What is FATCA?

FATCA is short for the “Foreign Account Tax Compliance Act”. It is a U.S. law that went into effect on 1 July 2014.

What is FATCA’s goal?

FATCA is designed to find U.S. taxpayers who are hiding their assets in non-U.S. banks and other non-U.S. “financial institutions”.

How does FATCA accomplish its goal?

FATCA requires non-U.S. financial institutions (so-called “Foreign Financial Institutions” or “FFIs”) to report their U.S. “account holders” to the U.S. tax authorities (the U.S Internal Revenue Service or “IRS”).

Why would a non-U.S. bank or other FFI comply with FATCA, which is purely a U.S law?

FATCA imposes a 30% withholding tax on any FFI that does not comply with FATCA. The tax is imposed on income earned on U.S. securities and is withheld at source. For example, if a foreign bank invested in Apple or Google shares and was to receive a dividend on those shares, FATCA requires that 30% of the dividend be withheld if the bank refuses to comply with FATCA. Since non-U.S. banks and other FFIs cannot afford to exit the U.S. capital markets, the threat of FATCA’s withholding tax is a huge incentive for FFIs to comply with FATCA.

But aren’t banks and other FFIs prevented by banking secrecy, data protection, and similar laws in many countries from disclosing information about their customers?

Yes. As a result, FFIs that wanted to comply with FATCA to avoid the withholding tax were caught in a bind: They could either comply and violate local laws, or they could not comply and then suffer the withholding tax penalty.

How did FFIs get out of this bind?

The U.S. persuaded over 100 countries to change their laws to require FFIs to comply with FATCA. In exchange, the U.S. entered into so-called “Inter-Governmental Agreements” (“IGAs”) with those countries. The IGAs withdraw the threat of a withholding tax penalty. The penalty is not needed in IGA countries because local law in those countries now requires compliance with FATCA.

 

Why did countries agree to change their law and enter into IGAs?

One reason is that they did not want their local FFIs to suffer the withholding tax penalty. Another reason is that the U.S. allowed countries to enter into so-called “reciprocal” IGAs if they wanted to.

What is a “reciprocal” IGA?

It is an IGA under which the U.S. promises to give the other country certain data about that country’s taxpayers with accounts in U.S. financial institutions.

I’ve heard there are two basic types of IGAs, so-called “Model 1” and “Model 2” IGAs. What’s the difference?

Under a Model 1 IGA, FFIs don’t report U.S. taxpayers directly to the IRS. Instead, they report to their home country’s tax authorities, which then sends the data to the IRS. Under a Model 2 IGA, FFIs report directly to the IRS.

Are there any other differences between Model 1 and 2 IGAs?

Yes. One of the most significant ones is that Model 2 IGAs are never reciprocal but Model 1 IGAs can be.

Where can I find a list of countries with FATCA IGAs and which ones have Model 1 and 2 IGAs?

On the U.S. Treasury Department website, available here.

How does FATCA impact the fiduciary industry?

Counter-intuitive as it is, many structures offered by non-U.S. fiduciary companies are defined as “FFIs” under FATCA. The result is that many such structures have FATCA reporting responsibilities. For example, a non-U.S. trust that is an FFI must report its settlor and certain beneficiaries if they are U.S. persons. Similarly, a private company that is an FFI must report any U.S. shareholders.

Are all structures offered by non-U.S. fiduciary companies FFIs?

No. But almost all that are not FFIs are so-called “Passive Non-Financial Foreign Entities” (“Passive NFFEs”). If a Passive NFFE holds an account at an FFI, the FFI itself will look through the Passive NFFE and report any of the Passive NFFE’s U.S. “Controlling Persons” or “Substantial U.S. Owners”. As a result, it is now very difficult for U.S. persons to hide accounts in FFIs or hide behind non-U.S. structures with account at FFIs.