What is FATCA? Understanding The Foreign Account Tax Compliance Act

The Foreign Account Tax Compliance Act (FATCA) is an important facet of the United States’ actions to combat global tax evasion. Under FATCA, certain US taxpayers and foreign financial institutions (FFIs) must report information on financial accounts held by US taxpayers to the IRS. This guide will help businesses understand their role in complying with FATCA and provide some best practices for avoiding non-compliance. 

FATCA, or the Foreign Account Tax Compliance Act, is a United States federal law enacted in 2010. Its primary purpose is to combat tax evasion by US citizens and residents holding financial assets and accounts outside the country.

The implementation of FATCA international payment regulations requires foreign financial institutions (FFIs) to report information on financial accounts held by US taxpayers to the Internal Revenue Service (IRS). This includes not only traditional banking institutions but also investment firms, insurance companies, and any other financial institution that handles US-sourced income.

FATCA aims to improve tax transparency on an international level by requiring FFIs to identify and report accounts held by US taxpayers, including non-resident citizens. Its ultimate goal is to reduce the use of offshore accounts for tax evasion.

The enforcement of FATCA has significant implications for businesses, particularly those with international transactions. Non-compliance can result in hefty penalties and reputational damage, making it imperative for businesses to understand and adhere to the law.

This guide will provide a comprehensive overview of FATCA, including its background, operational mechanics, compliance requirements, and consequences of non-compliance. While FATCA applies to certain individual US taxpayers, this guide mainly focuses on the implications of FATCA for FFIs. 

Introduction to FATCA

FATCA was enacted in 2010 as part of the Hiring Incentives to Restore Employment Act (HIRE). It requires FFIs to identify and report any accounts held by US taxpayers, as defined by the IRS.

Initially, FATCA faced criticism for imposing a burden on foreign financial institutions to comply with US tax laws. However, it has since gained support from other countries and is now seen as a crucial tool in combating tax evasion on a global scale.

FATCA’s implementation has also led to the signing of intergovernmental agreements (IGAs) between the US and other countries, easing compliance for FFIs operating in multiple jurisdictions.

Why it’s important—especially for AP teams

FATCA has significant implications for businesses, particularly those making international transactions. AP teams responsible for making payments must understand and comply with FATCA requirements to avoid penalties and reputational damage.

Non-compliance can result in a 30% withholding tax on certain US-sourced income, including interest, dividends, and gross proceeds from the sale of property. This can have a significant impact on a company’s cash flow and bottom line.

Moreover, failure to comply with FATCA can also result in being labeled a non-compliant FFI, leading to the loss of access to the US financial system. This could have severe consequences for businesses with global operations.

The genesis of FATCA: Why it was enacted

The genesis of FATCA can be traced back to the Global Financial Crisis of 2008, which exposed widespread tax evasion by US taxpayers using offshore accounts. This led to lost tax revenue for the US government, estimated to be in the billions.

FATCA was enacted as a reaction to this crisis, with the aim of closing loopholes and increasing transparency in international financial transactions.

Background and legislative history

FATCA was originally enacted as part of the Hiring Incentives to Restore Employment Act (HIRE) in 2010. It has since been amended several times, with the most significant changes made in 2014.

In 2014, FATCA expanded its scope to include not only individuals but also entities such as corporations and trusts. It also introduced a new requirement for FFIs to obtain a Global Intermediary Identification Number (GIIN).

Furthermore, FATCA introduced the concept of “recalcitrant accounts,” referring to accounts held by individuals who refuse to provide information on their US tax status. These accounts are subject to increased reporting and withholding requirements.

Objectives of FATCA in the context of global finance

FATCA’s objectives can be summarized as follows:

• Combat tax evasion by US taxpayers using offshore accounts
• Increase transparency in international financial transactions
• Promote fairness in the US tax system
• Encourage compliance with US tax laws by FFIs operating globally
• Create a global standard for information exchange between countries to combat tax evasion and promote fair tax practices

Within the context of global finance, FATCA plays a crucial role in promoting tax transparency and fair taxation. It is considered a key tool in the fight against tax evasion and has led to increased cooperation between countries.

