International Link - Hong Kong
http://www.internationallinkmagazine.com.hk/news/editorialjuly2014
A US-enacted law that is to go into force in July appears set to have
a major impact on the global financial sector as well as potentially
usher in a new era of tax sharing initiatives. China, so far, is
standing on the sidelines of the Foreign Account Tax Compliance Act
(FATCA), but it will be dragged into the regulation's net one way or
another.
According to some commentators, the Act will have an
adverse effects on the US economy – the dumping of Treasury Bonds (TBs),
the weakening of the dollar, lower foreign direct investment (FDI) –
and will be a contributing factor in hastening indebted America's
decline as a financial superpower.
To others, FATCA will lead to
greater global tax enforcement by curbing banking secrecy and offshore
tax havens - where an estimated $32 trillion is stashed away from the
tax man - with “sons of FATCA” laws being mulled by the OECD and the G20
countries to share tax information and go after tax evaders.
So
what is this new law that has such global reach, yet few outside of
financial circles are aware of, that is slated to go live on 1 July?
Enacted in 2010, FATCA is aimed at curbing tax evasion by American
citizens with accounts above $50,000. Under the law foreign financial
institutions (FFIs) around the world will have to screen all their
account holders to verify whether clients are US citizens or not. Such
an extra territorial law puts the onus on FFIs to act, essentially, as
unpaid agents of the US' Internal Revenue System (IRS), or face a 30
percent withholding tax on US account holders. Further motivation to
comply is the possibility of being cut-off from the US financial system
and not being able to deal with FATCA compliant institutions.
“The
withholding of 30 percent is the big stick the US is using to try and
force any recalcitrant banks or countries to sign up to FATCA. That is a
hefty fine, and it is going to make FFIs reconsider doing business with
US, but can they really leave the US market? The bet is that no one
will and if so, will only cause a small ripple, but we'll just have to
see it how plays out,” said Andrew Salzman, Senior Associate at law firm
Dezan Shira & Associates, which has offices throughout China and
South East Asia.
Given such an ultimatum, FFIs – primarily banks –
are getting ready to report by 1 July to central banks or directly to
the IRS, depending on what governments have decided – a Model 1
intergovernmental agreement (IGA) whereby the FFI reports directly to
their central bank/regulator, which then reports to the IRS, or the FFIs
report directly to the IRS themselves, known as Model 2, which only
seven jurisdictions have opted for, including Hong Kong.
Slow uptake
The
uptake of FATCA can be best described as lacklustre in the first years
since being enacted. Britain was the first to sign up, in 2012, followed
by Denmark, Switzerland and Japan; by the end of 2013, only 13
jurisdictions had signed IGAs. As a result, along with the complexities
of wading through 500 pages of legislation, later expanded by a further
500 pages – that was not translated from the English – the FATCA go-live
date was delayed multiple times and the US Treasury went on a global
offensive to get more countries on-board.
Only this year as the
go-live date looms have more countries signed up to FATCA, bringing the
total to 34 countries with Model 1 and Model 2 IGAs, while 36 countries
have, in the words of the IRS, “reached agreements in substance” to
comply – that means that while no IGA has been ratified, the US will
treat such jurisdictions as being compliant. Nonetheless, as of June,
123 countries (out of a total of 193 jurisdictions the US recognises
worldwide) including China and Russia, have not signed an IGA or reached
an agreement in substance. Furthermore, while some 77,000 FFIs have
signed up, an estimated 200,000 FFIs have not.
The lack of
agreements is raising question marks about how effective the law will be
once in force. “I don't know how they will be able to go live on 1 July
with so few IGAs signed. I am not saying they should delay again, but
is the market ready? Where's Russia? China?” said Camille Barkho, Chief
Compliance Officer at the Lebanon and Gulf Bank in Beirut.
