATCA,’" said the King & wood Mallesons briefing.

The OECD's proposals appear likely to be accepted as the new global standard, with many countries attracted to the advantages of having a single, common, global standard for reporting rather than numerous standalone systems.

"It is hoped that this unified approach will reduce the cost burden for [financial institutions] and avoid simply ‘relocating' the problem of tax evasion to other jurisdictions," the law firm said."Implementation time frames in this area have been ambitious from the outset and this does not seem likely to change now, with first reporting under this proposed regime being possibly as early as 2016."

Compliance implications

An initiative like GATCA would likely complicate the lives of compliance, legal and tax professionals at financial institutions in Asia, given the problems caused by the implementation of FATCA.

"It will only increase burdens on in-house counsel and compliance officers," says Karl Egbert, a partner with law firm Dechert in Hong Kong. "Compliance expertise is already stretched thin between reforms from the Dodd-Frank [Act], FATCA, European Market Infrastructure Regulation (EMIR) and other responses to the global financial crisis. It is hard to imagine that adequate internal resources will be forthcoming, no matter how much complexity GATCA adds."

Another issue is that of the interface between FATCA and GATCA, and to what extent  they will impose different or similar obligations on institutions. "If GATCA is not harmonised with FATCA and the various regional information sharing initiatives, GATCA will add more patches to the already patchwork quilt of global taxation," Egbert says.

While coordination between GATCA and FATCA was paramount, David Makso, a tax associate at law firm Paul Hastings in New York, told Compliance Complete that it could also make the lives of compliance officers and in-house lawyers at banks and financial firms easier.

"Although GATCA will add one more layer of complexity to their already very difficult compliance work … financial institutions in Asia-Pacific should welcome the possible implementation of GATCA as good news, if it can result in one standardised global system of information exchange that would avoid the unfortunate scenario where they have to deal with different and inconsistent FATCA regimes from different countries," Makso said.

With these developments, the issue of tax evasion has become more of a global issue, rather than a U.S. obligation on the rest of the world. "GATCA should be taken into account during the implementation of FATCA. It converts FATCA into a multilateral compliance regime and not one that is simply U.S.-centric," said Deloitte's Calvin.

At its core, GATCA is an initiative to implement a multilateral system for tax information exchange, and it will have short-, medium- and long-term ramifications for financial institutions and their compliance staff. "Short term, it would be wise to take into account the possibility of a multilateral tax information exchange initiative when taking steps this year to implement compliance systems with respect to FATCA," says Richard Weisman, a senior tax partner with law firm Baker & McKenzie in Hong Kong. "Medium and long term, there are likely to be very substantial new compliance obligations pursuant to both national laws and this global initiative."

GATCA is also likely to have geopolitical implications. "It will add additional layers of reporting obligations and risks relating to economic and political relations between Asian countries and other 'GATCA' participating nations," says Stanley Foodman, founder of Foodman & Associates in Miami.
Some steps are being taken at the transnational level that may alleviate institutions' compliance burdens. The business advisory group to the OECD on such issues, which is chaired by Keith Lawson, senior tax counsel to the Investment Company Institute (ICI) in Washington, D.C., is working closely with the OECD and others to limit additional burdens, beyond FATCA, that will be imposed by an automatic exchange of information (AEOI). He says that although the common reporting standard awaiting OECD approval was not identical to the first model IGA — signed by 17 countries thus far — the differences were relatively small. He says the best thing for GATCA compliance is to have effective FATCA compliance.

"Because FATCA's implementation date is almost here and AEOI presumably will not become effective for a few years, compliance officers and in-house counsel should maintain a laser-like focus on FATCA compliance," Lawson says. "At some future date, financial services firms will need to modify their systems and processes somewhat to implement AEOI," he says.

So long as the final AEOI initiative was modeled on FATCA's model IGA, any additional burdens would hopefully be small, Lawson told Compliance Complete.

At a time when many banks and financial firms are struggling to come to grips with FATCA, the fairness of besieging them with further compliance hurdles in the latter half of the decade is debatable. Some, however, are not swayed and regard FATCA and GATCA as just another cost of doing business.

"I do not think that whether it is 'fair' will prove to be very relevant. This is a worldwide case of what some governments see as an international 'fiscal epidemic' being viewed as requiring drastic eradication measures," Foodman says. "FATCA is being phased in over a four-year period. I do not see why this could not be phased in also, if the counterparties agreed."

Despite the OECD's fast tracking of GATCA, full implementation by most — if not all — major world governments by 2016 may be a bridge too far. Deloitte's Jim Calvin says that similar ambitions had been seen with FATCA. "The IGAs clearly indicate a 'shelf life' not extending past 2016. The IGAs are the foundation of GATCA, but I expect that the 2016 deadline will need to be extended," he says.

Will the U.S. go along?

It remains an open question as to whether the U.S. will accede to GATCA.

In a recent webinar, Deloitte's Calvin said the OECD's tentative timeline was overly ambitious, because it envisaged the release of GATCA guidelines by the summer of 2014 and full worldwide implementation between 2015 and 2016. He said that while significant changes to U.S. law and regulations were needed to permit sharing of information on foreign nationals' U.S. bank accounts with their home countries' tax authorities, such information exchange would ultimately happen.

Calvin said a key reason was that it would be hypocritical for the U.S. to not sign onto GATCA, given its own crucial role in pushing tax evasion to the forefront of the global agenda with FATCA. Additionally, he said that the "OECD has several bases of legal authority" to make GATCA a reality. However, he warned that reciprocity could easily get hung up in Congress threatening the effective implementation of GATCA.
Denise Hintzke, Deloitte's tax director in New York, says that although the U.S.-centric aspects of FATCA would likely be resolved to create a GATCA that was a more uniform and globally accepted system, to date, only China and Australia had been supportive of the initiative. There are, however, indications that the U.S. will not agree to GATCA. "The U.S. will not enter into AEOI agreements for two reasons. First, FATCA, which addresses the same concerns as AEOI, is being implemented sooner," says ICI's Keith Lawson. "Second, because AEOI focuses only on a customer's tax residence, which is the sole basis for taxation in most of the world and the U.S. also taxes on the basis of citizenship, AEOI is inadequate from a U.S. tax perspective."

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