The FATCA legislation of the US is now in force but the kind of extra-territorial reach it has is being mimicked on a global scale. This article considers the implications.

In the following article, Dalila Ver Elst, senior compliance officer, and Anthony Markham, partner, at Maitland, the fund administration and law firm based in South Africa, write about further developments surrounding the US FATCA legislation that is now in force and taking effect by stages over the next few years. It points out that the extra-territorial reach of such laws is being copied by other nations, and new, global regime of anti-tax evasion – and avoidance – is taking shape.

As always, this publication is grateful for such an expert analysis and welcomes responses.

When the US first introduced the Foreign Account Tax Compliance Act (FATCA) it was described by the international banking community as the “neutron bomb of the financial world”. Knee-jerk reactions across the globe were that this effort was impossible. However, over the last four years the US has worked hard to make FATCA possible notwithstanding that, before the process started, it was simply illegal in many countries to submit information of the nature requested to a foreign tax authority.

How did the US achieve extra-territorial application of its legislation?

It didn’t. Yet we are all dancing to the FATCA tune and learning the appalling FATCA acronyms. How did it happen?

The first reaction from the international finance community was that compliance would not be permitted under local laws. The US said, “Fine, but just to make sure we are closing the tax gap, we will withhold 30 per cent of the proceeds (not profits) of any US investments that are redeemed to any foreign account.” Ouch. The international financial community and its governments had to talk. After all, almost all trade with the US does not involve tax evasion; and a 30 per cent punitive tax on proceeds even when an asset is sold at a loss, was untenable.

International co-operation was necessary and the spores of the information exchange fungus were packaged into two models of Inter-Governmental Agreements, known as IGA’s, unimaginatively called Model 1 and Model 2. Under a Model 1 agreement, financial institutions report to their own governments which transmit the information to the Internal Revenue Service; under Model 2, the financial institutions report directly to the IRS.  Both models overcome local legal barriers to FATCA so that financial institutions in those jurisdictions can comply with FATCA and not suffer a 30 per cent withholding tax.

There are 45 IGAs signed and a further 56 IGAs “in effect” between the US and other jurisdictions. Not surprisingly, partner jurisdictions like to receive something in return from the US, and in many cases the agreements are reciprocal (Model 1A). Model 1B agreements are not reciprocal and are preferred by countries that do not tax the foreign assets or income of their taxpayers.

Once it became apparent to tax authorities around the world that FATCA-type legislation could work for them too, negotiations for similar intergovernmental co-operation were spawned.  The UK got in early with its special intermediate toadstool for the UK Crown Dependencies and Overseas Territories, known as UK CDOT.  The process culminated in the Common Reporting Standard. Note that the CRS does not replace FATCA or UK CDOT, rather it is in addition to FATCA and UK CDOT.

What is the Common Reporting Standard (CRS)?
Countries that tax foreign gains of their taxpayers wanted to follow the US example. The Organisation for Economic Cooperation and Development and G20 developed the framework by which greater international tax transparency could be achieved. This culminated in the Common Reporting Standard, a reporting model based upon FATCA and endorsed by all OECD and G20 countries on 29 October 2014, providing for automatic exchange of information among them. The CRS is a multilateral exchange of information, unlike FATCA agreements which are at best bilateral. The multilateral exchange is due to begin in September 2017, certainly among the Early Adopters Group[1]. Others will follow in 2018.

Why was the CRS inevitable?
Tax evasion is recognised as a global problem which requires a global solution. FATCA was a US Treasury response to the simple evasive technique of some US citizens with foreign accounts, to use their foreign credit cards on those accounts whilst not paying taxes on funds in those accounts at point of entry.

Treasury investigations revealed that the use of credit cards was only the tip of the iceberg, and a drastic measure was required. What seemed impossible has been achieved, and it is very difficult today for a US person to maintain a financial account outside of the US without it being reported to the IRS. Penal taxes and criminal liability for tax evasion make an undeclared account a most undesirable prospect.

Secrecy in financial affairs was lost in the first round of the global response to terrorism which has brought about strict due diligence and know your customer obligations on all financial services providers and other designated businesses. As the information was dutifully collected and available, it was inevitable that tax authorities would want to see it. Once the US showed the way, requests for automatic exchange of information mushroomed.

How will CRS work?
Governments will enter into Competent Authority Agreements with one another, and will obtain information on accounts and their holders from financial institutions in their jurisdictions, and exchange it automatically on an annual basis. In principle it has been agreed that beneficial ownership of legal entities will be available and exchanged as well as financial account information. Like the obligations under FATCA and UK CDOT, the CRS requires financial institutions to report the financial information of accounts held by individuals and entities, including trusts and foundations, and by the controlling persons of passive non-financial entities.

When does reporting under CRS start?
In 2015 the implementation plans for automatic exchange of information are due to be submitted by participating jurisdictions. These will be reviewed by the Global Forum which will be responsible for compliance ratings of the jurisdictions.  In 2016 reviews will begin, and in 2017[2] or 2018[3] the first exchanges of information will take place. The mushrooms will be ready for harvest.

[1] Early Adopters are: Argentina, Belgium, Bulgaria, Colombia, Croatia, Cyprus, the Czech Republic, Denmark, Estonia, the Faroe Islands, Finland, France, Germany, Greece, Hungary, Iceland, India, Ireland, Italy, Latvia, Liechtenstein, Lithuania, Malta, Mexico, the Netherlands, Norway, Poland, Portugal, Romania, Seychelles, Slovakia, Slovenia, South Africa, Spain, Sweden, and the United Kingdom; the UK's Crown Dependencies of Isle of Man, Guernsey and Jersey; and the UK's Overseas Territories of Anguilla, Bermuda, the British Virgin Islands, the Cayman Islands, Gibraltar, Montserrat, and the Turks & Caicos Islands.

[2]Exchange of info by 2017:  Anguilla, Argentina, Barbados, Belgium, Bermuda, British Virgin Islands, Cayman Islands, Chile, Colombia, Croatia, Curaçao, Cyprus, Czech Republic, Denmark, Dominica, Estonia, Finland, France, Germany, Gibraltar, Greece, Guernsey, Hungary, Iceland, India, Ireland, Isle of Man, Italy, Jersey, Korea, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Mauritius, Mexico, Montserrat, Netherlands, Niue, Norway, Poland, Portugal, Romania, San Marino, Seychelles, Slovak Republic, Slovenia, South Africa, Spain, Sweden, Trinidad and Tobago, Turks and Caicos Islands, United Kingdom, Uruguay.

[3] Exchange of info by 2018: Andorra, Antigua and Barbuda, Aruba, Australia, Austria, The Bahamas, Belize, Brazil, Brunei Darussalam, Canada, China, Costa Rica, Grenada, Hong Kong (China), Indonesia, Israel, Japan, Marshall Islands, Macao (China), Malaysia, Monaco, New Zealand, Qatar, Russia, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and the Grenadines, Samoa, Saudi Arabia, Singapore, Sint Maarten, Switzerland, Turkey, United Arab Emirates.