The Foreign Account Tax Compliance Act (FATCA) is a tax information reporting regime that impacts financial institutions worldwide.
Understanding FATCA
FATCA was enacted by the U.S. government to combat tax evasion by U.S. persons (citizens and residents) who may hold assets in foreign accounts. It mandates that financial institutions (FIs) outside the U.S. identify and report on accounts held by U.S. persons. Here's a breakdown:
Key Components of FATCA
- Due Diligence: FIs are required to perform enhanced due diligence reviews to determine if an account holder is a U.S. person. This involves examining documentation and other information.
- Reporting: Once U.S. accounts are identified, FIs must report specified information about these accounts to the U.S. Internal Revenue Service (IRS).
- Intergovernmental Agreements (IGAs): Many countries have entered into IGAs with the U.S. These agreements streamline the reporting process. Instead of reporting directly to the IRS, FIs in IGA countries report to their local tax authorities, which then share the information with the IRS.
How FATCA Works
- Identification of U.S. Persons: FIs analyze their account holders' information to identify individuals and entities that are considered U.S. persons for tax purposes.
- Information Collection: FIs gather relevant details about U.S. accounts, such as account balances, interest income, and the identity of the account holder.
- Reporting to the IRS (or local tax authority under IGA): The gathered information is submitted to the IRS either directly or through the local tax authority based on an IGA.
- Penalties for Non-Compliance: FIs that fail to comply with FATCA reporting requirements face significant penalties, including withholding taxes on certain U.S. source payments.
Impact on Banks
- Increased Compliance Costs: Banks must invest in systems and processes to comply with FATCA requirements, including enhanced due diligence and reporting.
- Operational Changes: Banks must adjust their onboarding processes and ongoing account management procedures to accommodate FATCA.
- Risk of Penalties: Non-compliance can result in financial penalties and reputational damage.
Example
Imagine a person who is a U.S. citizen and has an account at a bank in another country. Under FATCA, that foreign bank is required to identify this person as a U.S. account holder and report specific details about their account to the U.S. IRS, either directly or via a local tax agency, depending on the existence of an IGA.
Summary Table
| Aspect | Description |
|---|---|
| Purpose | To combat tax evasion by U.S. persons holding assets in foreign accounts |
| Requirement | FIs identify and report U.S. accounts |
| Process | Enhanced due diligence, information reporting |
| Reporting Authority | IRS or local tax authority (under IGA) |
| Impact on Banks | Increased costs, operational changes, risk of penalties |
