FATCA: Looks Harmless, but Can Be Vicious
Information sharing is now a worldwide trend
International exchange of offshore financial account information and tax records between governments has become the norm when it comes to international taxation. The United States initiated the trend of exchange of information by implemented the Foreign Account Tax Compliance Act (the “FATCA”) then, the OECD followed by introducing the Common Reporting Standard (CRS) for Automatic Exchange of Information (AEOI) in 2014. The main purpose behind both of these programs is to combat tax evasion and improve financial transparency.
FATCA was enacted on March 18, 2010, under the Hiring Incentives to Restore Employment (the “HIRE”) Act. It was a response to a series of scandals. The most famous is the 2009 Swiss banking scandal which concluded UBS agreeing to pay $780 million in penalties to the U.S. government.1 The UBS scandal is whole another story where the actual whistleblower (UBS private banker) received prison time, but when he got out a check of $104 million waiting from the U.S. government (so basically, he earned $3.5 million per month while in prison).
FATCA requires foreign financial institutions (FFIs) to register with the Internal Revenue Service (IRS) and obtain a Global Intermediary Identification Number (GIIN) unless there is an exception from registration. FFIs that act as a withholding agent use the GIIN to identify whether another FFI is FACTA compliant or not. Some FFIs are exempt from both registration and reporting requirements, for example, governmental entities, non-profit organizations, and small/local FFIs. Other FFIs that are not mentioned above are required to register, but they may be able to obtain an exemption from the reporting requirement.
The U.S. government has no jurisdiction to force FFIs to expose their account holders’ information. However, to obtain such information, the U.S. has levied a withholding tax on U.S. sourced outbound payments to foreign persons. Before the introduction of FATCA, the U.S. already had a withholding regime on payments made to a foreign payee.2 FATCA introduced a new type of withholding regime3 imposing a 30 percent withholding tax on any withholdable payments made to an entity payee that is an FFI unless the withholding agent can verify such payee entity is FATCA compliant (Participating FFI, deemed-compliant FFI, or exempt beneficial owner). A withholdable payment under this section considered as any payment of U.S. sourced fixed or determinable annual or periodical (FDAP) income, such as dividends, interest, royalties, compensation for personal services, pensions, and annuities.4 A U.S. or foreign person who has control of a withholdable payment and making such payment to a payee that is an FFI must withhold 30 percent on the payment unless a verification could be made that such FFI is FACTA compliant.
For example, a $100 dividend payment (withholdable payment) from U.S. corporation (withholding agent) to a foreign fund (payee FFI) that is not compliant under FATCA, will only receive $75 (assuming only Chapter 4 withholding applies).
Even though, at first glance of FATCA compliance seems highly complicated and cumbersome (for most it will be), once the FFI implements FATCA due diligence procedures, most of the time such FFI has to collect and report similar information. For example, most common information that an FFI required to gather are U.S. account holder’s name, account numbers, taxpayer ID, and in the case of the owner is a U.S. entity, the name, address, and tax identification number of each beneficial U.S. owner of an entity. An FFI could obtain majority of this information by requesting Form W-9 from its U.S. account holders.
In order to implement FATCA, the U.S. has entered into many bilateral agreements with countries (partner countries) also known as Intergovernmental Agreements (IGAs). IGAs explain requirements, obligations, due diligence procedures, and exceptions to registration or reporting. These agreements can be implemented without affecting existing double tax treaties. There are two models of IGAs. Under the Model 1 IGA, foreign financial institutions have to report information on U.S. accounts to the partner country’s tax authority. Then, the partner country’s tax authority transmits such information to the IRS. The Model 2 IGA requires foreign financial institutions to report directly to the IRS; the partner country agrees to change their privacy laws in order to avoid that the financial institutions break any local laws by complying with FATCA. FFIs under the Model 2 countries must obtain the consent of the account holders to disclose relevant information. The majority of the IGAs are Model 1 IGAs which are reciprocal. So, when a partner country enters into an IGA, in return for IRS obtaining information on U.S. accounts from the partner country the IRS has to report accounts belongs residents of the partner country.
Total of 113 partner jurisdictions have signed IGAs with the U.S. and more countries are expected to join this list. Switzerland has a Model 2 IGA with the U.S. Therefore, Swiss financial institutions with U.S. accounts have to register with the IRS and report their U.S. accounts directly to the IRS. Swiss IGA is not a reciprocal agreement.
Implementation of FATCA
Even though this law has been in the books since 2010 and with slow implementation. In 2014 IRS issued final regulations under chapter 4 providing for a phased implementation of FATCA beginning in 2014 and continuing through 2017. The IRS opened the FATCA registration portal on January 1, 2014, and published its first registered FFI list on June 2. It also required withholding on withholdable payments starting on July 1, 2014. The first FATCA reporting by FFIs began in 2015. The very first conviction for failing to comply with FATCA was obtained in 2018 by the U.S. Justice Department.
The first ever guilty conviction for failure to comply with FATCA involves the U.S. Justice Department, Federal Bureau of Investigation (FBI), Securities and Exchange Commission, UK Financial Conduct Authority (FCA), the Internal Revenue Department (IRS), and many other local and foreign law enforcement agencies.
