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Fatca rules explained Presentation Transcript

  • 1. FATCA REGULATORY UPDATE Understanding the Foreign Account Tax Compliance Act Challenges and Impact on the Global Financial Markets By Eddie Russo, Advent Software
  • 2. 2 REGULATORY UPDATE Background FATCA (Foreign Account Tax Compliance Act) was enacted in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act. FATCA requires FFIs (foreign financial institutions) to report to the IRS information about financial accounts held by US taxpayers, or by for- eign entities in which US taxpayers hold a substantial ownership inter- est. In order to avoid withholding under FATCA, a participating FFI will have to enter into an agreement with the IRS to be responsible for the identification of US accounts, the reporting of specific information to the IRS regarding US accounts, and the ability to withhold a 30 percent tax on certain payments to non-participating FFIs and account holders who are unwilling to provide the required information. FFIs that do not enter into an agreement with the IRS will be subject to withholding on certain types of payments, including US sourced interest and dividends, gross proceeds from the disposition of US securities, and pass-through payments. Industry Challenge FATCA is a direct result of increased efforts in the United States to com- bat offshore tax evasion and recoup tax revenues. The primary goal of the legislation is to alleviate deficiencies in the current methods used by the US Internal Revenue Service (IRS) and the US Department of Justice (DOJ) to identify US persons who utilize foreign financial accounts or foreign entities. FATCA will allow the US government to receive infor- mation on all assets held abroad by US citizens to determine the owner- ship of all US assets held in foreign accounts. Therefore, all FFIs will be required to enter into disclosure compliance agreements with the US Treasury. Non-financial foreign entities (NFFEs) will also have to report and/or certify their ownership or be subject to the same 30 percent withholding. Due to the amount of publicity this legislation has been receiving and the wide-ranging impact it will have, most, if not all financial institutions are concerned about its ramifications and have already begun to look at the requirements to become compliant under FATCA. One of the biggest challenges for firms is that as of late 2011, the legislation has yet to be completely finalized and a wide range of unanswered ques- tions still exist. It is unclear what the IRS agreements will consist of, what reporting will be required, who classifies as an FFI and, ultimately, what the ramifications will be for those who don’t comply. From a doc- umentation standpoint, questions still remain surrounding how the new requirements will impact the opening of new accounts, what types of forms will have to be submitted and whether or not existing docu- ments can be used or need to be replaced/updated. FATCA will allow the US government to receive information on all assets held abroad by US citizens to deter- mine the ownership of all US assets held in foreign accounts. About the Author Eddie Russo is a Senior Solutions Consultant in Advent’s Global Accounts group, where he works closely with sales to ensure that the Advent product suite satisfies the needs of investment man- agement firms around the globe. Prior to joining Advent, Eddie spent ten years in fund administration and asset manage- ment, working for some of the largest banks in the world. Contact him at erusso@advent.com.
  • 3. advent.com 3 One thing, however, is certain: FATCA is going to be extremely costly from both a time and resource perspective for those firms who will be required to enter into an agreement with the IRS. The lack of finaliza- tion is becoming a major roadblock for preparation and resulting in increased frustration for firms who want to begin the budgeting process for compliance. Although the IRS has recently released new information which should clarify some of the documentation questions, funds for the most part are still in a “wait and see” mode. Ultimately, the global concern is that FATCA legislation is another example of the US trying to wield its power and in this particular case, telling countries how to do business with the US. It’s noteworthy, how- ever, that FATCA is not mandatory. Financial institutions that are unwill- ing or unable to meet the new legal requirements have the option to not sign FATCA and thus must terminate all US client relationships and investments. IRS Notice 2011-34 issued 20122011 2013 2014 2015 Estimated milestone Known milestone Account governance commences Proposed regulations published Final regulations published FATCA becomes effective Account governance commences Complete US indicia review and solicit documentation Annual reporting of US accounts to IRS Withholding begins Recertification process commences Deadline to receive client (US indicia) documents Regulatory Milestones FATCA Milestones1 1 Adapted from “FATCA’s Impact on the Asset Management Industry” by Ernst & Young, 2011. For complete text and more information, visit http://www.ey.com/fatca.
