1. We’ve covered a lot of ground, yet a long journey lies ahead…

Everyone will now have read Chapter 1 which is available for download  at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2457671

I think it appropriate to begin this week with a quote by Senator Russell Long (of Louisiana) who was Chairman of the Finance Committee in 1969.  Senator Long, speaking of the Tax Reform Act of 1969 stated: “when the Finance Committee began public hearings on the Tax Reform Act of 1969 I referred to the bill as ‘368 pages of bewildering complexity.’  It is now 585 pages  . . . . It takes complicated amendments to end complicated devices.”

Since the original 10 pages of the March 18, 2010 enactment of the Foreign Account Tax Compliance Act, which was as a Pay As You Go revenue raiser for the Hiring Incentives to Restore Employment Act, FATCA has consumed nearly 2,000 pages of regulations, corrections, notices, international agreement models and as of yesterday, 101 international agreements.

To cite some of the important regulatory milestones that will bring us current to July 10, after the HIRE Act was enacted in 2010, the 365 page Draft Regulations were released on Feb 8, 2012, but as Senator Long said “It takes complicated amendments to end complicated devices” the Final Regs released January 28, 2013 came in around 543 pages.

Over the next year, Notices and Corrections added up to another hundred pages, followed by the 565 page Coordinating Regs released Feb 20 of this year.  On top of these, add the FFI agreement that was released Dec 26, 2013 but updated just 2 weeks ago on June 24.

This past March and April we saw the release of the new W-8s, Form 8966, Form 1042-S, and finally on June 25 the instructions for the BEN-E.  Last, but not least, the IRS, much to its credit, managed to release the new QI agreement before the July 1 expiration of all the former QI agreements.

Last month withholding agents began the chapter 4 withholding of 30% on withholdable payments, such as interest earned on bank deposits, made to payees in 143 countries and their dependencies that do not have one of the 101 IGAs with the US as of today.

 While the blog airwaves and commentators have in general been critical of the complexity of FATCA, sophisticated tax compliance officers from the financial industry are actually complementing the US Treasury for having listened to our stakeholder comments and concerns.  The complexity within the FATCA regulations, in general, results from drafting exceptions and exemptions, for institutions and entities, from various diligence, reporting, and withholding obligations.  

2. Trust but Verify… 

The United States is a self-reporting and assessment system whereby each year 150 million taxpayers fill in their 1040 with their worldwide income.  It is reasonably estimated by various government sources that 10 million of these taxpayers have reporting obligations regarding either their foreign income and / or their foreign accounts.  Unfortunately, less than 10% of Americans with international income or asset exposure are compliant with at least filing the dreaded, but very simple, FBAR form that requires reporting of signatory authority over accounts if the collective balance exceeds $10,000.  Only approximately 800,000 FBARs were filed for 2012 for that group of potentially 10 million American taxpayers.  With so little FBAR reporting, it’s no wonder that Congress and the IRS suspect that hundreds of billions of American’s foreign income goes unreported on the 1040 each year.   Absent alternative information forms, the IRS does not have a scalable method to verify 1040 and select for audit the returns of potential tax evaders.

In the infamous words of Ronald Reagan, “Trust but Verify”, the US tax system is not just based upon self-reporting.  The United States Congress has deputized financial institutions, and some businesses, to be information collectors, and verification auditors.  We know this information collection as forms 1099, W8, W9, and the 1042-S.  And we know the verification standards, such as by example “actual knowledge” and, requirements for “due diligence”.  

3. Bureau of Information Retrieval … 

Each year, tens of millions of these forms are transmitted to the IRS with information about US and foreign taxpayers.  Allow me briefly to introduce some salient metrics that have been collected by my research colleague, Haydon Perryman, who is Director of Compliance Solutions of Strevus”.

1. We know that when QI was introduced only 20% of W8s were fit for purpose. We also know that 13 years after QI’s inception that only 35% of W8s are fit for purpose.
2. We also know form interviews with large financial institutions that on average after a financial institution solicits a pre-existing customer for a new W8 it takes between 5 and 7 months for that W8 to be submitted, valid or otherwise.

When we apply these metrics to the customer base for whom we must reach out, – obtaining W8s or W9s (or their equivalent substitutes under an IGA), – validate those withholding certificates – and then we repeat this process in the 65% of the cases where the W8 submission was ‘invalid’, we can rapidly appreciate the size and scale of the challenge.