The
reluctance to sign IGAs has not been, in most cases, due to overtly
political reasons but more so to do with issues of sovereignty and the
regulatory changes required for FFIs to report to a foreign
jurisdiction. Under Chinese banking and tax laws for instance
institutions are not allowed to comply with a law such as FATCA. In
other jurisdictions privacy laws have had to be overhauled, and in some
cases, even changes to the constitution required.
The costs
attached to being compliant with FATCA is another factor, with FFIs
having to spend anywhere from $25,000, at smaller institutions, up to $1
million for large banks. Indeed, in the IRS’ 2013 Annual Report to
Congress, it notes that the Congressional Joint Committee on Taxation
estimates that while FATCA “will generate additional tax revenue of
approximately $8.7 billion over the next 10 years,” private sector
implementation costs could “equal or exceed” the amount FATCA may raise.
Jurisdictions
have also taken issue with the law being unilaterally imposed by the
US, as have investors. “I am on the record as saying that this is the
most arrogant legislation ever penned, as the US is effectively trying
to regulate other banks and jurisdictions. It only has teeth as the US
is at the centre of the global financial system,” said Simon Black,
founder of Sovereignman.com, one of the most popular asset protection
websites in the world.
The issue is that while global tax sharing
agreements are being mulled, FATCA is essentially a one-way street, of
FFIs providing information to the US but getting nothing in return. The
US has indicated it is willing to be reciprocal, but whether Washington
can in fact do this is a legal gray area. “Are these IGAs even legal?
They are not mentioned in the law, they are not passed by Congress, or
going through the proper treaty method. And can the US Treasury bind US
institutions to be reciprocal when no one has said where the information
will come from?” said Salzman.
Resistance
The
threat of the withholding tax and not being able to do business with
FATCA-compliant FFIs has spurred countries to sign up to FATCA this year
as well as for FFIs to optionally report directly to the IRS. Even
Syria, which is under US and EU sanctions, is requiring its banks to be
compliant.
But certain jurisdictions clearly will not be playing
ball. Iran, which is under the heaviest financial sanctions in modern
history, and international pariah North Korea are obvious cases. It is
Russia that has taken the strongest stance against FATCA, but only
following the Ukraine face-off between Moscow and the West. Within weeks
of sanctions being imposed on Russia, Moscow came out to say that
Russian banks complying with FATCA would be subject to penalties from
the domestic regulator. Indeed, Deputy Finance Minister Alexei Moiseyev
told the press in May that Russia will not become “tax agents for the
Americans, that will not happen under any circumstances.”
As for
China, while Beijing has not signed up, Hong Kong has (Model 2, “in
substance”), with commentators speculating it is to see how FATCA plays
out in the SAR, and so that FFIs in China do at least have a door to the
US market and correspondent banks. A further factor was to retain Hong
Kong's financial hub status. “I think a big issue was that Singapore
signed up, and there is rivalry between the two as Eastern Asia
financial centres. If Hong Kong had not signed US business would use
Singapore instead and Hong Kong would get squeezed,” said Salzman.
Beijing
has made it clear that while it supports tax sharing initiatives - and
is reportedly mulling its own form of FATCA – it wants this done
multilaterally not unilaterally. As Liu Xiangmin, deputy director
general of legal affairs at the People’s Bank of China, told the press
in 2013, “I agree that countering tax evasion is an important policy
bill but an uncoordinated extraterritorial measure such as FATCA is
unlikely to generate broadly accepted solutions with full consideration
of the effects on global financial systems and the conflicts
involved...A more co-ordinated multilateral approach should eventually
replace the unilateral approach of FATCA.”
While China will not
face the issues of some banking centres that have a lot of US citizens
on their books, Chinese FFIs will encounter issues dealing with the US
and other counterparts as they will not be FATCA compliant. According to
the Association of Certified Financial Crime Specialists, only 210
institutions from China and 513 from Russia have registered – compared
to 14,835 FFIs in the Cayman Islands and 4,000 in Switzerland.
“Signing
the FATCA agreement provides almost all downside and no upside, quid
bono FATCA, and China doesn't benefit. Beijing realises that. So they
may wait, which is tantamount to financial warfare if China holds out as
after July all FFIs will have to gang up on China as not compliant.