How FATCA works: The mechanisms explained

FATCA requires FFIs to identify and report any accounts held by US taxpayers, including non-resident citizens. This is achieved through the following mechanisms:

Due diligence

FFIs must conduct due diligence on all new and existing accounts to determine if they are held by a US taxpayer. This includes obtaining self-certification forms from account holders and verifying their tax status with the IRS. Due diligence is also required for certain high-value accounts and those with US-sourced income.

Reporting

FFIs must report information on US taxpayer accounts, including balances, interest, dividends, and gross proceeds from the sale of property, to the IRS. This is done annually through the FATCA reporting portal. Accurate and timely reporting is crucial to ensure compliance with the law.

Withholding

If an FFI identifies a recalcitrant account or fails to comply with reporting requirements, they may be subject to withholding tax on certain US-sourced income. This tax can be up to 30% of the payment made. By withholding tax, the FFI helps the US government recoup lost tax revenue and incentivizes compliance with FATCA.

Intergovernmental Agreements (IGAs)

The US has entered into IGAs with other countries to facilitate compliance for FFIs operating in multiple jurisdictions. These agreements outline alternative methods for information exchange between the US and other countries.

These mechanisms are designed to increase transparency and cooperation between FFIs and the US government, promoting a more fair and efficient tax system. By complying with FATCA, FFIs are also able to strengthen their own anti-money laundering and tax compliance measures.

FATCA compliance: Who needs to comply and how

Under FATCA, any FFI operating outside of the US with US accounts must comply with reporting and withholding requirements.

This includes banks, investment firms, insurance companies, trust companies, and other financial institutions. Non-financial foreign entities (NFFEs) may also be subject to FATCA if they have substantial ownership or controlling interests held by US taxpayers.

The IRS maintains an updated list of FFIs on their FATCA FFI List Search and Download Tool.

To comply with FATCA, FFIs must register with the IRS and obtain a GIIN. They must also implement due diligence procedures to identify US accounts and report relevant information to the IRS.

Non-compliance with FATCA can have severe consequences for both FFIs and their US account holders, making compliance essential for any business operating globally.

Criteria for businesses falling under FATCA

As mentioned, any FFI operating outside of the US with US accounts must comply with FATCA. This includes both foreign financial institutions and non-financial foreign entities that meet certain criteria. These criteria include:

• Having substantial ownership or controlling interests held by US taxpayers: This includes any entity where more than 10% of the ownership or control is held by a US taxpayer.
• Having significant US-sourced income: This includes entities that receive at least 50% of their gross income from US sources.
• Being classified as an NFFE (non-financial foreign entity) with passive income: This includes entities that are primarily engaged in investing, holding, or trading assets for passive income. 
• Being a US-owned foreign entity: This includes any non-US entity that is owned by a US person or company, either directly or indirectly.

Additionally, any entity classified as a “US person” for tax purposes, including corporations, partnerships, and trusts, may also be subject to FATCA reporting requirements. This includes entities with US ownership or controlling interests.

Understanding the scope of FATCA

The scope of FATCA varies depending on the size and sector of a business. Large multinational corporations may have more complex global financial compliance requirements due to their global operations and multiple layers of ownership.

Small businesses or startups with US accounts may also be subject to FATCA if they meet the criteria outlined above. It is essential for all businesses, regardless of size or sector, to understand their obligations under FATCA and ensure compliance to avoid potential penalties.

Some examples of how FATCA may impact different business sizes and sectors include:

• A large international bank with US account holders will need to implement extensive due diligence procedures and reporting systems to comply with FATCA requirements.
• A small consulting firm with a US subsidiary may need to register as an FFI and report information on any US accounts held by its clients.
• An insurance company operating solely in a non-US country may still be subject to FATCA if it has US account holders. 

Ultimately, the scope of FATCA can vary greatly depending on the individual circumstances of each business. It is crucial for companies to seek professional advice and fully understand their obligations under FATCA to ensure compliance and avoid potential penalties. 

