Foreign Account Tax Compliance Act takes aim at international tax cheats

FACTA – the new law put in place to oust tax cheats operating in the US – has raised global criticism among leading financial institutions

March 12, 2012

In an effort to stem the losses caused by failure to report offshore income, the US government recently signed FATCA (the Foreign Account Tax Compliance Act) into law.  Under the provisions of the legislation, both depositors and financial institutions have a responsibility to disclose offshore funds or face substantial penalties. While the law was designed to recoup lost tax revenue, some financial analysts say that FATCA could lead to negative consequences for the banking and finance industry in the United States.

Stemming a loss
FATCA was enacted as part of the HIRE (Hiring Incentives to Restore Employment) Act, which was signed into law in March 2010. Each year, the US Treasury estimates that it loses $8bn of income tax revenue due to citizens hiding funds in offshore accounts. The law was designed to recoup those funds.

Under FATCA, all foreign financial institutions (FFIs) must disclose the names, addresses, Tax Identification Numbers, bank account numbers, and account balances for all US depositors who have offshore accounts. The definition of FFIs can include any company that holds US funds through transactions or deposits, including hedge funds, insurance companies, mutual funds, banks, and brokers. FATCA also requires depositors who have at least $50,000 in offshore accounts to disclose their funds and balances on IRS Form 8938 to ensure that the appropriate income tax is paid.

Failure to comply with this law could result in substantial penalties for banks and depositors: FFIs that refuse to cooperate face a 30 percent withholding tax on all US income, including interest earned from US transactions. Participating institutions must also impose a 30 percent tax on any payment they send to a non-participating FFI.  Depositors who fail to report Form 8938 are subject to a penalty of $10,000 up to $50,000. If they underpay their income tax as a result, they would also be subject to an additional 40 percent penalty on the tax.

Financial institutions up in arms
Several firms, including Ernst & Young and Canadian co-op bank Caisse Centrale Desjardins, have criticised the legislation, saying that the law places the burden of enforcement on the FFIs rather than the US Treasury. According to some estimates, the annual cost of compliance for FFIs may exceed $150m, since FFIs must devote time and resources to tracking and identifying funds on the government’s behalf. The law may also lead to companies and individuals moving their capital assets out of the US to avoid compliance.

Several countries have already pledged to cooperate with FATCA, including Britain, France, Spain, Italy, and Germany. According to the International Swaps and Derivatives Association (ISDA), the act could lead to US taxes being imposed on international transactions. In a recent statement, ISDA said: “The pass-thru payment rules could potentially impose US withholding tax on an interest made by a British bank’s London office to a German bank’s Frankfurt office if the German bank is a non-participating FFI and the British bank is a participating FFI, providing the British bank holds any US assets in any of its global offices.” Such a transaction would require the British bank to withhold a 30 percent tax on the exchange.

The FATCA is scheduled to go into effect at the beginning of January next year.