Tuesday, September 27, 2011

Int'l Securities Associations Seek Changes in FATCA to Alleviate Compliance Burdens

The International Council of Securities Associations, the global forum for the trade associations and SROs that represent and regulate the securities industry, seek a delay in the implementation of the Foreign Account Tax Compliance Act and a cross border framework. In a letter to the IRS and Treasury, the Council said that, while fully supporting FATCA's overarching goals of preventing tax evasion and promoting financial transparency, its fears that the Act would impose significant compliance costs on all foreign financial institutions and, in a number of jurisdictions, cause financial institutions to violate data privacy laws if they were to comply with FATCA. In addition, FATCA sets new, unilateral standards for beneficial ownership, thereby undercutting the multilateral negotiations carried out under the leadership of the Financial Action Task Force.

Rather than the unilateral approach taken by FATCA, the Council suggested the development of a global framework allowing the US and other governments to obtain information regarding income paid to citizens of their countries by foreign financial institutions which is in harmony with each jurisdiction’s existing laws and does not create an excessive compliance burden for financial institutions. The Council believes that an approach developed through negotiations between governments and not through the agreements between the IRS and private entities mandated by FATCA, would be consistent with the G20’s emphasis
on building a coherent global framework for financial markets.

FATCA will effectively compel foreign financial institutions, broadly defined to include banks, hedge funds, investment companies and securities and commodities firms, to enter into an agreement with the IRS requiring them to report annually certain customer information and to withhold and pay to the IRS a 30% withholding tax on customers of those institutions who are US companies or US citizens that have not supplied certain information to the foreign financial institution. Thus, FATCA will compel foreign financial institutions to screen their existing customer database to identify clients that are US companies or individuals who are US persons.

But according to the Council, FATCA goes further than just requiring financial institutions to identify US companies and citizens. Financial institutions must be able to prove that their non-US clients are in fact not US companies or citizens or people born in the US. This requirement would apply not just to new accounts, but to many existing accounts as well, especially where clients may have US indicia on file, such as a U.S. mailing address (with some proposed exceptions). However, querying the nationality of customers is not part of the identification and verification of identity of customers under current anti-money laundering requirements in most jurisdictions.

The Council also noted that the definition of specified U.S. persons contained in the FATCA legislation encompasses foreign visitors who satisfy the substantial presence test. The test of whether an individual has a “substantial US tax presence” is based on whether or not a person has spent a weighted average of more than 183 days in the US over the past three calendar years, including at least 31 days in the past year. However, financial institutions generally do not collect such information as part of their initial or ongoing customer due diligence assessment.

In order to obtain this information, firms would have to explain the definition of a “substantial US tax presence” to their customers and then rely on the individual in question being able to both understand the definition and answer the question honestly. And the firm would not be able to verify the answer since it would not have access to the necessary documentation. In addition, given that the answer to the question may change from year to year, firms will need to identify such persons on an annual basis although they will not have access to the information that would allow them to actually verify if the customer were telling the truth or not.

Similarly, the definition of specified U.S. persons in FATCA legislation also includes green card holders. However, financial institutions are generally not required to request the details of a person’s green card status as part of their initial or ongoing due diligence. Therefore, to comply fully with the legislation, firms will have to attempt to indentify those existing and new customers who are green card holders without being able to independently verify the information that is given to them by the customers.

Even more troubling is the likelihood that all major non-US financial institutions will be captured by the requirement to be FATCA compliant due to their US exposures. As a result they will need to report all their US client dealings to the IRS and withhold 30% of US based income including gross proceeds of sales, from clients and counterparties that decline or for any reason do not cooperate with their US client identification regime. However, in a large number of countries, the legal basis on which they will be able to report their US client dealings and/or withhold 30% of US based income is not clear at this time. Indeed, there are a number of jurisdictions where financial institutions are expressly prohibited from undertaking these actions by data privacy and and other national laws.

For example, in Japan disclosure of personal information to a third party without the consent of the customer is prohibited by the Act on the Protection of Personal Information. If a customer did not consent to the disclosure, it would be difficult if not impossible for a financial institution based in Japan to withhold funds from the customer’s accounts based on an agreement with the US government, since that agreement would not have any legal basis in Japan. Similarly, under the Australian Privacy Act, every identified US person would need to consent to the disclosure of their personal information by the financial institution to the US government.

Financial institutions based in the EU would also face criminal prosecution as well as civil claims over breaches of data protection laws if those firms were to comply with FATCA. Absent direct EU legislative action, the FATCA obligations placed on the firms would mean that those financial institutions face a significant risk of customer claims of non-compliance with data protection and banking confidentiality obligations.