UNDERSTANDING FATCA: HOW AND WHY THE WORLD, EVEN SWITZERLAND AND GRAND CAYMAN, MUST NOW COOPERATE WITH THE IRS

Nathan Newman Jorn HollAllianceBernstein L.P. Wolf Popper LLP

October 22, 2015

FATCA CREATES A NEW WORLD OF BANKING

• FATCA (Foreign Account Tax Compliance Act) added a new Chapter 4 to the Code in 2010.

• FATCA aims to stop wealthy Americans from hiding financial assets in Swiss banks and other foreign tax havens, in efforts to evade U.S. taxes.

• FATCA changed the global banking system.

• It is America’s “global tax law.”

• See 26 U.S.C. §§1471-74.

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FATCA APPLIES TO ALL THE WORLD

• In Morrison v. Nat’l Australia Bank Ltd., 130 S.Ct. 2869 (2010) (Scalia, J.), the Supreme Court held that legislation only applies within the territory of the United States, unless unequivocal statutory text confirms an overt intent by Congress that the law applies in foreign countries. If a statute is silent as to extra-territorial jurisdiction, that statute has no application beyond America’s borders.

• FATCA clearly states that it shall apply to every country on earth. See 26 U.S.C. §1471.

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THE 2009 BANK SCANDALS• FATCA was enacted in 2010, after two Swiss banks, UBS and

Credit Suisse, and a British bank, Lloyds TSB, paid substantial penalties to American authorities.

• In 2009, UBS paid $780 million in penalties, signed a deferred prosecution agreement, and, pursuant to an order of the Swiss Financial Markets Authority (FINMA), provided the DOJ with all documents related to the bank’s American customers.

• In 2009, Credit Suisse paid $536 million in penalties and Lloyds TSB paid $567 million in penalties.

• Today, Switzerland is no longer a place where Americans can hide assets in anonymous bank accounts.

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THE “FFI” AND THE “NFFE”

• FATCA requires foreign financial institutions (FFIs) to report U.S. account holders to the IRS.

• This requirement broadly applies to FFIs worldwide.

• FATCA also requires reporting on foreign entities defined as “passive non financial foreign entities” (NFFEs).

• This requirement applies to passive NFFEs worldwide.

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REPORT TO THE IRS – OR PAY THE PRICEIf an FFI does not agree to “participate,” FATCA imposes a 30% withholding tax on future U.S.-source “FDAP” payments coming their way – i.e. almost all U.S. dollars flowing to the “nonparticipating” FFI (“NPFFI”).

Any maker of a withholdable payment, U.S. or foreign, isrequired to withhold on behalf of the IRS.

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“FOREIGN FINANCIAL INSTITUTION”• FFIs include, but are not limited to:

-”Depositary Institutions” (for example, banks)

-”Custodial Institutions” (for example, mutual funds)

-”Investment Entities: (for example hedge funds and private equity funds)

-Certain types of insurance companies that have cash value products or annuities

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FFI EXEMPTIONS• Certain categories of FFIs are “deemed compliant” and

broadly exempt from FATCA duties, including:

-most government entities-most non-profit entities-small, local financial institutions-certain kinds of retirement entities

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THE FATCA WEBSITE AND THE “GIIN”• The IRS has created a high-tech, secure “FATCA Registration

Website.”

• To avoid being withheld upon, FATCA requires FFIs to register with the website, and upon approval, the IRS will assign the FFI a “Global Intermediary Identification Number” (GIIN).

• Each month, the IRS now publishes a list of registered and approved FFIs and their GIINs (the “FFI List”). To search the list of approved FFIs and their corresponding GIINS, the IRS website has an “FFI List Search and Download Tool.”

• All entities with FATCA due-diligence or withholding-agent duties are required to regularly reference the FFI List.

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THE IMPORTANCE OF THE GIIN• Once an FFI and its GIIN are listed by the IRS, FFIs with

withholding duties may rely on the FFI List and not withhold on payments made to the registered FFI.

• All registered FFIs with GIINs have agreed to report information about their U.S. accounts for the benefit of the IRS, including accounts of certain foreign entities with substantial U.S. owners.

• Participating FFIs are required to withhold 30% on certain payments to NPFFIs and accountholders that fail to provide information sufficient to establish non-U.S. status (“recalcitrant account holders”).

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IMPLEMENTING FATCA• When enacted in 2010, FATCA was met with resistance from

many a country.

• Decried as an assault on national sovereignty, it also broadly conflicted with local privacy laws (even in jurisdictions not considered tax havens).

• But quickly many foreign sovereigns came to see FATCA as an opportunity to curtail tax evasion among their own residents.

