Need for FATCA Inter-Governmental Agreement with the US
The official website of the United States (US) Inland Revenue Service (IRS) shows that 67 Sri Lankan financial institutions mostly banks, few stockbrokers, finance companies and trust funds have entered into agreements on their own with the US Tax Office to assist the US Government to eliminate tax evasion by US persons.
The well-knitted Foreign Account Tax Compliance Act (FATCA) scheme established by the US Congress “forces” Foreign Financial Institutions (FFI’s) to enter into “Foreign Financial Institutions Agreements (FFI Agreements)” on their own, where their respective Governments do not execute Inter Governmental Agreements with the US, to absolve the institution being exposed to 30 per cent withholding tax on certain receipts from other financial institutions in the “FACTA Club”.
No prudent Sri Lankan financial institution would opt not to be in the “FATCA Club” as it would mean isolation in the international business arena. Yet many deposit-taking institutions, custodians, investment vehicles, certain insurance companies, some holding companies and treasury centres are in the darkness with regard to the impact of the scheme which one may say is still at an infant stage. Hence the reason for the non-appearance of the names of the Sri Lankan primary dealers, most of the stockbrokers and finance companies in the ‘Participating FFI list’ in the US Internal Revenue Service web site.
For those institutions that have registered, the initial demonstration of compliance with the terms and conditions of the agreement with the US IRS will commence with the annual reporting to be filed with the US IRS. Indeed this would be a test of the ability of these institutions to comply with the 53 page FFI agreement going beyond mere registration in the US IRS web site to obtain Global Intermediary Identification Number (GIIN). The effect of the prevailing situation is that the financial institutions that have entered into ‘FFI agreements’ with the US Government remains exposed to the mercy of a foreign government. The US IRS could make requests pertaining to information at their discretion and the Sri Lankan financial institutions would be bound to comply at their own cost. Perhaps to date not tested, but a clause in the agreement with the US IRS that may concern many financial institutions would be the provision pertaining to the right of the US IRS to institute action against financial institutions that breach the terms of the FFI agreement in the US courts. Defending suits in US courts by retaining US attorneys would be a challenge and this eventuality is a possible scenario as per the FFI agreement. The conditions in the ‘FFI Agreement’ with the US IRS includes complicated rules for carrying out due diligences using electronic and paper record search, establishing of a continuance compliance programme, periodical reporting of information and certifications to be furnished, withholding of 30 per cent from the payments to recalcitrant account holders and non-participating financial institutions (NPFFI’s) i.e account holders who do not provide the requisite direction to share information with the US IRS and those financial institutions who are not in the FATCA club.
These trying circumstances that the Sri Lankan financial institutions have been exposed to could have been averted with intervention of the Sri Lankan Government. Over 50 Governments in other countries to-date have executed Inter Governmental Agreements (IGA) with the US and as many a number have agreed in substance to sign IGAs which are being negotiated. If the Sri Lankan Government signs an IGA with the US government, Sri Lankan financial institutions would not be exposed to the headache of an obligation to deduct 30 per cent withholding tax and remit to US IRS periodically in addition to the receipts of the institution not being subject to 30 per cent deduction. Most importantly the legal barriers faced by financial institutions to fully comply with FATCA such as confidentiality and secrecy clauses in the Banking Act and the Finance Business Act could be easily eliminated via this process. Other added advantages include the ability to negotiate exemptions for some institutions and products from complying with the FATCA scheme, simplified rules pertaining to carrying out due diligence on pre –existing accounts and country specific provisions maybe negotiated for increased clarity on due diligence and the reporting deadlines maybe relaxed for convenience of compliance.
Singapore became the first Asian country to execute an IGA. The Annex II to the IGA between Singapore and the US provides a list of Singaporean financial institutions that are exempted from US tax reporting because they present low risk of tax evasion. These include financial institutions that have a local base with 98 per cent of their accounts held by Singaporean individuals. If Sri Lanka enters into an IGA it could also negotiate similar exemptions to the benefit of the most of the financial institutions in Sri Lanka, from the FATCA scheme where these institutions have a negligible number of US accounts. Though there are over 50 finance companies in Sri Lanka, very few of these have deposits from the US customers which provide the opportunity to negotiate an exemption for such finance companies. Whilst the IGA would act as a shield to cover the direct exposure of the Sri Lankan financial institutions, legal contractual obligations for the US IRS, the IGA may strengthen the relationship between the two governments. The attempts by Indian authorities to expedite the IGA with the US immediately prior to the visit by the US President Barack Obama in January 2015 is a clear sign of importance of IGA in foreign policy. In fact Indian Finance Minister Arun Jaitley emphasised recently on the consequences India may be exposed to on the failure to sign the IGA with US as disastrous and negating the effects of the Government to revive the economy of India, a statement that should be reflected upon by our policy makers.
Though the Singaporean IGA does not contain reciprocity many other countries including the UK have negotiated the reciprocity element in their IGA i.e. collection of tax information pertaining to their own locals in the US territory to be reported to the local government. The crucial aspect that should be borne in mind in negotiating a future IGA with the US Government is to include a clause to terminate the existing FFI agreements that have been entered into by the Sri Lankan institutions as there is no indication of automatic deregistration in the FFI agreement where an IGA is entered in to subsequently.
The Central Bank sometime back provided directions to banks to register on their own and comply with the FATCA obligations while intimating that the Sri Lankan Government was not considering executing an IGA with the US Government. However a comparison of merits and demerits of Sri Lankan financial institutions following the participating “FFI agreement approach” with “IGA Approach” clearly indicates that immense compliance burden, risk and cost on the Sri Lankan financial institutions could be mitigated by the Government intervening and executing an IGA with the US Government.