Recent industry events, and the reaction of the U.S. government, may make it much more difficult for U.S. individuals to use investments through foreign vehicles (offshore accounts and entities) as a means of avoiding their U.S. tax obligations. On March 18, 2010, President Obama signed into law the Hiring Incentives to Restore Employment Act (the HIRE Act), which incorporates provisions of the Foreign Account Tax Compliance Act of 2009 (FATCA). The FATCA provisions represent substantial changes to the information reporting and withholding tax rules with respect to global payments to help enhance the ability of the U.S. government to determine the direct and indirect ownership of assets in foreign accounts by U.S. individuals. The provisions require affected foreign entities and foreign financial institutions (FFIs) to disclose to the Internal Revenue Service annually this U.S. account holder information or be subject to a 30% withholding tax on U.S. source investment-type income (including gross proceeds from the sale of property giving rise to such income). An FFI will be subject to such withholding tax unless it enters into an agreement with the IRS and assumes substantial obligations to identify and report significant information with respect to the FFI’s “U.S. accounts.”
The legislation was followed on Aug. 27, 2010, with the issuance of Notice 2010-60, the first in what is expected to be many sets of guidance under the FATCA withholding tax rules.
While much additional guidance is still needed from Treasury, the statutory rules, as illuminated by the implementation framework described in the recent notice, are substantial enough in their implications that global financial services firms need to take notice and prepare.
More than a tax issue
The majority of global firms will house legal entities considered to be FFIs, and, as such, will be subject to these rules, which take effect as of January 2013. In this regard, the definition of an FFI includes foreign subsidiaries of U.S. financial institutions. An FFI that maintains direct or indirect client relationships with U.S. residents and citizens will not only need to understand the technical tax requirements and their applicability within the organization, but will need to consider a broad array of operational, compliance, technology and data issues and consequences.
It is unlikely that many firms are currently able to confidently and consistently identify and validate the citizenships of their clients, regardless of the countries in which they reside. Further, there remain open questions about exactly how the FATCA rules are to be applied in a variety of common situations, such as indirect ownership through foreign entities, trust relationships, insurance products, fund products, etc. At a minimum, from a holistic perspective, FFIs will need to gain an understanding of their existing customer bases and ensure that:
• The current client relationships are fully understood, validated and documented
• Internal governance and operational processes are calibrated to detect U.S. residents or citizens at the point of account opening
• The variety of local country procedures for identifying and validating customer information at account opening is understood, with gaps identified when compared to future requirements
• IT systems and customer data architecture are evaluated and constructed to be able to compartmentalize and report U.S. resident or citizen relationships
• Existing compliance functions are scaled to meet the demands of enhanced requirements for customer identification, account monitoring and reporting
A significant influencer of your firm’s preparedness for FATCA is the current consistency, quality, and depth of your firm’s anti-money-laundering-related client documentation. The Treasury notice includes due diligence account opening procedures that will require identification of all information corresponding to the account holder, including regulatory and AML/know-your-customer requirements, regardless of whether the information is available in electronically searchable files. This will present a major compliance and coordination effort. Building upon customer due diligence and information-gathering requirements that already exist could significantly minimize duplicative efforts and ultimately reduce the long-term cost of FATCA implementation. Unfortunately, it is unlikely that current AML compliance efforts will satisfy this more stringent future need, and those not working within AML may even have a false sense of confidence that validated, refreshed residence and citizenship information is globally at hand.
It has been suggested that the customer identification requirements of FATCA go well beyond the standards under the guidance of the Bank Secrecy Act and the USA PATRIOT Act because current AML requirements do not typically require information that characterizes beneficial owners’ U.S. residency or citizenship status—information that is necessary under FATCA. However, your current KYC framework, which has been built to satisfy anti-money laundering requirements, can be significantly leveraged to gather and provide a cost-effective solution and yield long-term efficiencies throughout the course of your FATCA implementation. According to Stephen Shay, deputy assistant secretary of the Treasury, in his testimony at the House Ways and Means Subcommittee on Select Revenue Measures, the KYC/AML standards that foreign banks are generally expected to follow to obtain information about their account holders have been quite helpful and should be used as a base to determine the ownership of these U.S. accounts. Notwithstanding gaps between the current state of the KYC framework and the FATCA requirements, existing vital information such as name, address, date of birth (for individuals) and government-issued identification number per the FFI’s Customer Identification Program (CIP) can serve as the foundation on which additional customer information can be layered to offer a “FATCA-ready” customer identification framework.
A step closer to “FATCA-ready”
An initial approach to achieving FATCA readiness would be to conduct a Phase-0 assessment. The key steps in this readiness assessment may include:
• Identifying FATCA sponsors/leadership and program governance
• Determining what entities in your organization are impacted by FATCA
• Identify financial institutions
• Determine whether they are US
• Determine whether they are controlled foreign corporations
• Determine whether they are non-US
• Identify non-financial entities
• Determine whether they are “excepted”
• Assessing FATCA requirements versus current state
• Customer identification processes and data
• U.S. account information reporting
• Withholding processes and systems
• Assessing the potential business impacts and related decisions that may be needed
• Working with Treasury and the IRS to provide input to the development of practical implementation guidance
• Defining needed communications, internally as well as externally with customers
• Internal education about FATCA
• Road map development to launch and guide implementation
Even in the absence of a firm strategy to build out this initial plan, AML leaders and technology professionals can start now to consider the current-state KYC policies and procedures within the context of FATCA. Some key elements of the KYC framework to consider are:
• How “account” and “customer” are defined, and re-scope as appropriate
• Account opening process
• CIP requirements and key risk drivers for CDD and EDD
• Documentary and non-documentary verification methods and escalation process
• Global dispersion of KYC data, and extent of centralization of this information
• Account closure process (i.e., exit strategy for individual clients
• Information-sharing and record-retention requirements
Determining authority—the hidden challenge
As a critical topic requiring immediate focus, FATCA is somewhat unique in that it requires a cohesive effort and leadership across various business units, geographies and support areas. While the technical driver is a tax requirement, the tax department in many organizations may not be empowered to fund and drive a project of this type. An organization’s compliance group, while a critical source of information and likely determinant of a firm’s ability to comply, may not be considered the “owner” of such an initiative. Meanwhile, large-scale changes in operations and technology will likely be required, so these groups are also critical to ensuring the success of your FATCA program. Ultimately, FATCA readiness becomes a business issue. Any failure in compliance could have significant implications and costs, and perceived client impact is often a driver of strategic focus areas.
The urgency is now
For any firm, the tax, compliance, technology, operations and data remediation that may be necessary necessitates immediate focus. While many firms are currently subject to regulatory duress regarding the effectiveness of their global compliance and AML programs, the current firefighting to address today’s issues cannot lessen the urgency of meeting the aggressive implementation date of January 2013. Fully understanding the current state, identifying gaps when compared to your future needs, and engaging the appropriate leadership and support to achieve your goals can help ensure that the increasing regulatory burden does not unduly disrupt your business and compliance agendas.