  • 4. 4 REGULATORY UPDATE Market Impact The application of FATCA is not driven solely by whether or not an FFI actually has US clients, and closing these accounts will not exempt a firm from having to comply. FFIs that hold and trade US investments on behalf of their clients will be directly impacted as well since they will also be required to enter into a FATCA agreement to avoid being clas- sified as recalcitrant and subject to withholding. Thus, it’s of utmost importance that any entity which makes or receives a payment of US sourced income consider whether they are subject to FATCA. “Withholdable” payments that must be reported are defined as: ៑ Any payment of interest (including any portfolio interest), dividends, rents, royalties, salaries, wages, annuities, licensing fees and other fixed or determinable annual or periodical (FDAP) income, gains, and profits, if such payment is from sources within the US. ៑ Any gross proceeds from the sale or disposition of US property of a type that can produce interest or dividends. ៑ Interest paid by foreign branches of US banks. This means that FATCA will affect more than financial institutions— because so many types of US payments to foreign entities will be sub- ject to withholding, multinational corporations and individuals outside the financial industry will also need to be compliant with FATCA once it goes into effect. All kinds of companies will likely need to make mod- ifications to their internal systems, controls, processes and procedures for compliance by January 1, 2013. US entities, both financial and non-financial, that make payments of US sourced income outside the US will also be impacted, as they may be required to withhold a 30 percent tax on that income if the recipient is deemed “recalcitrant.” They will therefore have to maintain appropriate documentation and track how those recipients are classified under FATCA. Workflow Impact From a company workflow standpoint, most if not all current proce- dures and processes from the top down will be impacted by FATCA. This enterprise-level effort will require allocation of people, budget and project ownership across the businesses, operations, compliance and tax. It will most likely force firms to centralize all of their process and systems across all of their divisions globally, which will not only be a massive undertaking but will lead to substantial organization costs and create a heavy burden on resources. The belief in the marketplace is that complying with FATCA could increase operational budgets All kinds of companies will likely need to make modifications to their internal systems, controls, processes and procedures for compliance by January 1, 2013.
  • 5. advent.com 5 anywhere from 25 to 50 percent. This doesn’t even include setting cap- ital aside for any fines that may be incurred for not fully complying with the legislation. Some ramifications of these costs include: ៑ Foreign funds may choose not to invest in securities creating US source income because FATCA’s compliance burden may be consid- ered too costly. ៑ US brokers/bank withholding agents and upstream FFIs may ask for compliance with certain clients since it may be too costly to do business with non-participating FFIs. ៑ Sophisticated investors investing in offshore funds will want to understand if an offshore fund is a compliant fund. ៑ Currently FATCA requirements are unique to those investing into the US; however, the future could lead to implementation in other jurisdictions. Technology Impact From a software and IT standpoint, it’s critical that firms have a plan in place for technology enhancements/updates as they look to consoli- date their process and procedures. Institutions will be required to change the way they support onboarding of new investors, capturing of accounting enhancements and changes, processing of new data as well as the ability to provide additional documentation that satisfies the new reporting requirements. Legal entities will require increased scrutiny and further analysis will be needed to determine the status of each entity under FATCA. This par- ticular area could be a major challenge because information about the various entities included within the expanded affiliated group may not be readily available. Also, transfer agency functions will be severely impacted as in some cases “KYC” (Know Your Customer) information may not be readily available. For information that is readily available, accessing it will most likely require a major process change, as few organizations have a single, centralized source of client information to make required determinations with respect to accountholders. There will also be numerous legal ramifications that have yet to be iden- tified across the wide-ranging jurisdictions presented by the legislation. Compliance Challenges Compliance with FATCA has significant business, strategic and brand implications, and there are many risks associated for those funds that do not comply. One of the biggest and most obvious risks is that “recalcitrant” funds stand to lose investors. In today’s market, investors The belief in the market- place is that complying with FATCA could increase operational budgets anywhere from 25 to 50 percent.
  • 6. 6 REGULATORY UPDATE are more risk averse than ever before and it would be hard to justify investing in a fund that is not compliant with FATCA due to the heavy tax consequences imposed on non-compliant funds. The high costs and far-reaching changes in policies and procedures as well as the intrusiveness of the legislation are causing both contention and frustration globally. Some of the more contested concepts include the actual definition of a US citizen as well as the requirement that for- eign financial institutions must submit information about their clients’ accounts to the IRS. This last requirement could prove to be a major obstacle for hedge funds on an international scale, as not only are they unsure as to how a US citizen is defined, they’re struggling to find ways to implement the new IRS requirement without violating their countries’ client privilege and privacy laws. Some have declared that they will no longer provide services to any US citizens. As a result, FATCA will have a major impact across the world and for- ever alter how financial institutions do business. Phase 1: Impact assessment Impact assessment Source Impact Plan Phase 2: Business process and systems Customer documentation Global on-boarding program Design Development Implementation Recertification of existing customers Electronic search on US indica Solicit documents Certify FATCA classification Withholding Withholding system enhancement Design Development Implementation IRS reporting IRS reporting Design Development Implementation Tax advisory Educate key stake- holders and engage with IRS and Treasury Ongoing tax advisory support Program manage- ment Project set-up Ongoing global and local FATCA coordination 2011 2012 2013 2014 2015 G G G G G FATCA Implementation Timeline2 2 Adapted from “FATCA’s Impact on the Asset Management Industry” by Ernst & Young, 2011. For complete text and more information, visit http://www.ey.com/fatca. The high costs and far- reaching changes in poli- cies and procedures as well as the intrusiveness of the legisla- tion are causing both contention and frustration globally.
