FATCA may identify tax cheats, but its dragnet for financial criminals may produce an even more

The Foreign Accounts Tax Compliance Act would require financial institutions worldwide to report information on accounts of US persons. The Act gives the IRS unprecedented new power to catch tax evaders worldwide, but its concurrent dragnet for financial criminals may be an equally desirable endgame. The landmark law creates major new compliance responsibilities for foreign and domestic financial institutions, and some question the law’s fairness and feasibility.


The days of US persons easily hiding their money in foreign bank accounts may be coming to an end.

The question currently posed by the federal government is how many US persons have foreign bank accounts. The answers will come when the Internal Revenue Service implements the final regulations of the Foreign Accounts Tax Compliance Act, or FATCA. Enacted in March 2010, the law is a huge US undertaking to stanch tax evasion through foreign financial institutions, including banks, brokers and securities dealers.

Targeting US tax evaders and financial criminals with undeclared assets offshore, FATCA would compel foreign institutions to collect and report the names, addresses and tax identification numbers of customers who are US citizens, as well as their account balances and annual receipts and withdrawals. Failure to do so, among other things, will subject the pertinent institutions to a 30 percent withholding tax on United States income, apart from other applicable taxes.

Foreign financial institutions would be required to register with the IRS starting on Jan. 1, 2013, as a reporting institution. The final IRS regulations on FATCA are not expected before the fall of 2012, at the earliest. The proposed rules are now in a “public comment” period.

FATCA threatens the bank secrecy of many jurisdictions, a vital cog in the operations of big-league financial criminals. Offshore secrecy havens facilitate the laundering of financial criminal proceeds, establishment of fronts to hold the dirty money and disguise the movement of money worldwide into investments that further mask beneficial ownership.

IRS Commissioner Doug Shulman is optimistic about ongoing efforts to pierce the veil of offshore secrecy havens. In a recent statement about FATCA, he said US enforcement agencies have “pierced international bank secrecy laws, and we are making a serious dent in offshore tax evasion. By any measure, we’re in the middle of an unprecedented period for our global international tax enforcement efforts.”

FATCA has roots in UBS case, secrecy havens still widespread

The groundbreaking UBS case inspired FATCA. In 2009, Senator Carl Levin and the U.S. Senate Permanent Subcommittee on Investigations identified 52,000 US persons with tax-evading bank accounts at UBS, the huge Swiss bank. The US Department of Justice issued “John Doe” summons against UBS, demanding the names and information of its US accountholders. The DOJ eventually reached a settlement with UBS, collecting a $780 million fine, a minor sum for the bank. With the Swiss government negotiating for UBS, the US also was granted the right to receive the names of 4,500 US accountholders. While the settlement was far less than what the US initially sought, the case focused federal government attention on international banking secrecy and its facilitation of financial crime, and the ensuing uproar in the US Congress over offshore tax evasion paved the way for FATCA.

It is unknown how many of the 52,000 accounts originally requested in the UBS case held the proceeds of Ponzi schemes, mortgage fraud, embezzlement, official corruption, and dozens of other lucrative financial crimes. What is not subject to guesswork is that there are about 60 secrecy havens around the globe allowing for the same kind of tax evasion that UBS was caught doing. Other developed countries are undoubtedly also pondering if the secrecy havens, including Swiss banks, have lured their own citizens with promises of protection from the tax laws.

Complex new compliance measures in store for US, foreign institutions

FATCA has caused its own uproar among domestic and foreign financial institutions complaining about the compliance burdens the law and the IRS regulations will impose. Foreign institutions will be required to sift through customer data to determine US citizens and gather required information. Some foreign institutions will have to augment customer due diligence procedures for new accounts to assure they are properly classifying and capturing information on US customers.

Although the compliance burden will fall most heavily on foreign institutions, the law also imposes new requirements on US institutions. Those who process payments to foreign financial institutions (called “pass-through” or “payable-through” payments) will be required to know if the foreign institutions have registered with the IRS to report the required information. If foreign institutions are not complying with FATCA reporting duties, the US institutions must withhold 30 percent on certain payments originating in the US, including interest, dividends, and proceeds from sale of property.

“Almost like anti-money laundering controls and alerts, US financial institutions will have to add a new alert to their transfers to foreign institutions,” says David Gannaway, a principal in Valuation and Forensic Services at Citrin Cooperman, a New York accounting firm.

“US institutions should expect to enhance their due diligence programs and enhance their internal controls of movement of funds outside the US,” he adds.

