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FATCA Tax Lawyers Update: FATCA Financial Institution Definition

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One of the key concepts in FATCA compliance is a “financial institution”. The definition of a financial institution (“FATCA Financial Institution”) is contained in the FATCA Model IGAs. In this article, I will explore some of the general concepts central to defining a FATCA Financial Institution.

Four Types of FATCA Financial Institutions

The concept of FATCA Financial Institution is defined in the Model IGA Agreements. Both Model 1 and Model 2 IGAs agree on the definition of FATCA Financial Institution: “The term ‘Financial Institution’ means a Custodial Institution, a Depository Institution, an Investment Entity, or a Specified Insurance Company.” Let’s go over each concept in more detail.

Definition of a FATCA Financial Institution: Custodial Institution

FATCA Model Agreements provide a fairly straightforward definition of a Custodial Institution: “The term ‘Custodial Institution’ means any entity that holds, as a substantial portion of its business, financial assets for the account of others.” In this context “substantial” means that, during the specified period of time, twenty percent or more of the entity’s gross income is derived from holding of financial assets and related financial services.

The specified period of time is defined in Model 1 IGA as “the shorter of: (i) the three-year period that ends on the December 31 (or the final day of a non-calendar year accounting period) prior to the year in which the determination is being made; or (ii) the period during which the entity has been in existence.”

Definition of a FATCA Financial Institution: Depository Institution

According to FATCA Model IGAs, “The term ‘Depository Institution’ means any Entity that accepts deposits in the ordinary course of a banking or similar business.”

This definition is fairly self-explanatory, but it should be noted that interest-paying client money accounts operated by insurance companies are included within the definition of a depository institution.

Definition of a FATCA Financial Institution: Specified Insurance Company

According to FATCA Model IGAs, “the term ‘Specified Insurance Company’ means any entity that is an insurance company (or the holding company of an insurance company) that issues, or is obligated to make payments with respect to, a Financial Account.” This definition basically applies to all insurance companies that issue or must make payments with respect to an Insurance Cash-Surrender Value Contract or Annuity contract (which is similar to an FBAR).

For the purposes of this essay, I am not going to engage in the discussion of a Financial Account definition (this is an issue that I addressed in another article); suffice it to say that the definition of a Financial Account under FATCA closely follows the FBAR definition of the same concept.

Definition of a FATCA Financial Institution: Investment Entity

Finally, FATCA Model IGAs provide a detailed definition of what constitutes an “Investment Entity”. This concept includes any entity that conducts as a business one or more of the following activities or operations for or on behalf of a customer:
“(1) trading in money market instruments (cheques, bills, certificates of deposit, derivatives, etc.); foreign exchange; exchange, interest rate and index instruments; transferable securities; or commodity futures trading;
(2) individual and collective portfolio management; or
(3) otherwise investing, administering, or managing funds or money on behalf of other persons. This subparagraph 1(j) shall be interpreted in a manner consistent with similar language set forth in the definition of “financial institution” in the Financial Action Task Force Recommendations.”

Notice that this definition encompasses any entity that is managed by an Investment Entity. Further note that the definition of an Investment Entity should be interpreted in a manner consistent with the definition of a “financial institution” in the Financial Action Task Force Recommendations.

Implications if FATCA Financial Institution Definition on Undisclosed Foreign Accounts

The broad definition of a FATCA Financial Institution has a profound impact on US taxpayers with undisclosed foreign accounts. The chief reason for this conclusion is the fact that as soon as an entity is classified as a FATCA Financial Institution, the entity must be FATCA compliant (unless it falls within a FATCA exemption) and should report all of its accounts owned (directly or indirectly) by US taxpayers.

Contact Sherayzen Law Office for Help With Undisclosed Foreign Accounts

The consequences of the IRS discovery of an undisclosed foreign account can be disastrous for the US owner of this account, including extremely high monetary willful civil penalties as well as criminal penalties.

This is why, if you have an undisclosed foreign account, please contact Mr. Eugene Sherayzen, an experienced international tax attorney of Sherayzen Law Office as soon as possible. Our team is well versed in FATCA compliance, FBARs and other foreign reporting issues. We have helped hundreds of US taxpayers around the globe and we can help you.