With the help of a confidential informant (CI), in March 2014, U.S. law enforcement officials were investigating various market manipulation schemes conducted by multiple Belize-based brokerage firms (the indictment name this as the “Belize Investigation”). During the Belize Investigation, law enforcement agents found out that there is an ongoing money laundering scheme occurring through bank accounts held by Loyal Bank.
On May 5, 2017, undercover agent based in the Eastern District of New York posing as a friend of the CI, contacted Mr. Adrian Baron the Chief Business Officer of Loyal Bank. The Loyal Bank has offices in Saint Vincent and Grenadine, and in Budapest, Hungary. Mr. Baron was also the Responsible Officer (the “RO”) named in the bank’s FATCA registration. The undercover agent wanted to open corporate bank accounts in the name of Belizean International Business Corporations (“IBCs”).
The undercover agent met with Mr. Baron at Loyal Bank’s Budapest, Hungary Office. During this initial meeting, the undercover agent conveyed his purpose of opening accounts. The undercover agent did not want to use his name to open the accounts for reason of him being a U.S. citizen, even though he was the true beneficial owner. Mr. Baron said that the bank does not do business with U.S. citizens, but said to the undercover agent could open accounts on behalf of his Belizean IBSs and use a Belizean person as the nominee of the account while omitting the U.S. citizen’s information altogether. They also met in Miami, Florida on a yacht where the undercover agent wined and dined Mr. Baron. After the second meeting, the undercover agent opened a few more accounts with the Loyal bank. During this whole process, Mr. Baron never requested information from the undercover agent in order to fulfill FACTA reporting requirements.
February 28, 2018, a federal grand jury in the Eastern District of New York came with an indictment where it charged Mr. Baron with money laundering conspiracy. On March 2, 2018, Mr. Baron was arrested in Budapest, Hungary pursuant to a provisional arrest warrant filed by the United States. March 20, 2018, the grand jury returned with a superseding indictment (replace the original indictment issued on February 28, 2018), which added Count Five charging Mr. Baron with conspiracy to defraud the United States government by failing to collect information under FATCA. On July 12, 2018, he was extradited from Hungary to the United States and arraigned under the superseding indictment. On September 22, 2018, Mr. Baron pleaded guilty, pursuant to a plea agreement, for FATCA violations. At the sentencing hearing on January 23, 2019, Mr. Baron was sentenced to time served (Credit for time served in custody in Hungary and in U.S. custody, which is around eleven months).
FATCA noncompliance is no longer with no repercussions
FATCA is an 18-year-old U.S. law that generated both positive and negative comments by tax professionals. Since it first went into effect, foreign financial institutions had to implement new due diligence procedures and information reporting process. Thomson Reuters conducted a survey and found that the majority of financial institutions spending between $100,000 and $1 million on FATCA compliance costs.5 The survey also found that a small percentage of financial institutions spending more than $1 million.6
An FFI could follow proper registration processes with the IRS in obtaining a GIIN but falsely report that the institution does not have any U.S. accounts to report and expect the IRS or the partner country’s financial authority would never find out. It is possible for someone to think that the IRS would never come across unreported financial accounts due to the fact that the partner country has strong financial privacy laws and IRS has no jurisdiction in the partner country. In this case, the FFI takes the risk of being subject to a 30 percent withholding and other financial penalties. The officers of the FFI, especially the individual(s) who is designated as the RO in FATCA registration could be criminally prosecuted by the U.S. Justice Department and face possible prison time in the U.S. The Loyal Bank and Mr. Baron’s case has shown us that U.S. authorities could somehow discover unreported U.S. accounts of an FFI. There are many paths that the U.S. government could use in order to obtain this information. For example, such information could come from a U.S. taxpayer, another FATCA compliant FFI, or by U.S. law enforcement agent posing as a potential client. With the first FATCA guilty plea, now it is highly likely that the U.S. authorities would pursue more investigations and prosecutions in regard to violating FATCA rules.
Even though it was not long ago since the implementation, FATCA has significantly changed the international tax law by requiring FFIs to disclose information to the IRS for certain foreign accounts and assets held by U.S. persons. This case highlights the methods and the means of investigation used by the U.S. authorities to tackle tax fraud. The U.S. Justice Department could work with the IRS, U.S. Securities and Exchange Commission (SEC), Federal Bureau of Investigation (FBI), foreign financial authorities, foreign law enforcement authorities, and other necessary organizations to bring entities and individuals who are trying to and helping others to defraud the United States government by not complying with FATCA and other U.S. tax laws.
In the current global environment, it is necessary to seek proper U.S. tax advice to understand U.S. tax compliance rules in order to smoothly operate and to prevent possible litigation either by local or U.S. authorities.
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1 William Byrnes & Robert J. Munro, Background and Current Status of FATCA, Research Paper No. 17–31, Texas A&M University School of Law.
2 IRC §§ 1441, 1442, 1443.
3 IRC § 1471,
4 IRC §1473(1)(A).
5 The Thomson Reuters survey, https://tax.thomsonreuters.com/site/wp-content/pdf/onesource/fatca-crs-readiness-survey.pdf.