Taxation

20 October 2014

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Illustrations by Martin Megino

The United States wants to round up non-resident tax evaders with its groundbreaking global FATCA legislation.

In the wake of recent agreements reached with Hong Kong and the Mainland, George W. Russell looks at the

repercussions for financial institutions

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T he Consulate-General of the United States in Cen-tral is a busy place at the best of times. The imposing Garden Road building is abuzz with Hong Kong res-idents and other non-U.S. citizens seeking visas and other official documents.

Americans, too, need the consulate for everything from passports to adoptions to notary services. One small but growing sub-section of U.S. citizens is making use of a less common facility: renouncing their citizenship in the wake of what they see as over-aggressive tax-collec-

tion policies by the much-feared Internal Revenue Service.While the number of Americans abandoning citizenship remains

tiny, it is growing sharply. There were 1,577 published renunciations in the first half of this year, on target to exceed the record-setting 2,999 published expatriations in 2013. This compares with 300 in 2009, and 170 in 2006.

It’s not just Hong Kong, where about 60,000 U.S. nationals reside. From Sweden to Singapore, more U.S. citizens say the reason for aban-doning their national heritage is tax obligations. The issue has been

TAX TENTACLES

underscored by high-profile renunciations, such as those of singer Tina Turner in 2013 and Facebook cofounder Eduardo Saverin in 2011.

Unlike most countries, the U.S. taxes its citizens worldwide income and requires an-nual filing. The last straw, say many, is the Foreign Account Tax Compliance Act of 2010, which compels foreign financial institutions to tell the IRS about assets held by their U.S. citizen account holders.

If these institutions fail to comply, FATCA mandates a 30 percent withholding tax on certain income and gross-proceeds payments made to them. Additionally, FATCA imposes requirements on account holders in financial intermediaries: if they do not comply, they are

subject to the 30 percent tax.The law now has an almost global reach

(see Signing up the world on page 25) and has caused substantial consternation among expatriates: some have sought to transfer their assets to the dwindling num-ber of non-FATCA-compliant countries. “I have clients and potential clients talk with me about their frustration, fear and confu-sion relating to FATCA,” says Christopher Chang, a Principal in American Pacific Tax in Hong Kong and an American Institute of CPAs member.

Although much media attention has been on FATCA’s effect on individual taxpayers, there is a heavy burden on non-U.S. financial institutions: not only retail and investment

banks but also life insurance companies, wealth managers, asset managers, brokers and custodians, among others.

Professional accountants, both in practice and business, can expect to be kept busy with FATCA. “Financial institutions will require input and professional knowledge from Insti-tute members,” says Frank Wong, Financial Services Partner with EY and a Hong Kong Institute of CPAs member. “Their expertise in operations, tax and compliance, as well as change and project management, can help FATCA compliance.”

Rush to complianceIn Hong Kong, FATCA’s effect on financial institutions is immense. Some financial in-

Taxation

22 October 2014

The very model of a modern tax agreement

A legal framework for Hong Kong to enter into standalone tax information exchange agreements with other jurisdictions was put in place only in July 2013.

Hong Kong’s first TIEA, concluded in March, was signed with the United States and under the legislation Hong Kong can enter into further standalone tax agreements with any jurisdiction with which it has signed a TIEA. That paved the way for the inter-gov-ernmental agreement over the U.S. Foreign Account Tax Compli-ance Act due to be signed by Hong Kong in the next few months.

The U.S. Treasury Department developed two model IGAs to encourage implementation of FATCA. The IGA models offer simplified reporting and due diligence procedures to reduce the compliance burden for financial institutions outside the U.S.

“The inter-governmental agreement was a kind of tailor-made agreement if a certain jurisdiction wants to exchange informa-tion with the U.S. under the FATCA regime,” explains Kenneth Leung, Legislative Councillor for the Accountancy Functional Constituency and a Hong Kong Institute of CPAs member.

