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FEATURE: FATCA - The Good, The Bad And The Ugly
3 September 2014
After being passed into law just over four years ago by the US government, the Foreign Account Tax Compliance Act finally became reality on 1 July. One individual is decidedly on the hostile side in assessing this legislation. “FATCA is an extraordinary piece of legislation and I have never seen anything as breathtakingly misguided and arrogant,” said James Quarmby, a lawyer who deals with high net worth clients at London-based law firm Stephenson Harwood.
Aimed at stamping out tax evasion and improving offshore financial transparency, the new legislation has not been welcomed with open arms by everyone, with detractors pointing towards the huge challenges firms in the financial services industry now face, such as increased compliance costs. Banks such as HSBC and Deutsche have ceased to offer services to expat Americans. However, some banks, such as RBC, for example, have sought to make a virtue out of continuing to serve US citizens living abroad, realising that this "orphan" client segment is a potentially profitable niche.
“What it attempts to do is make the entire world a tax collector on behalf of the IRS. I think it will be burdensome to administer and I do not think they will make any money out of it. The US Treasury is certainly not making any friends,” added Quarmby.
The US is the only developed country in the world that taxes its citizens on everything they earn, no matter where they live. FATCA requires all financial institutions outside of the US to regularly submit information on financial accounts held by American citizens to the US Internal Revenue Service.
Those who are not compliant will suffer a 30 per cent withholding tax on income and gross proceeds, as of January 2015. So far, more than 77,000 financial institutions worldwide have agreed to hand over information to the IRS.
The UK version, dubbed “Son of FATCA”, is the first FATCA-style regime to be implemented outside of the US and also came into force on 1 July. Based on the US model, financial institutions in the Crown Dependencies and the Overseas Territories now have to provide information relating to the financial affairs of UK resident clients in a reciprocal agreement.
UK FATCA is different in two major ways. Firstly, it is based on UK tax residence, whereas the US one is based on citizenship, and secondly, unlike the US regime, the UK model has no withholding requirement.
Andy Thompson, director of operations at the Wealth Management Association, the UK representative body for the investment community, said that while it was important people pay the right amount of tax, it was “difficult to see any positive impact” for the wealth management industry. “The cost is to the industry, the benefit is to the tax authority,” he said.
FATCA has come in for heavy criticism due to the increased financial burden that it places on foreign financial institutions at a time when firms are trying to recover from the 2008 market crash. As a result, significant requirements for registration, due diligence and reporting have forced entities to change operating models, invest in technology and spend more in order to meet compliance costs.
HMRC estimates the cost for UK business over the first five years to be between £1.1 to £2 billion, running thereafter at an annual cost of £50 to £90 million ($149.2 million).
“The impact will depend on the size of the organisation, which will vary from firm to firm. The banks will have significant burden. Wealth managers will cope like they always have done, by complying,” said Thompson.
“FATCA has created huge operational challenges for firms and another key impact will be on compliance. If you are asked by your tax authority to check if your clients are US persons and report details of these individuals, as well as their accounts, it’s easy to draw a negative view as far as the industry is concerned,” he added.
Quarmby is critical of FATCA as he feels that the gains made from it are negligible, with the costs failing to justify the revenues gained.
“The costs of implementing FATCA are likely to dwarf what the IRS brings actually brings in,” Quarmby said.
The figures on this back up his sentiment. The US Joint Committee on Taxation has now estimated that FATCA will result in a relatively minor gain of $8.7 billion dollars. This is only slightly higher compared to the $7.5 billion projected cost the top 30 foreign banks face paying in compliance fees for FATCA, according to the European Banking Federation and International Bankers Association.
“I don't see this happening in the UK as British bureaucracy is more efficient,” Quarmby said. “I think it will bring in some money, but I think it is more important for the political message it sends out.”
The implementation of FATCA has forced firms to reconsider their business strategy, leaving many US expats struggling to find advice.
An increasing number of US citizens around the world have found themselves in what can only be described as a financial black hole, after being dropped by firms such as HSBC, UBS and Brewin Dolphin, which have decided they no longer wish to service Americans clients with foreign accounts.
Ross Badger, director at London-based wealth manager Satis Asset Management, which has a large number of US clients, said that firms were shedding US clients as the risk of servicing them was not worth it in view of the returns.
