The US Government has long been concerned about US citizens hiding sums abroad in order to avoid US taxes, and between 2007 and 2010 the Internal Revenue Service (IRS) investigated several foreign banks, including UBS and Deutsche Bank, in light of allegations they had helped US taxpayers to hide billions of income abroad. This resulted in huge settlements being paid by those banks to the IRS.
In order to compel overseas banks and brokers to disclose US-owned wealth and to prevent these situations from occurring in the first place, the US Congress passed a federal law in 2010 called the Foreign Account Tax Compliance Act (FACTA) as part of a wider package of legislation.
Over 100 countries have signed agreements with the US to implement FATCA. If a country doesn’t sign up, the US tax authorities can impose a punitive withholding levy on income and capital gains on US-based investments for investors from that country.
The UK is one of the countries that signed up, and parliament passed legislation such that, with effect from 1 July 2014, FATCA became part of UK law.
The rest of the world
In 2014, the intergovernmental economic organisation the Organisation for Economic Cooperation and Development (OECD) created its own information-sharing standard based on FATCA called the Common Reporting Standard (CRS).
Again, the aim was to prevent tax evasion, but with CRS, its ambit was more global and cooperative than FATCA, given all countries that sign up agree to share information with all other countries.
Over 100 countries have signed up to CRS, from Cayman Islands to Switzerland to Singapore. These countries are referred to in the rules as ‘reportable jurisdictions’.
(There was also a short-lived reporting regime from a UK perspective towards the Crown Dependencies and Overseas Territories, known as a CDOT. However, this has since been folded into CRS.)
The UK signed up to CRS with effect from 1 January 2016. This means the UK is now legally bound to follow both FATCA and CRS.
What are the rules not about?
Before we get onto the rules, it’s important to mention that FATCA and CRS are not about blocking accounts for individuals who are tax resident elsewhere.
That said, US clients might find that some providers do still prevent them from opening accounts. There are various rules that apply to US clients based in the UK, which can make them more costly to provide accounts for. FATCA itself, however, does not require that accounts are blocked.
It’s also important to distinguish FATCA and CRS from MiFID II.
MiFID II is an EU directive that aims to prevent market abuse. Where it can appear similar to FATCA and CRS is that it requires providers to ask customers for their nationality.
Customers are also required to provide a National Client Identifier (NCI). In some cases, the same identifier can be used as an NCI in MiFID II and as a Tax Identification Number (TIN) in FATCA/CRS.
What are the rules about?
Both FATCA and CRS created a set of rules about due diligence and reporting. Fortunately, the rules for the two regimes are virtually the same, as CRS was modelled on FATCA.
The starting point is that these rules apply to financial institution (FIs), and FIs are responsible for conducting due diligence on all accounts they provide. FIs are then responsible for reporting certain accounts to HMRC for onward transmission to their counterpart tax authorities in other jurisdictions.
There are four different types of FI:
- depository institution;
- specified insurance company;
- custodial institution; and
- investment entity.
The first three are fairly self-explanatory and are all entities that we would recognise as financial services product providers of one kind or another.
The fourth type, investment entity, is more complicated, and some trusts and charities can inadvertently fall into this category even though they don’t really provide ‘accounts’ of any kind. We will come back to this later.
In terms of which accounts must be reviewed, it’s any account maintained for a specific and identifiable account holder.
Beyond that, the due diligence rules are split two ways: ‘new’ accounts and ‘pre-existing’ accounts; and ‘individual’ accounts and ‘entity’ accounts.
Entity accounts are those held by legal structures such as trusts, limited companies and charities. Individual accounts are those held by ‘natural persons’. This includes joint accounts.
There are slight differences in terms of how the due diligence is conducted, but they are both concerned primarily with identifying the country of residence for tax purposes of the account holder.
New accounts are those that were set up after the rules came into force in that country. Pre-existing accounts were those that were already open.
