FATCA’s Impact on Caribbean Financial Businesses on the Eve of the Final Regulations

The long anticipated Foreign Account Tax Compliance Act (FATCA) Final Regulations are now expected to be released in November 2012. On the eve of their release, it is clear that FATCA is not going away, and that this new US legislation will have far-reaching consequences for the financial industry worldwide. What is not clear yet is how Caribbean financial businesses will adapt and move forward with these regulations.

This article will provide an overview of the state of play of FATCA ahead of the release of the final regulations and outline the key issues facing Caribbean financial businesses including the possible benefits to those businesses if their country enters into an Intergovernmental Agreement (“IGA”) with the US.

Background

FATCA was designed to compel foreign entities to report information to the IRS about foreign accounts held by US taxpayers. These new reporting rules will impact foreign financial entities world-wide, including funds, banks, trusts and certain insurance companies, all of which reside with heavy concentration in the “offshore” world of the Caribbean. Once the Act comes into force, affected foreign financial institutions (“FFIs”) must either:

• Enter into a binding agreement with the IRS to identify US persons that hold affected accounts or financial instruments on a direct and indirect basis, and report certain information about them; or
• Pay a 30 per cent penal withholding tax on all US investment income and gross sale proceeds from US stocks and securities. The tax rate is so high it essentially means exiting US investments or entering into an FFI agreement with the US.

Avoiding the regime by excluding US assets and US investors from a business is not a realistic solution for most entities. Firstly, given how broadly US source income is defined, insulating a business from it will be difficult. Secondly, and more importantly, there is concern that counterparties such as prime brokers and custodian banks will demand that all FFIs be compliant in order to guard against the risk that an entity’s controls are not sufficiently robust to guarantee it will never have an exposure to US assets.

Although FFI’s still await the release of a draft FFI Agreement, it is expected the agreement will require the following from a participating FFI:

• Establish and maintain verification and due diligence procedures to identify US accounts
• Obtain documentation of each account holder to determine US or foreign status
• Report detailed information regarding US accounts to the IRS on an annual basis
• Provide the IRS with additional information regarding US accounts upon request
• Deduct and withhold 30 per cent tax on certain payments made to non-compliant holders known as “recalcitrant” persons.

6)    Exit the relationship if the FFI cannot obtain a waiver of local secrecy laws

Issues affecting the Caribbean Region

Deemed-Compliant Status

The proposed regulations contain criteria identifying certain types of non-US entities that are eligible for reduced compliance or even an exemption from FATCA compliance. For certain FFIs that are not likely to have US investors, or pose a low risk of having US investors, there is a “deemed compliant FFI” classification.

While the deemed compliant classification is a beneficial category, unfortunately the eligibility criteria for this classification is too narrow for most Caribbean financial businesses. For example some of the deemed compliant FFI categories prohibit website advertising of the availability of accounts in US dollars. As most Caribbean countries routinely conduct business transactions using the US dollar currency this is not practical for this region. Industry is hoping that the final regulations expand the deemed compliant FFI categories so that more Caribbean FFIs are deemed compliant FFIs.

Dual Nationality

FATCA is also likely to impact a large number of Caribbean residents who may fall within the scope of a US reportable person, and thus require the reporting of their bank accounts/investments in the region. Under FATCA, reportable US persons include anyone with a dual citizenship with the US, an American citizen living outside the US, a person born in the US, a green-card holder, or someone who has substantial presence in the US (generally meaning a person who is present in the US for at least six months). Given the Caribbean region’s close proximity to the US, it is not uncommon for Caribbean residents to have been born in the US and to hold a US passport. Because of this, many Caribbean “local” banks who believe they do not have any US investors may find themselves having a significant number of clients who have one or more US indicia. This will make the task of identifying and curing all US indicia more burdensome.

Privacy Laws

One of the conditions of entering into an FFI agreement with the IRS is to agree to obtain a waiver of confidentiality from investors or end business relations if privacy laws prevent the FFI from obtaining a waiver. Some Caribbean countries at present, including the Bahamas, have privacy laws which prevent companies from releasing information about their investors to third parties. Conflicts with local privacy laws and data protection issues are a significant impediment to FATCA compliance which must be addressed by those jurisdictions. A change or enactment of a new law to enable FATCA compliance may be a very slow process.