Moreover, the IRS estimates that 400,000 – 600,000 FFIs will register on its FATCA portal this portal, although my industry colleagues put the true figure around one million.  Now imagine every FFI registrant approaching its customers and counter-parties for withholding certificates and other documentation.  Industry estimates that there will be 900 million withholding certificates requiring validation for FATCA purposes.

4. Analysis of GIIN Registrations 

The July 1st GIIN list of financial institutions registrations is instructive in that it is indicative of certain compliance patterns that have emerged.  Again, my colleague Haydon Perryman and myself have undertaken hours of in-depth research of the June and now the July GIIN registrations lists.

87,933 financial institutions and their branches registered from the 250 countries and their dependencies recognized by the IRS for FATCA purposes. Note that not ALL countries and dependencies are recognized by the IRS, such as Kosovo.  And some jurisdictions, which are not recognized by the State Department, such as the State of Palestine, are recognized by the IRS.

Of the total 87,000 registered FFIs, 83,000 representing almost 95% are based in the 101 countries and jurisdictions that as of yesterday have an IGA.  48,000 FFIs registered from Model I IGA jurisdictions whereas approximately 15,000 of the FFIs registered as Model 2 reporting FFIs and branches.  Note that these 15,000 Model 2 FFI registrations are impacted by the FFI Agreement changes of June 24, 2014.  Most of the 4,000 FFIs from the remaining 143 countries and jurisdictions on the GIIN list registered probably either as Participating FFIs or branches.

While the exact number is unknown, based on the July GIIN list, industry and foreign government feedback, it is reasonable to estimate that half a million firms, funds, and other entities, such as trusts, will need to register.  In its FATCA FAQs, the IRS has said that “At this time, the full FFI list is expected to be less than 500,000 records.”, thus implying that it would be close to half a million registrations.  Therefore we can reasonably infer that less than 20% of the global FFIs are currently registered for FATCA.  Moreover, all these non-registered FFIs in the 143 countries without an IGA must be treated as non-participating and withheld upon for FATCA by withholding agents.

Unfortunately, the compliance story is even worse when we consider how many of the 87,000 FFIs are members of an expanded affiliated group.  3,700 of the FFIs registered are parents of “expanded affiliated group” (“EAG”) that have registered the affiliated group members, which includes entities related by 50% and more ownership.  What this slide and our data informs us is that while the large global institutions from the G5 have registered, the vast majority of smaller FFIs have not.  Interestingly, Cayman Islands leads with 813 EAG parents, followed very far behind by the UK.

Of the 250 countries and jurisdictions with FFI registrations, almost 20% of the total registered FFIs are from the Cayman Islands firms, representing 14,207 registrations.  Our research of the Cayman registrations shows a significant number of investment funds among that total.

The United Kingdom almost 7,000 FFIs are less than 10% of the 75,000 UK FFIs requiring registration as estimated by the United Kingdom Revenue.  Note that the 75,000 figure was reduced from the UK government’s initial estimate of 300,000 after it reassessed self-certifying FFIs that are not required to registered, based upon the USA-UK IGA. The UK list is dominated by fund management firms and their various funds, private equity and the plethora of feeder funds investment trusts and quite a few trusts.

NAFTA has thus far been a large disappointment for Treasury with only 2,500 FFIs registered from Canada and 410 from Mexico. However, Canada and the US already automatically exchange information about bank interest, and the US-Canada IGA removed the registration of trusts as FFIs, so it is expected that Canadian FFIs will have registered and be in full compliance by the end of the year.

Brazil leads the BRIC countries with 2,362 FFI registered, followed by Russia at 729, India at 321 and the world’s 2^nd largest economy China only has 213. 

The European countries and financial centers have mixed registration results.  France (2,422), Germany (2,894), Netherlands (2,280) and Ireland (2,007), Switzerland (4,279), Luxembourg (4,061), Austria (2,978), Guernsey (2,395), Jersey (1,618), Isle of Man (312), Lichtenstein (239), and Gibraltar (96).

Caribbean – BVI (2,373), Bahamas (6,146), Panama (484), Bermuda (1,579). 

5. GATCA

 FATCA is the most important development for a globalized model of international exchange of tax information that will be made on an automatic basis.  But its complexity and the high related costs of FATCA have been the source of important frictions and pressures at the highest level between the stakeholders concerned: the U.S. Treasury, the governments of all other countries, and the financial industry.

