FATCA implementation method remains uncertain for now

Government calling for private sector input

The financial services industry of the Cayman Islands is unable to plan effectively for the implementation of the US Foreign Account Tax Compliance Act, despite the deadline for the law drawing closer. Both the private sector and the Cayman Islands government are waiting for details from the United States on an alternative method of implementation based on an intergovernmental agreement different from the one already released in July earlier this year. 

FATCA requires foreign financial institutions to report the accounts of any US taxpayers, while foreign entities have to report substantial ownership interests of US persons to American authorities. Non-compliant organisations and account holders are facing a penalty withholding tax of 30 per cent on transactions involving the US under FATCA. 

The law, which is due to come into effect in July 2013 although most of the measures will not apply before 1 January, 2014, has been widely criticised in Europe for the burden it places on organisations to set up a reporting system and the potential duplication of efforts in the exchange of tax information. In response to the criticism, the US and five European countries – the United Kingdom, France, Germany, Italy and Spain – announced in February 2012 an intergovernmental agreement to improve tax compliance and to implement FATCA.  

A model agreement was released by the US Treasury in July 2012 and made available to other countries around the world. Instead of a direct reporting by foreign institutions to the US Treasury, which raises legal issues in some countries, the model establishes a framework for reporting by financial institutions of account information to their respective tax authorities, who then exchange the information automatically under existing bilateral tax treaties or tax information exchange agreements. 

“The intergovernmental agreements are a positive development for industry,” said David Conen, tax director with KPMG in the Cayman Islands, adding that between 60 to 80 countries are looking at concluding such an agreement with the US. 

The Channel Islands and the Isle of Man were the first offshore financial centres to announce that they would use the model agreement released in July.  

Speaking at the Global Compliance Solutions conference on Anti Money Laundering and White Collar Crime at the Grand Cayman Marriott Beach Resort on Thursday, 11 October, Mr. Conen said it will put competitive pressure on the Cayman Islands to conclude a similar intergovernmental agreement. 

“Cayman as a financial centre, in my opinion needs an intergovernmental agreement, because two years from now, if the Channel Islands got an IGA and Cayman did not and someone came to me and said where should I structure my fund, I would say go to a place with an IGA in place. That is the honest answer one would give,” he said. 

The reason intergovernmental agreements are positive, he added, is that the threat of having to close or withhold tax on most of the accounts is eliminated as long as an organisation’s investors are in partner countries with IGAs in place. 

While foreign financial institutions may still have certain investors from non-IGA countries, it would be a much smaller investor base to go through, he noted. “The closing and the withholding are the two scariest parts of FATCA.”  

The Cayman Islands government has formed a FATCA working group, which is in dialogue with the US government and the UK about the implementation of FATCA and considering the conclusion of an IGA with the US.  

Samuel Rose, the deputy chief officer in the Ministry of Finance and head of the FATCA working group, said the government is not required to do anything, but there are two other options in the form of intergovernmental agreements. In addition to the already released model agreement, a second model agreement, that may be more suitable for smaller countries, is expected to be made public by the US Treasury shortly.  

“Industry at this point in time needs to be concentrating on understanding model 1 and share this knowledge with government,” he said. “We cannot make a decision without the industry’s participation. You understand your business better than anyone else.” 

The second model will reflect the framework described in the two separate joint statements that were issued by the US with Japan and with Switzerland on 21 June, 2012.  

It will differ from the Model IGA released on 26 July in that financial institutions will provide information directly to the IRS, with the national tax authorities in jurisdictions with an IGA under this model agreeing to provide additional information upon request by the IRS.  

”The problem with the model 1 IGA is you have to have staff, you have to build a tax department and you have to have systems to take in may be 20,000 or in the BVI over 100,000 or 200,000 [foreign financial institutions] sending you information,“ Mr. Conen said. Creating these systems will pose a significant challenge for small governments with limited budgets, he added.  

“That is why model 2 seems better because you don’t have to build a system nearly as robust.” 

Mr. Rose said that the reporting required is not completely unprecedented in the Cayman Islands, given the reporting under the EU Savings Tax Directive, but conceded that reporting requirements will be greater. He added that government will approach the UK government to see whether there was the possibility to copy the system that the UK uses to lower development costs.  

In either case, government cannot make a decision without having evaluated the second model agreement, he said. “We want to see all the options first.” 

Mr. Conen agreed that it was prudent to wait until final regulations are issued. But this means financial institutions have to prepare for the various options, including entering into an agreement with the IRS, which would not be necessary under the model 1 IGA. 

Mr. Rose also warned that the US has made clear there will be no room for negotiation on the terms of the model agreements. However, each agreement contains an annex setting out financial institutions and products, for example retirement plans or tax-favoured savings plans, that will be deemed compliant or exempt under FATCA. This Annex 2 will be tailored to each partner country. 

The Cayman Islands government has therefore called for feedback from the various industry bodies, Mr. Rose said, to be able to negotiate the entities and products that should be included in Annex 2. 

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