An approach to ensuring compliance with FATCA The Foreign Account Tax Compliance Act (FATCA) is an important development in US efforts to improve tax compliance involving foreign financial assets and offshore accounts of US citizens. FATCA requires foreign financial institutions (FFIs) to report, certain information about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest either directly to the US tax authorities - the Internal Revenue Service (IRS) - or to the FFI’s local tax authority. FFIs failing to comply with this will face a 30% withholding tax on the income from their US financial assets. In addition the account holders in any of the non-complying FFIs would also face a similar withholding on their US sourced income. With FATCA, the US is effectively attempting to initiate a worldwide exchange of information on US persons. This initiative is a major undertaking to achieve greater tax transparency.

This paper highlights the changes brought about by the proposed regulations and attempts to provide a deeper understanding of what FATCA means for financial institutions including the impact it would have on IT systems and operations.

White Paper

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About the Authors

Bharath Raj

Bharat is a domain expert supporting the Capital Markets Business Solutions Group. Currently he is working as a business analyst with a large European Investment Bank.

Saurabh Gargava

Saurabh has been with TCS for the past five years and has rich experience in the banking and financial services domain. He specializes in the fields of retail banking and capital markets.

Anita Fondekar

Anita is a core member of the Capital Markets Risk Solutions Group at TCS. With 14 years of experience, she specializes in credit risk and operational risk. She has hands-on experience with leading global banks and has led several projects in Basel II and Risk Management.

Prabhakaran Pitchandi

Prabhakaran Pitchandi heads Capital Markets Solutions Group. He has over 18 years of experience in Capital Markets Risk Management & Derivatives and has worked with many leading global investment banks.

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Table of Contents

1. Introduction 4

1.1 What is FATCA? 4

1.2 What does FATCA aim to do? 4

1.3 Whom does FATCA affect? 4

1.4 The FATCA Joint Statement andIntergovernmental Agreements 5

1.5 Are there alternatives to FATCA? 6

1.6 FATCA Timeline and Key Dates 6

2. Getting ready for FATCA 8

2.1 Brief Overview of the Latest Proposed Regulations 8

2.2 Challenges in Implementation 11

2.3 The cost impact of FATCA 12

3. FATCA Impact on Banking and Capital Markets 12

3.1 Impact on Banking 13

3.2 Impact on Capital Markets 14

3.3 FFI Strategies & Preparedness 15

4. FATCA Impact on Technology and Operations 16

4.1 Impact on Technology 17

4.2 Impact on Operations 19

Conclusion 21

1. Introduction

1.1 What is FATCA?

FATCA enacted in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act, is an important development in US efforts to improve tax compliance with regard to offshore accounts of US persons. The initiative will also help combat tax evasion by US persons holding investments in offshore accounts.

Under FATCA, Foreign Financial Institutions (FFIs) will need to enter into agreements with the Internal Revenue Service (IRS) to report, in detail, the US accounts they handle, or be subject to a 30% withholding tax on any US sourced income and sales proceeds. FFIs will be required to identify US accounts, verify their ownership, report them to the IRS and either withhold 30% on recalcitrant accounts or obtain a waiver (such as in cases where the foreign law prevents reporting). Accounts deemed to be recalcitrant must be closed.

FATCA does not replace current US documentation, information reporting and withholding rules applicable to US and non-US persons, including the current Qualified Intermediary (QI) regime.

1.2 What does FATCA aim to do?

The primary goal of FATCA is to combat offshore tax evasion. The IRS aims to obtain information on US citizens who hold offshore financial accounts and identify people who are evading paying taxes on their income earned outside of the US. Statistics show that of the seven million US citizens who live or work outside the USA, less than 7% file tax returns. The IRS has publicly said that it hopes to generate zero revenue from implementation of FATCA. The IRS would rather prefer to know which Americans are using non-US accounts and investment vehicles. Nevertheless, by ensuring financial institutions around the world track down delinquent US taxpayers, the IRS expects to raise an additional $8.7 billion in taxes over the next ten years.

1.3 Whom does FATCA affect?

FATCA is an all pervasive law that will be applicable to all financial institutions such as private and investment banks, broker-dealers, insurers, mutual and hedge funds, custodians, intermediaries and withholding agents as well as ordinary US citizens (having offshore accounts) and even non-US citizens (who bank with FATCA non-compliant institutions). It can also affect Non-Financial Foreign Entities (NFFE) such as limited liability companies and partnerships. The impact on various stakeholders is given in Figure 1.

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1.4 The FATCA Joint Statement and Intergovernmental Agreements

A joint statement was issued on February 8, 2012, by governments of 5 EU nations. France, Germany, Italy, Spain and the UK came on board to combat international tax evasion and work with the US to enforce FATCA. According to this joint statement, the FFIs established in these countries (referred to as FATCA partners) are under no obligation to enter into a separate FFI agreement directly with the IRS. More importantly, this announcement has the potential to solve one of the stumbling blocks to FATCA implementation – the reporting requirements for FFIs in countries that prohibit divulging confidential information of its account holders. By making this joint statement, it is presumed that the U.S. will leverage the old established treaty exchange agreements to overcome this difficulty. It would make the financial institutions (in FATCA partner countries) report such confidential information to the local tax authority rather than to the IRS directly. From then on, it would be one government tax authority communicating with another government tax authority.