To briefly mention two frictions of local law that conflict with the FATCA regulations: firstly, many countries’ national data protection laws do not allow the transmittal of customer information without customer authorization, which is fundamental for FATCA to work, and secondly, some civil law countries do not allow a financial institution to unilaterally terminate certain customer relationships, which is required for recalcitrant account holders.

As a result of these difficulties, the U.S. Treasury issued the “Joint Statement from the United States, France, Germany, Italy, Spain and the United Kingdom regarding the intergovernmental approach to improving international tax compliance and implementing FATCA” known as the “G5 Joint Statement”. The Treasury issued this G5 Joint Statement on the same day of the release of the proposed FATCA regulations, February 8, 2012.

The G5 Joint Statement acknowledged the challenging character of implementation of certain FATCA regulations and resulted in the release on July 6, 2012 “Model Intergovernmental Agreement to Improve Tax Compliance and Implement FATCA”, referred to as an “IGA” model agreement, and specifically as “Model 1”. Basically, the model agreement allows FFIs in each of the jurisdictions to report U.S.-owned account information directly to their local tax authorities, using local reporting forms and systems, rather than the IRS, which in turn will automatically share that information with the IRS.

6. Intergovernmental Agreements 

This Model 1 IGA allows FFIs of those countries to be considered “deemed compliant”, will avoid the 30 percent withholding and, significant in addressing a substantial industry concern, will not be required to impose “passthru withholding” on non-U.S. source payments they make to other FFIs.

This first model has two versions: reciprocal and non-reciprocal. The reciprocal version includes a policy commitment from the U.S. to pursue regulations and support legislation permitting the U.S. to pass information relating to U.S. accounts held by residents of FATCA partners to other FATCA partners. The U.K. was the first country to sign a reciprocal Model 1 FATCA agreement on September 12, 2012.  Mexico signed one shortly later on November 19, 2012 but the USA and Mexico reissued it on April 4, 2014 to take into account the regulatory and IGA modifications, and implementation extensions granted other countries.

The second model, known as Model 2, was originally released on November 15 of 2012 but has since been updated, most recently re-released June 6 of this year.  This second model provides a framework whereby FFIs register with the IRS and either are exempted from FATCA or agree to share FATCA required information directly with the IRS.  In turn, these FFIs are to be treated by withholding agents as complying with FATCA and will not be subject to 30 percent FATCA withholding on payments to them. In addition, these FFIs would not be required to impose “pass-thru withholding” on payments they make to other domestic registered or exempt FFIs or FFIs in jurisdictions that have entered into an IGA with the U.S.

The most important IGA advantage relevant for today is that a GIIN not required until Jan 1, 2015.  Other advantages include Reporting of Tax Information to the Home Country Revenue instead of IRS, Replacement of “Substantial U.S. Owner” with the standard of “Controlling Persons”, which is an FATF anti money laundering standard, No Closing of and withholding upon Recalcitrant accounts and that Retirement Accounts are Deemed Compliant FFIs or are Exempt beneficial owners.  And finally, most Favored Nation Clause that allows IGA partner countries to Cherry Pick from any advantages granted to another partner or through an amendment to the regulations, such as the 6 month extension granted to treat entity accounts as preexisting ones thus not subject to the stricter FATCA documentation standards.

TIEAs and information exchange articles of the double tax agreements are still relevant because Model 2 countries, by example, must agree to provide additional FATCA information to the IRS about recalcitrant accounts, based on tax information request by the normal channels, that the US IRS may mop up such information that has not been passed in the first instance directly by a financial institution. 

7. Common Reporting Standards 

On February 13 of this year the OECD released the Standard for Automatic Exchange of Financial Account Information Common Reporting Standard, known by the two acronyms of CRS and GATCA for Globalized FATCA.

The CRS calls on jurisdictions to obtain information from their financial institutions and automatically exchange that information with other jurisdictions on an annual basis. It sets out the financial account information to be exchanged, the financial institutions that need to report, the different types of accounts and taxpayers covered, as well as common due diligence procedures to be followed by financial institutions.

Part I of the OECD report gives an overview of the standard whereas part II contains the text of the Model Competent Authority Agreement (CAA) and the Common Reporting and Due Diligence Standards (CRS) that together form the “standard”.