Reporting requirements for FFIs under FATCA

FFIs are required to report the following information to the IRS annually:

• Name, address, and TIN of each US account holder
• Account number and balance at the end of the year
• Interest, dividends, and other income earned on the account during the year
• Gross proceeds from the sale of property in which a US taxpayer had a direct or indirect interest

Due diligence requirements for foreign financial institutions (FFIs)

FFIs are required to conduct due diligence procedures on all new and existing accounts to determine if they are held by a US taxpayer. This includes:

• Obtaining self-certification from account holders regarding their US tax status
• Reviewing pre-existing accounts to identify indicia of US ownership
• Conducting enhanced due diligence on high-value accounts

FFIs must also implement procedures to identify and report any recalcitrant account holders who refuse to provide information on their US tax status.

Penalties for non-compliance: A cautionary overview

Non-compliance with FATCA can result in severe consequences for both FFIs and US taxpayers. The FATCA penalties for non-compliance may include:

• A 30% withholding tax on certain US-sourced income
• Loss of access to the US financial system for non-compliant FFIs
• Negative impact on a company’s reputation and business relationships

It is essential for businesses to fully understand the potential consequences of non-compliance with FATCA and take necessary measures to ensure compliance. Seeking professional guidance and implementing robust compliance procedures can help mitigate the risks of penalties and maintain a positive standing in the global business community. 

Best practices to avoid penalties

To avoid potential penalties and maintain compliance with FATCA, businesses should implement the following best practices:

Establish comprehensive due diligence procedures to identify US accounts and determine their US tax status

Banks and other FFIs must conduct due diligence on all new and existing accounts to identify any US account holders. This includes collecting relevant information, such as tax identification numbers, and determining the individual’s US tax status. IRS Forms W-8 BEN (for individuals) and W-8 BEN-E (for entities) are used as information-gathering tools.

Register with the IRS and obtain a GIIN

All FFIs must register with the IRS and obtain a GIIN to comply with FATCA. This allows the IRS to track compliance and ensure proper reporting of US accounts.

Train employees on FATCA requirements and compliance procedures

Employees responsible for handling international transactions and managing US accounts should be trained on FATCA requirements and their role in ensuring compliance. This can help prevent accidental non-compliance and maintain the integrity of a company’s reporting.

Seek professional guidance

Navigating the complexities of FATCA can be challenging for businesses. Seeking professional guidance from tax experts or consulting firms can help ensure compliance and mitigate potential penalties.

Keep accurate records of all due diligence efforts and report information correctly to the IRS

Accurate record-keeping is essential for demonstrating compliance with FATCA. Businesses should maintain detailed records of their due diligence efforts and report information correctly to the IRS to avoid any potential penalties for non-compliance.

Continuously monitor account activity to identify any changes in US ownership or control

It is crucial for businesses to continuously monitor their accounts and identify any changes in ownership or control that could impact FATCA compliance. This can help ensure all relevant information is reported accurately and promptly to the IRS.

Seek professional guidance and stay up-to-date on any changes or updates to FATCA regulations

FATCA is an ever-evolving law, and businesses need to stay informed about any changes or updates to the regulations. Seeking professional guidance can help companies stay compliant and avoid potential penalties for non-compliance.

By following these best practices, businesses can mitigate the risks of non-compliance and maintain a positive standing in the global business community. Compliance with FATCA not only ensures adherence to the law but also promotes transparency and integrity in international financial transactions. 

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Trolley provides a cloud-based payout platform that enables businesses to send tax-compliant payments across the globe efficiently. 

Stay compliant with IRS regulations on contractors and non-employees by streamlining supplier tax onboarding with collection of Forms W-8 BEN and W-9, and filing of Forms 1099 and 1042-S. Enjoy automated form collection, validation, withholding calculations, payouts, and year-end tax reporting. 

Choose Trolley for your business needs and ensure seamless international transactions while complying with tax regulations.

Contact us today to learn more about our services and how we can assist you in navigating the complexities of US and EU tax compliance.