December 16, 2023
How FATCA will Affect IFCs

by Denis Kleinfeld

Denis Kleinfeld offers an invaluable insight into the controversy surrounding the introduction of the US FACTA and highlights what jurisdictions should watch out for.

The Foreign Account Compliance Tax Act, better known as FACTA, is merely another step taken over the past 31 years by the United States to try and enforce the world-wide application of its income tax system.

There have been so many attempts to enforce the income tax system on a world-wide basis that it is not possible to list all the organisations and agencies (ie, United Nations, Financial Stability Forum, the EU, G7, G8, G20) involved and the reports published. For purposes of this rather brief article on an enormously complex subject, I have mentioned a select group to merely highlight the fact that there have been extensive and complicated previous efforts to deal with offshore income tax enforcement by the US and other OECD member states long before FACTA.

I have always considered the beginning to be January, 1981 when a report was made to the Commissioner of the Internal Revenue entitled “Tax Havens and Their Use by United States Taxpayers—An Overview.” As it was written by Richard A. Gordon, then Special Counsel for International Taxation, it is known as The Gordon Report. This Report became the foundation upon which the current United States international tax enforcement regime is based.

The Gordon Report was a study and analysis of “tax haven transactions, United States international tax laws applicable thereto, United States income tax treatises, and the attempts of tax administrators to deal with these transactions.” It is an extraordinary piece of work and well-worth reading even today. However, the Report which was published by the IRS as Publication 1150 somehow has disappeared from the various Federal Depository Libraries and the IRS. A copy was found in the Nevada State Supreme Court Federal Depository Library and is now reported by the Inspired Life Centers on its website[i].

The Report specifies a rather long list of administrative steps for the IRS to take to enhance international tax enforcement. Over the past years nearly all have been taken. One can conclude that the passing of FACTA is recognition that international tax enforcement by the United States is still an elusive goal. Non-the-less FACTA is now a fact of life for all international financial institutions.

In 1989 the Financial Action Task force was formed to allegedly combat money-laundering. Many commentators at the time felt that the FATF was a stalking horse for tax compliance. In 1990, the FATF blessed the world with it 40 recommendations on money-laundering. Following on this, in 1998, under the leadership of Jeffrey Owens , the OECD published its “”Harmful Tax Competition” and began its crusade against “Harmful Tax Practices”. Criticism of this approach included the observations that this OECD effort was nothing more than “fiscal colonialism.”

1998 was also the year when the G-7 outlined its plan to attack harmful tax practices and the UK, published its “Edwards Report” dealing with the regulation of offshore British financial centers. In 2000 the OECD followed up on its previous work by publishing a report on “Towards Global Tax Co-Operation.” Its “blacklist” was famous for not including any of the OECD countries as tax havens.

Skipping over numerous efforts, the most noted of the US offshore tax enforcement schemes involved the establishment of the “Qualified Intermediary” (QI) regime. Leveraging on the fact that the United States was by far the dominate leader in the investment world and its currency the only reserve currency, the US felt it was in position to dictate policy to the world’s financial service industries.

Without going into detail, the QI regime essentially set up the United States as the regulatory and enforcement agency to make sure foreign financial businesses complied with its complicated and intrusive guidelines for information reporting and withholding. The US played its QI tune and everyone else was expected to do the QI dance. FACTA is latest effort by the US to have the world’s financial industry dance a little better.

An Overview of FACTA

FACTA was enacted as part of the Hiring Incentives to Restore Employment Act 2010. Overall, as noted by numerous other tax commentators, FACTA imposes on foreign financial institutions and other withholding agents, another extensive layer of requirements for identifying account holders, reporting to the US tax authorities, and being subject to serious penalties.

FACTA is not just another version of the QI rules. It is a new regime that will impact every aspect of financial services in the Caribbean (and everywhere else) as well as businesses and investment funds doing business through the Caribbean. Its reach is through the entire chain of financial operations to get information on US persons.

Banks, investment brokers of all kinds, investment companies and fund structures are all regulated. Whether or not insurance companies are affected is unclear for now. US investments as well as non-US investments (that is non-regulated securities) are included in being regulated. It does not matter whether these are owned directly or indirectly using offshore structures or vehicles.

Covered foreign financial institutions are required to enter into an agreement with the IRS. If they don’t, they could face a 30 per cent withholding on all their passive income coming from the US. Products that previously were considered exempt from offshore reporting –such as total return swaps—are no longer exempt. At present, the definition of what is a “foreign financial institution” may well include some 100,000 financial intermediaries. Certainly, those in the Caribbean will be at the top of the compliance list of the IRS.

The affected financial institutions and intermediaries must identify all accounts of US persons. It is still unresolved as to the recognition and validity of local law regarding privacy of information. The IRS says it is developing systems so that such private information will be kept secure. Those systems are not in place as yet and necessary personnel have not be hired or otherwise not yet trained. Regulations are still being written which are anticipated to be extensive, detailed, complex and, as typical of US tax law and regulation, confusing at best.

Annually, the reporting institution will provide to the IRS:

  • The name of the US account holder and their holdings in companies and trusts.
  • Address and tax payer identification number of all intermediary structures.
  • Account and custody numbers.
  • Account balances and custody holdings.
  • Gross receipts and gross withdrawals (to be defined by yet unissed regulations.
  • Additional information that the IRS requests.
  • Any waivers as to an account must be on a basis of each account and not by way of an institutional waiver.

