The FATCA legislation that has had such a big impact on expat Americans and financial services went live a year ago. How has it taken shape in practice over the last 12 months?

Time flies when one is having fun. Yes, the 12-month anniversary for the US Foreign Accounts Taxation Compliance Act’s going live was yesterday. This thumpingly-controversial piece of legislation has, as readers know well, had all kinds of consequences including several firms no longer being willing to offer financial services to expat Americans. Figures in the wealth management compliance and technology space tell us that some countries and firms remain behind schedule. So what to make of FATCA after this first year? Here is the view of Marnin Michaels, a partner at the global law firm Baker & McKenzie, who specialises in international tax and private banking issues. We plan to run other commentaries on the FATCA anniversary – and where the wealth industry goes next – in coming days. This publication is grateful to Marnin Michaels – who is also an excellent speaker on these topics – for sharing these insights.

This week marks the one year anniversary of the “go-live” date for FATCA. The sky did not fall and the world did not come to an end. Yes, it is a compliance headache. Yes, it is unduly burdensome. Yes, the disclosures required for many who do not have US connections are disproportionally burdensome. All of the bad things that were said about FATCA in advance can still be said. For example, one such issue is the treatment of US trusts that are treated as foreign trusts for tax purposes. However, as a practical matter, the system is adjusting and finding a new equilibrium. The wealth management industry is finding a new balance by adapting to the burdens that come with FATCA.

Soon after FATCA became law, I wrote in an article that the law was the equivalent of using an atomic bomb to kill a fly. I was wrong. The method in which FATCA was implemented was rather ingenious. One aspect of this implementation was the use of Intergovernmental Agreements entered into between the US and other jurisdictions on a bilateral basis.

Model 1 IGAs require the local jurisdiction to enact statutes to implement FATCA under local law and require financial institutions to report to their local tax authorities, who in turn report to the US Internal Revenue Service (IRS). Model 2 IGAs require jurisdictions with local law impediments to reporting to allow their financial institutions to report directly to the IRS. Most countries elected for Model 1 IGAs. That means that most countries agreed to enact FATCA under local law.  It also means that those countries now have a common reporting platform for reporting information to the US. 

At first glance, this seems like a highly disproportionate and burdensome regime for these jurisdictions and their financial institutions, because it requires them to put in a great deal of effort to provide information valuable only to the US government. However, the legislation that was put in place for FATCA can now easily be modified for use in a broader information exchange regime. Additionally, the IT platforms created for information exchange under FATCA can also be used for such a broader regime with more countries. Thus, FATCA can be and has been used as the model structure for a broader automatic information exchange regime with a larger spectrum of countries going forward. 

The Organisation for Economic Co-operation and Development (OECD) has created a Common Reporting Standard (CRS) for the automatic exchange of information that is explicitly based on FATCA, and which requires participating jurisdictions to enact the CRS under local law. The system that will be used to implement the CRS will certainly be based upon the now existing FATCA laws in multiple jurisdictions.

I could not see these concepts in the original FATCA legislation nor could I see implementation occurring in such a fashion. Quite frankly, I don’t think most of the implementation methods actually existed in the initial legislation. Yet, nevertheless, those involved in the implementation of FATCA should be congratulated for the way in which it was carried out. Part of the reason the “go-live” date did not cause massive problems and chaos is a direct result of the implementation approach. The FATCA implementation approach provides a benchmark and framework for more global automatic information exchange regimes.

One major flaw that exists in the FATCA system relates to the reciprocal Model 1 IGAs. The reciprocal IGAs require the US, in addition to the partner jurisdiction, to agree to collect and exchange information on the partner jurisdiction’s taxpayers. However, problems arise because the definitions that are in place create situations in which similarly situated taxpayers from different jurisdictions are not reported in the same way.

Take the following example: If a US citizen owns 100 per cent of the shares of a British Virgin Islands (BVI) company that has an account in Mexico City, that US citizen would be reported to the Mexican government and then on to the IRS. In contrast, a Mexican resident owning 100 per cent of the shares of a BVI company with an account in New York would not be disclosed to the Mexican authorities. This is a direct result of the technical approach taken by lawyers focusing on the US tax concepts of beneficial ownership.

If FATCA and the IGA system are going to work in practice and be respected over time, these types of mismatches need to be addressed and corrected. Absent these corrections, the system will lack the legitimacy it needs to be the basis for automatic information exchange on a more global level.

Should the US wish to continue to be the leader in encouraging automatic information exchange as it did with FATCA, then it needs to also be a leader in stopping these mismatches that cause competitive arbitrage. I have been to meetings in recent months where the discussion has been to consider moving structures and accounts to the US to avoid disclosure. This type of regulatory arbitrage needs to stop if the system is to work.

There are challenges ahead, for example: How will countries deal with this new massive collection of data? How will the mechanical exchange of this data take place? How will the home country sort the data and use this data as part of tax enforcement? These challenges are not resolvable in the short term. The exchange of information will be based on the definition of income in the home country and not the country where the income is reported.

The challenges of implementing the IGA system and automatic exchange of information will take years to resolve. However, the FATCA system has fundamentally changed the basic conversation on global transparency: taxpayers must report their income in their home jurisdiction and pay tax on their income according to local law.