• Accordingly, they sought to achieve “reciprocal reporting” of U.S. accounts held by their residents, as a condition of cooperating with FATCA.

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THE IMPORTANCE OF THE INTERGOVERNMENTAL AGREEMENT (IGA)• After the initial foreign outcry over FATCA’s global reach, the

U.S. government collaborated with other governments to develop IGAs – Intergovernmental Agreements.

• IGAs supplant certain FATCA duties with easier procedures.

• An IGA is an agreement between the U.S. and another country designed to make FATCA compliance more efficient.

• The U.S. government’s backing of IGAs was very successful and now most countries have signed FATCA IGAs.

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THE TWO TYPES OF IGA• There are two types of IGA: Model 1 and Model 2.

• Under Model 1, FFIs must conduct due diligence to identify U.S. accounts, and file reports with their local regulator. The partner country then reports such information to the IRS on an automatic basis. Model 1 FFIs are excused from acting as FATCA withholding agents.

• Under Model 2, FFIs must report directly to the IRS as much FATCA-required information as permitted by local law. The IRS will then obtain any missing information from the partner jurisdiction, under preexisting tax information exchange treaties.

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THE OFFICIAL IGA LIST• The Department of the Treasury keeps a FATCA archive on its

website. See http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA.aspx.

• Most countries have chosen Model 1, which is quickly becoming a worldwide standard.

• All the world’s major economies have signed an IGA, including China, Brazil, France, Germany, Mexico, Japan and the U.K.

• Switzerland, Hong Kong and Japan signed Model 2 agreements, though Switzerland is currently negotiating a switch to Model 1.

• The Treasury’s current IGA country list is attached as Exhibit 1.

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THE NEW RECIPROCITY• Many countries signed IGAs that provide a measure of

reciprocity. These countries will receive certain information about their residents’ financial accounts within the U.S.

• But the U.S. provides less information than what it demands. FFIs must “look through” personal investment companies to identify substantial U.S. owners. Currently, U.S. FIs need not pierce the corporate veil in this manner.

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COUNTRIES WITH RECIPROCITY IN IGA• As of October 5, 2015, the following countries signed IGAs in

which they provide information to the U.S., and the U.S. has agreed to send information to those countries about U.S. accounts held by their citizens:

Australia, Brazil, Canada, Czech Republic, Denmark, Estonia, Finland, France, Germany, Gibraltar, Guernsey, Hungary, Iceland, India, Ireland, Isle of Man, Italy, Jersey, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Mauritius, Mexico, Netherlands, New Zealand, Norway, Poland, Slovenia, South Africa, Spain, Sweden and the U.K.

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NON-IGA COUNTRIES• Russia had sought to sign an IGA, but the U.S. suspended talks after

Russia’s occupation of Crimea. To save its FFIs from FATCA’s withholding, Russia amended its laws to permit its FFIs to “participate” by reporting directly to the IRS.

• A long list of countries have not signed an IGA. Most are in Central America (including Belize, El Salvador and Guatemala), South America (including Argentina, Uruguay and Venezuela) and Africa (including major African economies such as Nigeria, Egypt and Morocco). Two European countries have not signed an IGA: Andorra and Monaco. Vietnam has not signed an IGA.

• FFIs in non-IGA countries have more onerous FATCA duties (due diligence, withholding and reporting directly to the IRS).

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IRS POSTPONES “HAND OVER” DEADLINE FOR MODEL 1 COUNTRIES• On September 18, 2015, in IRS Notice 2015-66 (attached as

Exhibit 2), the U.S. agreed to provide Model 1 IGA countries one more year before they must hand over U.S. account information to the IRS. The prior Model 1 deadline for the first transfer of account information to the IRS was September 30, 2015. Notice 2015-66 does not, however, change the deadline for FFIs to report information to their local tax authority.

• The IRS recognizes that many countries do not yet have secure computer systems in place and may still be in the process of enacting legislation to implement FATCA within their borders.

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WITHHOLDING DEADLINES POSTPONED• Also part of Notice 2015-66 is a new “start date” for FATCA’s most

punitive withholding requirements. Withholding on “gross proceeds” has been postponed for two years, to January 1, 2019.

• The “start date” for FATCA withholding on “foreign passthrupayments” has been delayed for at least two years, to the later of January 1, 2019, or the date of publication in the Federal Register of final regulations defining the term “foreign passthru payment.”

• However, “simple” withholding on U.S.-source dividends and interest, is currently in effect and is not impacted.

