The FATCA window

The implementation of the Foreign Account Tax Compliant Act is showing consistent progress with thousands of banks in over 150 countries agreeing to share financial accounts data of their US clientele with US taxation authorities.
This clearly indicates the firm resolve of the US administration to make this initiative a success to bring the hidden global wealth of its citizens and green-card holders into the tax net. At the same time, the administration is also showing flexibility in terms of recognising the legal and administrative difficulties faced by foreign governments striving to become compliant. The recent extension announced by the US Treasury to allow banks until September 30, 2016 to report information on accounts owned by US citizens and green-card holders is a reflection of the adaptability in implementation strategy.
According to US tax law enacted in 1906, an American is required to report his global income on his US tax returns and bank accounts to US tax authorities. FATCA is a continuation of the past measures that the US administration had taken to fight tax evasion. Despite the fact that the IRS faced several years of budget reductions, the agency remained committed to stopping offshore tax evasion and continued to pursue cases in all parts of the world. This current endeavour is part of the IRS’ efforts to implement the legislation enacted by the US Congress in 2010 to target non-compliance by taxpayers using foreign accounts or entities to hide financial assets outside the US. The act requires withholding on certain payments made to non-US banks and financial institutions unless such institutions agree to report to the IRS information about the financial accounts held by US persons.
Considering the huge scope of the FATCA initiative, US authorities spread the implementation plan over several years while 2014 and 2015 being treated as a transitional period. Beginning third quarter of 2016, FFI’s across the globe including Pakistani Banks and other financial institutions will start reporting US customers’ data to the IRS or else face thirty percent withholding tax on their US source income. The deduction would be made by US financial institutions (USFIs) and other US withholding agents such as US banks and financial institutions, non-US banks and financial institutions, US and non-US businesses. In addition, non-complaint financial institutions can also face clearing house restrictions in the US, black-listed status with US banks and companies, restrictions on banking operations in the US and its territories, legal proceedings in US courts etc.
As part of its implementation strategy, the US government has entered into a number of bilateral inter-governmental agreements that set the groundwork for cooperation between the jurisdictions. As a result of these agreements, the information available would provide the US and partner jurisdictions an improved means of verifying tax compliance of taxpayers using offshore banking and investment facilities, and improved detection of those who may attempt to evade reporting offshore financial assets as well as income attributable to those assets.
The IGAs can also incorporate provisions for reciprocity if the foreign government desires to receive similar information about its citizens from financial institutions in the US. However, the IRS will only engage in reciprocal exchange with foreign jurisdictions that, among other requirements, meet the IRS’ stringent safeguard, privacy and technical standards. Before exchanging with a particular jurisdiction, the US will conduct detailed reviews of that jurisdiction’s laws and infrastructure concerning the use and protection of taxpayer data, cyber-security capabilities, as well as security practices and procedures.
Interestingly, Pakistan agreed to a mutual income tax treaty with the US back in 1957, which ensured avoidance of double taxation and was designed to prevent evasion of income tax by citizens of either country. After multiple ratifications, the agreement materialised into a full-fledged tax treaty in May 1959. Signing the IGA will be a sequel of this long-standing cooperation between the two countries. Since Pakistan is not formally a party to the TIEA, the tax treaty of 1957/1959 will serve as a legal basis for exchange of specific information stipulated by the FATCA regulation. This is why the IGA pertaining to FATCA implementation and compliance in Pakistan is likely to refer to Article XVI (Mutual Assistance) of the existing treaty with a view to dispelling any possible resistance and restrain US authorities from any conflict with Pakistan’s sovereign law and internal regulations.
Though Pakistan has not yet formally signed an agreement with the US under FATCA, there are strong indications that such agreement will be in place before the deadline to clear the way for information flow to US tax authorities from banks and financial institutions in Pakistan. This is because of the compulsion that FATCA non-compliance entails huge penalties for banks on their US-based income, fear of black listed status as well as other serious legal repercussions. This view is further endorsed by the fact that Pakistan is primarily a US-dollar based economy and accordingly a large volume of its international trade and overall financial dealings are routed through the US financial system. Hence the country cannot afford to ignore FATCA compliance and face potential disruptions in its international trade transactions.
Cognizant of this reality, policymakers in Pakistan are already putting efforts to become FATCA compliant. The BPRD circular issued by the State Bank of Pakistan asking banks to register with the IRS is a reflection of this policy intent. Treasury resources of the US frequently update the list of Pakistani banks and financial institutions that have already registered with the IRS and agreed to provide the required information.
Considering the complexity of the legal and regulatory infrastructure in Pakistan, a year of extension in deadline to comply with FATCA provides an excellent opportunity to the government of Pakistan to update it policy framework and adjust the existing local regulations to facilitate banks and financial institutions in the country, enabling them to share information with competent authorities in Pakistan for subsequent electronic transfer to the US authorities. The IRS notice also emphasises the generous extension it offers to Pakistani banks and financial institutions to adopt necessary measures and establish an appropriate compilation system to consistently collect FATCA-related information from its existing and new account holders.
At the same time, certain entities in Pakistan – the government, retirement funds, the central bank, banks with local customers, international organisations and other exempted beneficial owners – may fall under chapter 4 of the US Code Title 26 IRC sections 1471 and 1472. This means that these entities will be deemed compliant despite being non-reporting and – depending on their classification and structure of operation – may or may not be required to register with the IRS and obtain the GIIN. However, such exception will be partially determined by the contents of the favoured nation clause of the standard Model 1 agreement (if included in the IGA between the two countries) and based on determination by local authorities in Pakistan.
While keeping its resolve to implement FATCA in its true spirit, the IRS is also encouraging US persons to become compliant and avoid heavy penalties through various amnesty programmes such as the Offshore Voluntary Disclosure Program (OVDP).
Another option to achieve compliance is the ‘streamlined procedures’ initiated in 2012 and significantly expanded in June 2014. It is, therefore, fair to state that the main beneficiary of the recent extension in reporting deadline are US citizens and green-card holders living in Pakistan, since it allows them more time to take advantage of the amnesty schemes and straighten their outstanding US income tax matters by either correcting their previously filed incomplete and incorrect informational and income tax returns or addressing non-filing by submitting the required information to the IRS.
It is not surprising that since the inception of the ongoing reporting regime tens of thousands of individuals around the world have come forward voluntarily to disclose their foreign financial assets, taking advantage of special opportunities to comply with the US tax system and resolve their tax obligations.
Estimates suggest that the US tax agency has collected over eight billion dollars from US persons taking advantage of the amnesty schemes before they risk losing this opportunity with the start of FATCA reporting in 2016. It is therefore time US persons in Pakistan did the same. Once their banks independently report their financial data to the IRS next year, the window of opportunity through the amnesty schemes will not be available.
The writer is a New York and Dubai based US tax advisor and FATCA specialist.
Email: squadri@swqpc.com