This article looks at the latest adjustments of the FATCA legislation that continues to affect the compliance functions of banks around the world.

The US FATCA legislation continues to affect countries around the world. This article looks at the global picture.

The world recently took another step towards a unified
personal tax-collection regime last month when Spain and then Germany signed
agreements to co-operate with the US Foreign Account Tax Compliance Act on the
14th and 31st of May and Singapore promised to do the same in the near future.

Under such agreements, which come into effect in January,
each non-exempt financial institution in the co-operating country and the US will tell
its home tax authority about the financial accounts of customers who are
citizens of the other. The home tax authority will then share the information
with its overseas counterpart in a standardised way.

High-net-worth individuals are going to be a favourite
target for the Internal Revenue Service as, it believes, they are more likely
to cheat the taxman than anyone else. This is because a great deal of their
income is self-certified and a great many of them are entrepreneurial
“chancers”. The IRS estimates that Americans underpay their taxes by about $345
billion every year, according to Barron's, the financial news website and
magazine. The IRS collected about $65 billion of enforcement revenue in the financial
year of 2011 – nearly 13 per cent up on the previous year's figure of $57.6
billion, which itself was 18 per cent up on the $48.9 billion of 2009. This
process required the employment of thousands of revenue officers, agents and
special agents. The IRS says that its staff in “key enforcement occupations”
rose in number from 20,203 to 22,184 between 2001 and 2011.

Some eight countries have so far signed intergovernmental
agreements in respect of FATCA with the US. These are the UK (which signed first on 12 September 2012); Denmark and Mexico
(November); Ireland
(January); Switzerland
(February); Norway (April);
and Germany and Spain (May); with Singapore to follow soon. All
follow the text of a pre-existing US model agreement (see link below)
almost word-for-word. The carve-outs or exemptions that the US has allowed
in each case are sparse to say the most.

Anatomy of an intergovernmental agreement

Spain's
carve-outs are to be found in Annex II of the document. The exempt beneficial
owners are the big governmental entities such as the Banco de Espana and the
regulators and retirement funds. These, which HNW individuals often use along
with the less affluent, comprise any fund regulated under the amended text of
the Law on Pension Funds and Pension Schemes of 2002; and any entity defined
under Article 64 of the Amended Text of the Law on the Regulation and
Monitoring of Private Insurance of 2004.

This second exemption applies to mutual funds as well but
only if all the participants are employees, if the promoters and sponsoring
partners are their employing firms and benefits are exclusively derived from
the social welfare agreements (a Spanish phenomenon) between both parties. This
will tend to exclude HNW individuals.

There are, at least potentially, some carve-outs for private
banks as well. Small banks can be classified as “deemed-compliant financial
institutions” but only if they pass a battery of stringent tests. These are as
follows:

(a) the bank must be regulated in Spain;

(b) it must have no fixed place of business abroad;

(c) it must not solicit account-holders outside Spain;

(d) the tax laws of Spain must require it to report
information or withhold tax on its accounts;

(e) at least 98 per cent of its accounts must belong to
citizens of the European Union;

(f) it does not provide accounts to (I) any specified US
person who is not resident in Spain, (ii) a non-participating financial
institution, or (iii) any “passive NFFE” (a type of non-US entity defined in US
Treasury regulations) with controlling persons who are US citizens or
residents;

(g) it has systems in place on or before 1 January to make
sure of this and to close any accounts that do not comply;

(h) it reviews the existing accounts of people who do not
live in Spain
for compliance with FATCA;

(i) it ensures that all its related entities are
incorporated in Spain
and are themselves compliant with FATCA; and

(j) it must not discriminate in its business policies
against opening accounts for American residents in Spain.

This last, and some might say rather sneaky, requirement
seems to be designed to keep such an entity in constant fear of transgression
against FATCA. It does not say whether the IRS would interpret a policy of
keeping a bank's foreign customer base lower than two per cent - and therefore
turning away all Americans whose enrolment would tip the balance over that
figure – as “discrimination”. Any Spanish institution that answers to this
detailed description - if such an institution exists at all – is likely to
suffer from constant insecurity as far as FATCA is concerned. This is probably
the first time in the modern era when one sovereign state has treated others in
this way.

What happens if there is no intergovernmental agreement?

The Hire Act of 2010, of which FATCA is a part, allows the
US Treasury, acting in tandem with the IRS, to waive certain requirements and
this discretion forms the basis for intergovernmental agreements. The US authorities
prosper from these agreements by receiving the active co-operation of foreign
governments in their tax-collecting drive; the partner-countries benefit by
obtaining a few meagre exemptions. In the case of non-signatory nations,
however, foreign financial institutions are expected to co-operate directly
with the IRS. If they have a presence or any resources in the US, dire
consequences will follow if they fail in this regard.

Withholding taxes are common in the tax world. One example
of them is the money that an employer automatically takes out of an employee’s
monthly wage and gives to the tax authority without any permission from – or
involvement by – the employee in the process. Under the new regime, if a
non-compliant foreign bank has an American customer who wishes to make a
transfer from the US to it,
the sending bank in the US
will deduct the 30 per cent and the IRS will keep it for itself.

Things do not necessarily improve if the foreign bank
dismisses all its American customers. If it receives a payment from a firm in
its own country that is owned by Americans, or has a substantial American
ownership, any holdings it may have in the US will be subject to the 30 per
cent withholding tax. FACTA is designed to make it unprofitable for such a bank
to hold any assets in the US.

If the non-participating foreign financial institution or
private bank has an American affiliate or subsidiary, the tax will have an even
more drastic effect. In nearly all cases, 30 per cent of monies coming into its
coffers or the accounts under its care from American or other participating
institutions will be deducted before it reaches it. If the institution's turnover
is of any size, it will lose its assets quickly. If it tries to repatriate all
its assets home, it will lose 30 per cent of everything it sells even before it
can do so because the assets' buyers will pay through accounts at their own
banks, which will deduct the 30 per cent automatically. No bank or other
business can prosper under such circumstances.

Lastly, withholding taxes traditionally attempt to capture
money for underlying taxes. The Hire Act does not do this; the 30 per cent,
with a few possible exceptions, is totally punitive for the purposes of the US campaign
against tax-evaders. The IRS is about to replace the Office of Foreign Assets
Control as the US
regulator that banks around the world fear the most.