As of last week, 66 countries and major financial centers committed to early implementation of this automatic exchange of information between their jurisdictions.  These early adopters includes all 34 OECD member countries, as well as countries such as the BRIC nations, Argentina, Colombia, Costa Rica, Indonesia, Latvia, Lithuania, Malaysia, Saudi Arabia, Singapore and South Africa.  Thus, more than half the 121 Global Forum members have committed to early adoption of GATCA, with the remaining group expected to join by the end of the year after the publication of the detailed Commentary.

The OECD stated that it will deliver a detailed Commentary on GATCA, as well as technical solutions to implement the actual information exchanges, during the G20 finance ministers meeting in September 2014.

What are the main differences between the OECD’s CRS and the US’ FATCA? 

The CRS consists of a fully reciprocal automatic exchange system but the US specificities have been removed. For instance, the CRS is based on residence and unlike FATCA does not refer to citizenship. Terms, concepts and approaches have been standardized allowing countries to use the system without having to negotiate individual IGAs.

Unlike FATCA the CRS does not provide for thresholds for pre-existing individual accounts, and it includes a residential address test derived from the EU tax savings directive. The CRS also provides for a simplified indicia search for such preexisting accounts. Finally, it has special rules dealing with certain investment entities where they are based in jurisdictions that do not participate in the automatic exchange under the standard.

The CRS is similar to FATCA in its broad application across three dimensions:

• The financial information to be reported with respect to reportable accounts includes all types of investment income (including interest, dividends, income from certain insurance contracts and other similar types of income) but also account balances and sales proceeds from financial assets.

• The financial institutions that are required to report under the CRS do not only include banks and custodians but also other financial institutions such as brokers, certain collective investment vehicles and certain insurance companies.

• Reportable accounts include accounts held by individuals and entities, which includes trusts and foundations, and the standard includes a requirement to look through passive entities to report on the individuals that ultimately control these entities.

UK Son Of FATCA

EU TSD.

(a) income from employment

(b) director’s fees

(c) life insurance products

(d) pensions

(e) ownership of and income from immovable property 

Clients in the 170 countries and their dependencies that the US does not have a tax treaty already suffer chapter 3 withholding.  So what is it in for them to comply with FATCA? 

Because Chapter 3 has important exemptions to its withholding, such as portfolio interest and interest on bank accounts that chapter 4 does not. FATCA’s 30% will hurt the most when it applies to the gross proceeds of a bond, that is, including its return of the underlying debt, because so much of the world’s financial system depends on US debt such as treasuries as the safe reserve. 

8. W8-BEN 

That brings us to the forms wherein we will start the discussion about the simple W-8BEN.

The Form W-8BEN has been split into two forms.  The new 2014 Form W-8BEN is for use solely by foreign individuals, whereas the new Form W-8BEN-E is for use by entities for 2014 (revision date 2014) to provide US withholding agents.

Foreign individuals, such as non-resident aliens – that is NRAs, must use Form W-8BEN to document their foreign status and also to claim any applicable treaty benefits for chapter 3 purposes. A NRA (nonresident alien individual) is any individual who is not a citizen or resident alien of the United States.

The NRA should enter the country of nationality on line 2 of the form.  If the NRA is a dual national, enter the country where the NRA is both a national and a resident at the time of completing the W-8BEN.  If the NRA is not a resident in any country of nationality, then the NRA should type in the country where most recently resident.

However, if the individual is a dual national and one nationality is the United States, then the individual is NOT an NRA.  The US national is always a US taxpayer.  A US taxpayer must file a W-9 even if holding nationality in another jurisdiction.

Moreover, a foreign person who has a “green card” and not had it revoked or voluntarily turned it in, or a foreign person who meets the “substantial presence test” for the calendar year is a resident alien, that is, a US taxpayer.  Resident aliens must also submit a W-9.

However, an alien who is a bona fide resident of one of the five US territories, being Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, or American Samoa, is considered an NRA, and thus should fill out a W-8BEN, not the W-9.

The NRA must give the Form W-8BEN to the withholding agent if the NRA is the beneficial owner of an amount subject to withholding, — or if the NRA is an account holder of an FFI — then to the FFI to document his/her status as a nonresident alien.   Also, an NRA receiving payments from a payment settlement entity for credit card transactions and other third-party network transactions, such as paypal, must provide a Form W-8BEN.  Finally, to avoid backup withholding by a broker of securities, an NRA will need to provide a W-8BEN.