The agreement with FATCA partners also provides different treatment for recalcitrant accounts and passthru payments. The FFIs established in the FATCA partner need not terminate recalcitrant accounts or impose passthru payment withholding tax on such accounts. Also in addition, no passthru payment withholding tax needs to be implemented on payments to other FFIs that are organized in any of the FATCA treaty partners. It is estimated that FFIs can reduce implementation costs from around $150 million to less than $100 million due to the reduced burden as a result of the joint statement between governments.

Figure 1: Impact of FATCA on various stakeholders

30% Withholding Tax Required

IRS

FFI with FATCAAgreement

Entity/CorporateAccounts

Individual/RetailAccounts

USPerson

Non-USPerson

Recalcitrantaccount

ParticipatingFFI

Non-ParticipatingFFI

NFFE(Can be

recalcitrant)

n US Citizensn Ex-US Citizensn Person with US Indicia

n Banksn Custodiansn Broke-Dealersn Mutual Funds

n Hedge Fundsn Trustsn Clearing Housesn Private Equity

n Private Trade and Business

n Partnershipsn Startups

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The joint statement also mentions US' commitment to collecting and reporting information regarding accounts in the US held by citizens of FATCA partners to the concerned FATCA partner regulatory body. This would lead to an obligation on the part of financial institutions incorporated in the US (also known as USFIs) to implement FATCA like systems and processes to fulfill this commitment.

On July 26, 2012, the IRS issued an intergovernmental model agreement (IGA) which is a follow-up to the joint agreement wherein member nations had agreed to collaborate on preparing an intergovernmental approach for FATCA implementation. The five FATCA partners have also issued a joint endorsement requesting finalization of bilateral agreements based on the IGA.

The IGA has two versions —reciprocal and nonreciprocal. In both cases, a framework is established for financial institutions to report FATCA related account information to their local tax authorities, followed by the exchange of such information under existing bilateral tax treaties or tax information exchange agreements. In addition, the legal issues that had been raised earlier have also been addressed in order to simplify FATCA implementation for financial institutions.

The reciprocal version of the model allows the United States to exchange information relating to partner country residents who hold an account with U.S. financial institutions. The US has also expressed its commitment to finalize regulations and support legislation for information exchange.

1.5 Are there alternatives to FATCA?

Financial institutions have the option of becoming a non-participating FFI by not agreeing to enter in to an agreement with the IRS for undertaking due diligence, reporting and withholding. In such cases, US withholding agents must withhold 30% on every withholdable payment made to the FFI. This includes all US-source payments of interest, dividends, annuities and other payments of income subject to the withholding tax rules currently enforced. It also includes gross proceeds from the sale of property which produces US-source dividends or interest. Withholdable payments do not include payments constituting income effectively connected with the conduct of a trade or business within the United States.

In this scenario, the non-participating FFI can close all its businesses, such as US accounts and US securities, which produce US sourced income. But doing this does not guarantee exemption from withholding as the non-compliant FFI might still suffer as a result of withholdable passthru payments. Also, this raises the huge disadvantage of not doing business with the largest economy in the world and hence may prove to be an unsustainable option in the long run.

1.6 FATCA Timeline and Key Dates

On October 25, 2012, the IRS issued updated timelines for due diligence and other requirements under FATCA. It outlines new timelines for withholding agents and FFIs to complete due diligence and other requirements and also provides additional guidance concerning gross proceeds withholding and grandfathered obligations. These guidelines modify the rules set forth in the regulations proposed issued

Choice of Non-Compliance

Exit U.S. Business

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on February 8, 2012. Figure 2 depicts the key timelines for FATCA compliance. The timelines are applicable to participating FFIs and withholding agents that are participating FFIs.

Figure 2: Key FATCA dates for FFIs

Notices &FFI Governance

Due Diligence forPre-existing & New accounts

Withholding Reporting

2010&

2011

Mar 18, 2010 – FATCA enacted to law

Aug 27, 2010 – Notice 2010-60 with initial guidance on due diligence and reporting requirements

Jul 25, 2011 – Notice 2011-53 released with transitional relief for pre-existing account due diligence, withholding and reporting

2012

Feb 8 – IRS issues proposed draft regulations and joint intergovernmental statement

July 26 – Issue of model Inter Governmental Agreement (IGA) by IRS

December – Final FATCA regulations expected from IRS

2013

Jan 1 –Online process available for FFI applications

Jul 1 – Effective date of FFI agreements entered into before June 30

Jan 1 – End date for obligations to be exempt from FATCA withholding (Grandfathered Obligations)

2014

Jan 1 – FATCA agreements come in to effect

Jan 1 – New account opening procedures must be in place to identify US accounts

June 30 – Identification and documentation of payees that are prima facie FFIs (or 6 months after effective date of payor FFI’s FATCA agreement)

Dec 31 – Identification and documentation procedures for preexisting high value Individual accounts (or 1 year after effective date of FFI’s FATCA agreement)

Jan 1 – FATCA withholding on FDAP income payments to non-participating FFIs and recalcitrant payees begins

2015

Dec 31 – Identification and documentation procedures for pre-existing entity accounts (or 2 years after effective date of FFI’s FATCA agreement)

Dec 31 – Identification and documentation procedures for all remaining low value Individual accounts (or 2 years after effective date of FFI’s FATCA agreement)

Mar 15 – Reporting on withholdable income payments begins (with respect to the 2014 calendar year)

Mar 31 – FFIs begin U.S. Account information and balance reporting (with respect to the 2013 and 2014 calendar years)

2016

Jan 1 – End of transitional provisions relating to affiliates within a group.

