What FATCA means to Singapore's financial institutions

FATCA is a term that must be familiar to anyone who deals with US institutions or US persons. By way of background, a 2008 Senate Homeland Security and Governmental Affairs Permanent Subcommittee report on Tax Havens estimated that the United States loses about $100 billion in tax revenue each year as a result of offshore abuses.

Fingers tend to be pointed at concealed and undeclared accounts held by U.S. taxpayers or their controlled foreign entities in particular. It is therefore natural that the government would seek to focus on taxpayers that structure their activities to avoid reporting the income from offshore accounts.

In March 2010, the Hiring Incentives to Restore Employment (HIRE) Act introduced a new U.S. withholding and information tax regime. These new rules are based on proposals that originally appeared in the Foreign Account Tax Compliance Act (FATCA) of 2009.

The stated purpose of the law is ‘‘to clamp down on tax evasion and improve taxpayer compliance by giving the IRS new administrative tools to detect, deter, and discourage offshore tax abuses.’’ FATCA is expected to raise $7.6 billion in tax revenue over a 10-year period.

The impact of FATCA is felt by three (3) groups. Firstly, it affects individuals with US tax filing requirements as they now have to comply with the requirements of Form 8938 which requires reporting of taxpayer’s specified foreign financial assets over certain thresholds.

Secondly, some governments have been signing information sharing agreements (called intergovernmental agreements or IGAs) with the US which means that offshore financial information of US persons will be shared.

Thirdly, some financial institutions based outside of the US (called foreign financial institutions or FFIs) are sharing the financial informations of US persons directly with the US or indirectly via their respective governments.

But what about FATCA as it applies to Singapore? On July 18th, 2013, the Singapore Ministry of Finance announced the opening of a consultation on proposed amendments to the draft legislation to facilitate FATCA compliance.

This development follows a previous announcement from the Singapore government that it plans to sign a Model 1 IGA and the US Treasury statement that the United States and Singapore were actively engaged in a dialogue towards concluding an IGA.

The Model 1 IGA, which Singapore is negotiating with the US, differs from Model 2 IGAs. With the Model 2 IGA, FFIs are required to enter into an FFI Agreement and report directly to the IRS, but with aggregate disclosure of so-called “recalcitrant” account holder data, subject to exchange of information requests by the IRS.

As at the time of writing, only Bermuda, Chile, Japan, and Switzerland have entered into Model 2 IGAs. Model 2 IGA governments are less involved in the compliance process and are leaving their financial institutions to come to terms with the FATCA process.

Various studies point to FATCA compliance costs being fairly high and so, it does make sense for some foreign governments which prefer to have FFIs shoulder the cost. With Model 2 IGAs, the foreign government is involved with the IRS only when called upon for information requests pursuant to the agreement.

Model 1 IGAs essentially see FFIs reporting to a local government entity which then forwards it to the US. Model 1 IGAs have been signed with Canada, the Cayman Islands, Costa Rica, Denmark, Finland, France, Germany, Guernsey, Hungary, Ireland, Isle of Man, Italy, Jersey, Luxembourg, Malta, Mauritius, Mexico, Netherlands, Norway, Spain, and of course, the UK.

On November 13, 2013, the Singapore Ministry of Foreign Affairs announced that discussions with the United States to finalize a Model 1 IGA were “progressing smoothly."

FFIs that need to register directly with the IRS are guided by IRS Revenue Procedure 2014-10. It is expected that the FFI agreement described in IRS Revenue Procedure 2014-10 will not apply to a reporting Model 1 FFI, or any branch of such an FFI.

The FFI agreement described in the Revenue Procedure will generally not apply because FFIs that are covered by, and comply with, a Model 1 IGA will send information directly to a specific entity within their own government who will in turn send it on to the IRS.

Thus, there is generally no need for such FFI’s to enter into a direct agreement with the IRS. Such an FFI will be treated as “deemed-compliant” with FATCA, and will generally not be subject to withholding.