“Firms with a relatively small number of clients have decided that the risk was too great on the fee they might get from managing the US client’s money. I would understand fully if that was their reason for doing it,” said Badger.
“For smaller firms, the risks are even greater as they do not necessarily have the capital to cover any potential claim by the IRS on them,” he added.
According to US Treasury Department figures published in the Federal Register last year, 3,000 US citizens handed in their passports - three times the average of the past five years. In the first quarter of 2014, 1,001 Americans gave up their passports or green cards, an increase of 47 per cent on the same period last year. It is also expected that a record number of US citizens will give up their passports this year, meaning more than 3,000 are forecast to do so before the end of 2014.
Badger said that this dramatic spike in American citizens renouncing their citizenship over previous years was directly attributable to the new legislation.
“We are finding that clients are contacting us and saying they want to renounce their citizenship, even though they do not want to. It is not because of the tax, it is because of the complexity. They feel that it is unfair and that they are being victimised because they are not in the US and their money is overseas,” said Badger.
Quarmby believes that the new regulation has huge implications for the Crown Dependencies and Overseas Territories and warned it could force firms out of business as clients seek greater privacy elsewhere.
“It's either going to drive the business in new directions, or it's going to force them out of business. High net worth individuals in the Crown Dependencies and Overseas Territories won’t want their details disclosed to everyone and will probably choose another jurisdiction that does not have automatic disclosure,” said Quarmby.
He said that FATCA would leave fiduciary providers wondering how to attract new business or even to retain the business they already have.
"Many firms are adapting their business model and are actively looking for clients not resident in Europe and are opening offices in Dubai and are also interested in Chinese business and opening offices in Hong Kong,” he added.
William Byrne, head of technical at Jersey Finance, is confident that Jersey is adequately resourced and suitably positioned to absorb the impact of the new reporting requirements, but felt that smaller or newer international finance centres may find themselves more challenged through having less well-developed regulatory infrastructure.
“We live with regulation and have done for years, so we will be able to cope. For those jurisdictions that do not have such a long history of financial services provision I think there could be some vulnerabilities highlighted; they may find that they do not have in place the requisite mechanisms, trained personnel and, frankly, experience with which to meet what will no doubt be demanding international expectations,” said Byrne.
“Jersey has for many years pitched itself at the more sophisticated end of the market and has proved itself extremely resilient when faced with increased supervision and regulation. I do not think you can say the same about all finance centres, whether offshore or onshore. There is a marked differential between the standards required across jurisdictions and this could well be exposed by international reporting requirements,” he added.
The world of tax havens and the ability to hide money in secretive bank accounts looks set to become a thing of the past as governments across the globe move towards greater tax cooperation and transparency.
Earlier this year, the Organisation for Economic Co-operation and Development unveiled the Common Reporting Standard, a new single global standard for automatically exchanging information between tax authorities. So far 44 countries have signed up to the legislation which is set to be implemented in 2016.
“Our members are now making great strides to ensure that they are compliant. The Wealth Management Association is assisting them to make sure that they meet the requirements of FATCA in the UK and we will continue to do so to ensure that they are able to comply with the requirements of the CRS,” said Thompson.
“Ultimately, it is the way the tax authorities are going and we have to embrace that and try to work with them to make it as cost effective and administratively straightforward to comply with as possible,” he added.
Critics have also warned that FATCA poses a serious threat to individual privacy. Last year, US senator for Kentucky Rand Paul introduced a bill to repeal the legislation, saying that it infringed “upon basic constitutional rights" arguing that providing bank account information of private customers to foreign nations “diminished US privacy protections”.
“There is a move towards additional transparency and global disclosure, but there will come a time when people will say enough, we are still entitled to our privacy,” said Quarmby.
“Governments have the right to tax their citizens, and there should be an exchange of information between governments. What I do not accept is that this information should be made available to the public. We all have right to privacy, and if we forget this, I feel we are stepping into territory leading to an abuse of human rights,” added Quarmby.
After being passed into law just over four years ago by the US government, the Foreign Account Tax Compliance Act finally became reality on 1 July.
One individual is decidedly on the hostile side in assessing this legislation.
“FATCA is an extraordinary piece of legislation and I have never seen anything as breathtakingly misguided and arrogant,” said James Quarmby, a lawyer who deals with high net worth clients at London-based law firm Stephenson Harwood.