Ever heard of Cayman Islands – the place where there are more companies registered than the number of people working there; an offshore financial centre which gives opportunities on a lesser tax pay condition for non-resident companies. And guess what – an offshore company and its benefits attract a lot of interest of taxpayers from the high-income bracket.
But before we draw judgment on an ‘offshore account’ or holdings as illegal let us understand what it means and how it benefits us. It is simply investing money abroad where the opportunity of earning is good and taxes are less. Naturally, the income bracket gets bigger and is also within legal parameters. This happens since an individual gets an opportunity to save taxes that take away a large portion of earnings and this is completely legal. This makes it lucrative for people to invest in such companies not to mention the privacy from local and home governments these opportunities provide. The correct word would be ‘haven’ for money.
Since this mode of earnings has gained a lot of popularity over time and can be a potential tax evasion technique, the United States brought in an Act called Foreign Account Tax Compliance Act (FATCA) to make these investments and transactions transparent. This act goes after the pockets of money that were earlier hidden and hence it is bound to attract controversies. Let’s see what this act says.
Going literally by the phrase we can understand it as an act that has to be followed to comply with taxation regarding a foreign account. It has been framed by the US for tracking the foreign investments by US domestic tax-payers. Following this act, provides transparency about a U.S. citizen’s holdings and income. It is an act that does not require paying any additional taxes but will have an effect on the taxes that get hidden from the tax collectors. Hence, it is easier to levy taxes on the income that was earlier hidden and has now come to the fore by the virtue of the levying FATCA.
The main agenda or aim of this legislature is an exchange of information. If a U.S. citizen earns or holds foreign investment, then this particular detail becomes declared information through this act. It is a form of reporting that helps reveal the actual earnings of a US citizen. So, in short, all Foreign Financial Institutions (FFI) will provide the IRS the details of every U.S citizen’s account information.
IRS or Internal Revenue Service of U.S is responsible for overlooking the working of FATCA. All the U.S. citizens around the world are required to share their exact income and taxes paid. This is because they are liable to provide both these details. If a U.S citizen is involved with a non-U.S. citizen or institution for business purposes then the entire details have to be shared with the IRS.
To make this move streamlined, the IRS has asked to enter into Inter-Governmental Agreement (IGA) with foreign countries which help the process to be monitored. This, intentionally, will in turn help in maintaining the nature of exchange or business very clear and transparent between the US and the IGA country.
Non-compliance to this act will not only affect a U.S. citizen working out of U.S. but also the nations involved. Since IGA is signed by the respective nations with the U.S, a financial institution has to provide the information of the U.S citizen and the nature of his business to its own government and then this eventually is provided to the IRS. Example, if a US citizen invests money in HDFC bank in India, then the details of this transaction and account of the US citizen will have to be provided by HDFC bank to the Indian government who in turn will provide this information to the IRS. However, if this information is not shared, FATCA entails 30% ‘withholding tax’ on foreign source income of the FFIs that do not share information and these FFIs will be termed as non-participating FFIs. It also exercises the right of withholding tax when the U.S pays certain income to Non- Financial Foreign Entities (NFFE). Thus, the bilateral business relations get affected.
Transparency is a great move to keep businesses real and ethical. But transparency in partnership businesses exposes the private details not only of a U.S. based citizen but also the Foreign Institutions/ Individuals involved which is distasteful on the part of the foreign organizations. However, since the US has many holdings abroad and income from these sources gets withheld by ‘enforcing’ this act it becomes an obligation from the point of view of a nation receiving the funds. It apparently shows the power that a capitalistic nation can have on a developing nation.
Along with more than 50 nations, India has entered into an IGA complying with FATCA. On signing this, India will also receive information, similar to the U.S., about Indian FFIs situated in the US through a regulatory agreed as the Automatic Exchange of Information – a clause chosen to be included in IGA while signing of FATCA with India. This system of curbing tax evasion had a beneficial manifest making it a bilateral effort for both the nations. India started receiving all information from July 1, 2014, about Indian FFIs situated abroad adding to the efforts to fight the flow of illegal money into India.
U.S citizens are finding it hard to make this feature work because of additional paperwork and also the sudden sprouts of requirements to provide their details. To make this possible, the FFIs also have to work at an increasingly faster rate to match the time limit for its executions. Many US citizens are also thinking of immigrating out of US and giving up US citizenship in order to escape the FATCA regulations. FATCA requires US taxpayers to submit Form 8938 to disclose all the foreign assets once they reach a threshold. Also since US citizens have to pay tax on their worldwide income they face a lot more taxation even if they do not earn income in the US.
Complying with the provisions of FATCA involves a lot of paperwork and hence there is a dire need to have a proper framework to help fulfil the conditions laid down by it. In this case, there are IGAs that are signed between countries and hence there has to be robust and scalable infrastructure that drives this information exchange. In conclusion, although FATCA is intentionally beneficial it has to be evaluated on the implementation level with changing time. In order to make it a workable solution, a number of amendments and improvisations in the processes will have to be made. Some of the major compliance issues are –
FATCA entails disclosure of many details relating to the financial accounts of US persons maintained by FFIs. This may have some implications since these disclosures may be against the secrecy, confidentiality and data protection laws of the FFIs. This means that in order to comply with the FATCA the FFIs will have to make certain changes in their standard policies which might not be acceptable.
FFIs need to enter in an agreement with the IRS to provide information and for this, they have to sign an agreement which calls for some complicated paperwork and hence poses difficulties at the implementation level. Although now this has to be done with the domestic government it will involve similar administrative and legal procedures.
The FFIs who sign this agreement with the IRS need to report on all the accounts held by the US resident taxpayers. If some account holders do not disclose information then FFIs may also be responsible for levying the withholding tax as agents of IRS. In such cases, they need to have a detailed account of how many US accounts they have, US investments that either they have or their customers have etc. This will also mean that they have to make some changes to the internal controls and reporting systems in order to comply with the FATCA requirements.
In conclusion, although FATCA aims at making international transactions transparent, it does pose some challenges to FFIs. Since it is at an evolutionary stage we can expect that it simplifies in future making it a more viable option for participating nations and FFIs.