Mar 31 – Reporting on U.S. Account income by partici-pating FFIs begins (with respect to the 2015 calendar year)

2017

Jan 1 – FATCA withholding on gross proceeds payments to non-participating FFIs and recalcitrant payees begins

Jan 1 – Withholding on foreign pass-thru payments not expected to begin before this date

Mar 15 – Reporting on U.S. Account gross proceeds by participating FFIs begins (with respect to the 2016 calendar year)

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2. Getting ready for FATCA

The level of change an organization and its business units would undergo to achieve FATCA compliance depends on their level of involvement with US customers. Hence, the complexity of implementation and the time taken to become FATCA compliant would only be clear after conducting an impact assessment into the extent to which FATCA requirements will affect their strategy, products, services, processes, systems and people. In a broad sense, an FFI would have to develop new capabilities with respect to existing customer base (pre-existing accounts), customer-on boarding processes (for new accounts), withholding operations and reporting requirements in order to comply with FATCA.

2.1 Brief Overview of the Latest Proposed Regulations

2.1.1 Due Diligence (FATCA Profiling) for Pre-existing Individual Accounts

The latest proposed FATCA regulations require FFIs to conduct due diligence and threshold monitoring on pre-existing individual (a) accounts with balances of over $50,000 (b) insurance or annuity accounts with balances of over $250,000.

For accounts with aggregate balances ranging from $50,000 to $1 million, the FFIs may limit due diligence for US indicia to just electronic searches. The need to distinguish between private banking accounts and other accounts has been done away in the new proposed regulations. Instead, the concepts of ’high value accounts’ and ’relationship manager test’ have been introduced. High value accounts, i.e. accounts with values in excess of $1 million, must perform a manual review for indicia of US ownership and must make an inquiry to the relationship manager who maintains the account. If an indicia of US ownership is found, the FFI must conduct additional due diligence. Figure 3 shows the due diligence workflow for pre-existing individual accounts.

Figure 3: Due diligence workflow for pre-existing individual accounts

Pre-ExistingIndividual Account

Electronics Search +Manual Review

BalanceMonitoring and

StatusRe-identification

Electronics Searchfor US Indicia

STOP Treat as Non-US Account

STOP Treat asUS Account

RequestW9/W8ben form

No response received

STOP Treat asrecalcitrant Account

STARTIndividual Account Identified

A/cValue<=$50,000

?

A/cValue>$50,000< =$1M

?

W8ben W9

No No

YesYes

Yes

No IndiciaFound

?

STOPDeemed compliant FFI No reporting required

STOPNPFFI/Recalcitrant FFI

Withholding and reporting Requirements

STOPParticipating FFI

No reporting required

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2.1.2 Due Diligence for Pre-existing Entity Accounts

FFIs need to conduct due diligence and threshold monitoring on pre-existing entity accounts with balances of over $250,000(determined by aggregating all accounts held by the entity at the FFI and its affiliates). The FFI can rely on its Know Your Customer (KYC)/ anti-money laundering (AML) records to determine whether the account holder is a US entity. If the account balance is $1 million or less, the FFI can rely on its records to determine whether the entity has substantial US owners. If the account balance is in excess of $1 million, the FFI must make an independent search to determine if the entity has US owners or obtain certification from the entity that it does not have substantial US owners.

We anticipate challenges in being able to conduct customer profiling due to disparate customer databases, lack of centralized customer management systems and non-inclusion of critical data elements required to detect US indicia. The profiling process for entity accounts is given in Figure 4.

STARTEntity Account Identified

STOP No Reportingrequirements

PublicListed?

YesNo

No

STOP No Reportingrequirements

STOP No Reportingrequirements

Exemptions?

Yes

NoIsbalance

>$250K?

No

Yes

Documentedas US person

Electronic search for US Indicia

Aggregate (at FFI andaffiliates level) account balances

by Name/EIN/TIN etc.

STOPReporting

requirementsUS

Indiciafound?

YesRequestInformation

ReceivedInformation?

Yes

Determine if entityis 1] FFI 2] NFFE

NFFE obtain documentsto identify substantial owners

No

No

Yes

USstatus?

STOPRecalcitrant A/c

Withholding andreporting

No

STOPReporting

requirements

STOPDeemed compliant FFI No reporting required

STOPRecalcitrant A/c

Withholding and reporting

STOPExempted NFFE

No substantial US ownersNo reporting required

FFI obtain documentsto determine entity status

Figure 4: Due diligence workflow for pre-existing entity accounts

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2.1.3 Due Diligence for New Accounts

The proposed due diligence rules rely more extensively on FFIs’ existing customer onboarding procedures. For new individual accounts, FFIs may rely upon their existing KYC and AML procedures to determine if a new account belongs to a US person. AML/KYC information and other account opening information must be examined, which suggests that such systems may need to be integrated with withholding tax systems.