The Model 1 IGA establishes a framework of reporting ac-count information on “U.S. persons” by financial institutions to the relevant domestic tax authority, which in turn provides the information to the U.S. Internal Revenue Service. As of 25 August, 88 jurisdictions had signed or agreed to the Model 1 IGA.

“We did not enter into a Model 1 IGA because under that model the Hong Kong Inland Revenue Department would be exchanging information with the IRS,” says Leung. “The current legal frame-work would have to be rewritten if we were doing this.”

IRD and officials encouraged the adoption of a Model 2 agree-ment due to the complexities of the Model 1. “If you decide for a Model 1 IGA, you will have to build the capability, the technology and the infrastructure within your local tax authority structure,” observes Tim Clough, a Risk Assurance Partner with Pricewater-houseCoopers in Hong Kong.

The Model 2 IGA establishes a framework of enabling relevant financial institutions to seek consent for disclosure from U.S. clients, and to report relevant tax information of such clients to the IRS. (If the U.S. account holder refuses consent, the financial institution has two options: withhold 30 percent of all payments or close the account). As of 25 August, 13 countries and territories had signed or agreed to this model.

On 9 May, the U.S. Treasury announced that Hong Kong had agreed in substance on the Model 2 FATCA IGA. Hong Kong was only the seventh jurisdiction to choose a Model 2 IGA. “Although we have already signed the TIEA with the U.S., this is a very gen-eral agreement and under FATCA you still need to sign an IGA,” says Leung.

Jurisdictions that have signed agreements (Model 1)

Jurisdictions that have signed agreements (Model 2)

Jurisdictions that have reached agreements (Model 1)

Jurisdictions that have reached agreements (Model 2)

Non-signatories

UNITED STATES

FATCAworld map

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stitutions have given up already, refusing to take on new U.S.-connected clients and, in some cases, closing the accounts of existing American customers.

“If you are an American, you are going to have a lot of problems opening an account in Hong Kong because banks do not want to be encumbered with the annual reporting to the IRS,” warns Guangzhou-based Institute member Laurence Lipsher, author of Larry’s Tax Guide for the U.S. Expat and Green Card Holder in User-Friendly English (2014: Asian Tax Review).

For other institutions, it has sometimes been a battle to be ready in time for the first of the FATCA provisions, which took ef-fect from 1 July. “FATCA has been hanging

around for the past three or four years now, but from 2010 to early 2013 they issued pieces of guidance and different types of reg-ulation that articulated what the law really was,” explains Tim Clough, Risk Assurance Partner at PricewaterhouseCoopers in Hong Kong.

While many Organisation for Economic Co-operation and Development nations signed on early, countries in the Asia-Pacific region – outside of Australia, New Zealand and Japan – were slow starters. “Regional and local institutions didn’t wake up to FATCA until late-2013,” says Clough.

Financial institutions were prompted to mobilize in relation to FATCA by the pros-pect of an inter-governmental agreement

between the U.S. and Hong Kong, agreed to in May although yet to be ratified (see The very model of a modern tax agreement on page 22). “The to-be-signed Hong Kong IGA was generally welcomed by financial institutions in Hong Kong,” says Charles Kinsley, Tax Principal with KPMG China and an Institute member.

However, misconceptions abounded. Some local financial institutions that had no U.S. account holders or investments thought they would be automatically exempt. “Under FAT-CA, it is the responsibility of the financial in-stitutions to demonstrate with procedural and documentary evidence that they do not have any U.S. holders nor receive financial income from the U.S.,” Kinsley points out.

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24 October 2014

An agreement with China followed in June. Clough was unsurprised by Beijing’s readiness to accede to FATCA despite its appar-ent extra-territorial nature. “China has an ele-ment of worldwide taxation,” he notes. “What also may appeal to the Chinese government is some of the IGAs we’ve seen have a reciprocal agreement. The U.S will force its banks to pro-vide information on Chinese investors.”

CPAs on front lineThe effort to meet FATCA’s compliance re-quirements was undertaken in a hurry. “The first half of this year saw an awful lot of activ-ity and an awful lot of questions and an awful lot of noise in the market,” says Clough. “I’m not sure how they did this, probably by a lot of blood, sweat and tears.”

