Summary of the US Foreign Account Tax Compliance Act ("FATCA")
The US Foreign Account Tax Compliance Act (“FATCA”) is intended to address tax avoidance and evasion by US persons (citizens and permanent residents) who have financial resources outside the US. It operates in three main ways:
1. Disclosure of account information:
It requires foreign financial institutions, such as banks, to agree with the IRS to identify all their US account holders and to disclose the account holders' names, tax numbers, addresses, and the accounts' balances, receipts, and withdrawals.
This disclosure obligation is not enforceable as such against the foreign institutions but there is a cost imposed on those which do not comply. US based payers making any payments to non-compliant foreign financial institutions must withhold 30% of the gross payments and account for that to the IRS.
Foreign financial institutions which are themselves the beneficial owners of such payments cannot get a credit or refund on withheld taxes unless they are in a country which has a tax treaty with the US, which overrides the credit denial. This is directed primarily at foreign institutions operating in tax havens which do not typically have a tax treaty with the US. It means that unless they disclose, they stand to lose 30% of the value of payments to them from any US source.
At a practical level this means that if a NZ based person who is an investor into the US is receiving payments from that country into a NZ bank which has not entered into a FATCA agreement, the payments will be subject to a 30% withholding, no matter how the payment is characterised. Despite the existence of a tax treaty between NZ and the US, 30% is a significant hole in cash flow. Most if not all NZ financial instructions will not want to be exposed themselves to such withholding or to subject their customers to it, so they will inevitably agree to information disclosure. This will mean that the account details of a NZ based investor who is a US person will be routinely sent to the IRS.
If a disclosure agreement is not made, and the NZ based investor is a US person, then that person’s desire to claim a credit for, or refund of, the withholding tax taken in the US, will compel disclosure of their offshore affairs in all events.
2. New reporting obligations for US persons:
U.S. persons owning foreign accounts or other specified financial assets must report them using a new form which is filed with the person's US tax returns. There is a general reporting threshold of US$50,000 but a higher reporting threshold applies to overseas residents and others.
The reporting obligation is buttressed by the disclosure regime above and by increased penalties and a longer exposure to the risk of audit.
Account holders will be subject to a 40% penalty on understatements of income in an undisclosed foreign financial asset. Moreover, understatements of greater than 25% of gross income are subject to an extended statute of limitations period of 6 years, during which the IRS may assess. FATCA also requires taxpayers to report financial assets that are not held in a custodial account, eg physical stock or bond certificates.
3. Loophole closure:
It closes a tax loophole that foreign investors had used to avoid paying taxes on U.S. dividends by converting them into "dividend equivalents" through the use of swap contracts.
These reporting requirements are in addition to the requirement for reporting of foreign financial accounts to the U.S. Treasury.
The US and other governments may enter into agreements as to how FATCA will be complied with. The US has entered into such an agreement with 22 countries, though not yet with NZ. An agreement with NZ id being negotiated which will allow NZ financial institutions to send their FATCA reports directly to the Inland Revenue to exchange with the IRS, instead of dealing individually with the IRS. IR will provide the secure electronic system to receive and send on the FATCA reports.
NZ institutions must register under FATCA no later than 25 April 2014.The IRS will publish its first list of registered foreign institutions by 2 June 2014. Institutions must start to collect FATCA data as of 1 July 2014 and, if an agreement is concluded (as expected) a data exchange between IR and the IRS must have been made by 30 September 2015.
IR has published guidance notes in anticipation of NZ concluding a FATCA agreement. These set out IR’s understanding of the scope of the registration obligation and how it will administer, verify and enforce FATCA compliance by NZ institutions. The guidlines can be viewed at:
© G D Clews 2014