So, Contact Us Now to Schedule Your Initial Consultation!

FATCA Compliance Presents Challenges for Hedge Funds

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The Foreign Account Tax Compliance Act (FATCA) created a worldwide international tax compliance regime that has influenced more industries than simply foreign financial institutions. FATCA compliance presents a formidable challenge even to hedge funds.

FATCA Compliance Challenges for Hedge Funds

The challenges that FATCA compliance poses to hedge funds is best understood by analyzing what FATCA compliance requires of hedge funds – a multi-group coordination effort from various divisions within a business enterprise: business, operations, technology, finance and compliance.

The compliance department, most likely with the cooperation of the in-house counsel (and outside counsel who specializes in FATCA compliance, if in-house counsel lacks such knowledge) should lay out the FATCA compliance goals and make sure that the FATCA compliance process complies with these goals. The operations division should create the framework for the FATCA compliance process, including how this process should be controlled and managed for tax reporting and tax withholding purposes. The technology division needs to build the IT infrastructure to address the technological challenges of FATCA goals in a cost-effective way. The members of the business division (which incorporates the actual customer intake) should be thoroughly educated in the FATCA compliance process as well as the company’s specific IT solutions.

When this FATCA compliance process is applied to the hedge fund industry, one can clearly see the numerous challenges that the hedge funds face in the implementation of their FATCA compliance. The hedge funds need to register their funds for FATCA on the IRS portal, gather various investor data with respect to numerous (and often changing) customers, review and assess such data, and properly report customer data to the IRS.

Another challenge for hedge funds is the required tax withholding. Unlike previous attempts at international tax legislation, FATCA has very effective enforcement mechanisms which forces all US banks, brokers and financial institutions to essentially work for the IRS, including withholding taxes. In fact, the hedge funds that deal in US dollars are likely to be subject to the withholding tax requirement at an increasing rate in the near future.

However, the tax withholding challenge for hedge funds goes far beyond the more straightforward fact that it will need to withhold tax. Rather, the biggest headache for hedge funds is the identification of the beneficial owners and controlling persons of their clients. A lot of investors in hedge funds operate through unregulated legal vehicles or individual agents; this fact makes the FATCA data collection process a much more difficult challenge for hedge funds.

Finally, the variations in IGAs to implement FATCA present an additional challenge. While this problem is not specific to hedge funds, it is the one that they still have to manage.

Impact of FATCA Compliance By Hedge Funds On US Taxpayers

Despite these challenges, many hedge funds are successfully addressing FATCA compliance issues and are incorporating advanced software solutions to make their look-through process more efficient.

These successes of hedge funds in their FATCA compliance make it difficult for US persons investing in mutual funds through foreign entities to conceal their ownership of these entities. This means that one can expect an increase of the IRS discovery of such investors.

If these investors are not in full compliance with their US tax obligations – particularly with respect to FBAR, Form 8938, foreign business ownership reporting, foreign trust ownership and foreign income disclosure – they may be facing catastrophic US tax consequences, including draconian FBAR willful penalties as well as potential imprisonment.

Contact Sherayzen Law Office for Help With Undisclosed Foreign Assets and Income

If you have undisclosed foreign assets or foreign income, please contact Sherayzen Law Office as soon as possible. After reviewing the facts of your case and analyzing the available voluntary disclosure options, Mr. Sherayzen will conduct your voluntary disclosure process from the beginning through the end, including the preparation all of the required legal documents and tax forms.

Contact Us to Schedule Your Confidential Consultation Now!

FATCA Attorneys Update: IRS Launches International Data Exchange Service

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On January 12, 2015, the IRS announced the opening of the International Data Exchange Service (IDES) for enrollment. The appearance of IDES is not a surprise to FATCA Attorneys, because most FATCA attorneys knew IDES was the next logical step since its purpose is going to be for foreign financial institutions (FFIs) and host country tax authorities (HCTAs) to securely send their FATCA reports about US account holders under regular FATCA compliance or pursuant to the terms of an intergovernmental agreement (IGA), as applicable.