We expect that FFIs would face the highest IT costs for implementation of due diligence procedures concerning client on-boarding and classification of both new and pre-existing accounts.

2.1.4 Withholding Tax Implications

An FFI must be able to recognize non-participating FFIs and recalcitrant accounts and withhold tax on withholdable payments made to them in addition to reporting such actions to the IRS. A withholdable payment is any kind of payment (such as interest, dividends, and wages) and gross proceeds (from sale of any property) that is sourced from the US. One of the challenges here is the method to be used to identify non-participating FFIs. Even though an FFI can rely on the IRS for such information, FATCA provides no explanation in case such data is not of the required quality and the FFI ends up withholding or not withholding incorrectly.

Our view on identification of passthru payments is that it is a complex issue. A passthru payment is a payment where some (or all) of the value of the money being paid to a recalcitrant account or a non-participating FFI in the form of interest on deposit is derived from US assets backed by the deposit. Financial institutions will need to identify such transactions and calculate a passthru percentage – ratio of the compliant bank’s US assets to its total assets - and withhold 30% as passthru percentage on such payments to the recalcitrant account or the NPFFI. An FFI’s payment system adhering to this requirement, correctly identifying such payments and withholding on them, is very vital to remaining FATCA compliant. Withholding on Fixed, Determinable, Annual or Periodical (FDAP) payments needs to be in place by 1 January 2014, whereas the deadline for implementing passthru payment withholding has been extended till 1 January 2017.

2.1.5 Reporting Requirements

FATCA obliges an FFI to report certain information with respect to each US account – compliant or recalcitrant. For FFIs established in the FATCA partner jurisdiction, such reporting can be done to the local tax authority in order to circumvent any prohibition laws. For others, the reporting is through an electronic form to the IRS. The proposed regulations have extended the transition period for reporting obligations of participating FFIs. Reporting can be implemented in the following staggered manner:

1. On withholdable income payments for the year 2014 by March 15, 2015.

2. On U.S. account information and balances for the years 2013 and 2014 by March 31, 2015. This would contain details such as name, address, TIN, account number and account balance.

3. On U.S. account income for the year 2015 by March 31, 2016.

4. On U.S. account gross proceeds for the year 2016 by March 15, 2017

For recalcitrant accounts, the number and aggregate value of financial accounts held need to be reported in addition to other account data. Also, FFIs must provide any extra information that the IRS may request for on an ad-hoc basis.

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According to the proposed regulations, USFIs need to report information about owners of passive NFFEs. But it is not yet clear if such reporting can be done using the existing Form 1099 and Form 1042-S or if the FATCA reporting form has to be used.

We believe that reporting will not be straightforward for FFIs. The most arduous FFI would face in reporting are the reporting requirements concerned with account balances, gross receipts and withdrawals. In addition, the IRS would lay down various ad-hoc reporting requirements. Although FATCA has outlined specific methods for calculating amounts of income and gross proceeds paid to the account, FFIs will need more clarification on these in the final regulations from the IRS. Also as mentioned earlier it might become imperative for large FFIs to implement a single customer view in order to resolve such complexities in the long run.

2.2 Challenges in Implementation

Just like any other large scale regulatory program, FATCA also comes with certain challenges:

Organizations must make sure that they understand how FATCA regulations will affect their operations and the potential risks arising out of compliance and non-compliance. The challenge is to identify areas that FATCA would affect and develop an enterprise wide or a Line of Business wise approach to tackle FATCA implementation. FFIs would also have to conduct a vendor assessment in case they opt for a third party solution. Estimations of effort required and cost of compliance, program ownership and co-ordination across business divisions are some of the challenges that have to be addressed for the smooth implementation of FATCA.

Looking at FATCA requirements, most of the FFIs fall behind in terms of quality of customer data required to establish FATCA status. Also, most of them do not have a centralized customer data source which could mitigate the effort required for due diligence tasks, e.g., aggregation of account balances. FFIs would have to employ efficient client communication strategies and technology services in order to overcome these challenges.

The most challenging requirement of FATCA is the implementation of due diligence process required to identify FATCA status of the FFI’s customers. This would require modifications to existing systems, such as KYC/AML systems, databases and many more. Also, new sophisticated data mining tools to determine the relationship between accounts using link analysis may need to be developed. Further, the FFI has to ensure that systems are in place to monitor changes to an account’s status under FATCA and the application of withholding and reporting as necessary. This can add to the on-going maintenance and reporting burden of an FFI.

There are two important challenges associated with the implementation of passthru payments. The first relates to the technology needed to correctly identify transactions involving non-participating FFIs and recalcitrant accounts that are subject to passthru withholding. The second is with respect to the

1. FATCA Program Governance

2. Data quality and lack of central customer data

3. Technology

4. Passthru payments

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calculation of passthru payment percentage (PPP). This would require inputs from different divisions of an FFI, such as Treasury and Finance, to calculate the value of its US assets and total assets. Also, there is a possibility of calculation of various values of PPP for an FFI corresponding to the US assets of its affiliates and determination of the correct percentage applicable to a transaction can be challenging.