Would it force the Chinese to sell treasury bills and so on? This is a
possibility,” said Black.
The unknown unknowns
This
is the unknown factor about what will happen when FATCA goes live. Will
there be a slump in business transactions as some 200,000 recalcitrant
FFIs will not be able to deal with compliant FFIs? “What happens July 1?
There is no line in the sand. There are huge direct costs (of
implementing FATCA). As for indirect costs, there will be a loss of
business, and it will close the doors on swathes of customers for years
or even decades to come,” said Black.
Analysts expect a two-tier
financial system to possibly develop: compliant and non-compliant FFIs,
with institutions effectively policing one another for compliance.
Non-compliant FFIs will clearly deal with one another; compliant FFIs
will not, or charge an extra fee.
“Let's assume small and medium
sized FIs are not ready, this could have a cascading effect on larger
ones, creating a ripple effect,” said Ranjith Kumar, Director at
Keypoint, a financial services consulting firm in Bahrain. “But what I
believe may happen is that the cost attached to not participating may
result in a higher cost of service for financial services, or costs for
maintaining the relationship with an FFI. It is unlikely that an FFI
will totally stop dealing with them, although there will be a lot of
pressure to participate. Some FFIs not critical (to a compliant FFI) for
business may be asked to stop doing business.”
A further factor
is what may happen with US Treasuries, with overseas institutions
holding $5.9 trillion, or 48.5 percent of TBs, more than double the
amount held in January 2008, according to the US Federal Reserve.
“What
happens when we start shorting payments on our TBs by 30 percent? A
sovereign holder is not subject to withholding, but for a private
institution, what if the interest payment is done through SWIFT to a
commercial bank that has not signed an IGA? Treasury will take the
interest,” said Jim Jatras, Manager of RepealFATCA.com, which is
lobbying against the law in Washington. “This is the kind of thing that
could promote dumping TBs, and affect interest rates and the dollar as a
global currency, which are issues nobody has thought out.”
FATCA
has arguably already had an effect on US Treasury bills. In March,
Russia sold $26 billion, or 20 percent, of its holdings in Treasuries.
To offset the sale of TBs by Moscow, Belgium stepped in, becoming the
third largest foreign holder of treasuries, although it is not clear if
it was Brussels acting independently or through coercion.
“Russia
is selling off treasuries – why? Two things came together at once, one
FATCA and the other the new advance in Ukraine, as the Russians couldn't
anticipate the US response, so sold TBs to be insulated from
sanctions,” said Jim Rickards, a veteran Wall Street investor and author
of current New York Times bestseller The Death of Money. “Look at the
enormous surge in buying TBs through Belgium, it could be
(clearinghouse) Euroclear or a third party, or the European Central Bank
(ECB) using dollar proceeds from Fed Swaps. Or is it holders in places
like the Cayman Islands moving accounts to Belgium to avoid FATCA? It is
a good question, and I speculate that FATCA has something to do with
it. Russia is dumping, China is not, but they are not buying more and
Belgium is, so put all together and we are shuffling deck chairs around
on the Titanic.”
It would be ironic if FATCA backfires on the US,
as a primary motivation for the Act, and the OECD and G20 mulling
multilateral legislation, is that governments are scrambling for tax
revenues following the 2008 bailouts of banks due to the financial
crisis. Indeed, governments are in debt to the tune of $100 trillion
worldwide, with that figure having surged 30 percent since the 2008,
according to Bloomberg. What is clear is that FATCA's go live date is
bad timing, given the Russia-West standoff, Russia and China
strengthening financial ties, and fears in the market of another
financial crisis.
“I think we are heading for another financial
collapse, and the next one will be bigger than central banks can keep a
lid on. Central banks could barely subdue the last crisis and used
trillions of dollars to do that, but at this point there's not much left
to deal with another crisis, which would be bigger. The only clean
balance sheet is the International Monetary Fund's, so it would have to
bail out the EU and US,” said Rickards.
