FATCA: Why your bank is asking for more of your information

1 June 2016

Why does your bank suddenly want more of your information?

One word: FATCA.

The Foreign Account Tax Compliance Act, FATCA’s full title, is a system of information exchange instigated by the US Internal Revenue Service. The US Treasury Department website summarizes the act this way: “FATCA requires foreign financial institutions (FFIs) to report to the IRS information about financial accounts held by US taxpayers, or by foreign entities in which US taxpayers hold a substantial ownership interest.”

Non-US financial institutions must abide by FATCA in order to preserve their US-compliant status. The act is enforced by a network of intergovernmental agreements (IGAs) between the US government and certain foreign governments that recognize FATCA under local law.

A short history of FATCA

FATCA came into law in the US in March 2010 in response to US corporations and individuals perceived to be sheltering funds in overseas accounts to avoid (or evade) paying US taxes. To prevent this, FATCA forces foreign (i.e., non-US) financial institutions to report information on US account holders, or possible US account holders, to the IRS. Non-participating FFIs face a punitive 30% withholding tax on any fund flow from the US or from any participating FFI (even when those funds are not US-sourced).

One challenge that arose during the development of FATCA involved non-US data protection laws, which are typically more stringent than their US counterparts. To ensure that FATCA reporting did not contravene local data protection laws, and to obtain approval from other national governments, the US entered into intergovernmental agreements. Under these IGAs, FATCA information is typically reported to the local tax authority and then passed to the IRS, effectively avoiding local data protection rules. In return for receiving sensitive information under this structure, the IRS does not apply the aforementioned 30% withholding tax. In addition, the US will (in theory) reciprocate and report information on relevant foreign individuals and entities in the US to the cooperating tax authority. Finally, under an IGA, FATCA rules become local law, not just US law.

Given this fundamental shift in information reporting, FATCA has taken a number of years to come into full effect, with most reporting only taking place for the first time in 2016. This brings us to why your bank may be asking lots of questions now.

Why your bank may be asking you FATCA-related questions

Banks are the archetypal financial institutions, though there are less obvious examples such as investment holding companies, fiduciary service providers and custodians. Under FATCA, all foreign financial institutions including banks are required to review their client bases and determine whether any of their account holders are US persons or foreign entities in which US taxpayers hold a substantial ownership interest. (Classifying an entity under FATCA generally involves examining that entity’s activities and controlling persons.)

In May 2014, the IRS announced that the calendar years 2014 and 2015 would be regarded as a transitional period for the enforcement and administration of FATCA. Basically, during that period the IRS relaxed FATCA enforcement for those FFIs that made good-faith efforts to comply. That transition period came to an end this year. In light of this, many banks located outside the US are contacting their clients to obtain confirmation of their status as US taxpayers. Those banks may request that their clients provide an IRS Form W-8BEN (for individuals) or Form W-8BEN-E (for entities), which are used to confirm non-US tax residency status. Many non-US persons have never had to provide such information before and are naturally concerned.

Most people in this situation will need to provide limited information only, which should provide some comfort. Generally, if you operate a non-US trading entity, that entity will only need to confirm this and provide nothing else. Where the entity receives a majority of passive income (e.g., interest, dividends, royalties, etc.), it may need to report further information including information about its US owners. (If you are in any doubt about your status or what information you need to provide, you should seek professional help.)

Foreign financial institutions bear considerably more burdens than individuals and non-financial institutions under FATCA. As mentioned, banks are the archetypal FFI. However there are many less obvious examples, including investment holding companies, trusts and nominees (all of which are common in international group structures). In technical terms, an FFI is any entity that meets the definition of a depository institution, a custodial institution, an investment entity, a holding company or treasury center, or a specified insurance company.

If your institution is classified as an FFI, you may need to register with the IRS and report on your own account holders. Failure to comply may result in financial penalties, reputational damage and/or the loss of good standing with your local tax authority. Again, if you are in doubt about your status you should obtain professional advice.

FATCA’s intergovernmental agreements are part of a trend of increased international cooperation between tax authorities. And FATCA itself is just one effort among many designed to crack down on tax avoidance, including for example the Organization for Economic Cooperation and Development’s Base Erosion and Profit Shifting initiative (BEPS). The OECD has also launched its own international version of FATCA, called the Common Reporting Standard.

In short, businesses and individuals can from now on expect much greater scrutiny of their overseas activities, even where such activities are carried out through a separate legal entity. Many individuals and businesses are already finding such requests to be burdensome, and many may view them as unnecessary or as an infringement on privacy. But whether or not you think FATCA and similar global financial regulations are justified, there’s no doubt that failure to comply can bring severe consequences.