The Foreign Account Tax Compliance Act (FATCA) is likely to radically alter how asset managers conduct business on a global scale. With final regulations to be issued in July, financial institutions must then take immediate steps to prepare for this game-changing legislation or risk stiff fines.
Closing Tax Loopholes
An outgrowth of the Hiring Incentives to Restore Employment (HIRE) Act of March 2010, FATCA is part of a government effort to close loopholes that have allowed U.S. investors to avoid taxation by stashing funds in offshore accounts held through foreign financial institutions (FFIs). FATCA originally required these institutions to enter into an agreement with the Internal Revenue Service to provide financial data pertaining to the investment activity of their U.S. clients. Firms that failed to do so would face hefty tax penalties.
Most recently, however, U.S. authorities have agreed to pursue an inter-governmental framework with a number of European countries-the UK, France, Germany, Italy and Spain-for the implementation of FATCA. Under the new proposal, FFIs in these FATCA-partnering countries would not have to enter into a detailed agreement with the IRS, but only "register" with the tax authority. This latest development alleviates many of the industry's legal and compliance concerns that were present with the original proposal.
Additionally, Asian financial institutions, including those in Hong Kong and China, will need to make significant process and technology changes to comply with FATCA. The diverse jurisdictions across Asia-Pacific increase implementation challenges. Some countries have data confidentiality and privacy laws that restrict financial institutions from releasing customers' information to third parties unless proper consent has been obtained from customers.
However, it does not lessen the penalty for non-compliance. Companies that continue to maintain U.S.-based accounts without disclosing these relationships to the IRS would be subject to a 30% withholding tax on interest, dividends and other income derived from domestic entities based offshore. FATCA would also penalize institutions issuing payments to non-compliant foreign investors. Firms that conduct business in the U.S. would be classified as U.S. financial institutions (USFIs), and would also be liable for withholding under FATCA.
Far-Reaching Impact
Not only does FATCA touch almost every asset management firm, but its changes will reverberate throughout all areas of a financial institution from compliance departments to IT to operations. FATCA is more than a tax issue. It is a global business issue and an enterprise-wide challenge.
In spite of the importance of compliance-and the heavy fines for non-compliance-financial institutions have been slow to ramp up for FATCA. The heightened due diligence and process changes required to meet the legislation's complex documentation, withholding and reporting requirements are overwhelming. And, the cost of implementing FATCA is far-reaching. It spreads beyond U.S. taxpayers to the entire global financial services community-including fund managers -who will be saddled with the cost and responsibility of handling the bulk of the massive tax collection exercise.
The Clock is Ticking
The U.S. Treasury and IRS are expected to issue final rules for FATCA in July 2012 with requirements for documentation, withholding and reporting to take full effect by 2013. That means asset managers must act now to ensure that all funds, investors and affiliated entities along the global payment chain will be FATCA-ready by the time the new legislation kicks in. While the burden is on the transfer agency to provide an IRS number for all U.S. investors in non-U.S. products, the cost of non-compliance impacts investors and institutions alike. Companies that fail to meet key implementation dates will be exposed to substantial tax liabilities and hefty fines. And, they will find themselves at a competitive disadvantage to firms that are compliant.
Flexibility is Key
Buy-side institutions have dedicated an enormous amount of time and resources to implementing solutions that satisfy global tax mandates.
Disjointed tax policies and diverse laws from one country to another only add to the complexity. To ensure operational effectiveness and compliance, asset managers must aggressively monitor country tax codes. Adjusting their accounting and reporting systems on a flexible basis, jurisdiction by jurisdiction and law by law is the first step.
As FATCA looms near, the winners will be those asset management firms that can adapt quickly to new regulations and changing tax jurisdiction issues regardless of country. To meet the new standards for regulatory compliance, asset managers need to put a best practice strategy in place.
While the mechanics and technical details of FATCA are still unfolding, buy-side firms should start by assessing their existing processes, systems and operations and take steps now to identify gaps and remediate for compliance. Doing this is the difference between being FATCA ready or letting your institution face heavy loses or death by non-compliance.
Doug Morgan is president of SunGard's institutional asset management business.