Whether another financial
crisis is on the cards requires a crystal ball, albeit the fundamentals
are pointing in that direction. In any case, there seems to be a global
rebalancing in financial power, as the West is in debt and the Asian
markets are in much better fiscal health.
“I think we are rapidly
seeing more signs of Asian banks becoming increasingly powerful and
developing their own financial infrastructure, and places like Hong
Kong, Singapore and Shanghai will become more powerful financial centres
and the US a secondary system,” said Black. “This creates the
conditions for rebalancing as capital goes where it is treated best, and
the West goes out of its way to treat savers as poorly as possible. If
all the savings are in Asia, and debt and consumption in West, where
will power reside?”
China's stance
Beijing
has not made its official position on FATCA crystal clear, other than in
not signing an IGA. What is clear is that Beijing is in favour of a
multilateral approach to tax sharing initiatives. Furthermore, in
January, Beijing introduced new legislation that requires wealthy
Chinese citizens to declare their overseas assets – the “Foreign Asset
Reporting Requirements” (FARRs). It is similar to the US forerunner of
FATCA, Foreign Bank Account Reports (FBAR) – which has a lower reporting
threshold of $10,000 – in that the FARR has no requirements for FFIs to
file on Chinese account-holders.
The US providing information on
Chinese account holders would be of clear benefit to Beijing for tax
enforcement purposes, but the US is highly unlikely to do so, even if
China signed an IGA. As noted earlier, the legality of reciprocity is a
gray area and has essentially been used as a fig leaf by the IRS to
coerce jurisdictions into signing up. Additionally, reciprocity on the
US side could lead to the loss of significant funds that are parked in
US banks, especially in tax havens, which is a reason why US financial
institutions are opposed to multilateral tax sharing initiatives (see
below).
For China to comply with FATCA, domestic regulations will
need to be changed – such as bankruptcy protection rules - which will be
onerous and with minimal benefit to the state or Chinese financial
institutions. A further factor is that FATCA could affect Beijing's
financial dealings with countries under US sanctions, such as Iran and
Sudan, with which China has significant trade relations, especially for
hydrocarbons, while US dollar transactions for these countries are often
transferred via China.
In international politics, China not playing
ball with the US over FATCA would have far reaching affects by being a
major global player that will not bend to US diktats, and on the flip
side could potentially benefit from inflows of cash from investors
avoiding the American market and resultantly aiding further in China's
financial rise.
China is in a position to help derail FATCA
altogether by not complying. In Beijing not doing so, it would set a
strong precedent that could be followed by other countries pulling out,
especially if they had minimal business with the US. Indicative is that
few of the countries in China's immediate sphere of influence in South East
Asia have signed up with the US – Thailand, Malaysia, Cambodia,
Vietnam, Myanmar and Laos, as well as US allies the Philippines and
Taiwan. Neither has Macau.
Further afield, a region where China has
made significant economic inroads is Africa, where only a handful of
countries have signed up to FATCA. China could benefit from this in
having African funds that had previously gone to the US destined instead
for Chinese financial institutions, as well as making amenable African
states stay out of FATCA and join the “not FATCA compliant club”.
In
other words, China certainly has international leverage, as if it signs,
others would too, and by not doing so it will put the breaks on FATCA's
global effectiveness, regardless of the fact that Hong Kong has signed
an IGA “in substance”. China should press this advantage with the US in
its discussions over taxation, fiscal and other economic issues.
However,
a financial war is not necessarily in either sides interest, but in the
case of FATCA, it was initiated on the US side, and how Washington will
respond to China being recalcitrant is not overly clear.
In any
case, China has time to see how effective global FATCA-compliance will
be before having to make a firm decision either way, as the IRS has
deemed 2014 and 2015 a period of transition, with jurisdictions that
have to adapt domestic laws to comply with FATCA not to be issued
penalties for delays.
