Foreign financial institutions must report the accounts of US persons for tax purposes.

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 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 whistleblower a UBS private banker, received prison time, but received $104 million from the U.S. government for his role in exposing the scandal.

FATCA requires most foreign financial institutions (FFIs) to register with the Internal Revenue Service (IRS) to obtain a Global Intermediary Identification Number (GIIN). Some FFIs are exempt from both registration and reporting requirements; for example, governmental entities, non-profit organizations, and small/local FFIs. Other FFIs are required to register, but they may be able to obtain an exemption from the reporting requirements.

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 qualified 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 qualified payment under this section is any payment of U.S. sourced, fixed, determinable, annual or periodical (FDAP) income, such as dividends, interest, royalties, compensation for personal services, pensions, or annuities.4 A U.S. or foreign person who has control of a qualified payment and makes such payment to a payee that is an FFI must withhold 30 percent of the payment, unless a verification could be made that such FFI is FACTA compliant.

For example, a qualified $100 dividend payment from a U.S. corporation or withholding agent to a foreign fund, or payee FFI that is not compliant under FATCA, will only receive $75,assuming only Chapter 4 withholding applies.

Even though, at first glance, FATCA compliance might seem complicated and cumbersome,  once the FFI implements FATCA due diligence procedures, most of the information the FFI is required to collect will be pro forma. For example, most common information that FFIs are required to gather are: the U.S. account holder’s name, account numbers, taxpayer ID, and, in the case of an owner is a U.S. entity, the name, address, and tax identification number of each beneficial U.S. owner of the entity. An FFI could obtain majority of this information by requesting Form W-9 from its U.S. account holders.

FATCA implementation

In order to implement FATCA, the U.S. has entered into bilateral agreements with countries 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 accounts with US indicia, or an indicator of a connection to a US taxpayer, to the partner country’s tax authority. Then, that tax authority transmits the 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 so that financial institutions in their country do not break any local laws by complying with FATCA. Under Model 2 rules, FFIs must obtain the consent of the account holders to disclose relevant information to the IRS. The majority of the IGAs are Model 1, which are reciprocal. So, when a partner country enters into an IGA, in return for IRS obtaining information on accounts with US indicia from the partner country, the IRS has to report accounts belonging residents of the partner country.

Total of 113 partner jurisdictions have signed IGAs with the U.S., and more countries are expected to participate in FATCA reporting. Switzerland has a Model 2 IGA with the U.S. Therefore, Swiss financial institutions that have accounts with US indicia have to register with the IRS and report their U.S. accounts directly to the IRS. The IGA between the US and Switzerland is not a reciprocal agreement.

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 qualified 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.

FATCA’s first conviction

The story behind the first 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 several other local and foreign law enforcement agencies.

On March 2014, with the help of a confidential informant (CI)  U.S. law enforcement officials were investigating various market manipulation schemes conducted by multiple Belize-based brokerage firms. During the Belize Investigation, law enforcement agents found out that there was an ongoing money laundering scheme involving bank accounts held by Loyal Bank.

On May 5, 2017, an 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 had offices in Saint Vincent Grenadine in the Caribbean and 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 accounts in the name of Belizean International Business Corporations (“IBCs”).

The undercover agent met with Mr. Baron at Loyal Bank’s Budapest 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 because he was a U.S. citizen, even though he was the true beneficial owner. Mr. Baron told him the bank does not do business with U.S. citizens, but said the undercover agent could open accounts on behalf of his Belizean IBCs and use a Belizean person as the nominee of the account while omitting the U.S. citizen’s information altogether. During the entire process, Mr. Baron never requested information from the undercover agent that would fulfill FACTA reporting requirements.

February 28, 2018, a federal grand jury in the Eastern District of New York charged Mr. Baron with money laundering conspiracy. On March 2, 2018, Mr. Baron was arrested in Budapest pursuant to a provisional arrest warrant filed by the United States. 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.

FATCA noncompliance now has consequences

FATCA is an 9-year-old U.S. law that is viewed with ambivalence by many tax professionals. When it first went into effect, foreign financial institutions had to implement new due diligence procedures and information reporting process. A Thomson Reuters survey found the majority of financial institutions spent between $100,000 and $1 million on FATCA compliance costs.5 A small percentage of financial institutions spent more than $1 million.6

Would FATCA work? Would FFIs report all the accounts they held with US indicia? An FFI could follow the proper registration processes with the IRS to obtain a GIIN, but falsely report that the institution does not have any U.S. accounts to report in the hope the IRS or the partner country’s financial authority would not discover those accounts. Someone at a reporting FFI may believe 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 risks being subject to a 30 percent withholding and other financial penalties. The officers of the FFI, especially those designated in the registration process as Ros, could be criminally prosecuted by the U.S. Justice Department and face possible prison time. The Loyal Bank and Mr. Baron’s case has demonstrated that U.S. authorities could, in fact, uncover previously unreported accounts with US indicia held in a reporting FFI. There are many ways the U.S. government could 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 now likely that the U.S. authorities will pursue more investigations and prosecutions for violating FATCA rules.

Conclusion

FATCA has significantly changed international tax law by requiring FFIs to disclose information to the IRS for certain foreign accounts and assets with US indicia. The Belize investigation  highlights the methods and the means used by the U.S. authorities to tackle tax fraud. The U.S. Justice Department routinely works with the IRS, U.S. Securities and Exchange Commission (SEC), Federal Bureau of Investigation (FBI), foreign financial authorities, foreign law enforcement authorities, and other financial and criminal investigatory agencies to bring entities and individuals who are trying 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 prevent possible scrutiny and even litigation, or criminal sanction, either by local or U.S. authorities.

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