Is there a silver bullet for FATCA?

There are no silver bullets for FATCAAnon

This is a phrase those of us working on FATCA for a number of years have heard many times.

To an extent this is true, another phrase we often hear is “FATCA is complex”.

No kidding, if ever anyone wanted to admire a problem FATCA would be a good place to look.

I’m going to argue that FATCA is actually quite simple and that there is a silver bullet. I will also argue that there are a few unexploded grenades and if you act quickly you can prevent the pins from being pulled out of those grenades right next to your customers.

(No you can’t pull out the pins and throw the grenades at the regulators.)

FATCA is about four things: Documentation (sometimes called CDD) Reporting and Withholding.

Those of you who know a little about the author might now be thinking that I must have been a terrible accountant (because that is only three).

The fourth would be Governance, under which I would include the Compliance the Responsible Officer, Attestations and Certifications. (To digress, I would argue that these concepts apply across both IGA and Non IGA jurisdictions but with certain distinctions – perhaps a topic for another paper.)

There you have it:

  1. Due Diligence / Documentation
  2. Withholding
  3. Reporting
  4. Governance / Compliance / Certifications

FATCA has been around for more than four years now. Hopefully most of us now fully understand that divesting from US markets and exiting American customers won’t get us “off the grid” for FATCA. Such an approach robs institutions of American revenue streams and leaves the cost of FATCA largely unchanged.

The challenge is that FATCA assumes everyone is an American until there is evidence that they are not – exiting American customers does nothing to help with the burden of evidencing that our remaining clients are not Americans. Again, this would be a subject for another paper – but my hope is that by now no one seriously believes that exiting the US market and US customers is a good strategy.

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In the illustration above the Due Diligence/Documentation is foundational. This is because:

  1. If you get the Documentation right you would only be reporting on the right entities and individuals.
  2. If you don’t get the Documentation completed appropriately amongst the whole population you Report and Withhold on not just tax evaders but also those who simply were not motivated to provide the documentation within the deadlines because they were not approached and educated soon enough (lay people).
  3. Failure to meet the Documentation deadlines will lead to Governance, Compliance, Attestation and Certification complications (regardless of whether the jurisdiction is covered by an IGA) because the Responsible Officer has to attest to the IRS that the CDD deadlines were met. (Please don’t assume that an IGA will remove such certifications locally.)

We can appreciate then that unless the FATCA CDD is robust and achieved within the deadlines then the whole of the rest of the FATCA program becomes contaminated because you’ll have reported and withheld on customers not all of whom were tax evaders (but just missed the deadline) and because the Responsible Officer will have to make a qualified attestation to the IRS (or competent tax authority in IGA countries) about having met the deadlines (or not).

Revealing to the IRS that the FATCA Documentation Deadlines were missed is not on the ‘happy path’.

This is the grenade I alluded to earlier – you must act swiftly to convert those customers without FATCA Documentation if you are to avoid reporting and withholding on a population of customers who are not truly tax evaders.

Having explained where the grenade is I will now explain where the silver bullet is.

Allow me briefly to introduce some salient metrics:

  1. We know under QI (FATCA’s predecessor) that when QI was introduced only 20% of W8s were fit for purpose. We also know that 13 years after QI’s inception that only 35% of W8s are fit for purpose.
  2. We also know that on average after a financial institution solicits a pre-existing customer for a new W8 it takes between 5 – 7 months for that W8 to be submitted (valid or otherwise).

There are some large estimates out there for how much FATCA will cost the industry. The costs are not in reporting; reporting is nothing new – the challenge of reporting for FATCA relates to prerequisite fields that can only come from having completed FATCA CDD. Nor is the bulk of the expense on Withholding; withholding only occurs on Non Participating FFIs and Recalcitrant Account Holders.

I would categorize the population of Recalcitrant Accounts and Non Participating FFIs into to two account groups:

  1. True tax evaders (candidates for offboarding?).
  2. Those who need educating as to why it is in their interest to provide FATCA documentation (lay people).

Lay people can be converted. Not all lay people are the same, that is true, but the sooner we reach out and educate those customers, the fairer we treat them and the greater the changes of early conversion.

Inevitably some customers will leave their existing banks because they feel that how they were treated for FATCA purposes was less than exemplary (not that they would phase it that way).

Is there any institution that truly wants to withhold and report on customers who are not tax evaders? Of course not, but that is what we risk if don’t act.

It is worth pointing out that in IGA Countries the concept of recalcitrant and non-participating are redundant for FATCA purposes. In those Countries FATCA compliance becomes law in line with their own IGA (and implemented legislation). Only individuals and entities operating outside the laws in the IGA country would be withheld upon. Arguably such accounts would be candidates for offboarding providing that local laws allow for such.

The point being here that FATCA is not about Withholding. Withholding under FATCA is not a tax, it is a penalty: a penalty for failure to provide documentation.

To reiterate, FATCA is not a reporting problem, because reporting itself is nothing new, what is new is the data that is to be reported. That data comes from Client Documentation. FATCA is not about Withholding either; withholding is a penalty for non compliance.

Reporting still has to be done of course.

This leaves Governance. If CDD is robust then the required reporting should be relatively easily. Hence, Governance would be a simple matter.

Of course, I am over simplifying – but hopefully the over simplification is helpful.

Nail down your FATCA CDD if you want a well-run, efficient, effective FATCA programme.

