Many trustees and professionals have been trying to get to grips with this complicated piece of legislation, bemused at the idea of becoming international tax agents for the US Internal Revenue Service.
25 October 2014 was the IRS registration deadline recommended by the UK’s professional bodies. The latest actual deadline for registration is 1 January 2015, but trusts could face administrative delays if not registering in good time before the New Year. So, if you haven’t done so already, the importance of getting your head around FATCA cannot be overstated: trustees need to consider their position under FATCA, regardless of the size of the trust they administer or the fact that the trust has no connection with the USA at all. Failure to comply with FATCA could result in onerous penalties that may have to be borne by the trustees themselves.
There is a plethora of information available, including Guidance from HM Revenue & Customs (the latest version of which was only published on 24 August 2014, and runs to 181 pages). The UK’s professional bodies, including the Society of Trust and Estate Practitioners, have tried to distil this Guidance into a more manageable framework (STEP Guidance), but HMRC has warned that this should be used as a supplementary tool only and will not take the place of HMRC’s Guidance.
So you will be forgiven for finding it hard to pin down your position under FATCA. At the risk of oversimplification, this article attempts to provide an outline of FATCA as it applies to private family-type trusts and trustees who operate them. Hopefully, it will assist those who have as yet not fully considered its impact.
So what is FATCA?
The Foreign Accounts Tax Compliance Act (FATCA) is a piece of US legislation that was introduced in 2010. It is aimed at enforcing US tax laws abroad and, in particular, ensuring that US citizens are paying the appropriate tax on their worldwide income.
So why, I hear you say, should this be of any concern to a UK citizen? You have your Government to thank for the duty that is now imposed on you. To give effect to FATCA, the USA has entered into intergovernmental agreements with other jurisdictions to ensure compliance, by placing a reporting obligation on financial institutions that pay money to US citizens. The UK entered into such an agreement with the USA on 12 September 2012. As a result, FATCA is now part of English law (under section 222 of the Finance Act 2013, whose main elements took effect from 1 July 2014).
The significance of this cannot be understated – a trustee is now obliged under English law to assist the US government in enforcing its tax laws internationally.
How does it work?
Before FATCA, US international tax enforcement focused on “recipient-based” measures, such as Foreign Bank Account Reporting, where US citizens were obliged to report their overseas investments themselves. The IRS felt that this approach was not sufficient to ensure US tax law compliance and so sought to impose obligations on the payer to identify when funds are being transferred to US citizens.
The draconian element in this new approach is how wide FATCA casts its net, causing many trustees to find themselves with obligations to the IRS, but otherwise with no connections to the USA at all.
A financial institution that is subject to FATCA must identify all reportable accounts, establish the tax residency of account holders and inform the IRS when payments are being made to any international account (either to or from US citizens).
Failure to comply with FATCA is a breach of English law, and the penalties include a 30% withholding tax on payments on US source income, including dividends, interest and even sales proceeds from shares or other property.
The US Congress expects to raise $800 million a year in additional revenue from FATCA. It is, however, estimated that the initial costs of implementing FATCA in the UK could be more than £1 billion, along with ongoing administrative costs.
These figures seem unsurprising in light of the costs involved in implementing the legislation into English law, the time spent by professionals getting to grips with its rules, the fees charged by professional firms to advise clients on their obligations and the ongoing administrative checks required to ensure compliance.
For certain small trusts, FATCA could prove fatal, as trustees will have to ask themselves whether the cost of complying will make the trust economically unviable.
Which types of trust have to comply?
FATCA uses a wealth of terms to categorise whether institutions are caught by the legislation and so required to register and report to the IRS. Put simply, a trust will be classed as a Financial Institution (FI) or a Non-Financial Foreign Entity (NFFE). FIs will be required to register and report to the IRS, but NFFEs will not.
A trust will be an FI if it is an “Investment Entity”. There are two typical situations in which a trust will be an Investment Entity:
(a) where the trust carries on a business in the UK (i.e. if 50% or more of its gross income is derived from undertaking investment activities on behalf of customers); or
(b) where the trust has more than 50% of its gross income attributable to investing, reinvesting or trading in financial assets and has outsourced the management of the trust or the trust’s assets to an FI.
There are other scenarios in which a trust be an FI, and a more detailed version is provided by the STEP Guidance (which can be found on the STEP website).
The STEP Guidance suggests that, in practical terms, a trust is likely to be classed as an FI (and so have registering and reporting obligations to the IRS under FATCA) where: (i) the trust has a corporate trustee (as the corporate trustee will manage the trust and will generally be an FI); or (ii) the trust’s assets are managed on a discretionary basis (since a discretionary fund manager will manage the trust and will generally be an FI).
It is worth noting that registered charitable trusts are treated as “deemed compliant Financial Institutions” and do not have to register with the IRS.
How do trustees comply?
There are two less onerous options available to trustees to satisfy their obligations under FATCA, depending on how their trust is structured.
- Trustee-documented trust – Where an FI is a trustee (typically a corporate trustee), the responsibility of registering and reporting is passed on to the corporate trustee. The trust will become a “deemed compliant FI”, and the trust can then rely on the trustee to fulfil the trust’s obligations.
- Owner-documented trusts – Such a trust need not register with the IRS. It must, however, appoint a withholding agent, which must be an FI, who will in turn take care of the FATCA returns. This service is only available where the trust can prove that all beneficiaries are and remain non-US citizens. Many investment houses are starting to provide this service.
Both of these options should be considered, as they effectively pass the registering obligations to other FIs. Otherwise, a trustee will need to comply personally by registering with the IRS and obtaining a Global Intermediary Identification Number (GIIN) by completing Form 8957 online, and in due course by reporting to the IRS (via HMRC) where required under FATCA rules.
While many have voiced criticisms of the compliance burden under FATCA, there is only a short window for compliance before the New Year.
The reality is that FATCA is likely to be the trailblazer for other multi-jurisdictional tax agreements. The EU has indicated an interest in implementing its own FATCA-like rules, while the OECD has already developed the Common Reporting Standard, otherwise known as the Global Account Tax Compliance Act (GATCA). Both of these agreements, if they are implemented, would add similar obligations to those now imposed by FATCA.
Trustees have no choice but to get to grips with international tax agreements and so, where FATCA applies, should look to comply in as quick and painless a manner as possible. As a trustee, the best way to minimise any concerns and costs is to react to FATCA now. Trustees should explore their obligations under FATCA by looking carefully at HMRC’s latest Guidance, along with the latest materials provided by the STEP Guidance.
If you require advice or further assistance, you can contact Paddy Grafton Green, who would be happy to advise on your FATCA compliance obligations.