October 2017

Seven years ago, the US Foreign Account Tax Compliance Act was enacted, spawning a complex network of intergovernmental agreements between the US and other countries. Douglas S Stransky and Geoffrey L Wynne summarise its impact on financial institutions and cross-border financing

Globalisation has expanded trade, increased prosperity and raised global living standards. But it has also exposed the global financial system and financial institutions to abuse.

In response, there has been a global proliferation of operational tax obligations imposed upon the financial services sector, as governments seek to maximise tax revenues and effectively tackle tax evasion. The environment for tax reporting between international jurisdictions has been undergoing significant change in a global effort to improve tax transparency. At the core of these obligations are requirements to adequately identify customers from a tax perspective, to report tax-related information on those customers to tax authorities and, where appropriate, to withhold tax from payments made to those customers.

The US Foreign Account Tax Compliance Act (FATCA) is one example of this developing transparency landscape and the growing momentum behind automatic exchange of information. This article provides an overview of FATCA and then focuses on FATCA’s impact on financial institutions and, in particular, compliance requirements for those financial institutions. Finally, the article closes with a discussion of how to address FATCA risk in cross-border financing transactions.


In 2010, the US Department of Treasury and US Internal Revenue Service (IRS) introduced FATCA to encourage better tax compliance by obtaining detailed account information for US taxpayers located anywhere in the world on an annual basis. Since its enactment, 110+ jurisdictions and more than 75,000 banks worldwide have agreed to share tax information with the United States under FATCA.

FATCA encourages better tax compliance by preventing persons from using financial institutions and foreign entities to avoid taxation on their income and assets. For example, financial institutions in the UK are required by UK law to seek answers to certain questions for the purposes of identifying those accounts that are reportable to HM Revenue & Customs (HMRC), and through HMRC to the respective tax authorities party to FATCA.

The legislation requires foreign financial institutions (FFIs) around the globe to report details about their US customers to the IRS. Failure to comply results in the imposition of a 30% withholding tax on any US source income received by those FFIs. Recognising the important FATCA-related legal and cost issues, the US developed, together with France, Germany, Italy, Spain and the UK, a model for the intergovernmental implementation of FATCA (Model FATCA IGA). The Model FATCA IGA provides for the implementation of FATCA through reporting by FFIs to their local tax authorities, which then exchange the information on an automatic basis with the IRS.

Impact on FFIs

FATCA (in addition to the wider process of global tax transparency) requires significant compliance efforts by FFIs worldwide. The FATCA regulations require FFIs to review existing onboarding and withholding processes and enhance them where necessary to satisfy FATCA regulations. Since FATCA has been in effect, most FFIs are proactively implementing changes to their current business practices to comply with FATCA.

The compliance efforts for FFIs boil down to three levels: 

  1. Client entities (including funds, personal investment companies, trusts, foundations, etc.) in any structure must comply with FATCA and tax regulations and legislation in the country where the entity is established.
  2. Each entity must comply with FATCA and in accordance with the Model FATCA IGA.
  3. The ultimate beneficial owner (UBO) must comply with tax reporting requirements and other regulations in the country where the UBO is tax resident, which often will include FATCA.

FATCA compliance requires FFIs, including foreign subsidiaries of US-based organisations, to:

  1. Register and enter into FFI agreements with the IRS;
  2. Conduct due diligence for new and existing accounts to classify account holders or investors as either US or non-US; 
  3. Withhold 30% in US taxes when individuals fail to provide the appropriate documentation or when doing business with non-compliant entities; and
  4. Report account information directly to the IRS or indirectly through their national government.

FFIs that register on the IRS FATCA Registration Website receive a Global Intermediary Identification Number (GIIN) from the IRS. Every month, the IRS publishes a list of registered and approved FFIs and their GIINs. Withholding agents may rely on the IRS-published list to verify FFIs’ GIINs and not withhold on payments made to those FFIs.

Allocating risk in cross-border financing transactions

Many cross-border financing transactions may be subject to FATCA requirements, including:

  1. Import/export letters of credit;
  2. Documentary bankers’ acceptances; and
  3. Trade acceptances and open-account payments resulting in payments to a party other than an FFI either directly, or through an FFI.

Therefore, a significant issue in these transactions is to determine how to allocate the risk of 30% US tax withholding under FATCA. Common circumstances that can require imposition of a FATCA withholding tax include the following:

  1. The borrower is a US entity, or (in certain circumstances) has its obligations guaranteed by a US entity, so that interest payments are US-sourced and subject to FATCA withholding if paid to a non-compliant lender.
  2. The borrower is an FFI that earns some US-sourced income, and rules are issued during the term of the loan requiring withholding on Foreign Pass-through Payments (which, to date, have not been defined).
  3. Payments on a loan that otherwise would avoid withholding because the loan is a grandfathered obligation (prior to FATCA) could become subject to withholding if the loan loses that status.

The party who assumes the contractual risk of FATCA is largely down to the relative commercial bargaining power of the parties. For transactions with US borrowers, the consensus position in the US financing market is to allocate the risk of FATCA withholding to the lender because compliance is within the lender’s control.

Outside the US however, the lending market has not yet coalesced around a single approach to FATCA withholding for financing transactions. Accordingly, an agreement can reflect ‘borrower risk’ and contain wording that effectively makes the application of FATCA withholding to the particular financing the borrower’s risk. Alternatively, an agreement can reflect ‘lender risk’ by facilitating the application of the grandfathering rules to the loan financing in question, by giving lenders the right to veto any amendment or change of borrower(s) that would result in the financing losing grandfathering.

In the name of transparency

FATCA has marked a pivotal start to some very serious moves on global transparency that are continuing apace. For FFIs, there are substantial compliance requirements in FATCA implementation, and such requirements will continue to increase as governments introduce other global tax transparency rules. In addition to the many compliance requirements, FFIs cannot escape the impact of FATCA on cross-border financing transactions - all in the name of transparency.

Douglas S Stransky is a partner in the Tax Department of law firm Sullivan & Worcester’s Boston office and the leader of the International Tax Practice group. Geoffrey L Wynne is a Partner and Head of the Trade and Export Finance practice at Sullivan & Worcester UK LLP in London


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