Proposed FATCA regulations issued

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Finance Nation
March 2012

More clarity for foreign financial institutions

The Foreign Account Tax Compliance Act (FATCA) provides the US Internal Revenue Service (IRS) with a tool which strengthens the information and compliance reporting process used to identify US persons who have money invested outside the US. For most Foreign Financial Institutions (FFIs), FATCA compliance is a significant challenge. In February 2012, proposed regulations were issued clarifying a number of FATCA requirements. While there is some good news, the challenge of FATCA implementation remains substantial for most FFIs.

The proposed regulations
Since the enactment of the FATCA provisions in March 2010, FFIs have been increasingly active in mobilizing teams to comply with FATCA. For most, the breadth of FATCA’s scope has meant that this compliance is a significant challenge. Furthermore, in the absence of clear guidance, they have had to build their programs on assumptions about what the detailed implementation requirements of FATCA would be.

In February 2012, the US Treasury Department and the IRS issued long-awaited proposed regulations under the FATCA provisions.

The proposed regulations lay out the process for US account identification, information reporting, and withholding requirements for FFIs, other foreign entities, and US withholding agents. They address many, but not all, of the major questions or concerns that remained following the three prior preliminary guidance notices issued on FATCA.

The proposed regulations reflect the US government’s attention to comments it has received from affected financial institutions, foreign governments and other stakeholders on the magnitude of the burdens associated with the various elements of FATCA, incorporating approaches aimed at reducing the compliance burden while maintaining the policy objective of improved information reporting on US taxpayers with assets invested in non-US jurisdictions. This demonstrates the value that the FFI community has achieved from engaging with the Treasury and the IRS.

Broadly, these proposals will be welcomed by FFIs, as they bring more clarity and a better defined scope to the FATCA requirements, but the challenge of FATCA implementation will remain sizeable for most FFIs.

An intergovernmental approach?
At the same time as the proposed regulations were released, the US Treasury also released a joint statement from the United States, France, Germany, Italy, Spain and the United Kingdom, indicating the six countries’ intention to develop an intergovernmental approach to FATCA to address legal impediments to compliance, simplify practical implementation and reduce FFI costs. The approach relies on FFIs reporting to their home jurisdiction which, in turn, would automatically pass this information to the IRS. It is likely that, if this approach is pursued, other countries would look to follow, both in the EU and elsewhere.

While this alternative approach may deal with any potential conflicts between FATCA and laws in FFI home states (e.g. privacy laws) and remove the worst aspects of FATCA, in particular the passthru payment regime, it appears that customer identification and documentation requirements will broadly remain the same.

At this stage, given the significant uncertainty about the timing and content of any measures to implement an intergovernmental approach (including the need for legislation in the participating states), FFIs are unlikely to change their approach to FATCA, at least in respect of requirements for new account opening.

Key dates
As the 1 July 2013 deadline for new account opening processes to be in place remains, the first delivery date has not changed; FFIs now have less than 16 months to design, build and test the required changes to their systems.

The proposed regulations reflect a phase-in of dates for FATCA reporting requirements applicable to FFIs in three steps: (1) the identity of US account holders must be reported starting in 2014, (2) information about income on US accounts must be reported starting in 2016, (3) full information on US accounts, including information about gross proceeds, must be reported starting in 2017.

In addition, the FATCA withholding rules for FFIs will not apply to certain payments made before 1 January 2015 and withholding by FFIs on foreign “passthru” payments will not be required before 1 January 2017.

Key implications for financial industries
Overall, the effect of the proposed regulations on FATCA programs is mixed.

The clarifications that the proposed regulations have provided are welcome to all FFIs running FATCA programs, as much of the uncertainty which prevented programs from moving into design and solution phases of work has been removed.

The account identification requirements for pre-existing accounts have been changed, with the introduction of enhanced de minimis exceptions and, for accounts of individuals, a US$ 1 million threshold below which the checking for US indicia can be performed through an electronic review of records rather than a search through paper files. Consequently, the proposed regulations may be considered to provide sensible frameworks for applying FATCA particularly to private banking, insurance and retail banking.

Unfortunately, even if a lot of detail is included in the proposed regulations, much further analysis will be required to understand the full impact, particularly on the asset management industry. The proposed regulations expand the categories of FFIs that are “deemed compliant” without bearing the full range of obligations of a participating FFI, particularly categories that are relevant to investment funds and their distribution. However, the pre-conditions for deemed compliance still appear to be rather restrictive and it is disappointing that a number of key technical aspects that significantly drive compliance logistics have not been addressed, for example, the treatment of sub-funds and umbrella funds; and the proposed regulations reserve on the definition of foreign “passthru” payments.

There continues to be a lot of uncertainty, and asset managers will have to build that uncertainty into their ongoing FATCA impact assessment and implementation projects.

What should financial institutions do now?
It is now time for all financial institutions to reassess the precise implications of the proposed regulations on their customers, products, processes and systems, with the objective of achieving cost-effective compliance. Only then will financial institutions be able to determine whether they benefit from the changes in the proposed regulations.
There needs to be a continued focus on delivering FATCA programs efficiently, as well as using the revised rules to revisit existing planning decisions and determine where compliance can be delivered more cost-effectively.

FFIs established solely in the countries adopting the intergovernmental information-sharing approach may ultimately benefit from an intergovernmental approach but, given the uncertainty around potential domestic implementation, in the meantime, will still need to progress their FATCA programs.

The immediate implementation priority for many organizations is to introduce new FATCA-compliant on-boarding processes. This is still a significant undertaking, which needs to be embedded and tested by 1 July 2013.

As the preamble to the proposed regulations acknowledges, many issues remain to be clarified. Treasury and the IRS continue to actively seek comments on specific topics as they work toward finalizing the FATCA regulations. Affected financial institutions and other stakeholders should consider whether it would be beneficial to participate in the comment process, supported where available by key data gathered as part of FATCA impact assessment projects, keeping in mind that the comment period is brief as written comments are due to Treasury and the IRS by 30 April 2012.

By Christophe Wintgens, Nadège De Biasio and Christian Daws, EY, Luxembourg