With FATCA compliance deadlines starting from Jan 2013, FFIs have limited time to analyze the impact of FATCA on their organization, define their strategy and start implementation. Although, most FFIs have already embarked on a gap and impact analysis, one major challenge still remains - the creation of an enterprise wide dedicated FATCA task force across all geographies which is fundamental to timely and smooth implementation of FATCA.

An FFI could also face problems due to lack of awareness about FATCA’s impact and implications amongst its staff and clients. Staff training and awareness workshops would need to be customized for employees according to FATCA’s impact on their specific business units exacerbating the situation further. Last but not the least, FFIs should communicate their stance on FATCA to their customers and update them regularly on the latest developments to prevent any potential legal risks arising in the future from its US and recalcitrant accounts.

2.3 The cost impact of FATCA

Whilst a lot has been said about the impact of FATCA on IT systems and processes, there is also a high cost implication involved.

The Banking Federation and the Institute of International Bankers, in what they call conservative figures, estimate that it will cost each foreign bank with more than 25 million accounts $250 million to sift through these accounts and identify those held by Americans. In total, that would cost the top 30 foreign

[1]banks $7.5 billion .

James Broderick, head of JP Morgan’s European, Middle Eastern and African asset management business, [2]has estimated that FATCA could cost big banks $100 million .

Charles Kinsley of KPMG has indicated that global financial institutions will spend anywhere from $30bn [3]to $40bn to comply with FATCA .

Whilst the above statistics clearly indicate that FATCA is going to have high cost implications for financial institutions to streamline IT and operations, the major challenge is the massive effort that would be required across the enterprise and various business lines, which would be time consuming for both financial institutions and its customers. Also, the Inter-Governmental Agreements between the IRS and various other countries is a significant step in easing the implementation of FATCA for FFIs in those partner countries which in turn is expected to reduce the required FATCA spending (for FFIs in partner countries) to a considerable extent.

5. Tight deadlines and Creating awareness

[1] Wall Street Journal: http://blogs.wsj.com/corruption-currents/2012/05/01/fatca-creating-a-compliance-gold-rush/ dated 1 May, 2012

[2] Forbes: http://www.forbes.com/sites/robertwood/2011/11/30/fatca-carries-fat-price-tag/ dated 30 Nov, 2011

[3] legalbusinessonline.com: http://asia.legalbusinessonline.com/news/features/bracing-for-fatca/109297 dated 3 Oct, 2012

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3. FATCA Impact on Banking and Capital Markets

3.1 Impact on Banking

A large multinational bank would face challenges in coordinating the impact and implementation of FATCA across its business operations. At TCS we have carefully studied the latest FATCA regulations to identify how it would affect the retail, corporate and private banking functions of a bank.

As discussed earlier, FATCA will impact account opening, transaction processing, tax calculations and reporting. The challenge for a large retail bank would be in handling the large volumes of accounts it holds in addition to the diverse geographies it operates in. As FATCA requires a bank to aggregate various accounts across same customers, a huge effort is required in terms of analyzing and identifying the applications impacted. Even though a large number of accounts need to be processed in the beginning, once aggregation is done, the number of accounts falling under FATCA purview could reduce due to the account value threshold of $50,000. Figure 5 maps key FATCA initiatives to indicative core banking areas that FATCA might impact.

The impact on corporate banking activities would be similar to that of retail banking except that the percentage of accounts falling above the threshold limit might be more. The task of identifying and monitoring the 10% shareholding and details of substantial owners in these entities will become more strenuous and time consuming. Thus large banks would need to use sophisticated data analytical tools in order to make their compliance efforts easier.

1) Retail Banking:

2) Corporate Banking:

Figure 5: LoB wise Impact on Banking/Capital Markets Functional Areas

FATCA Profiling Threshold Monitoring Tax Calculations Reporting

Client On-boarding

Data Processing

Product Setup

Document Management

Payments Monitoring

TransactionsAccounting

AccountManagement

Portfolio Management

Order Management

SecuritiesBorrowing/Lending

Compliance Checks

Client Master

CounterpartyMaster

AccountMaster

ProductMaster

InterestCalculations

Position Keeping

Portfolio Valuations

Corporate ActionsProcessing

Accounts/BooksMaintenance

RegulatoryReporting

TaxReport

ClientReporting

Alerts &Notifications

Enterprise Reporting

Impact on Core (Retail & Corporate) Banking functional areas

Impact on PWM/IB functional areas

Impact on both Core & PWM/IB functional areas

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3) Private Banking: For private banks, the real impact of FATCA would be felt on their KYC processes. For private clients, banks have to assess if they have any US connections and whether they directly or indirectly hold investments or derive income from a US source. For clients who have an US indicia but not a US tax status, the bank has to obtain necessary certification from them in order to avoid imposing withholding tax on their accounts. Also, due to the implications of FATCA, private clients may request information on investment funds they are investing in as a FATCA non-compliant fund could reduce the return on their investment. Also, the withholding on cash flows from a participating FFI could impact a NPFFI even though it has no US assets. Hence it is in a bank’s best interest to become FATCA compliant so that its clients are not affected in an adverse way. Figure 5 attempts to map key FATCA initiatives to relevant private banking areas that FATCA might impact.