Foreign financial institutions, including banks and broker-dealers that process payments to foreign institutions will also be required to implement similar new tax withholding procedures and payment monitoring to compliant and non-compliant institutions.

The taxing of pass-through payments has been criticized by many banks, accounting firms and trade associations, including the British Bankers Association. They call it unenforceable and unreasonably complicated. A KPMG report says the withholding system on pass-through payments may be burdensome and complex by design, in order to stimulate greater compliance with FATCA by financial institutions.

The Treasury Department has implied as much, saying it hopes it will not collect revenue from the withholding taxes.

“The withholding requirements incorporated in FATCA are not intended to raise revenue,” said Emily McMahon, Treasury’s Acting Assistant Secretary for Tax Policy, in a recent speech. “Ideally, every foreign financial institution would comply with the reporting requirements, and (none) would be subject to withholding tax,” she said.

FATCA may be expensive for institutions, and revenue producer for IRS

Foreign financial institutions may face steep costs for FATCA compliance, according to studies by KPMG and Deloitte. KPMG recently estimated that as many as 200,000 foreign institutions would fall under FATCA’s purview, including banks, broker-dealers and investment firms. Estimates of their FATCA costs—mainly in compiling, analyzing and sifting huge amounts of customer data and creating new systems to handle pass-through payments—range from hundreds of millions of dollars to well over $10 billion.

The European Commission estimates it will cost European banks alone $100 million to comply with FATCA. Unless the final IRS rules change which foreign institutions are covered by FATCA and what information must be reported, KPMG estimates the cost of compliance for foreign institutions will far outweigh any tax revenue the IRS may collect.

What the studies do not discuss is what the totals of financial crime proceeds may lie in foreign financial institution accounts that are uncovered by FATCA compliance by foreign institutions. That could be the biggest surprise emerging from enforcement of the new law.

According to IRS estimates, $8 billion in tax revenue may be recovered from offshore accounts over the next 10 years. The real total may be far higher. Already, since 2009 the IRS has received more than $4.4 billion in revenue from its “Offshore Voluntary Disclosure” program that was a byproduct of the UBS scheme. The Offshore Voluntary Disclosure program allows US taxpayers with hidden offshore accounts to voluntarily disclose their assets and accounts and avoid criminal prosecution.

Proposed IRS rules clarify coverage and reporting duties, but leave uncertainties

The proposed IRS rules define the institutions and types of accounts that would be covered and extend the date some of measures take effect. The rules addressing some of the points raised by the foreign institutions that have objected to the requirements in dozens of letters the IRS has received from them, as well as investment firms and trade associations.

Only accounts that have more than $50,000 for individuals and $250,000 for businesses would be subject to reporting. The rules would narrow the type of covered accounts to brokerage, money market and bank accounts, along with interest on investments. Information-gathering requirements have also been relaxed. Many foreign institutions will be able to meet the requirements with the customer information they already collect.

The proposed rules also define types of institutions that are automatically “deemed compliant” or are not required to register with IRS. They would include entities like retirement plans and banks that operate solely on a local level.

One of the more significant changes would delay compliance with FATCA in countries where reporting would clash with domestic bank secrecy laws. The institutions in those countries would get an extra two years to become compliant.

Many foreign banks and trade associations had voiced concerns about conflicts between FATCA and their bank secrecy and privacy laws. Credit Suisse, Barclays, and the Japanese Bankers Association were among those that raised this issue in comment letters to the IRS.

The requirement to withhold 30 percent on pass-through payments has also been extended to January 1, 2017. By that year, FATCA will apply fully to all foreign institutions specified in FATCA, regardless of their local laws. Financial institutions that do not report the required information after this date would be subject to the 30 percent withholding tax on income or revenue that originates in the United States.

Some foreign institutions are already taking an alternate approach to compliance. Rather than compiling customer data, they are simply closing accounts of US persons.  At the end of 2011, Deutsche Bank, Credit Suisse and HSBC had adopted this approach, closing the investment accounts of US persons and refusing to open new accounts. Other European banks are considering similar action, although many are taking a wait-and-see approach until the final IRS regulations emerge.

Uncertainty surrounding FATCA may be the largest obstacle to compliance by financial institutions.

“We’re all sitting in the airplane at the gate, but they haven’t backed us out onto the tarmac yet,” says Gannaway, referring to FATCA implementation. “I don’t think we’ll find out how it’s working until we’re in the air and there’ve been some tests.”