• The decision to postpone the start date likely derived from a lessened sense of urgency to impose FATCA’s most draconian penalties, due to broad international cooperation. Furthermore, the forthcoming rules regarding “foreign pass-thru payments” promise to be especially complicated to administer.

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FFI DUTIES: “PURE” FATCA VS. IGAS

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FATCA IGAConduct specified due diligence to identify reportable U.S. accounts

Report on specified U.S. persons or reportable U.S. accounts

directly to the IRS

Model 1: locally

Model 2: to the IRS

Responsible person must certify compliance

Comply with information requests from IRS from local regulator

Deduct 30% tax on withholdablepayments to non-registered FFIs and recalcitrant accountholders

Model 1: never

Model 2: sometimes

UNPAID REVENUE AGENTS• A common criticism of FATCA is that it uses the great power of

the U.S. economy to force people across the world to act as unpaid IRS revenue agents. The IRS gets the money and passes off the costs to everyone else.

• The work required of FFIs is time-consuming and expensive.

• Some studies show that the amount recovered by FATCA will be approximately $800 million per year, but that the worldwide cost of the program, a cost paid by the world’s FFIs and foreign tax authorities, totals over $8 billion. See Exhibit 3 – A. Katzman: “Pushing Back Against the Worst Law You Never Hear Of,” Jerusalem Post, February 12, 2014.

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UNPAID REVENUE AGENTS – CONT’D• Large, global FFIs have created entire in-house departments solely

devoted to FATCA compliance.

• This substantial, extraneous cost has made FATCA unpopular throughout the world’s financial systems.

• The Wall Street Journal reported that Canada’s five biggest banks spent a total of US$693.5 million in initial FATCA compliance expenses. See Exhibit 4: R. Trichur, “Canada Banks Tally Their Tax Compliance Tab,” The Wall Street Journal, July 27, 2014.

• Some claim that FATCA has caused foreign banks to stop doing business with Americans living abroad – as the bank’s additional paperwork would be too much “hassle.” See Exhibits 3 and 4.

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FATCA CERTIFICATIONS TO THE IRS• All registered FFIs must establish a FATCA compliance program.

• An officer of the FFI is responsible for the adequacy of the compliance program under FATCA; IGAs are looser.

• Under FATCA, this officer and his/her agents must conduct periodic review of the FFI’s compliance program.

• Under FATCA, the FFI’s officer must certify to the IRS that no material failures were identified prior to the date of certification.

• FATCA allows the IRS to request an external audit of the FFI.

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THE DANGER OF DOING BUSINESS IN NON-IGA COUNTRIES• If one is doing business in a non-IGA country such as Argentina

or Vietnam, any FFI one works with in the country MUST have independently applied to the IRS without the benefit of its government’s IGA, and MUST have been approved and given a GIIN. If the FFI is in a non-IGA country and is NOT found on the official FFI List, it is highly unwise to sign contracts with that FFI. All payments made to, or by, that FFI are subject to FATCA’s 30% withholding provision.

• NOTE: There are currently three countries with both no IGA in place, and no registered FFIs within their borders: (1) Iran, (2) Cuba and (3) North Korea.

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THE IRS LAUNCHES THE INTERNATIONAL DATA EXCHANGE SERVICE (IDES)

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HOW IDES WORKS• To implement FATCA, it is important to all countries that necessary

safeguards exist ensuring that all tax information sent and/or received will remain confidential and used solely for tax purposes.

• To guarantee a confidential system that cannot be hacked, the IRS created IDES. IDES uses the latest “extensible markup language (XML) and “schema” technology. The IRS provides IDES technical assistance Monday through Friday, 24 hours per day, except federal holidays.

• IDES is available over the internet via “Hypertext Transfer Protocol Secure (HTTPS). IDES only accepts encrypted electronic submissions.

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HOW IDES WORKS• IDES provides additional protection via a “Public Key

Infrastructure” (PKI). A “Transport Layer Security” (TLS) cryptographic protocol encrypts all data to ensure confidentiality.

• At each end of a transmission is a user with a current “digital certificate” and a correlated private key. Both are used to decrypt all messages. Each digital certificate binds an identity to each public key. A certificate authority (CA) issues a digital certificate after an identity proofing process, to verify the exact identity of the digital certificate owner.

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APPROVED CERTIFICATE AUTHORITIES• The IRS will only accept digital certificates issued by seven

approved Certificate Authorities. These CAs are considered to be the world’s best, most secure digital certificate creators.

• They are: Digicert, Entrust, GlobalSign, IdenTrust, StartCom, Symantec and Thawte.

• IDES is not yet used to transfer confidential tax information, but its hardware, software and security protocols are fully in place.

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