As part of an ongoing series of posts on financial regulation, this post will focus on the subject of tax policy and regulation. Specifically, it will discuss the Foreign Account Tax Compliance Act (FATCA) of the United States. While this is an American law, its target is international and thus relevant for many multi-jurisdictional companies.

Before delving into the implications of FATCA, it is worth going over its background and the motivations behind its implementation. The act itself forms a part of the wider Hiring Incentives to Restore Employment Act (HIRE Act), which encourages businesses, through means such as the use of tax breaks, to hire unemployed workers and engage in job creation. FATCA is classified as an offset provision under Title V of the HIRE Act in order to recover the costs of the rest of its provisions.

But how does FATCA achieve this? It requires non-US financial institutions (i.e. foreign financial institutions, FFIs) to report the holdings of American taxpayers in order to combat tax evasion and avoidance. Failure to comply will result in material penalties. This is reinforced through the Internal Revenue Service’s (IRS) tax policies, which state that US taxpayers are required to report offshore financial activities. Before this, self-reporting was deemed to not be effective enough by the Government Accountability Office. The overall effect of FATCA will result in the generation of USD 800 million over the coming years.

The implications of the act has caused a number of criticisms from FFIs and individuals alike. What appears to be one of the primary points of contention is its role as an offset provision – that is, through the generation of the aforementioned millions of dollars, it burdens foreign institutions with the task of pseudo-tax collecting for the United States. For example, in 2011 it was reported that several large European banks were divesting themselves of American clients due to FATCA. The rationale for this sort of action is simply that the reporting requirements set out by the act have been widely deemed to be too expensive to integrate into compliance regimes.

The extraterritorial implications of FATCA, along with those that make FFIs tax collectors and enforcers, are just a few among the several controversies surrounding the act. However, regardless of controversial requirements, compliance must be achieved at the end of the day by FFIs. This includes meeting reporting and due diligence obligations placed onto these institutions. The best way to go about this is to initiate adequate procedures when establishing new relationships with customers for proper identification. Additionally, there is a very clear need to communicate to applicable clients about any of their obligations towards the IRS. Overall, companies should reinforce a culture of compliance rather than steer towards questionable areas of creative compliance or non-compliance. Using and building on existing systems and protocols is the first step towards meeting the obligations of FATCA.

References: Hiring Incentives to Restore Employment Act

Offshore Financial Activity Creates Enforcement Issues for IRS

Reaction to US Tax Law: European Banks Stop Serving American Customers