FATCA: The facts (plus a few observations)

December 20, 2012 at 10:50

Few people outside of the financial services industry have heard of the Foreign Account Tax Compliance Act (FATCA), and even fewer would expect it to have any direct impact on UK charities. However, the early signs are that this complex piece of US legislation will add another unwanted layer of red tape to UK charity regulation.  But before delving into what it might mean for charities, here’s a brief summary of the legislative beast that is FATCA:

  • FATCA is new US legislation aimed at combating tax evasion by US residents using foreign accounts – an uncontroversial policy goal but with far more dubious means of achieving it.
  • To target these tax evaders, the new FATCA rules aim to get every single financial entity outside the US (or ‘Foreign Financial Institution’, FFIs) to enter into agreements with the US Internal Revenue Service (IRS) and identify and report on their US account holders.
  • To force compliance, the US is using its mighty financial clout:  If an FFI fails to comply or meet its obligations, it will be subject to a 30% withholding tax on all US source income (to include any payment of interest, dividends, rents, salaries, wages, premiums, annuities… and more, provided such payment is from sources within the US).  Therefore sanctions could amount to billions for a big multi-national bank.
  • The FATCA definition of ‘financial entity’ is very broad, so this doesn’t just apply to banks but more or less all deposit taking organisations, from insurance companies to pension funds and charities (more below).

So, despite not being widely known, FATCA is actually a hugely ambitious extraterritorial tax regime which will enable the US to gets its tentacles into the financial affairs of institutions all over the world.

Since it was announced in 2010 FATCA implementation has faced a number of practical and legal hurdles:  the reporting requirements clash with many countries’ data protection and client confidentiality laws, for example.   There has also, understandably, been widespread concern about the administrative burden and cost.

As a means to help tackle these glitches and reduce compliance burdens, many countries are looking to enter into intergovernmental agreements with the US (IGAs), so that FFIs can report to their own tax authority rather than the IRS.  In September 2012 the US and UK signed the first of such agreements, reducing – but not eliminating – the FATCA headache for financial institutions in the UK.

So what does this mean for UK charities?

As deposit-takers (i.e. they receive funds and donations), charities find themselves in the unlikely position of being deemed ‘financial institutions’ for the purposes of FATCA.  Thankfully, however, FATCA rules recognise that charities make poor tax avoidance vehicles in this context and exempt them from regular FFI requirements, provided they can prove their charitable status.  Under the UK IGA, this will simply entail Charity Commission, Office of the Scottish Charity Regulator or HMRC (for tax purposes or as a Community Amateur Sports Club) registration.

However, there are other worrying aspects to consider and in November we held a fact-finding meeting with HMRC, eleven charities and a lawyer to better understand how FATCA could affect the sector.  We identified three main areas:

1.       Banks may require a FATCA number from charities wanting to open a bank account, obtained by registering with the IRS.

Under the UK IGA, FFIs will need to report on their US account holders to HMRC, rather than directly to the IRS (HMRC pass on the information instead).  However, FFIs will still be expected to register with the IRS and receive a FATCA number to provide the US with some auditability.

Understandably, given the threat of mammoth, bankruptcy-inducing sanctions, banks and other FFIs will want to avoid any trouble with the IRS, in the cheapest and most efficient way possible.  As a consequence of this, it is currently looking like banks will require a FATCA number from charities too, as an easy (for them), globally recognised way of certifying their exempt status.

We think it is likely many charities operating abroad will choose to obtain a FATCA number to make life easier; however for all other charities the requirement seems like another piece of pointless admin.  We are engaging with banks on the issue and hope a Charity Commission or HMRC number should suffice for charities working solely in the UK – information which banks already recognise and make use of.

2.       UK charities with US ‘connected persons’ (e.g. a trustee who is a US citizen) will have their details passed to HMRC by FFIs, who will in turn pass these to the IRS.

This sounds alarming but it isn’t – this is simply what banks or other FFIs need to do as part of their FATCA reporting requirements.  At present, it is looking like account holders will have to disclose their US connections through a process of self-certification, i.e. charities will simply have to tick a box to confirm whether or not they have US controlling persons, and only provide further details if so.  Hopefully banks will favour this process over anything more onerous that requires reams of documentation or background checks.

3.       Charities with operations overseas will have to pay attention to how the provisions will affect them, particularly with regard to partners and banks used. 

A bit of a nebulous point, but that’s because it’s the lack of clarity that is the problem – from discussions from HMRC it does not appear that the potential difficulties the rules may cause for charities based in FATCA-compliant countries operating in non-FATCA compliant countries have been considered.  What will happen when a UK charity sends money to its regular bank in Haiti to support operations there if the bank in Haiti hasn’t met FATCA requirements adequately, for example?   Will the charity get hit by the 30% withholding tax for the bank’s non-compliance?!  Like many globally enforced regimes, the varying levels of compliance and methods of application between different states becomes a problem.

What next?

At present, lots of the detail around FATCA hasn’t been finalised, and the implementation date has already been pushed back twice.  While clearly the biggest challenges will be for the banks and other financial institutions, it’s important that charities don’t get inadvertently caught by the arrangements, and we’ll continue to work with HMRC and keep the sector briefed on this issue.

For further information on FATCA read our charity briefing.