There are other things that can be done such as a judicious off boarding program as well as future proofing for the OECD’s AEoI or “CRS” (Common Reporting Standard) but these are issues for another paper.

Recently, the IRS issued notice 2014-33 under which US FATCA is “transitional” for 2014 and 2015. My own fear was that many institutions would take their “foot of the gas”. Not a bit of it. Not a single institution that I have spoken to is treating either 2014 or 2015 as transitional. In fact, some are planning to complete ALL their FATCA CDD well within the regulatory dates (no small undertaking).

Having explained that FATCA CDD is the silver bullet how might that silver bullet be applied/targeted?

In a word: mutualization.

Most of us realize that FATCA is not a withholding or reporting problem and that is it a documentation problem, we don’t have that documentation in many cases – this makes it an outreach problem.

Given the metrics above, 5-7 months and 35% of W8s being fit for purposes when submitted and we apply those metrics to the customer base for whom we must reach out, obtain W8s or W9s (or substitutes), validate those withholding certificates (and then repeat in 65% of cases where the submission was ‘invalid’) we can rapidly appreciate the size and scale of the challenge.

The IRS estimates that 400,000 – 600,000 FFIs will register on its FATCA portal. Many experts put the true figure north of 1M.

Now imagine every registrant approaching its customers and counter-parties for withholding certificates and other documentation. It is estimated that there will be 900M withholding certificates (for entities alone) requiring validation for FATCA purposes.

The problem is that many entities operate with many banks and that each bank will obtain its own withholding certificate from that customer. Recent changes to the US tax code allowed for digital W8s, this is huge step forward but much more still needs to be done.

What the market needs is a repository that will house all withholding certificates for all market participants (and will share this information freely). The market needs this because:

  1. Presently each bank approaches their customer for the same documentation.
  2. The documentation captures no commercially sensitive information (a possible exception being DR-NFFEs, but they report directly to the IRS and can simply share a W8-BEN-E declaring their GIIN and that they are a DR-NFFE).
  3. Every bank is currently validating individually every withholding certificate it solicits.

There is a massive amount of duplication here, most of which is redundant.

This is hugely inefficient and does not benefit financial institutions, nor their customers.

Worse still, this is a terrible customer experience. What customer wants to be contacted by multiple banks for the same documentation? Furthermore, what customer wants to be re-contacted for a resubmission of document where the original documentation proves invalid? Worse still, what if the response times of the banks are staggered resulting in the customer finding it hard to keep track of which version of the documentation the particular bank currently calling them is working with?

The finance industry as a whole needs a repository to address this.

Some financial institutions have grouped together under a consortium for this purpose but the way they have done it won’t work because the umbrella they have formed contains none of the names of the banks it represents. Hence, retail investors won’t recognize the party requesting the information and certainly will not submit a withholding certificate to a source it does not recognize.

Customers who would submit a withholding certificate to such a platform are likely to be those who know about FATCA and understand the requirement. Customers like these are the “low hanging fruit” i.e. they would readily supply a withholding certificate and hence are not part of the true FATCA outreach challenge.

In Europe we have a number of repositories that routinely collect entity data for compliance with existing regulations. In Europe it is often claimed that these same repositories are the solution for FATCA. Not so – yes, institutional investors know these platforms and may use them for FATCA purposes but institutional investors are not the problem.

The problem is retail investors who don’t know about FATCA – i.e. the vast majority.

Even if all your customers are institutional investors, do the current platforms facilitate reaching out to customers if the information contained on the platform is at variance to your pre-existing KYC? What if you have “reason to know” that the information on the platform is incorrect? This is going to happen.

At best pre-existing platforms with no dynamic customer outreach address FATCA’s low hanging fruit, to that extent they are useful and should be used to convert those customers easily converted into FATCA compliance.

But what of the rest – the vast majority?

The true challenge remains those customers who do not use such platforms. This is to say nothing of such customers who have no intention of using pre-existing platforms for FATCA.

Interestingly, many of these platforms charge for use of the data. This is interesting because the data belongs to the customer, not the platform.

The value of such a platform (in the context of FATCA) is where:

  • it contains a VALIDATED customer withholding certificate
  • it contains one version of the truth
  • data can be challenged and confidence intervals set
  • customers can self service and correct their data
  • customers can point to it as the de-facto repository for FATCA rather than being inundated by requests by their various banks and their own customers and suppliers wishing to verify their FATCA status.
  • transition to the AEoI’s Common Reporting standard is offered.

Of course the value of such a platform can be simplified thus:

  1. Customers only have to be contacted once –

    no subsequent outreach for FATCA purposes is required by the entire industry

  2. If the customer needs to submit and/or modify documentation they can do it in one place, once, that information is available to the whole industry and the whole industry is notified.

This is a better experience for the customer and it is a far more efficient and effective way for Financial Institutions to achieve (and be seen to achieve) regulatory compliance.

Of course, for this to be achievable customers need to be able to ‘opt in’. This could be achieved by adding, say, a tick box permissioning this on the Withholding Certificates themselves. This is perhaps something the IRS should be lobbied on.

Why would customers want to opt in? Well, quite simply, once they have been persuaded that completion of a Withholding Certificate is necessary they may well be sympathetic to not having to repeat the process unnecessarily.

I have yet to meet anyone who wanted to complete the same withholding certificate twice.

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