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August 11, 2011

Fatca(ts) Beware

By Spear's

The American government are forcing banks around the world to sack their US clients, says Kristin Konschnik, as the new FATCA rules take effect
IF THE US dollar is as close as we have come to a global currency — accepted everywhere from Fifth Avenue boutiques to Coca-Cola stands in Afghanistan — why are some American citizens finding it hard to put their money where they’d like?

According to several reports, and anecdotal evidence, some non-US retail and private banks are considering refusing to admit new, or terminating relationships with existing, US clients. A primary reason behind such a seemingly drastic move is the US Foreign Account Tax Compliance Act (FATCA). With the first phases of FATCA implementation beginning in January 2013, FATCA will require all non-US ‘foreign financial institutions’, including banks, brokerage houses, hedge and private equity funds, trust companies and perhaps individual trusts that directly or indirectly invest in the United States, to identify all their clients and transmit information regarding their US clients to the US Internal Revenue Service.

FATCA’s particular genius (from the US government’s perspective) is that it effectively leverages third-party resources to enforce US tax law. According to FATCA guidance, announced by the IRS, every non-US financial institution must implement, and certify compliance with, complex customer identification procedures. If any American clients are identified, the financial institution must send information regarding those clients to the IRS. Specific compliance procedures apply to ‘private banking’ relationships, requiring private bank managers to conduct a ‘diligent review’ of the client’s files and presuming a greater familiarity with the client’s potential US connections.

These increased compliance burdens are causing some financial institutions to re-evaluate their commitment to US markets and US clients, at least in the short term while banks come to grips with these rules. As a result, multi-jurisdictional high-net-worth individuals and families may find themselves forced out of existing banking or trust company relationships and have difficulty finding suitable replacements.

FATCA may be the most far-reaching, although not the first, of the recent US compliance efforts. Americans are subject to US tax and reporting on their worldwide income and assets, regardless of where they live. In recent years, Congress and the IRS have become increasingly convinced that many Americans, including those living both inside and outside the US, do not comply with these obligations.

To combat this perceived non-compliance, FATCA joins the existing FBAR reporting, recently enacted ‘foreign financial asset’ reporting, the 2011 Offshore Voluntary Disclosure Initiative (2011 OVDI), which follows a similar 2009 programme, and the recently formed IRS Global High Wealth (GHW) audit unit focused on GHW compliance. Together, these enforcement mechanisms may have a significant impact on HNWs.

FBAR reporting requires all Americans to annually report their non-US financial accounts, including bank and brokerage accounts, if the aggregate value of those accounts exceeds $10,000. Americans must also report certain debt and equity interests in non-US issuers under new ‘foreign financial asset’ reporting. The latter obligation was enacted simultaneously with FATCA and may allow the IRS to match FATCA and taxpayer reporting. There are stiff penalties for non-compliance and HNW clients, who often have complex structures, will need to ensure they comply with all applicable reporting obligations.

The FBAR is also a focus of the 2011 OVDI, which is the only IRS-approved method for eligible Americans with unreported offshore income and assets to ‘regularise’ their US tax affairs. Although some Americans become compliant by ‘quietly’ submitting their back returns and FBARs outside the 2011 OVDI, the IRS does not view ‘quiet’ filings as ‘valid’ for purposes of mitigating sanctions.

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Another indication that the IRS is concentrating on high-net-worth clients is the recently formed IRS Global High Wealth audit unit that focuses on understanding the complex multi-jurisdictional structures of high-net-worth individuals and families to increase compliance.

FATCA and other available enforcement tools will make it increasingly difficult for non-compliant Americans. Further, with some financial institutions such as private banks and trust companies re-considering their approach to US clients, even fully compliant American high-net-worth individuals, particularly those that live outside the United States, may find it more challenging to conduct their affairs as they wish.

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