The process to deal with a recalcitrant account holder is similarly complex and time-consuming. In any event, the recalcitrant account holder must be identified and then reported to the IRS.

All the definitions used in FACTA involve a deep understanding of the relevant US tax code sections. In identifying a “specified person”, a “US person” which is not included would be, for example, any trust that is exempt from tax under section 664(c) or as described in section 4947(a)(1). FACTA is a framework which is expected to be filled in by the IRS through regulations. As a tax compliance and enforcement law, it is couched in what can be thought of as tax language with nearly every provision making reference to some other section(s) of the US internal revenue code.

New International Agreements

The IRS has released a model Intergovernmental Agreement for implementing FACTA. As an international tax agreement it will not be necessary for the US Senate to approve it as it would if such agreement were a treaty. Countries entering into this form of Agreement include France, Germany, Italy, Spain, and the United Kingdom.

Other countries have expressed significant interest in entering into the Agreement but on a reciprocal basis. Mexico, Venezuelan, and Russia would all like to get information on their citizens or residents who have secrete accounts in the United States. It is expected to become more than interesting as US financial institutions realise that they have become foreign financial institutions to other countries and that the new compliance enforcement regime will be applicable as if they were an offshore tax haven financial operation.

The impact on the Caribbean and other similarly situated regions would be substantial because of the Tax Information Exchange Agreements in place. It should be expected that information on non-US persons would be sought by the United States to fulfill its obligation to provide information that it obtains under a request for information.

This would be in keeping with the final regulations issued by the IRS on April 17, 2012 which will require US banks to annually report to the IRS the amount of interest held by non-resident aliens residing in countries with which the US has a bi-lateral agreement, treaty, or agreement. The goal of this reporting is allegedly to help increase the mutual exchange of information with other jurisdictions to combat tax evasion. It should be noted that bills have been introduced into both houses of Congress to block the implementation of these regulations.

There are three areas which as a practical matter will impact offshore areas, such as the Caribbean jurisdictions, and keep them from fully implementing the FACTA regime. These would include costs, privacy issues, and loss of customers.

As the FACTA regime, as well as its multi-national agreement component, is not understood as it is and subject to regulations still to be forthcoming, it will likely be impossible to develop the computer programs to be able to comply. Computer programmers need to have most if not all the salient parts of the design requirements in order to write a program. Presently, even the IRS has not developed a FACTA program. Even if the computer program becomes available, there will be a significant number of additional compliance persons and advisors required. Every step of the way will necessitate having a well-qualified and experienced US international tax expert as an advisor. It will be a difficult for financial institutions which are fighting for business, trying to cope with the financial mess created by the US and other OECD countries, and already in need of more capital to spend the extraordinary amounts of money it will most likely take to comply with yet another US effort to enforce its income tax regime. All the expense will be non-income producing.

Then there may be a problem of developing protocols that will assure compliance with FACTA requirements. Previous experience in the Caribbean and elsewhere shows that US compliance is an ever moving target. Then there will be the cost of developing the manuals that will be needed by the back-room staff and the initial on ongoing training required. There is no methodology yet developed that would allow even a fair guess as to the costs involved.

There is nobody who wants their financial information exposed to fraudsters, identity thieves, kidnappers, or rogue government bureaucrats. Presently, the IRS is sorely underfunded by Congress, overburdened with ever more duties, and consequently undermanned. There can be no assurance of any reasonable degree of informational privacy. This is a risk exposure that many, most, if not all prefer not to take.

Lastly, the financial institutional customer relationship officers may see that the due diligence intrusion will result in loss of their customer base. While the need for a financial institution to not be a conspirator in criminal acts such as trading in women and children, or the proceeds of thefts (whether privately or by governmental officials) is understood and accepted, legitimate customers object to unnecessary exposure of their lives and for ever increasing income taxation.

There is, to be sure, a backlash by people who are subject to an income tax regime who see that their respective governments (mostly the members of the OECD) are being, to be kind, poor shepherds of the taxes that are paid. Besides the normal and historical aversion to paying income tax, customers are clearly unhappy with being treated as sheep to be shorn if not otherwise slaughtered.

The offshore financial institutions will be faced with an environment where an unsympathetic, if not downright hostile customer base is being forced to be exposed to the risk they perceive as most dangerous. FACTA represents a significant hurdle for the Caribbean and other financial centers to not only obtain new customers but are expected to threaten their existing customer base.

The Caribbean financial centers as well as offshore financial centers around the globe are finding themselves forced to enforce an income tax system which, for the most part, they reject.

If I may be permitted a personal observation, it seems that FACTA is bringing to a head a long simmering dispute between the OECD member states and the Caribbean and other offshore financial centers. The basic disagreement is easily understood.

On one side is the belief that these financial institutions should devote their precious time, and limited money and resources to efforts that benefit the financial institution’s owners, employees, and customers. On the other side are the OECD member states that prefer that the successful offshore financial jurisdictions support their tax systems and spending policies which have resulted in economic failure, social disruption, and public corruption.

FACTA, if implemented, will impact the Caribbean and all other similar offshore regions in dramatic economic, social, and political ways. FACTA creates, in effect, a fork in the road for the offshore financial jurisdiction. What choice they make may well be a deciding factor in their future success or failure. There will be decisions to be made which will impact the success or failure of any offshore financial jurisdiction.

[i] Richard A. Gordon; “Tax Havens and Their Use by United States Taxpayers—An Overview.”;; accessed 29/08/2012