Intergovernmental Agreement (“IGA”)

In late July 2012, the IRS released a draft “Model I” IGA together with a joint message with France, Germany, Italy, Spain and the UK. This agreement sets out a government-to-government framework for implementing FATCA. The Model I agreement contemplates reporting by FFIs to their respective governments, followed by the automatic exchange of this information with the United States. The agreement would significantly reduce the burden of FATCA by eliminating withholding tax on payments and removing the necessity to close accounts with an investor if they are ‘recalcitrant’ or non-compliant. Unfortunately the Model I IGA does impose a significant resource and IT systems burden on the foreign government to first gather and then forward electronically the information on FFIs in its jurisdiction.

A more viable option for many Caribbean countries may be the “Model II” IGA which was announced in June 2012 in the form of a Joint Statement by the US Treasury with both Japan and Switzerland. The Model II establishes a framework of direct reporting by FFIs to the IRS, supplemented by information exchanged between the governments of the partner countries upon request. This agreement appears much more practical for most Caribbean countries as they will receive a lot of the same key benefits (no/reduced withholding tax requirements, no requirement to close “recalcitrant accounts”) enjoyed under Model I without the need for significant government resources to facilitate the reporting.

While to date only seven countries have clearly indicated they will be entering into an IGA with the US there are reportedly discussions ongoing with approximately 80 foreign countries. While some of these discussions are still very preliminary, at this point in time it certainly appears that the IGA regime is going to be very prevalent.

What should Caribbean FFIs be doing now?

FFIs can begin the journey to becoming FATCA compliant by establishing a FATCA committee within the business. This committee should have representation from key departments (Legal, IT, Risk Management, Investor Relations etc.) in the organisation so that there is a voice from each group at the table to discuss implementation issues and challenges. Additionally, one of the issues each FFI will face is determining who will act as the Responsible Officer (“RO”) for the FFI. The RO is truly a critical role. The RO is required to be an individual officer of the FFI in a position to register and sign the FFI agreement stating that the FFI will comply fully with the terms of the agreement. For many entities the path to implementation may accelerate once the RO is identified as they, knowing the assertions they personally need to make on behalf of the FFI as part of the agreement, will be a key driver in pushing the FFI into compliance with the FATCA regulations.

Many Caribbean financial businesses form part of a larger network of regional/global businesses. These FFIs are likely to fall within the affiliated group rules under FATCA and must establish what the global FATCA strategy will be for the group and start identifying the FATCA status (FFI, Deemed Compliant FFI, Non-Financial Foreign Entity etc.) for each legal entity in the group. Another consequence of the two different IGA models, and some countries ultimately not entering into an IGA, is that FATCA withholding/closing account requirements may vary from one jurisdiction to another.  This is an area that will need to be monitored closely.

For many FFIs the changes to customer information fields and IT systems will be very significant and a critical part of adopting a path to FATCA compliance in 2013. One of the challenges for the FATCA committee is to start looking at both the electronically searchable and paper records of the FFI and consider how effectively they can be reviewed as part of the enhanced review requirements for high value accounts. One of the positive aspects of the proposed regulations was the affirmation that enhanced review of clients will be required only for those with a balance of US$1 million or greater.

Key Deadlines

FFIs and their FATCA committee should closely monitor the anticipated flurry of FATCA releases over the next few months (September to December 2012). In particular, we expect the draft Model II IGA to have been released by the end of September 2012. After the Model II IGA is released, it is strongly advised that Caribbean financial businesses provide their comments to local government on whether it will be beneficial to their business if their local government enters into an IGA with the US.

Final regulations are predicted to be released sometime in November 2012 with the draft FFI agreement expected shortly afterwards. According to the latest information from the Treasury Department, the registration process to become a participating FFI will open on 1 January 2013 and FFIs will need to register by 30 June 2013 in order to ensure they receive a FATCA identification number (“FFI EIN”) before compliance is required. However, with significant changes expected in the FFI agreement, and the notable delays in the release of the final regulations, industry is currently expecting the cut-off date for changing client on-boarding procedures will be pushed back to 1 January 2014, which is in line with the deadlines in the Model I IGA agreement. The first reporting under FATCA is expected to start 30 Sept 2014.

Although several Caribbean countries have announced special task forces to deal with intergovernmental issues relating to FATCA, no Caribbean country has yet announced they will be entering into an intergovernmental agreement with the IRS. Industry is in a “wait and see” period of observation to see which other jurisdictions sign up to an IGA, and which Model of the IGA they agree to with the US.

Caribbean financial businesses cannot wait until their respective governments have decided what course of action they will take with respect to FATCA. There is simply not enough time between now and June 30, 2013. Rather, it is important to start preparing for FATCA now and monitor closely the developments this fall in addition to IGA announcements by their respective local governments.