FATCA’s compliance requirements focus

on six broad categories: registration with the IRS; identification of new customers; review of the pre-existing customer base; reporting of relevant data to the IRS; withholding of payments where necessary; and the estab-lishment of a certification programme that ensures they comply with the regulation and self certify on a regular basis.

CPAs have been at the front line of the pro-cess and can expect to have a vital continuing role. “Various departments across a financial institution, including the business, tax, com-pliance, legal, information technology and change management teams need to work to-gether,” says Wong at EY.

Given that FATCA is a new U.S. regulation, Hong Kong financial institutions can expect to encounter difficulties in interpreting the regulations and applying them to their oper-

ations. “Finding advisers who will help to ex-plain the complex set of rules and staggered implementation deadline is critical to making any FATCA project efficient,” Wong says.

Clough at PwC expects that Institute mem-bers with a compliance function will bear the brunt of responsibility. “This is very much about controls,” he says.

Furthermore, FATCA compliance is open-ended. “CPAs are going to have a large responsibility to ensure the on-going integrity of the certifications that the IRS expects,” says Clough. “They’re asking you to put in place a programme to ensure on-going compliance and when you find a deficiency or exception you have to self-report that.”

One aspect that lacks clarity is what re-sponsibility Hong Kong regulators have to ensure that financial institutions comply. Kinsley at KPMG asks: “Will the [Hong Kong] regulators enforce FATCA compli-ance and what action, if any, will the reg-ulators take with those who choose not to comply?”

Kenneth Leung, Legislative Councillor for the Accountancy Functional Constitu-ency and an Institute member, says Hong Kong’s Inland Revenue Department has already issued some guidelines. But Leung notes that the IRD remit does not cover en-forcement of foreign laws. “We are not work-ing for the IRS, so financial institutions need to follow up with the IRS under the IGA,” he says.

Globalized futureFATCA has blazed a trail for more extraterri-torial tax-related legislation. “By unleashing FATCA upon the world, the U.S. has given many other nations the green light to go after potential tax evasion by their own citizenry in ways they never would have before,” says Lip-sher in Guangzhou.

In July, the OECD published the first edi-tion of the Standard for Automatic Exchange of Financial Account Information in Tax (known as the Common Reporting Standard), which is intended to facilitate the automatic

FACTS ABOUT FATCA

The legislationTitle: Foreign Account Tax Compliance Act of 2010Introduced: October 2009 Passed: March 2010 House of Representatives vote: 217-201 Senate vote: 68-29

6 millionEstimated American citizens who live outside the U.S. as well as citizens and permanent residents with accounts outside the U.S. that are affected. These eligible persons must report foreign-held assets on U.S. tax returns if they are worth more than US$50,000.

95,000Banks and financial institutions from 220 countries and territories, including 2,426 financial institutions in Hong Kong have registered on the IRS site as FATCA participants as at 25 August 2014. The final list is expected to include up to 500,000 financial institutions.

US$100 billionAmount of taxes being evaded each year by U.S. citizens through the use of offshore accounts as claimed by Senator Carl Levin. However, the U.S. Treasury hopes to reclaim US$8-10 billion over the next decade through FATCA. The IRS says US$6.5 billion in unpaid tax and penalties have already been paid due to FATCA since 2010 through 45,000 Americans who voluntarily disclosed their offshore holdings.

US$30-80 million per bankEstimated compliance costs for a large retail bank, according to a study by Crossbridge, a London-based consultancy whose major clients are all from the investment banking industry. A more recent study by RBC Dexia Investor Services found that “about 85 percent of the banks estimated the cost of complying with FATCA at less than US$1 million and 54 percent expect to spend less than US$100,000. Only 5 percent of respondents are anticipating expenses over US$5 million.”

SOURCES: Crossbridge, RBC Dexia Investor Services, KPMG China, U.S. Government (Government Accountability Office, Internal Revenue Service)

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“ By unleashing FATCA upon the world, the U.S. has given many other nations the green light to go after potential tax evasion.”