So far, more than 145,000 financial institutions have registered through the IRS FATCA Registration System. Moreover, the IRS made tremendous progress with IGAs – there are now more than 110 IGAs, either signed or agreed in substance.

FATCA Attorneys Update: How Will IDES Function?

Using IDES, a web application, the sender encrypts the data and IDES encrypts the transmission pathway to protect data transfers. Encryption at both the file and transmission level safeguards sensitive tax information. This means that FFIs and HCTAs can have a high level of confidence in the data about US account holders that they will be transmitted to the IRS.

“The opening of the International Data Exchange Service is a milestone in the implementation of FATCA,” said IRS Commissioner John Koskinen. “With it, comes the start of a secure system of automated, standardized information exchanges among government tax authorities. This will enhance our ability to detect hidden accounts and help ensure fairness in the tax system.”

Where a jurisdiction has a reciprocal IGA and the jurisdiction has the necessary safeguards and infrastructure in place, the IRS will also use IDES to provide similar information to the host country tax authority on accounts in U.S. financial institutions held by the jurisdiction’s residents.

IDES runs on all major browsers, including Chrome, Internet Explorer, Safari, and Firefox and will support application-to-application exchanges through the SFTP transmission protocol enabling a wide variety of users to interact with IDES without building additional infrastructure to support transmission.

FATCA Attorneys Update: IDES and Model 2 IGA Jurisdictions

The IRS encourages HCTAs in Model 2 IGA jurisdictions and FFIs to begin the enrollment process well in advance of their reporting deadline. To begin transmitting information in IDES,an FFI or HCTA will need to first obtain a digital certificate. Digital certificates bind digital information to physical identities and provide data integrity. IDES stores each user’s public key and related digital certificate. All IDES enrollees (including host country tax authorities) must obtain a proper digital certificate in order to enroll (there is a list of approved Certificate Authorities available on irs.gov).

FATCA Attorneys Update: IDES and Model 1 IGA Jurisdictions

For HCTAs in Model 1 IGA jurisdictions, the IRS will directly notify them to let them know when it is time to enroll. FFIs will initiate enrollment online on their own; in order to enroll, the financial institution will need to have registered as a participating financial institution through the IRS FATCA Registration System and have a global intermediary identification number (GIIN) that appears on the IRS FATCA FFI list. The online address for IDES enrollment can be found here.

FATCA Attorneys Update: IDES and Offshore Voluntary Disclosure

The opening of IDES is considered by FATCA attorneys as an important development in FATCA implementation which is likely to affect a very large number of US persons with undisclosed foreign accounts. It should be remembers that if the IRS receives the information about an undisclosed foreign account through IDES, it may prevent the US owner of such an undisclosed foreign account from being able to enter into the IRS Offshore Voluntary Disclosure Program.

FATCA attorneys also should warn their US clients who closed their foreign accounts prior to 2014 that the closure of such accounts prior to the implementation of FATCA does not mean that these accounts will not be reported later. On the contrary, FATCA attorneys should stress to their clients that the IDES is likely to be used by FFIs and HCTAs to report prior non-compliance with respect to closed accounts to the IRS as early as March 31, 2016 if not earlier.

Contact Sherayzen Law Office for Help With Undisclosed Foreign Accounts

Almost all FATCA attorneys stress that time is running out for US persons with undisclosed foreign accounts to start their voluntary disclosure process. With the introduction of IDES, a significant practical hurdle to FATCA implementation has been removed. This means that your undisclosed foreign account may be reported at any point now to the IRS.

If you have undisclosed foreign accounts, you should contact Sherayzen Law Office as soon as possible to explore your voluntary disclosure options. Our experienced FATCA law firm will thoroughly analyze your case, determine your existing exposure to U.S. tax penalties, identify the available voluntary disclosure options, prepare all legal and tax documents for your voluntary disclosure, and vigorously advocate your position against the IRS.

Contact Us Now to Schedule Your Confidential Consultation!