The Foreign Account Tax Compliance Act (FATCA) has now gone live. Various countries have completed the relevant FATCA Model 1 Intergovernmental Agreement (IGA) with the US allowing for the provision of standardised information about US citizens to US authorities. For some, that is the end of the story. FATCA is simply seen as another all too typical example of the US extending its reach beyond its own borders in pursuit of its own citizens; and requiring cooperation of friendly governments to achieve its objectives. According to this interpretation, anyone who is not a US citizen or does not do business with US citizens will see very limited impact.
Many however are far less confident. While FATCA is indeed a US phenomenon, it has captured the imagination of governments around the world. In April 2013 the G5 nations (France, Germany, Italy, Spain and the UK launched a process aimed at establishing a multilateral automatic tax information exchange project in an effort to combat tax evasion. In February of this year the G20 finance ministers and heads of central banks agreed the Model Competent Authority Agreement (CAA) and the Common Reporting Standard (CRS) and in May 34 member countries endorsed the previously little-noticed OECD Declaration of Automatic Exchange of Information in Tax Matters at the Annual Ministerial Council in Paris. More than 65 countries have committed to implementing CRS with 40 of these further committed to having the requisite legislation and operational capability to complete the first automatic information exchanges in 2017. The full version of the relevant Standard was approved by the OECD Council in July and is being presented to G20 Finance Ministers when they meet in Cairns on September 20-21. What seemed to be a very slow burning fuse is now very much alight. The impact of the explosion on the ways that wealthy individuals manage their affairs can only be imagined, but many see it as a seismic shift.
It appears likely that within a relatively short period of time standardised automatic tax information exchange will be the new paradigm within which all will have to operate. Governments have alighted on a constituency with few votes that, as a result of its high levels of wealth, has few sympathisers among the masses.
The banker’s burden
Much of the work of implementing the programme looks like it will be outsourced to banks. They may not like the extra work, nor the extra intrusions they are required to make into the personal business of their clients. Under different circumstances, according to Bill Ahern, Partner, Family Capital Consultants in Hong Kong and Associate of Global Partnership Family Offices, the banks might have managed to resist the pressure. However, following the financial crisis of 2008 and the money laundering and ‘sanctions busting’ activities to which many have pleaded guilty, the banks have few cards to play at the negotiating table. With the ability to refuse access to the payments mechanism in any currency worth owning, authorities are waving some big sticks and banks are yielding with little sign of meaningful resistance or objection.
Family offices have always used onshore and offshore structures, companies, trusts
and partnerships. The reasons for using such structures are many and varied. They help families manage wealth with sensible governance structure and efficiently pass wealth from one generation to another. They provide a measure of protection from intrusion into their activities by others and, of course, they offer ways legally to avoid and defer tax that might, without the structures, become payable. These structures will also be affected by the global agreement, with the CRS including reporting not only by financial institutions but also covering accounts held by individuals and entities including trusts and foundations.
Against this background we asked three prominent advisors to family offices and high net worth individuals to comment on the state of play as it now exists with FATCA and the potential ramifications of more globally applied arrangements. Helen Hatton is a partner at SATOR in the Channel Islands, and, as noted above, Bill Ahern is based in Hong Kong. We also spoke to Creatrust in Luxembourg.
Luxembourg caution
Creatrust believes that many private banks and wealth managers in Luxembourg have avoided having US clients for some time because of the difficulties posed by previous regulations. However, in terms of FATCA itself, the firm accepts that even for entities that do not do business with US clients, they will need to have procedures to ensure they do not do so in the future, as the burden of proof of not dealing with a US person is on them, not the IRS. The role of the Responsible Officer, certifying that the institution has no US clients is one that is fraught with uncertainty and no little personal risk. Asset Managers and UCITS funds, an important part of the Luxembourg economy, will see increased compliance costs as will banks and custodians.
Having already borne the cost burden of the EU Savings Directive, banks now have to create a new reporting capability. Ahern sees an additional problem with FATCA in the ‘indicia of US citizenship’. This sounds straightforward enough, but in practice anomalies can and do occur. His concern with the OECD effort is that it is focused on ‘indicia of residency’, which is much harder for banks and others to ascertain. This is critical as it determines to what tax authority reports of income and accounts have to be made. At present the likelihood is that affected entities will seek to make ‘self certification’ an acceptable option, though authorities may resist this approach. Alternatively assumptions could be made about tax residency with the individual or entity required to prove that in fact residency is in a different jurisdiction.