Signing up the world

The Foreign Account Tax Compliance Act of 2010 has been one of the most controversial pieces of legislation passed in the United States in recent years. It was designed to be a financial offset to the Hiring In-centives to Restore Employment Act of 2010, which was signed by U.S. President Barack Obama as a measure designed to boost employment.

FATCA dramatically modified the withholding tax provisions and tax information exchange reporting regimes for a class of people known as U.S. persons, encompassing citizens, permanent residents, former permanent residents and non-Americans with personal and economic ties to U.S. individuals and entities through marriage, investment or directorships.

The principal provision was a new 30 percent withholding tax mandated on payments to foreign financial institutions that do not comply with disclosure requirements for those individuals and entities identified as U.S. persons.

One controversial aspect of FATCA was the shift of the burden of disclosure from the U.S. person to his or her financial institution. Non- compliant institutions, the U.S. Treasury Department warned, could be frozen out of U.S. markets. “Everybody who looks after money or financial assets for others may be affected by FATCA,” observes Michael Izza, Chief Executive Officer of the Institute of Chartered Accountants in England and Wales.

The U.S. mixed sticks with carrots to encourage compliance. The turning point was the inter-governmental agreement that offered a sig-nificant reduction in compliance requirements as well as the prospect of reciprocity. With more than 100 jurisdictions having either signed an IGA, or announced their intention to do so, FATCA is here to stay.

Canada is the country most affected by FATCA, given its high pop-ulation of U.S. persons. “The introduction of FATCA raises yet another U.S. issue for us to deal with in Canada,” says Kevin Dancey, CEO of CPA Canada. Several Canadian citizens, including two CPAs, have filed suit against the Canadian government, challenging the constitutionality of the IGA. (The cases are pending.)

One focus of interest was tax havens. Many observers were sur-prised by the IGAs signed by the U.S. with Switzerland, Liechtenstein, Bermuda and the British Virgin Islands. Indeed, the jurisdiction with the most Internal Revenue Service-registered institutions is the Cayman Islands.

“Cayman has made it clear that it intends to be a leading jurisdiction when it comes to the implementation of international standards on tax transparency,” says Nicholas Plowman, a Partner in Hong Kong with Ogier, an offshore law firm. “The IGA will place Cayman financial institutions in an advantageous position.”

exchange of financial information and has already been nicknamed GATCA, or Global FATCA.

About 45 countries have signalled their intention to early adopt these rules from 1 January 2015. While Hong Kong is not one of the early adopters, Secretary for Financial Services and the Treasury K.C. Chan said last month that Hong Kong was committed to implementing the Common Reporting Standard.

“The government will have to make another commit-ment quite soon to tell the OECD countries whether Hong Kong is prepared to go into the automatic exchange of in-formation regime,” says Leung, the LegCo member. “This is outside FATCA but the extent of information that we will be exchanging is still unknown,” he adds, citing that major ju-risdictions haven’t agreed on standardized rules.

Some differences have already been identified. While FATCA focuses on information reporting to the U.S., the Common Reporting Standard allows for information ex-change among all jurisdictions that have signed a multi-lateral agreement.

The Common Reporting Standard considers only the res-idency of an individual for information reporting, while FAT-CA takes U.S. citizenship or visa status into account. More-over, the Common Reporting Standard lacks the US$50,000 de minimis asset reporting threshold that applies to FATCA, “So far more accounts will be required to be reviewed than under FATCA,” Kinsley notes.

Institutions who will end up dealing with Common Re-porting Standard data will also have to make sure they abide by Hong Kong’s privacy laws. “Institutions and the business sector are very concerned about what kind of information will be exchanged and what are the safeguards,” says Leung. “I will need to ensure that confidential information, sensi-tive personal data and anything which is prohibited by law cannot be passed on to another jurisdiction.”

However, Hong Kong is unlikely to be able – or perhaps even desire – to stop the tide of greater global tax transpar-ency and more cross-border agreements. “FATCA is not the end,” says Clough at PwC. “It’s almost just the start.”