How Will The Islands Handle FATCA?

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A new American tax law that will have consequences for finance centre across the world will soon come into effect and the Channel Islands have to decide how to they are going to address it, explains Maxine Rawlins, Head of Tax, EY, Channel Islands.

ONE thing is clear about the Foreign Account Tax Compliance Act (FATCA): it is not going away and when it does take effect, its consequences will be far-reaching. What is not yet clear, however, is how Channel Island businesses will adapt.

Although a US law, FATCA will affect many of the world’s financial services organisations, including funds, banks and trusts. Funds will be affected and most fund managers will look to their fund administrators to assist with compliance. The trust industry will also be impacted with widespread and complex provisions potentially applying.

So how will FATCA actually affect businesses in the Channel Islands?

Given the complexity of FATCA, it will come as no surprise that there isn’t a simple, single answer to this question. In fact, there are a number of possibilities for the way that FATCA could be dealt with and the authorities in Jersey and Guernsey are considering which will be most suitable for the islands.

The first option would involve conformity with the FATCA regulations when issued in final form, leading many to enter into an agreement directly with the US Internal Revenue Service (IRS). This would likely involve the reporting of an annual return to the US authorities that details all US investors known to be involved with the financial institution. The consequences of not doing so would be the imposition of withholding tax on US source income and eventually proceeds. Although this sounds like a fairly easy process, the reality is that the job of identifying all US investors could be difficult and lengthy for Channel Islands businesses.

An outline of how the second option could appear was seen at the end of July in a model Inter-Governmental Agreement (IGA) issued by the governments of the US with France, Germany, Italy, Spain and the UK (EU5). Whilst a potentially more simplistic regime, it comes at the cost of the automatic exchange of information and will require adherence financial industries in those countries signed up to the agreements. We have now entered a period where we will wait and see which other jurisdictions will sign up to an IGA and what forms they will take.

It’s also worth bearing in mind that while an EU5 IGA-type agreement may make administration simpler for individual businesses, such free-flow of information is not something that the Channel Islands have traditionally endorsed or agreed to.

A third option for the Channel Islands would be to follow the Swiss-US Inter-Cooperation Framework (ICF), an outline of which has been announced and which does not include automatic information exchange. It does, however, implement FATCA legislation on individual businesses and places an obligation on them to deal directly with the IRS. With both the IGA and ICF some of the more complex elements such as withholding and pass-through of FATCA are minimised or obviated.

It is down to the Channel Islands’ authorities to determine the most suitable resolution but – as of the start of August – at the date of writing there is no clear indication of what this might be. Only when an announcement has been made will the finance industry gain certainty.

We do know that island businesses will have to identify how FATCA will affect them before July 2013, (the expected effective date of FATCA) or, if the Channel Islands sign an EU5-type agreement, by 1 January 2014. Once the effects have been identified, firms will have to modify their business and system processes to ensure that all existing US investors and their investments are identified and the relevant information is captured for submission in the annual return. They will then have to ensure that the ongoing risks of non-compliance are minimised.

FATCA compliance is likely to be a project that will require significant resources, but the cost of not complying will be greater. Firms that do not comply will face a potential 30% withholding tax, not only on US source income but also on the gross proceeds from the sale of investments giving rise to US source interest or dividends. This is financially costly in itself but the real cost of non-compliance will be in non-FATCA compliant businesses seeing themselves cut off from future US business as clients look to work with those that can provide evidence of a stringent FATCA compliance regime.

FATCA implementation is an unfolding saga that still has some way to run, but as the details become clearer, island businesses will be able to make arrangements that will see them ready for the new law, whenever it comes into force.