  • 7. advent.com 7 FATCA and Advent Solutions The time to begin looking at what needs to be done to comply with FATCA throughout all areas of a fund’s business has already come and gone, as the necessary infrastructure and technology changes could take anywhere from 12–18 months to complete. Despite the fact that the legislation has yet to be finalized, some form of it will eventually go into effect. How FATCA will look once it’s finalized is anyone’s guess, but firms need to begin reviewing what it currently entails and begin putting together a game plan to satisfy the requirements. Those who are not prepared or haven’t started looking into compliance requirements could incur much greater costs down the road in penal- ties and fees as they rush to get things done in order to comply. The same holds true for software vendors as they look to enhance their solutions to help their clients support everything that FATCA entails. In this respect, Advent Software has already started the process of analyzing how its solutions can be architected to support the various components that make up the FATCA legislation. There are a number of areas that will need to be changed and/or enhanced to satisfy the final set of FATCA requirements. Through vari- ous provisions of FATCA as part of the HIRE Act, Advent’s product suite enables firms to account and report on withholding tax for long and short positions on equities, fixed income, as well as complex derivative instruments, including Total Return Swaps. Advent solutions will also allow FFIs to employ time series tracking and reporting for negotiated prime broker withholding tax rates. Other areas where FFIs will be able to utilize Advent products to support FATCA include the ability for users to tag and track all US sourced income. Firms will also be able to calculate pass-through pay- ment percentages and electronically apply, account and report on the necessary withholding tax against a recalcitrant account holder’s US sourced income. Advent solutions will provide support for light transfer agency functions to electronically track an investor’s account status under FATCA, including but not limited to: “Specified US Accounts,” “Other than US account” and “Recalcitrant Account Holder.” Using Advent’s award-winning platforms, compliant hedge funds will have the ability to track, tag and be alerted when capital is received from recalcitrant account holders or non-compliant FFIs. Advent Software has already started the process of analyzing how its solutions can be architected to support the various components that make up the FATCA legislation.
  • 8. 8 REGULATORY UPDATE Find out more: www.advent.com Find out more: www.advent.com ADVENT SOFTWARE, INC. [HQ] 600 Townsend Street, San Francisco, CA 94103 / PH +1 800 727 0605 [NY] 1114 Avenue of the Americas, New York, NY 10036 / PH +1 212 398 1188 [HK] Level 7, Two Exchange Square, 8 Connaught Place, Central, Hong Kong / PH +852 2297 2280 [UK] 127–133 Charing Cross Road, London WC2H 0EW, UK / PH +44 20 7631 9240 Copyright © 2012 Advent Software, Inc. All rights reserved. Advent and the ADVENT logo are registered trademarks of Advent Software, Inc. All other products or services mentioned herein are trademarks of their respective companies. Information subject to change without notice. c Printed on recycled paper. REGFATCA0212 ADVENT ® You can count on us. Current Advent clients are at a distinct advantage as they are able to rely on a technology firm that has nearly three decades of experience in dealing with shifts in the market place and is extremely adept in keeping pace with this ever-changing industry. The lines of communica- tion between Advent, its clients and market influencers are open and remain strong, as these new regulatory requirements affect the alterna- tive investment industry. About Advent Software Advent Software, Inc., a global firm, has provided trusted solutions to the world’s leading financial professionals since 1983. Firms in over 60 countries count on Advent technology to manage their mission-critical operations. Advent’s quality software, data, services, and tools enable financial professionals to improve service and communication to their clients, allowing them to grow their business while controlling costs. This communication is provided by Advent Software, Inc. for informational purposes only and should not be con- strued as, and does not constitute, legal advice on any matter whatsoever discussed herein.