With deadlines looming, Hong Kong’s government announced on May 9th a much-anticipated agreement with the United States regarding the U.S. Foreign Account Tax Compliance Act (FATCA). Without this intergovernmental agreement (IGA), some Hong Kong financial institutions faced an uncertain road to FATCA compliance. The announcement of the IGA, along with other temporary compliance relief from the U.S. Internal Revenue Service (IRS), eases some of FATCA’s most pressing tasks. But Hong Kong financial institutions still have work to do—this article discusses both the recent relief as well as the remaining deadlines.
The State of Intergovernmental Agreements in Asia
IGAs provide a sorely-needed bridge between FATCA’s regulations and local market requirements. In some cases, financial institutions face a choice between complying with FATCA and local law. Because FATCA requires non-U.S. financial institutions to report to the U.S. government regarding certain account holders, privacy concerns abound. IGAs ameliorate many of these concerns by allowing each jurisdiction to shape how such potentially sensitive information is shared. IGAs virtually eliminate FATCA withholding against local financial institutions. IGAs can also exempt certain financial institutions where such financial institutions present a low risk of U.S. tax evasion.
At the start of 2014, only two Asian jurisdictions (Japan and Mauritius) had entered into IGAs with the United States. Hong Kong’s principal retirement plans, Mandatory Provident Funds (MPFs) and Occupational Retirement Schemes (ORSOs), were unable to qualify for exemption under the FATCA regulation’s carve-outs for retirement plans—but they also faced local law hurdles in complying with FATCA. Without an IGA, many MPFs and ORSOs would have faced FATCA’s 30% withholding on their U.S.-source income. Other Hong Kong financial institutions faced another problem: under FATCA, all non-U.S. financial institutions in a group are required to comply with FATCA, or find an exemption. Non-compliance by even a single group member could subject the other group members to FATCA withholding. While these rules apply worldwide, this issue was acute in Hong Kong because many local financial institutions have affiliates in mainland China—and there was no official word on when or if mainland China would enter into its own intergovernmental agreement.
Relief was announced in April 2014. The U.S. Treasury Department noted that IGAs were still not finalized in a number of jurisdictions, but stated that “agreement in substance” would be sufficient. Following this announcement, financial institutions in 19 additional jurisdictions would be allowed to register with the IRS—until December 31, 2014—as if IGAs in their countries had been completed. While Hong Kong was not on the initial “agreement in substance” list, on May 9, 2014, Hong Kong’s Financial Services and Treasury Bureau announced that agreement had been reached.
What Does the IGA Mean for Hong Kong?
Hong Kong financial institutions will now have two sets of tax reporting obligations—their existing basic reporting obligations to the Inland Revenue Department, and FATCA reporting directly to the U.S. IRS. The first reporting deadline will be March 31, 2015 and will initially consist of basic identifying information for certain U.S.-owned non-financial entities, certain U.S. persons, and owner-documented trusts. The scope of reporting will expand to include additional information in subsequent years—most IGAs will require that financial institutions report on “non-participating” non-U.S. financial institutions as well.
While the official text of the Hong Kong IGA has not yet been released, it is expected that “reporting” financial institutions will be required to register on the IRS FATCA website. Hong Kong financial institutions that did not register prior to July 1, 2014 would have been subject to FATCA withholding. However, the IRS announced that calendar years 2014 and 2015 would be treated as a transition period for enforcement of many of FATCA’s requirements, including withholding, for financial institutions that are making “good faith efforts” to comply with FATCA. Crucially, withholding agents, tasked with implementing FATCA’s 30% penalty tax, are also given leeway if they, too, are making good faith efforts at compliance—as a result, Hong Kong financial institutions are unlikely to face withholding before 2015. Through the transitional relief, financial institutions also have additional time to start conducting due diligence on new accounts that are opened by entities.
Should financial institutions register now? While the specter of withholding on July 1 is greatly diminished, registering with the IRS creates a “global intermediary identification number” (GIIN), which allows withholding agents and others to automate their compliance efforts. But where a financial institution still needs further guidance from local authorities before full compliance, the entity may wish to postpone registration as long as possible. Regardless of the path chosen, a financial institution should use the transition period as a lower-risk trial run of its FATCA compliance procedures—it is better that any problems occur during the transitional-period safety net.
Possible Exemptions in the Hong Kong IGA
The final version of the IGA is expected to contain exemptions for certain public or retirement funds. In particular, the IGA should contain an exemption for retirement plans that is broader than the exemption contained in FATCA’s regulations and cover MPFs, as well as many ORSOs (in particular, ORSOs that serve as an alternative to MPFs). Such MPFs and ORSOs would not necessarily have to limit employee contributions to US$50,000 as required by the regulations—such a provision will be crucial because most MPFs and ORSOs contain no such limitation. It is anticipated that the IGA will subject MPFs and ORSOs to other requirements, such as requiring that they be exempt from tax by virtue of their status as retirement plans.
Unless exempt under the IGA, Hong Kong financial institutions must still prepare for FATCA compliance. Fund documents must be updated, and subscription processes must be tested. The IGA illuminates their path, and the transitional “good faith” relief should allow compliance officers to sleep easier. But FATCA remains an intricate law—and the interplay of the transitional relief, local IGAs and the underlying regulations adds a new complication.