Compliance is the big question as FATCA law enters force

Commercial Crime International, July 2014

www.icc-ccs.org

The United States' Foreign Account Tax Compliance Act (FATCA) is to go into force on July 1. Aimed at curbing tax evasion by US citizens around the world, foreign financial institutions (FFIs) are required to report on US account holders, but over 200,000 FFIs and 123 countries have not yet signed up. This has raised issues about implementation, as certain non-compliant jurisdictions may try to attract US tax evaders, Paul Cochrane reports from Beirut.

Financial institutions around the world have been scrambling to get ready to comply with FATCA. Under the law, FFIs have to provide information on American customers to the US Internal Revenue Service (IRS). FFIs that are not compliant will be subject to a 30% withholding tax on US sourced income, and risk being locked out of the US financial system.

It is a strong incentive to comply, while compliance is also being driven by financial institutions wanting to only deal with FATCA compliant FFIs. “Very simply, any country that is not involved (with FATCA) gets cut off from the US financial markets,” said Camille Barkho, Chief Compliance Officer at the Lebanon & Gulf Bank, in Beirut.

Long haul

FATCA was introduced in 2010, but the IRS had an uphill battle to get jurisdictions on-board due to the complexities of reporting – the law is over 1,000 pages long – and because some jurisdictions have needed to amend their domestic laws to report to a foreign regulator.

Overriding banking secrecy in certain jurisdictions, for instance, has required letters of non-recourse to be signed by clients, while banks have had to improve compliance systems.

Such requirements by foreign regulators have delayed FATCA's roll out until this year. But with a firm date now in place, there has been a flurry of jurisdictions signing inter- governmental agreements (IGAs) with the IRS. Currently 34 countries have signed IGAs and 36 countries have, in the words of the IRS, “reached agreements in substance” to comply (while no IGA has been ratified, the US will treat such jurisdictions as being compliant).

But as of June, 123 countries – out of a total of 193 jurisdictions recognised by the US - have not signed an IGA or reached an agreement in substance. And while some 77,000 FFIs have signed up, according to the IRS, an estimated 200,000 FFIs have not. The number of recalcitrant FFIs could in fact be even higher as many institutions have registered subsidiaries and other entities as well. “If you look at the list it is not 77,000 FFIs, as this includes branches or affiliates. Some banks for instance are listed eight times, so in fact there are not that many,” said Barkho.

Momentum expected

Analysts expect that more jurisdictions and FFIs will sign up to FATCA once it goes live, driven in part by peer compliance and wanting to access the US market, but with so many FFIs not compliant this could present opportunities for circumventing FATCA.

“Ultimately any smart money launderer could place funds across multiple FFIs in a range of accounts, financial and non- financial, and as long as the deposited funds fall below US thresholds (of $50,000) could launder a fair bit of money that way and FATCA does little to reduce the potential for money laundering,” said Anthony Quinn, Founder of Financial Crimes Consulting in Australia.

Such risks will be greater in the initial years of FATCA until understanding of the law increases and the IRS expands its databases. For instance, a customer may not declare to an FFI that they have US citizenship. The bank has done its due diligence by asking a customer about US indicia, although the customer has effectively broken US law.

“FATCA is a long term project, and the US doesn't expect fast results, so if a taxpayer has evaded FATCA for a while, the IRS now has the ability to ask FFIs about non- reported individuals. I think that catching US tax evaders by the IRS will be only a matter of time,” said Barkho.

Recalcitrant jurisdictions

A bigger issue where the outcome is less certain is the number of recalcitrant jurisdictions, including Russia and China (note: both countries signed up at the last minute, prior to publishing). By not being compliant, this could play into a jurisdiction's hands: “I think that what may occur is certain jurisdictions will hold out, looking for an opportunity to be the destination of funds from jurisdictions that have signed with the IRS,” said Joe Bognanno, Principal, AML Solutions – Americas, at NICE Actimize, a financial crime, compliance and risk management solutions provider in the US. “It is interesting to look at the parallels between jurisdictions that are a risk for money laundering that are also recalcitrant in signing IGAs,” he added.

Indeed, out of the 65 countries of “primary concern” in the US State Department's ‘International Narcotics Strategy Report: Money Laundering and Financial Crimes Volume 2’, March 2014, there are 30 jurisdictions that do not have an IGA in effect or in substance. Other countries that are on the OECD's Financial Action Task Force's (FATF) list of high-risk and non-cooperative jurisdictions are also not in compliance, notably Myanmar, Nigeria, Pakistan, Iran, Syria and North Korea.

Hinderances

What may hinder the effectiveness of FATCA is that it is unilateral. If the multilateral tax enforcement initiatives that are being mulled by the OECD and G20 go into effect, this would bolster FATCA while also leading to greater transparency and a reduction in tax crimes. “One of two things may happen (because of FATCA): account holders will either move to another FFI or some FFIs may say get me out of the US market to where we get 100 percent returns. But that will be a short term thing unless the OECD initiative doesn't happen,” said Bruce Zagaris, a partner at law firm Berliner, Corcoran & Rowe in Washington DC. “With the automatic exchange of tax information it is going to be more difficult for people to conceal their income and assets from the tax authorities, especially as tax authorities are going to be comparing notes and facilitating information, so I think there will be less not more financial crime.”

FATCA's success will depend on greater global adoption, while the IRS has indicated it will provide FFIs with a degree of flexibility in the first 18 months, such as the requirement for banks to carry out know your customer (KYC) on all clients to check for US citizen indicia. Only then will the financial sector and regulators really be able to gauge whether FATCA is open to abuse or not.

“With new regulations and controls there is always the initial execution and then a period to see how effective it is and what gaps there are, which is what we have seen in anti-money laundering laws, that people find new ways around regulations. I am sure FATCA will be the same,” said Bognanno.