FATCA impact: all costs on Europe?

All the downsides of the highly controversial FATCA regulation would fall on European investors, says James Broderick, head of European sales at JPMorgan.

Speaking at a conference in Milan organised by Assogestioni, the Italian association of fund managers, Broderick warned of the extensive effects that the incoming US legislation would have for global firms and investors.

He noted that the provision on foreign account tax compliance, enacted by Obama’s administration last year, barely considers the balance between costs and benefits.

“Costs are all in Europe and benefits entirely in the US side. More precisely, costs of implementing FATCA could easily be higher than benefits made in US.”

According to Broderick, there is a preliminary question on why investors around the globe should comply with US tax regulation. Problematically, the offshore rule would clash with local and national legislations and some the elements implied would breach European provisions on privacy.

“The regulation would clash with shareholders’ and policyholders’ rights, and create difficulties for smaller companies to contract directly with the US internal revenues’ department.”

In addition, the legislation is based on the connectedness of the financial system, rather than on jurisdictional clarity, Broderick said. “Compliant strategies and responses would be inconsistent, as the implementation would  differ substantially in different parts of the globe, which would cause varied impacts on the businesses.”

Although the FATCA taps into key themes of the financial sector, such as the governments’ focus on tax accountability, the cross-border nature of financial regulation and “know your costumer” procedures, its “extremely complex terms” made it very unpopular with the investment management industry.

Broderick said that considering how much resource firms will have to put into shareholders’ identification, clients’ reporting and withholding systems, the FATCA will bring along daunting implications affecting primarily banks. “The banking system will have a much harder time excluding US taxpayers from its wide client base.”

Foreign financial institutions (FFI) will be held liable from US revenues authorities starting from June 2013, the implementation date, after which they will be expected to report on their clients annually.

The most unwelcome element of the legislation is that US authorities will apply a 30% withholding fee to any payments made by “recalcitrant” account holders and non-compliant financial groups from January 2014. Ironically, if a third party distributor refuses to be compliant, an investment group will be forced to apply the withholding fee on each and every investor.

As investment managers will be directly exposed to non-compliant distributors, financial trade bodies have been also calling for the creation of a standalone position for the latter, so that groups would not have to review their business model in order to exclude “recalcitrant” third parties.

Broderick warned that the provision produces the “untenable situation” where clients could take contradictory decision, prompting some groups to disengage with a part of them. “It does have a crucial impact on asset managers’ business model in that if someone who refuses to be compliant, they may need to review their business, disengaging from some of their third parties and clients.”

While dealing with non-compliant financial institutions will be tricky,“investment firms will have to do their best to ensure their clients are not subject to the hardship imposed by this very draconian regulation”, Broderick said.

He added that at this stage raising awareness is key to limiting the downside of the implementation. “Non-compliant subjects would make things very complicated for us, so acceptance and awareness are crucial at this stage. There have already been some accommodations applied to FATCA implementation, and our hope is that there will be room for more.”

“While influencing decisions made in Washington may be beyond the capability of European firms, connecting with overseas lobbying groups make some difference,” he commented.

While governmental institutions and pension funds would be less impacted, funds that distribute solely through participating financial institutions should also benefit, alongside with funds that have limited direct US investors – which can potentially handle the procedure manually – and funds that exclude them in total, such as JPMorgan, reducing the scale of exposure to US tax accountability.

However, given FATCA’s far-reaching definition of the US taxpayer, excluding such investor would not be feasible for the majority of investment groups.

Overall, jurisdictions that systematically identify the nationality of their clients will be favoured, while for the others it has been calculated that costs in terms of staffing, governance and tracking systems will raise significantly. According to Keith Lawson, senior counsel tax law at ICI, the US investment companies institute, the same process should pay as much as $8.7bn to US Treasury over the next ten years.

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