Tax Haven Hypocrisy
Overall
the roll out and implementation of FATCA has not been well handled by
the US. The IRS has implied that it will only gradually enforce FATCA,
and will provide FFIs with a degree of flexibility in the first year and
a half, with for instance the onerous requirement for banks to sift
through all their clients to check for US citizen indicia part of the
second phase.
While FATCA is expected to generate $800 million a
year for the IRS in tax revenues, commentators suggest the US should
look closer to home. “The US is the number one tax haven in the world,
yet goes around and terrorizes all these places (through FATCA); the
biggest culprit in this charade is the US. If they want to solve the
problem, why not make the tax code more attractive?” said Black. “And
the funny thing is that most of the money sitting offshore is from the
big companies, the Fortune 500, and offshore is permissible under the US
tax code.”
Indeed, there is a degree of hypocrisy by the US on
clamping down on US tax evaders globally, and requiring FFIs to do so,
while still letting it happen within the US and for anyone globally to
do so on US territory, such as in Delaware, the top tax haven on the
planet. This is preventing the US from being reciprocal when it comes to
tax sharing with other countries and, moreover, undermines initiatives
for a global move to tackle tax evasion.
“Delaware is highly
protected by political lobbies in the US. A huge number of Fortune 500
companies use Delaware, and that is why it will be so hard to push
through reciprocity in Congress,” said John Christensen, director of the
Tax Justice Network in London. “Perhaps some of the most extraordinary
discussions I've had have been in (the state of) Wyoming, where service
companies and trust companies seem to compete with one another on being
devastatingly secret and illegal. It is real Wild West territory and
beyond the federal government. In terms of scale it is not like Delaware
but tends to be attracting low life activities, not the Fortune 500, so
a bottom feeder.”
To Christensen, FATCA is a good move, and if
handled right will push forward initiatives at the G20 and OECD for
greater tax sharing initiatives. Indeed, the days of tax havens are
limited it seems, although the loopholes need to be stopped. “There is
definitely a movement by the OECD for a global tax system and the
impediment has been tax havens, Swiss banks and so on, but one by one
those dissenters have been knocked out,” said Rickards.
China is
for such a global tax sharing initiative, as the People’s Bank of China
has stated, while at the 18th Party Congress there was agreement for
giving priority to greater political transparency and the rule of law.
For
a global tax initiative to work, major economies need to be on-board
and especially emerging economies, which have more often than not been
the victims of capital flight and tax evasion by the political and
economic elites. Done well, a global tax initiative would circumvent
concerns about sovereignty, which Christensen regards as “a great
rhetorical device.”
“My view is that any country that is unable to
tax its own citizens as they are using offshore accounts and tax havens
have long since lost sovereignty in tax matters, and need tax measures,
including FATCA. For me the sovereignty argument is bogus,” he said.
Some
analysts have suggested that FATCA should be delayed to take into
account G20 and OECD initiatives. “If FATCA was delayed a final time and
its launch coincides with OECD tax initiatives it would make sense, as a
tax exchange system would be more powerful and global. I bet China
would join, and no one would say this is just from the USA, it would be a
worldwide trend to be ethical,” said Barkho.
What the OECD tax
regime looks like has been kept under wraps, but there appears to be a
move towards a new era that will not tolerate tax evasion. “On the
positive side, the OECD is going ahead with proposals. I don't know what
they will look like, and I've had long discussions with OECD officials,
so we can certainly see a window for moving forward. That is progress,”
said Christensen. “Will it achieve political support? It's very hard to
say. What is clear is that the fiscal crisis facing many countries is
not receding, and governments are under pressure on tax policies because
they are increasingly seen as regressive.”
As for the impact of
FATCA on the global financial system, the US markets and non-compliant
institutions, as well as on future tax sharing initiatives, we will have
to wait and see. “There are certainly some people opposed to FATCA and
want it to fail – US overreach, impact on the dollar, and predicting
doom and gloom. With this being so open-ended and not knowing how it
will go, people choose their own narrative,” said Salzman.
Photo from http://www.iexpats.com/china-sign-fatca/