For new individual accounts, the FI will require the account holder to complete a self-certification. A self-certification can take any guise (and is often woven into application forms), but it must include the following information: name, residential address, date of birth, all countries of residence for tax purposes, and Tax Identification Numbers (TINs) for all countries of residence for tax purposes.
For new entity accounts, the FI must identify first whether the entity itself is deemed to be tax resident in a reportable jurisdiction. If so, the account will be reportable.
The FI must also identify if the entity falls into a classification called ‘Passive Non-Financial Entity’ (Passive NFE or PNFE).
There are various different entity classifications, which is one of the areas where the rules get very complicated. We won’t go into all of that here, but the PNFE classification is probably the most significant.
In terms of what a PNFE is, it is almost a default classification. If an entity account holder isn’t an FI in its own right (see later) and is not an Active NFE (i.e. an entity with income derived mainly from the trade of goods and services), it will be a PNFE.
The reason the classification is significant is because, if an account is held by a PNFE entity, the FI provider must then get a self-certification for each of the controlling persons (e.g. trustees, directors).
If a controlling person is tax resident in a reportable jurisdiction, the FI must report details of the account to HMRC for onward transmission to the jurisdiction in question.
In practice, a large number of trusts will fall into this classification.
For pre-existing individual accounts, FIs had to do a one-off sweep of their files for specific clues or indicators that the account holder was resident for tax purposes in a reportable jurisdiction.
For pre-existing entity accounts, it was a similar process, albeit it included checking the entity classifications as well.
Furthermore, any pre-existing account that has subsequently increased in value to more than $1 million as at 31 December in any year may be subject to additional checks.
In terms of implications for clients, an important point to be aware of is that HMRC-registered pension schemes and ISAs are exempt from FATCA and CRS. Providers will not need to conduct due diligence on these accounts or report them to HMRC.
General investment accounts, cash deposit accounts and some insurance products, however, are in scope for the rules.
Clients opening those accounts (and therefore their advisers) will find they are asked for information about their countries of residence for tax purposes. Given that FATCA and CRS are part of UK law, providers are required to ask for it, and they may refuse to open an account without it.
An individual’s country of residence is determined in accordance with each jurisdiction’s own rules – there is no central definition in FATCA or CRS – and it is virtually impossible not to have a country of tax residence.
Clients will also be asked to provide a TIN for each country in which they are deemed a tax resident. Again, this is just whatever identifier is used in that country for tax purposes. Very helpfully, the OECD has published a guide to TINs that covers most of the reportable jurisdictions, which you can access here.
Some jurisdictions do not use TINs – the United Arab Emirates, for example – and there may also be valid reasons why an individual doesn’t have one, perhaps if they moved to a country and never worked there. In which case, a provider should accept the fact there is no available TIN.
If you are advising trustees who are opening a new bank account or investment account, it is worth being aware that some trusts may be considered an FI in their own right if they are ‘managed’.
‘Managed’ in this context means (a) some of the trust’s funds are managed on a discretionary basis or (b) there is a corporate trustee that performs administration and management activities on a commercial basis for the trust.
The issue here does not relate to opening accounts. The issue is that if either of these criteria applies, the trust will be viewed as an FI, which means the trustees themselves will be responsible for conducting due diligence on anyone deemed to be an ‘account holder’ in respect of the trust (such as they exist). A failure to file reports can lead to penalties.
A corporate trustee is likely to be on top of the FATCA and CRS requirements. If you are advising on a trust where funds are being managed on a discretionary basis by you or by a DFM, it might be worth the trustees seeking specialist advice about their reporting requirements.
This can also apply to charities. Charities are exempt under FATCA but not under CRS. If a charity receives the majority of its income from investment returns rather than donations and any of the funds are discretionarily managed, the charity may be viewed as an FI, despite not being considered a financial organisation in the traditional sense.
Charity trustees might find they have reporting requirements they weren’t expecting. Specialist advice here will again be important.
This article was previously published by FT Adviser
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