Creating processes to deal with all of the information gathering and reporting, even limited to new accounts, will be a logistical challenge and Ahern is not convinced that
the structures can be in place by 2017. Hatton meanwhile believes that as a result of the implementation of whatever new requirements are put in place, the new dispensation will gradually influence the behaviour of asset owners. She hopes they will become less concerned about creating structures to minimise tax liabilities and more focused on the other benefits they can confer. Ahern agrees, commenting that, “I would far rather be helping clients solve complex issues around governance, asset allocation and generational transfer than helping them comply with regulations.”
As far as setting up structures in offshore locations is concerned, Hatton recognises that it will get harder to create structures that are not open to challenge and that all structures are likely to be scrutinised more robustly by tax authorities. She believes that individuals will have to accept the need to incur the costs of detailed record keeping and proper processes as well as establishing a real presence in the jurisdiction concerned. For individuals that may be a residence; for a family office that may include having its own investment management and operations staff. As Hatton notes, “The net effect on Jersey will be positive, but organised in a different way. There will be real presence on the island, based on the quality of the skills pool available and the willingness and ability to attract the kind of skills that will be needed.”
Interestingly, Creatrust expects a similar outcome for Luxembourg. In this case, however, the benefit will result from the decision of the country to go ‘onshore’ as much as possible. Luxembourg has different advantages from Jersey, being at the heart of the EU. Becoming more transparent is simply going with the grain of political and social developments. Ahern’s view is that Asia is different in a number of ways. The tax situation is more complex and less harmonised, but rates are generally lower. Families use corporate structures in large part to help protect their privacy. According to Ahern, most wealthy families in Asia simply have not yet grasped the ramifications for them of what is happening. As an example, he cites the trend of banks requiring to be shown copies of trust deeds before opening bank accounts in the name of the trust. Such a level of intrusion is unheard of in Asian markets until recently. With more and more people having sight of ‘private’ documents, the ability to preserve the benefits of a corporate veil will be diminished and, in that eventuality, the costs of operating the relevant structures may become prohibitive.
The upside
In terms of the overall impact of the different initiatives, Hatton sees them as positive,
not only for governments and particular service sectors in specific jurisdictions, but more importantly for the wealthy individuals themselves and their families. “The development of technology generally and social media in particular, means that older generations’ views of what should and can be kept private may no longer be practical,” she says. “The next generation, far from ruing their loss may in fact be more than happy with a different approach, in the same way that many younger family members have different ideas about the appropriate tax burden they should bear. That is not true for everyone, but among my clients, attitudes are definitely evolving.”
Creatrust, on the other hand, sees the initiatives generating additional cost and bureaucracy, without necessarily producing a very material change. Certainly the EU Savings Directive and efforts by the UK tax authorities to clamp down on ‘offshore’ accounts have produced far less revenue for governments than their sponsors promised. What FATCA has definitely already achieved, however, is to make it much harder for US citizens to invest through European funds and wealth managers, thereby reducing their choice.
Who knew?
Inevitably with such initiatives there will be unintended consequences that their authors never imagined. Increased costs will make some investment funds uneconomic and they will be withdrawn. Some smaller firms, whether private banks, wealth managers or asset managers, may find it easier to sell up to a larger rival with the technology and relationships in place to facilitate compliance. Choice will thus be further reduced, with high performing but smaller hedge funds potentially among the most vulnerable.
Further consolidation in other respects, such as fund administration and custody, appears likely. And of course the regulations will produce new firms designed to help individuals and companies comply with the new requirements. Wealthy individuals, faced with higher costs and reduced choice will change their behaviour, but not necessarily in the ways that governments would like and expect. For some, as Hatton certainly hopes, it will indeed be to embrace the greater transparency and to use wealth wisely and perhaps less selfishly. These individuals will realise that governments who have to provide infrastructure and education that enable wealth to be created, need support so that the next generation has the same opportunities. However some will continue to believe that their success is solely down to their own efforts and ability and strive to keep as large a proportion of their wealth and income out of sight of others. The fact that it will be harder for them to succeed does not mean they will not spend time, money and effort to achieve that objective.