Much will depend on how the negotiations proceed between the US and Singapore and the final wording of the IGA. A look at Annex II of the Model 1 IGA between the Cayman Islands and the US carefully identifies which FFIs are “deemed compliant”.

One would expect that the Singapore – US IGA will have a similar annex and it remains to be seen which FFIs will get a free pass. Like Switzerland, in Singapore many FFIs already turn away US clients.

It remains to be seen whether the FFIs that are specifically licensed by the Monetary Authority of Singapore (MAS), to solicit only non-Singaporean clients, will be deemed compliant by the future IGA. Given the risk and compliance costs, I would not be surprised if they are specifically excluded by the future IGA and are left to register directly with the IRS.

A question remains as to what FFIs should do in the meantime. Should FFIs consider self-registering to become participating FFIs (PFFIs)? To be honest, it cannot hurt to do so.

More importantly however, these FFIs should also start instituting their own verification and due diligence procedures or know-your-customer (KYC) processes. Regardless of the nature of the IGA, this will be a requirement. For larger institutions this tends to primarily be an IT exercise.

For small to medium sized firms (SMEs) however, it is more of an education process for their front line financial advisors. They need to be trained in how to spot clients with any “US indicia”.

The IRS has listed seven indicia of US status: US citizenship or permanent residence (i.e. a green card), US birth place, US residence address or US correspondence address, US phone number, Standing instructions to transfer funds to an account maintained in the US, a Power of Attorney or signatory authority granted to a person with a US address, and an 'in care of' address or 'hold mail' address in the US.

Also companies and partnerships have to be checked intensively whether they are substantially owned by U.S. persons i.e. whether the interest of a U.S. person in a company is higher than 10 percent (for some jurisdictions a higher ownership threshold may apply).

US Tax Counsel for Lloyds Bank, Dean Marsan, noted in a special report that IRS officials have apparently indicated that they intend to use the information FFIs provide on the FATCA portal for audit purposes and will be checking on whether withholding agents have improperly failed to withhold under section 1471(a).

IRS officials have also indicated they will match the information provided by the FFI about U.S. account holders and accounts held by recalcitrant account holders against the individual reporting by U.S individual persons the Form 8938, ‘‘Statement of Specified Assets Attached to Their U.S. Form 1040.’’

Marsan goes on to quote a former U.S. Treasury official involved in the FATCA implementation effort. He says that the IRS will evaluate the information it gets from a jurisdiction’s FFI. It also will receive information from U.S. taxpayers about the taxpayer’s foreign accounts so the IRS will have different sources of information it can use to match up and see if there are any issues with an FFI’s reporting.

Furthermore, it is also likely that the information the IRS obtains from FFIs that is submitted on the FATCA portal will be shared by the IRS with other FATCA partner countries if requested under existing tax information exchange agreements or bilateral income tax treaties.

By April 25th, 2014, FFIs must complete registration on the IRS’ FATCA portal to ensure inclusion on the initial IRS FFI list. On June 2nd, 2014, this first FFI and branch list will be published and the list will be updated monthly.

In practice withholding has already started but officially, it is on July 1st, 2014 that withholding is supposed to start on US source FDAP payments to financial institutions, non-financial foreign entities (NFFEs), and direct account holders of participating FFIs (PFFIs).

FDAP stands for Fixed, Determinable, Annual, or Periodical (FDAP) income such as Dividends, Interest, Original issue discount, Pensions and annuities.

One Financial Advisor with an SME FFI here in Singapore said to me that he does not think that his firm will have any compliance burdens because the financial products they offer are already FATCA compliant. They are as such, happy to rely on FATCA reporting undertaken by other members of their value chain.

This may be true for the FFI that has absolutely no custody of client assets so they never have any financial account on behalf of any client. But for those that do manage any financial accounts for clients, they will have to comply or completely avoid US persons.

Let’s keep an eye on the Model 1 IGA being negotiated. In the meantime, all of Singapore’s financial institutions need to get ready.