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Tackling overseas tax evasion - US style

6 November 2012

The Foreign Account Tax Compliance Act (FATCA) is a US regulation enacted in an attempt to improve tax compliance involving foreign financial assets and offshore accounts. FATCA imposes widespread disclosure obligations on offshore financial institutions which hold assets on behalf of US citizens regardless of where the owner resides. These obligations are backed with financial penalties for the institutions which fail to report information regarding the financial accounts, assets and interests they hold for US citizens. Before we consider how these obligations will affect the UK it may be useful to consider the FATCA history and its wide reaching implications.

What is FATCA ?

FATCA is due to come into force on 1 January 2013 as part of the Hiring Incentives to Restore Employment Act 2010 to combat the use of offshore accounts by US taxpayers wishing to avoid paying US tax. The provisions of FATCA are set out between sections 1471 to 1474 of the Internal Revenue Service (IRS) code. US Congress decided that existing methods of preventing tax evasion did not provide sufficient regulation to prevent this form of tax evasion.

FATCA requires foreign financial institutions (FFIs) to enter into agreements (known as FFI Agreements) where they will have to annually report directly to the US Internal Revenue Service (IRS). Reports are required, not only on financial accounts held by US taxpayers, but also on foreign entities where US taxpayers hold a substantial ownership interest. As the US tax system is based on citizenship, US tax payers do not need to be resident in the US .

An obvious predicament for the US Government was how they would ensure the foreign institutions comply with the reporting obligations. Undoubtedly, additional reporting requirements will incur additional expense and could potentially be very time consuming for these institutions. A direct legal obligation on FFI s to disclose information would likely be unenforceable outside the US . For institutions based offshore what inducement could be offered? In answer to this, FATCA imposes a withholding tax of 30 to all payments of US source income unless the FFI complies with FATCA. In effect, this means that the international financial community will, itself, be responsible for enforcing FATCA compliance.

This sweeping disclosure obligation falls on many parts of the international financial community, regardless of whether they are located in the US. These obligations are problematic in many jurisdictions as they conflict with local laws and existing contractual obligations. Careful consideration was required as to the best way to implement these additional reporting obligations without imposing disproportionate and unreasonable burdens.

The Model Agreement

A way of simplifying the steps required to comply with FATCA and lessening the burden is provided through the Model Agreement; a document developed by US Treasury in connection with the UK , France, Germany, Italy and Spain Governments.

The Model Agreement proposed that local tax authorities should be responsible for gathering the required information about the US tax payers in their remit and then passing this on to the IRS . It sets out a reciprocal approach so there would be a bilateral exchange of tax information between the signatory government with the US .

The Model Agreement proposed that FFI s in signatory jurisdictions would not have to enter into a FFI Agreement (although they may still need to register), nor would withholding tax be applied. In short, the FFIs may rely upon national implementing legislation to cut though local law conflicts and contractual impediments; simplifying the process.

Implementation in the UK

As of September 2012, the UK Government has entered into an intergovernmental agreement with the US . "The Agreement with the US to improve international tax compliance and implement FATCA" is closely based on the US Model Agreement. Within the agreement, certain UK institutions are classed as "low-risk" of evading US tax and are effectively exempt for the FATCA reporting requirements. The agreement addresses the legal barriers which financial institutions face in complying with FATCA , ensures that withholding tax is not imposed and establishes a reciprocal approach to FATCA implementation. Another important focus of the US - UK agreement ensures that the burdens imposed on financial institutions are proportionate to the goal of tax evasion.

Privacy Implications

FATCA requires FFI s to disclose personal information of US accountholders, including name, address, Taxpayer Identification Number, account number, year-end balance (if over 1m), gross receipts, and gross withdrawals and payments disclosed to IRS through an annual reporting mechanism.

As such, there is tension with European data protection legislation and the right to a private and family law under the UK Human Rights Act and the European Charter of Fundamental Rights.

In its analysis of the legality of sharing data under FATCA , the European Article 29 Data Protection Working Party considered the necessity of FATCA in its letter to the DG Taxation and Customs in the European Commission in June this year.

In the view of the Working Party, it is imperative to ensure that the required data are the minimum necessary in relation to the goal to be achieved and that a bulk transfer of data is not the best way to achieve such purpose. In its letter "More selective, less broad measures should be considered in order to respect the privacy of law-abiding citizens."

The Working Party goes on to state that without domestic law and/or European law to recognise FATCA, FFI s will not have any lawful grounds upon which to process the personal data required.

It has been suggested that FFI s may obtain a waiver from any US customer to the local laws protecting the privacy of such individuals in order to report the tax information to the US Government. If the individuals fail to provide such a waiver (or consent, which would be required from each individual in the UK to comply with the Data Protection Act 1998) then the suggestion is that the account must be closed.

The view of the Working Party is that a waiver is unlikely to be a valid criteria for disclosure of the information given the imbalance between the financial institution and the individual, and the impossibility of withdrawal of consent, and the fact that consent is not "freely given" as is required by the European Data Protection Directive.

None of this is unlikely to provide any comfort to financial institutions whose systems are unlikely to be set up to enable this disclosure.

Practical compliance issues will hit hard; FFI s would need to carry out due diligence to uncover customers who are US persons. They are required to review all information at account opening stage, including identification and any documentation collected under the KYC or anti money laundering procedures.


Comments are being sought by the Treasury from businesses, representative bodies and tax professionals in relation to the US - UK agreement. The Consultation will close on 23 November 2012 and draft legislation will be published by the end of the year with a view to introducing legislation in the Finance Bill 2013.

Helena Wootton speaking at The Caribbean Association of Banks Inc AGM & Conference (November 14-17, 2012)

This article first appeared in Global Banking & Finance Review

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