Important to note – a sole member of a “disregarded” entity is considered the beneficial owner of income received by the disregarded entity, and thus the sole member must provide a W-8BEN. The sole member should inform the withholding agent if the account is in the name of a disregarded entity. The sole member includes his or her own name in line 1, but must include the name and account number of the disregarded entity on line 7 where it states “reference number”.  However, if the disregarded entity is claiming treaty benefits as a hybrid entity, it must instead complete Form W-8BEN-E.

If the income or account is jointly owned by more than one person, the income or account can only be treated as owned by a foreign person if Forms W-8BEN or W-8BEN-E are provided by EVERY owner of the account.  If the withholding agent or financial institution receives a Form W-9 from any of the joint owners, then the payment must be treated as made to a U.S. person and the account treated as a U.S. account.

In general the W-8BEN will remain valid until December 31^st of the 3^rd year after the date of the signature unless there is a change of circumstances.  There are exceptions to the validity period that our last two speakers will bring up.

If any information on the Form W-8BEN becomes incorrect because of a change in circumstances, then the NRA must provide within 30 days of the change of circumstances the withholding agent, payer, or FFI with a new W-8BEN.   By example, if an NRA has a change of address to an address in the United States, then this change is a change in circumstances that requires contacting the withholding agent or FFI within 30 days.  Generally, a change of address within the same foreign country or to another foreign country is not a change in circumstances.   However, if Form W-8BEN is used to claim treaty benefits of a country based on a residence in that country and the NRA changes address to outside that country, then it is a change in circumstances requiring notification within 30 days to the withholding agent or FFI.

On line 2, the NRA must enter the country of citizenship. If the NRA is a dual citizen, then the NRA must enter the country where the NRA is both A citizen and A resident at the time of completing the W-8BEN.  If the NRA is not a resident in any country in which the NRA has citizenship, enter the country where the NRA was most recently a resident. 

Line 3 requires the NRA’s permanent resident address in the country where the NRA claims to be a resident for purposes of that country’s income tax. If the Form W-8BEN is to be used for claiming a reduced rate of withholding under an income tax treaty, then the NRA must determine permanent residency in the manner required by that tax treaty.  The NRA may not use the address of a financial institution, a post office box, or any of other type of mailing address.

If the NRA does not have a tax residence in any country, then his permanent residence is where the NRA normally resides.

If the country does not use street addresses, line 3 allows a descriptive address, such as “Manor House, Kensington Estate”.

Line 5 requires a taxpayer identification number, which is the US social security number (SSN), or if not eligible to receive a SSN which most NRA are not, then an individual taxpayer identification number (ITIN).  To claim certain treaty benefits, either line 5 must be completed with an SSN or ITIN, or line 6 must include a foreign tax identification number (foreign TIN).

Individual Taxpayer Identification Numbers (ITINs) will expire if not used on a federal income tax return for five consecutive years, the Internal Revenue Service announced today. To give all interested parties time to adjust and allow the IRS to reprogram its systems, the IRS will not begin deactivating ITINs until 2016.

The new, more uniform policy applies to any ITIN, regardless of when it was issued. Only about a quarter of the 21 million ITINs issued since the program began in 1996 are being used on tax returns.

Under the new policy, an ITIN will expire for any taxpayer who fails to file a federal income tax return for five consecutive tax years.  Any ITIN will remain in effect as long as a taxpayer continues to file U.S. tax returns. This includes ITINs issued after Jan. 1, 2013. These taxpayers will no longer face mandatory expiration of their ITINs and the need to reapply starting in 2018, as was the case under the old policy.

A taxpayer whose ITIN has been deactivated and needs to file a U.S. return can reapply using Form W-7. As with any ITIN application, original documents, such as passports, or copies of documents certified by the issuing agency must be submitted with the form.

Line 6 of Form W-8BEN requires a foreign tax identifying number (foreign TIN) issued by a foreign jurisdiction of residence when an NRA documents him or herself with respect to a financial account held at a U.S. office of a financial institution.  However, if the foreign jurisdiction does not issue TINs or has not provided the NRA a TIN yet, then the NRA must enter a date of birth in line 8.

At this point let us turn to our client case studies… 

Standard Chartered Fined $300m For Lax Controls.

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