3.2 Impact on Capital Markets

The FATCA regulations have important implications for capital markets participants such as brokers, custodians, portfolio and hedge fund managers, and others. While the impact and requirements for client identification would be similar to other FFIs, these participants need to have enhanced systems for monitoring account transactions in capital markets for any potential withholding and reporting. The business rules (concerning FATCA governance) would differ based on the nature of products that are

[4]traded. The impact of FATCA on various capital market transactions are summarized below .

Implications of grandfathered obligations

Payments/gross proceeds from obligations issued before 1 Jan 2013 are excluded from FATCA

Debt instruments issued before 1 Jan 2013 are excluded from FATCA

US equities regardless of when they were issued to come under the purview of FATCA

Derivative transactions ‘confirmed’ after 31 Dec 2012 will fall under FATCA compliance

Impact on debt and equity issues

Debt and equity issued by non-US issuers and FFIs (banks, brokers, custodians and insurance [5]companies) are not classified as ‘financial accounts’ and hence not subject to FATCA

Offerings by FFIs that are investment funds (and similar entities) fall under FATCA purview i.e. they need to identify their US investors

Interest payments/gross proceeds from short-term debt (less that 183 days) are excluded from FATCA withholding and reporting

Withholding tax under FATCA is subject to any ‘gross-up clause’ exclusion

Impact on securitization transactions

Securitization Vehicles (SVs) that are not held by FFIs or US FIs have to perform FATCA due diligence, withholding and reporting

FFIs and US FIs with debt/equity interest in a SV need to comply with FATCA to the extent of their interest in the SV

n

l

l

l

l

n

l

l

l

l

n

l

l

[4] Cleary Gottlieb Steen & Hamilton LLP

[5] Subject to exception if issued instrument derives value from US assets

n

l

l

l

Impact on derivative transactions

Payments from all instruments referencing US assets subject to FATCA withholding (even if the counterparties are non-US persons)

Under passthru payments, payments on derivatives not referencing US assets are also subject to withholding for e.g. a fixed-to-floating Interest Rate swap on GBP between two German counterparties

According to amended ISDA Master agreement, FATCA withholding tax burden falls on the recipient of the payment (not to be included under ’Indemnifiable Tax’ or gross-up)

Our view is that FATCA will hit the fund management industry the hardest. This is because most funds are the beneficial owners of their assets from a US tax perspective, allowing them to claim non-US status (Form W8BEN). In addition, most funds do not know who their investors are. Hence, FATCA implementation could prove to be the most challenging for fund managers. On the other hand, it could be easier for banks - the custodial, transactional, lending, and retail divisions - to implement FATCA. This is because they are better prepared to identify US persons as they have been subject to the US qualified intermediary regime for the last decade. Hence it is a matter of upgrading systems to make them work with the compliance requirements. Nevertheless, each bank would have to do an analysis of their US client base to decide if the cost of upgrading systems to achieve compliance is worth it or if it makes better business sense for the bank to exit US businesses, keeping its future plan in mind.

3.3 FFI Strategies and Preparedness

Whilst the new proposed guidelines have lessened some of the implementation pressures, FATCA is changing the way most FFIs view their business strategy with respect to US indicia customers. The pay-off between the expected implementation costs and the revenue from US businesses is a deciding factor for maintaining or exiting US accounts as depicted in Figure 6.

Figure 6: Effect of FATCA on business strategy

FFIs

FATCA 30% TAX TO BE LEVIED ON

Proceedsfrom sales

PersonalIncome

Impact on processes, people, IT Systems

BusinessStrategy

Exit USbusiness

InvestmentReturns

Maintainexisting US

business

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We have spent considerable time discussing FATCA with our clients and currently FATCA preparedness can be broadly classified into two categories:

Financial institutions that have already established an internal FATCA task force and have done the initial impact analysis on systems and processes; i.e., those who are ready with a roadmap. Most of these FFIs have already started implementing enhancements to IT systems and processes for onboarding new customers. For existing customers, FFIs are in various stages of multiple enhancements.

Financial institutions that have adopted a wait and watch approach and have just started getting their FATCA program in place.

There is another group of foreign financial institutions that has even gone so far as to have turned away from US business to avoid regulatory hassles. HSBC decided in July 2011 that it would no longer offer wealth-management services to US persons from locations outside their home country after tax authorities stepped up a probe of the London-based bank’s U.S. clients. Deutsche Bank AG, Bank of Singapore Ltd. and DBS Group Holdings Ltd. (DBS) all say they have turned away businesses. UBS discontinued its offshore accounts for US citizens in 2008. The firm now refers them to its wealth-management offices in the US, or to its Swiss Financial Advisers unit, which complies with US and Swiss regulations. The company continues to provide Americans outside the U.S. with services other than securities investments, including consumer and commercial loans, foreign-currency spot trading and

[6]precious-metals transactions .

The enactment and implementation of FATCA could also pose certain business risks to banks and FFIs in general, in addition to the risks of non-compliance discussed earlier:

Reputational risk: A bank’s reputation could be seriously harmed if it applies withholding incorrectly or miscalculates the amount to be withheld against an NPFFI or a recalcitrant account.

Systemic risk: Non-compliant financial institutions could face financial distress in the long run as all payments made to them by compliant FFIs would be subject to a penalty (withholding). This could result in loss of investor confidence and market value leading to a run on the bank.

Also, other countries may soon follow suit and implement their own FATCA like law which could pose serious business risks to financial institutions that choose to ignore FATCA.

