It has long been known that FATCA was coming. But what exactly will German financial services providers and businesses be confronted with? This article seeks to answer that question in the light of the latest developments. The Foreign Account Tax Compliance Act was passed in the United States on 18 March 2010 and is set to enter into force on 1 January 2013. The Internal Revenue Service (IRS) published a draft directive on the FATCA on 8 February 2012, which explains application of the law and details a number of relief provisions.
FATCA represents the attempt of the American government to shift the cost of identifying US citizens holding accounts with foreign financial services providers who are liable to tax onto the latter. As an initial reaction, some German banks have already terminated their business in securities for US clients.
In its current form, the FATCA will apply to all foreign financial institutions, including insurance companies (Foreign Financial Institution – FFI). FFIs are required to enter into an FFI agreement with the IRS. In that agreement, they undertake to identify their US clients according to specific US attributes, as well as reporting personal and account data. From 1 January 2014, FFIs that do not sign such agreements (non-participating FFIs) will suffer a 30% withholding tax on all types of income and sales proceeds.
For disclosure, identified US clients must waive their data protections rights vis-à-vis the FFI, otherwise they will be classified as “recalcitrant account holders”. Participating FFIs are required to apply withholding tax to payments passed to recalcitrant account holders or to non-participating FFIs (in addition to local taxation at source). This withholding requirement enters into force on 1 January 2017.
In addition, all foreign legal entities in which US persons may participate (Non-Financial Foreign Entity – NFFE) are affected, unless they are listed on the stock exchange. These entities are required to disclose all US owners (with ownership of more than 10%). This also applies to German companies if they wish to avoid withholding tax on payments received or payments passed through by an FFI.
To begin with, the draft directive extends the protection for “grandfathered” obligations. All time-limited payment obligations (i.e. primarily loans) that exist prior to 1 January 2013 (previously 18 March 2012) are thus exempt from withholding (but not from disclosure). However, any material modification of outstanding obligations will lead to them being treated as newly created. What exactly constitutes a material modification, however, is as yet unclear.
The draft directive also expands the class of deemed-compliant FFIs. These FFIs can apply for exemption from the disclosure and withholding requirements. They primarily include banks whose operations are mainly domestic (local FFIs) and companies affiliated with an FFI group. Deemed-compliant FFIs also include certain investment vehicles.
Joint declaration of 8 February 2012
On 8 February 2012, Germany, France, the UK, Italy, Spain and the USA published a joint declaration on the FATCA. It announces their intention to move the exchange of information with the IRS to an intergovernmental level via contracts under international law. FFIs will report to the responsible financial authorities on the basis of national regulations and not be required to enter into direct agreements with the IRS. The IRS will treat the participating states’ FFIs as deemed-compliant FFIs once they have been registered. They are then only indirectly subject to the FATCA rules when they process payments with FFIs in nonparticipating states. The nature of the obligations under FATCA in such a scenario is not yet clear.
It is important to note that the planned agreements do not restrict the reporting requirements. The data is merely gathered by the German authorities instead. It remains to be seen whether at least the implementation costs are reduced. Some sources put the worldwide cost of FATCA at a billion US dollars. However, the US government is not primarily concerned with the anticipated additional income of USD 800 million, but rather with collecting data relating to US citizens living in other countries (who remain partly liable to tax in the USA).
The implementation of national regulations on disclosure could have the advantage of defusing criticism that FATCA disclosure infringes data protection laws. There are particular concerns due to the fact that consent to disclosure is not really voluntary because of the threat of a withholding tax and the negative implications of noncompliant status. Accordingly, FFIs face potential fines as well as claims for compensation from US clients.
If FATCA were to be embedded in international law and the exchange of data between the authorities restricted to genuinely suspicious cases, these data protection concerns can be resolved.
- Under the current plans, FFIs will be required to sign an FFI agreement and obtain consent from identified US clients from 1 January 2013.
- Disclosure of data to the IRS commences in 2014, as does deduction of withholding tax in the USA.
- Payment obligations established up to 31 December 2012 and not modified are not subject to withholding tax.
- It remains to be seen whether the joint declaration will lead to specific results and how these affect the requirements outlined above.