FATCA, or the Foreign Account Tax Compliance Act, represents the culmination of several years of U.S. initiatives aimed at uncovering unreported offshore accounts owned by U.S. taxpayers. It was signed into law on March 18, 2010, as part of the HIRE (Hiring Incentives to Restore Employment) Act. FATCA imposes a 30 percent withholding regime on all payments of income from and proceeds of sale of any U.S. security payable to any foreign financial institution that has not entered into an agreement with the IRS to report all worldwide income of its U.S. clients. Non-financial foreign entities are also required to disclose U.S. persons with more than 10 percent beneficial ownership of the entity or face withholding.
When this law was initially enacted, an informed survey of non-U.S. people in the financial industry found that most of them adhered to one of two very different schools of thought regarding FATCA. Many talked about the great incentive foreigners would now have to invest in totally non-U.S. portfolios and thought FATCA would discourage foreign investment in the United States. They envisioned the emergence of institutions that would invest only outside the United States and would not comply with any U.S. requirements and believed foreign investors would flock to these institutions. In fact, the now-defunct Wegelin Bank in Switzerland announced it would become the first such institution. In addition, these people believed foreign governments would resent the high-handed imposition of FATCA on the rest of the world and would jointly create an alternative market comprising only non-U.S. securities. Ultimately, it was thought, the United States would admit defeat and the imposition of FATCA would be repeatedly deferred until it was finally repealed.
The second point of view, not as widely held at the outset, was that FATCA represented the wave of the future. Instead of imposing its will on the rest of the world by fiat backed by economic might, the United States was merely leading the charge in an action that most other developed countries supported and within a few years they would happily clamber on board by cooperating with the United States and enacting similar legislation to cover their own securities and taxpayers. The end result would be an interlocking series of automatic exchange-of-information agreements resulting in a worldwide reporting system.
Three years later, it is clear the adherents of the second viewpoint were correct. FATCA has not gone away. Western European countries did voice some initial concerns about FATCA, but they did not band together to offer an alternative for global investment. Instead, they asked the United States to make certain modest changes so that the FATCA regime could fit within their national regulatory systems. The United States complied by proposing a series of intergovernmental agreements that modify the operation of FATCA while maintaining its basic thrust: the reporting by non-U.S. institutions to the United States of all U.S. owners of foreign accounts.
Meanwhile, within the United States, FATCA did not cause major ripples, because the whole intent of the law was to push the burden of U.S. tax enforcement onto non-U.S. institutions. Today, FATCA is finally receiving attention in the United States as U.S. institutions address the complex withholding rules they must follow whenever they make payment to a foreign institution or entity.
In the most recent development, as stories of undisclosed foreign accounts have made headlines across Europe, the United Kingdom and other EU countries have praised FATCA and proposed "mini-FATCAs" for their countries that would provide for automatic sharing of information.
While we are not yet at the point whereby a client who opens a financial account anywhere in the world must provide a global identification number so the data can be automatically shared with every relevant taxing jurisdiction, we are clearly headed in that direction.
The new era in financial regulation ushered in by FATCA (perhaps to be known to future historians as "the Age of FATCA") will lead to a number of changes in the international private banking world. These include:
- Compliance: There will be a greater need for accountants around the world who can prepare accurate tax returns disclosing worldwide income, and for lawyers who can interpret the myriad international rules about taxation and disclosure. There will also be a need for technicians within institutions who can set up systems to provide compliant disclosure to their account holders.
- Tax Planning: There remain many opportunities for legitimate, sophisticated multinational tax planning. Those engaged in fully transparent planning for decades used to face shadowy competition in the form of nondisclosure. This will no longer be an option. Of course, legitimate planning requires a high level of expertise, research and keeping up with the latest developments, which will entail professional costs and complex structures.
- Investment Performance and Fees: Institutions can no longer charge a substantial fee to offer confidentiality alone. They will have to provide respectable investment performance and will be under pressure to offer competitive fees as well. This may push some to seek very aggressive investment performance, as was seen by the move of certain institutions to Bernard Madoff shortly before his fall. The wiser institutions will focus on consistent, diversified, reliable performance rather than spectacular gains at the cost of high risk.
- Client Service: Clients seeking confidentiality did not frequently communicate with their institutions or ask them for services beyond secrecy. Now they will demand more attention and will be less hesitant to change institutions if they do not get it. While investment performance and sophisticated technical advice will be prized, it is often excellent service that keeps clients from moving to another institution. Those institutions that want to retain their clients will seek to offer clients the best service possible.
In the Age of FATCA, new rules will apply. Those who recognize and adhere to them will survive; those who cling to the past will not.