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How the Foreign Account Tax Compliance Act Will Impact Foreign Financial Institutions and How to Incentivize Compliance

What is FACTA and who is affected by it?

The Foreign Account Tax Compliance Act (FATCA), coming into effect in July 2014, requires any Foreign Financial Institution (FFI) that elects to comply with the Act to do three things: 1) identify its U.S. account holders; 2) annually report the account holders to the IRS; and 3) withhold thirty percent (30%) on certain payments to foreign payees if such payees do not comply with FATCA.1  A FFI is defined as “any financial institution which is a foreign entity”, excluding financial institutions which are organized under the laws of any possession of the United States.”2 Under this broad definition, FFIs include venture capital funds, private equity funds, mutual funds, banks and other investment vehicles.3

FACTA generally applies to two defined payment types: “withholdable payments” and pass-thru payments.4 A “withholdable payment” is subject to certain exceptions:

(i) any payment of interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income from sources within the United States; and (ii) any gross proceeds from the sale or other disposition of any property of a type which can produce interest or dividends from sources within the United States.5

A pass-thru payment is defined as “any withholdable payment or other payment to the extent attributable to a withholdable payment.”6 Withholding on pass-thru payments will go into effect upon July 1, 2014.7 Accordingly, even if funds have no direct U.S. investment, their payments could be withheld due to payments made by other complying financial institutions. Ultimately, directly or indirectly, FATCA will affect virtually all non-U.S. entities that receive most types of U.S. source income.8

How will FACTA affect FFIs?

FACTA can have two possible impacts on FFIs. It may change the current operating system of FFIs, or, in the alternative, may make FFIs bar Americans and American assets. If an FFI chooses to register with the IRS, it is required to provide information  regarding each U.S. account maintained, including the name, address, and Taxpayer Identification Number (TIN) of each relevant account holder, account number, account balance or value, and gross receipts and withdrawals or payments from the account.9 According to one estimate, it will cost every large multinational institution one hundred million dollars to comply with FACTA.10 Another estimate predicts that it will cost each foreign bank with more than twenty-five million accounts two hundred and fifty million dollars to comply.11 These compliance costs would adversely affect existing FFIs by putting a financial burden on them and may also create a barrier to entry for start-ups.12

FFIs that choose to comply with FACTA would have to considerably adapt their processes and systems, including those related to client identification and documentation, reporting, and customer relationship management.  Because FACTA is transforming how asset managers track, collect and report data about their investments and clients it has been described as “not simply a compliance exercise; it’s one in a string of reporting requirements that are reshaping the industry at its core.”13 Unsurprisingly, FATCA will require changes to account opening and investor on-boarding procedures for new accounts in the form of stricter documentation and due diligence requirements.

Some FFIs, on the other hand, may simply drop American clients and investments. If FFIs do not register with the IRS, they will then be regarded as “non-participating” and a thirty percent withholding tax will be applied to all of their income on American assets starting in 2014 and to the proceeds from the sales of these assets starting in 2015. Reportedly, HSBC Holdings PLC, Deutsche Bank AG, Bank of Singapore Ltd., and DBS Group Holdings Ltd. have rejected U.S. citizens as clients.14  A similar situation could happen with American investments if FFIs come to the conclusion that the costs of compliance outweigh the benefits.

How can FFIs be incentivized to comply with FACTA?

One possible method to incentivize compliance with FACTA would be to create safe harbor provisions similar to the “prior year safe harbor”, whereby taxpayers pay in one hundred percent (100%) of the prior year’s income tax as estimates.15 FACTA’s high compliance costs are partially driven by the fact that FFIs need to annually report to the IRS. Accordingly, a safe harbor provision such as that of income tax would reduce the compliance costs and incentivize more FFIs to report to the IRS.  Another incentive is to create tax credits or tax deductions for compliance. In addition, the IRS could incentivize compliance by compensating FFIs for their costs. The IRS could compensate FFIs for all compliance costs16, or create different compensation mechanisms based on the compliance costs.  Such incentivized compliance would fulfill FACTA’s original objective of reporting foreign financial assets.17


  1. 26 U.S.C. § 1471(b)(1) (2012). 

  2. Id. 

  3. FATCA Information for Foreign Financial Institutions and Entities, http://www.irs.gov/Businesses/Corporations/Information-for-Foreign-Financial-Institutions (last visited Sept. 18, 2013). 

  4. Thomson Reuters, FACTA: FAQS, http://fatca.thomsonreuters.com/about-fatca/faqs/(last visited Sept. 18, 2013). 

  5. 26 U.S.C. § 1473(1)(A) (2012). 

  6. 26 U.S.C. § 1471(d)(7) (2012). 

  7. Steven T. Miller, Regulations Relating to Information Reporting by Foreign Financial Institutions and Withholding on Certain Payments to Foreign Financial Institutions and Other Foreign Entities, Internal Revenue Service Website, http://www.irs.gov/pub/newsroom/reg-121647-10.pdf (last visited Sept. 18, 2013). 

  8. FATCA Frequently Asked Questions (FAQs), Deloitte, http://www.deloitte.com/assets/dcom-unitedstates/local%20assets/documents/tax/us_tax_fatca_faqs_061711.pdf (last visited Sept. 18, 2013). 

  9. 26 U.S.C. § 1471(c)(1) (2012). 

  10. Robert W. Wood, FATCA Carries Fat Price Tag, Forbes, (Sept. 19, 2013, 5:32 PM), http://www.forbes.com/sites/robertwood/2011/11/30/fatca-carries-fat-price-tag. 

  11. Christopher Matthews, FATCA Creating a Compliance Gold Rush, Wall Street Journal Blog, (Sept. 18, 2013, 3:23 PM), http://blogs.wsj.com/corruption-currents/2012/05/01/fatca-creating-a-compliance-gold-rush/. 

  12. Samer Ojjeh et al., Asset Managers Preparing for FATCA: Bracing for Major Changes, EY Website, http://www.ey.com/Publication/vwLUAssets/CK0553_EY-Asset-managers-preparing-for-FATCA/$FILE/CK0553_EY-Asset-managers-preparing-for-FATCA.pdf (last visited Sept. 18, 2013). 

  13. Id. 

  14. Sanat Vallikappen, U.S. Millionaires Told Go Away as Tax Evasion Rule Looms, Bloomberg, (Sept. 17, 2013 1:23 PM), http://www.bloomberg.com/news/2012-05-08/u-s-millionaires-told-go-away-as-tax-evasion-rule-looms.html. 

  15. Ashlea Ebeling, Why High Income Earners Need to Pay Extra Attention to 2013 Estimated Tax Payments, Forbes, (Sept. 17, 2013, 3:32 PM), http://www.forbes.com/sites/ashleaebeling/2013/02/15/why-high-income-earners-need-to-pay-extra-attention-to-2013-estimated-tax-payments. 

  16. See David Gamage & Devin J. Heckman, A Better Way Forward for State Taxation of E-Commerce, 92 B.U. L. Rev. 483, 504-11 (2012). 

  17. Id