Even though FATCA agreements will not come into effect until January 2014, preparations for compliance with the regulation are expected to be time consuming and costly. Implementation would have to be phased such that a strong alignment between business units coupled with a comprehensive strategy and stringent timelines minimize the impact of FATCA on core business. Chief Compliance Officers, Heads of Tax or Operations and other key leaders within any FFI will need to evaluate the potential impact of these regulations and develop a plan for managing the operational impact of FATCA.

At a compliance/governance level, financial institutions need to appoint an executive to oversee the entire FATCA program. As FATCA has far reaching consequences across business divisions, a senior

Pro-active FFIs:

Passive FFIs:

n

n

n

4. FATCA Impact on Technology and Operations

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[6] Bloomberg: http://www.bloomberg.com/news/2012-05-08/u-s-millionaires-told-go-away-as-tax-evasion-rule-looms.html dated 9 May, 2012

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executive such as the chief compliance officer must sponsor and guide the program. Subsequently, a FATCA task force must be setup to do a gap analysis between existing procedures and FATCA requirements. This would lead to a FATCA compliant business model in relation to identification, withholding and reporting requirements set out by FATCA.

For a successful business wide implementation of FATCA, in addition to compliance and tax, financial institutions would need alignment between technology and operations divisions.

4.1 Impact on Technology

FATCA would impact the following systems of a bank:

4.1.1 KYC/AML and CRM Systems

For achieving FATCA compliance, financial institutions would need to make significant changes to their IT systems. First and foremost, financial institutions would have to enhance their existing KYC/AML processes and systems to align with FATCA requirements. With FATCA, it becomes imperative to not only have customer information but also classify customers across lines of

Payment Systems n

n

Build functionality to identify transactions for withholding and calculating withholding taxKeep record of withholding transactions/credit withheld amounts to escrow account

Trading andSettlement Systems

n Build the capability to identify recalcitrant accounts and apply necessary withholding during settlement

Reporting Systems n

n

Ensure external IRS reporting – annual and ad-hoc basisEnsure internal reporting to risk and compliance office

Figure 7: FATCA impact on a FFIs’ IT systems

Gap Analysis, Requirements Definition, Development, Testing and Implementation need to be carried out for all systems impacted

KYC/AML and CRM Systems

IT Systems Impact

n

n

n

Change KYC/AML systems for new customer on-boarding Classify customers across lines of business, account types and countries - Single Customer ViewProvide web-based services to customers to share and update their information

Data Processing andWarehousing Systems

n

n

n

Connect disparate pieces of information to determine customer characteristicsOrganize customer information across lines of business and account types for aggregationCreate data store to track customer’s FATCA status for withholding and reporting

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business, types of accounts and countries. Therefore, systems need to implement a complete view of the customer (Single Customer View) in order to ensure high quality data source to process for customer characteristics. Financial institutions/relationship managers would have to request their customers for FATCA related information on a constant basis. In such a situation, it would be useful to enhance their CRM systems, for example, enable web-based services for customers to share and update their information on a regular basis. This will ensure minimum disturbance for customers and also for financial institutions’ operations. Also, information related to waiver status could be updated and tracked through CRM systems.

4.1.2 Data Processing Systems

Data processing and other analytics tools would need to be developed for data mining and identification of customers under FATCA. Customers need to be scanned for any potential US indicia as mentioned under FATCA for withholding and reporting purposes. Sophisticated tools will have to be built that can connect various disparate pieces of information and determine customer characteristics. This will reduce the number of times a financial institution would need to contact a customer to establish his/her account status under FATCA.

4.1.3 Data Warehousing and Operational Data Store

Data warehousing capabilities of a financial institution would have to be enhanced to service new client classification and reporting requirements under FATCA. The due diligence procedure requires mapping of customers to their aggregate account balances. In order to accomplish this, data warehouses would need to organize customer information across lines of business and account types and enable transactions to be aggregated at a customer or account level. Also, a FATCA operational data store can be built to store a customer’s FATCA specific attributes that can be used while withholding and reporting.

4.1.4 Payment Systems

FFIs would have to impose a withholding tax on payments that have a US source of income and also on passthru payments (that ultimately reach a non-participating FFI) flowing into recalcitrant accounts. This requires that the payment systems be correctly configured to identify transactions that are liable for withholding based on the nature of the transaction. Also, the system would have to calculate the amount to be withheld, and after withholding keep a record of the withholding process in the corresponding database for reporting at a later date.

4.1.5 Trading and Settlement Systems

In case of trading and settlement systems, recalcitrant trading accounts would have to be identified through the FATCA due diligence procedure and a withholding tax would need to be applied to the settlement process for such accounts. The challenge here is the involvement of various parties (clients, brokers, and clearing agents) in the trading and settlement process and the identification of the entity that needs to apply the withholding tax. Also, currently, most settlement systems do not have a provision for application of withholding tax and its imposition could raise other issues such as increase in number of failed trades and settlement risk.

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4.1.6 Reporting Systems

The requirements of FATCA mandate that financial institutions build new reporting systems in order to report details of accounts of US persons and recalcitrant accounts, including account balances and gross proceeds for such accounts, and withholding tax imposed on payments made to recalcitrant accounts to the IRS on an annual or ad hoc basis. More importantly, internal reports would also need to be generated on a regular basis to be shared with the compliance team and other concerned stakeholders. The staggered implementation of FATCA gives financial institutions time till for having such a system in place.

