September 2012

FATCA INSIDE VIEW: Regulatory ripples

Global-RippleFirms are likely to face significantly increased administrative burdens and need to review operational processes and technology infrastructures to cope with the demands of the new legislation, says Mark Benzing, of DST Global Solutions. One of many new regulations affecting the global investment management sector, the Foreign Account Tax Compliance Act (Fatca) will have a far-reaching impact on asset managers. Fatca is a new tax regime being introduced by the United States government, requiring global participation. The goal is to prevent tax evasion by US taxpayers or foreign entities in which US taxpayers hold substantial ownership.  The act will require foreign financial institutions to report to the US government and withhold 30% tax on US-sourced income and gross proceeds of sale in cases of non-compliance. This regulation is expected to be finalised by the end of summer this year and fully implemented by the end of 2017. The main requirements for Fatca implementation are consumer identification for both new and existing customers, withholding tax, and reporting. Fatca will place onerous operational requirements on a wide range of foreign financial institutions, including hedge funds, asset managers, wealth managers and custodians. They will have to identify relevant accounts and report these to the US Internal Revenue Service. Under Fatca, foreign financial institutions are classified into six main categories:
• Participating foreign financial institution
These have agree to enter into an agreement with the US Internal Revenue Service to supply the required information to identify US accounts
• Deemed compliant foreign financial institution
These entities do not need to execute a Fatca agreement to comply with Fatca
• Exempt beneficial owner

Retirement Funds may be exempt or deemed compliant, depending on their structure and whether the country has a tax treaty with the US
• Non-participating foreign financial institutions

All foreign financial institutions that have not entered into agreement with the US Inland Revenue Service
• Recalcitrant individual account holders

Uncooperative account holders who refuse to provide the necessary information to become Fatca-compliant
• Non-financial foreign entities

A foreign entity that is not a financial institution. In reality, the desired result of Fatca is to generate reporting to the US Inland Revenue Service and reduce the chances of tax evasion. Firms will face key challenges in detecting and reporting on US customers in existing and new accounts. There is also a likelihood of smaller companies disinvesting from the US. Recent announcements have reduced the required due diligence for pre-existing accounts to analysis of electronic records. Know your customer and anti-money laundering documentation remains the key challenge for new clients. Strategic decision
Systems and processes will need to be in place to detect US clients, using indices defined by the Inland Revenue Service, to provide the information required and to deduct 30% withheld tax in the role of withholding agent, where applicable. Foreign financial institutions 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. Smaller foreign financial institutions may decide to disinvest from the US. Already there is evidence that American wealth management clients who want to bank offshore are being redirected to private banking in the United States. 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 to approve these documents. 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 to create a common approach to the implementation of the act. The concern is whether the Fatca partners reach agreement in accordance with the implementation timetable. There is ongoing debate as to how the Fatca partners will impact the introduction of the legislation. They could introduce an additional upfront administrative burden to foreign financial institutions, 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. The US has already indicated that it will reciprocate data sharing, by collecting and exchanging information on accounts held in US financial institutions by residents of the Fatca partners. Currently, Fatca will only benefit the US Inland Revenue Service, to the detriment of the investor, and will 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 most challenging implications of Fatca for asset managers will be coping with changing requirements for client on boarding and classifications. As a consequence, these will potentially generate the higher implementation costs. Although these costs will vary, they could be significant. Responsible officer
The recommendation for foreign financial institutions is to not just build a Fatca solution but rather build a global solution, but 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? Each foreign financial institution is required to nominate a responsible officer. This is fundamental to the successful implementation of Fatca. It creates specific ownership and responsibility to a regulation that is seen as providing no benefit to financial institutions. A formal project structure already needs to be in place, with a detailed project plan, owners and timelines. Fatca becomes effective from June next year with a phased implementation through to 2017, and it is not going away. Sitting back and waiting for further clarification of requirements is not an option – Fatca cannot be ignored. Mark Benzing is an investment and compliance consultant for DST Global Solutions ©2012 funds europe

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