We anticipate that financial institutions would incur high costs for technology implementation with regard to client on-boarding and classification procedures. Various tools will have to be built to meet these requirements. On the upside, firms that take up this initiative and successfully implement the necessary infrastructure would be able to add value to their clients by helping them avoid the risk of withholding and thereby give themselves a competitive edge.

4.2 Impact on Operations

Figure 8 shows the impact of FATCA on the typical operations of an FFI

March 2015

Client Classification

Operations Impact

n

n

n

n

Ensure that relevant FATCA indicia data elements are captured for new accounts Conduct review of all accounts to identify US persons and US indiciaMonitor account balances and statusesLay down CRM – Client communication strategy

Documentation n

n

n

Obtain latest W8 and W9 forms for IRS reportingObtain self-certification, waivers/exemptionsEnsure document storage

Asset Servicing and Withholding n

n

Identify products with US sourced incomeInitiate Master Data Management – Account, product, counterparty for transaction withholding

Regulatory Reporting n

n

n

Create new templates for reporting US and recalcitrant accounts along with aggregate balances and gross proceeds to the IRSEnsure reporting of withholding transactionsCreate dynamic templates for internal reporting

Figure 8: FATCA impact on an FFI’s operations

4.2.1 Client Classification and Documentation

The onus of co-ordinating various activities would lie with the FATCA operations team. Gaps in existing KYC/AML procedures will have to be reviewed and upgraded which will also apply for new client on-boarding/account opening procedures. The operations team needs to ensure that relevant FATCA indicia data elements are captured for new accounts. It also needs to identify existing accounts and conduct a review of all such accounts to classify US persons and to identify accounts with potential US indicia. The team also needs to implement procedures to handle any changes in balances of accounts on a continuous basis. On the CRM side, the operations team must have a client communication strategy (for instance, using web-based self-service tools or relationship managers) in order to educate their customers about FATCA and to obtain FATCA related information. It must also obtain due consent from clients to report information to the IRS. Also, the team needs to gather operational information and analyze the impact of new FATCA processes on the bank’s operations in order to evaluate their efficiency.

The operations team needs to obtain and store documents related to customers’ FATCA status. Enhanced W8BEN and W9 forms have to be obtained for tax reporting purposes. In addition, a FFI can also use a self-certification tool to capture information from customers that would identify their classification and generate respective W8 or W9 forms.

4.2.2 Asset Servicing and Withholding

One of the most important tasks with respect to asset servicing would be identification of products that earn US sourced income and the appropriate action to be taken. Data related to account, product and counterparty (master) would have to be maintained for processing of transactions and correct application of withholding tax whenever necessary. Also, records of withheld amounts need to be maintained and deposited with the IRS.

4.2.3 Regulatory Reporting

Reporting of all US accounts and recalcitrant accounts along with aggregate balances and gross proceeds will impact back office operations of regulatory reporting. Reporting of withholding tax imposed on payments made to recalcitrant accounts also needs to be carried out on a regular basis. Necessary consent or waivers need to be obtained from clients before reporting their information to the IRS. This activity could prove to be less strenuous for financial institutions in FATCA partner countries as they need not report to the IRS directly. Also, in addition to external reporting requirements, the operations team needs to ensure that FATCA reports are shared internally with the compliance team and senior management on a timely basis.

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Conclusion

The scope of FATCA is potentially vast. While it is intended to uncover substantial amounts of tax evasion for the US authorities and improve tax compliance with regard to offshore accounts of US persons, the additional compliance burden it will place on global FFIs has to be fully understood. Financial Institutions across the globe will need to take swift action in working towards complying with the new regulation, but they should not take hasty decisions and invest in wrong systems which would prove costly in the long run.

The FFIs need to act on two fronts: first, FFIs need to work with the US Treasury and the IRS to help them develop practical procedures that minimise the inevitable compliance burden. Now is the time for FFIs to assess the steps they can take to ensure they will be compliant with FATCA on its effective date. Second, a detailed understanding of the Act has to be obtained and a strategic plan has to be laid out based on the impact on financial institutions’ operating models.

Organizations need to prepare a detailed plan immediately to be FATCA compliant by 2013. Additionally, the US and five European countries (FATCA partners) have issued a joint statement that states the commitment of the US to exchange information on accounts held by residents of FATCA partners in US financial institutions. This would require US-based financial institutions to develop FATCA-like capabilities in the future and, needless to say, impose a similar burden on financial institutions operating in other countries. Therefore, FFIs should look at developing a robust technology platform and reporting system which not only caters to FATCA requirements but is also adaptable to any future laws introduced by other regulatory authorities. We have worked with varied financial institutions across the globe and partnered with them in complying with similar regulatory changes introduced by regulatory authorities from time to time. Thus, we are in an ideal situation to leverage our expertise in helping firms tackle the challenges posed by FATCA without affecting their core business. “It’s Time to Act on FATCA!”

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other applicable laws, and could result in criminal or civil penalties. Copyright © 2013 Tata Consultancy Services Limited TCS

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