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World: FATCA responsible officers: be careful, very careful

06 June 2014   (0 Comments)
Posted by: Author: Chris Kentouris
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Author: Chris Kentouris (FinOps Report)

You’ve just been named by your financial firm as a responsible officer under the US Foreign Account Tax Compliance Act, or FATCA for short.

Should you hand in your two-week notice, take the job in stride, or brace– and protect yourself – from hefty operational and legal liabilities?

Those are the decisions and options now faced by potential FROs, or thousands of high-ranking officials working outside the US, who have been tapped by their financial institutions to help comply with the controversial FATCA legislation.

Coming up with the answer isn’t simple. It will likely depend on three factors: the country in which your firm is located, how much personal risk you are willing to absorb, and just how much of your personal life you are willing to give up.

"Learning all the complex intricacies of what the legislation requires is just the beginning of what must be done,” says Kathleen Celoria, executive director of DMS Offshore Investment Services in New York City. Such specialists may then have to set up a compliance program, ensure it is followed and depending on the country in which they are located, certify to the US Internal Revenue Service (IRS) or local tax authority that all of the reporting work and withholding taxes are correct.

"At the very least, it is a job which is not to be taken lightly, because of the extensive responsibilities involved,” agrees Dermot Mockler, group head of regulatory affairs and compliance for fund administrator TMF Custom House Global Fund Services in Dublin.

Skills and Power

Chief compliance officers, chief financial officers or chief operating officers are first in line to be tasked as FROs. The reason: any individual appointed needs the expertise and clout to interact with the operations and technology departments to get the job done. The IRS, in its eagerness to extend its enforcement reach beyond US waters, is using foreign-domeciled financial institutions to do so.

"The FRO role is not a job for anyone who doesn’t have the best people skills, because it requires project management and leadership,” says Marc Lewin, tax adviser and member of the FATCA team with Arthur Bell CPAs in Baltimore.  If the job isn’t handled correctly, at the very least the financial firm will be on the hook for punitive action by the IRS. That means they will be required to deduct a 30 percent withholding tax for all US persons on all US sourced income — initially dividends and income payments in 2015 followed by gross proceeds in 2017. Such a scenario will practically speaking mean the death of the firm’s business — and revenue stream – from US persons — individuals, domestic partnerships and corporations.

Foreign governments have agreed to help financial firms in their home markets comply with FATCA in one of two ways: through what is called a Model I intergovernmental agreement (IGA) or a Model II intergovernmental agreement. Either way, the FFI doesn’t have to be concerned about violating local data privacy rules, because the foreign government has given its blessing to the task of identifying new and existing US persons as well as their accounts.

That’s the good news. Now for the bad news: under a Model I IGA which has either been signed or will be signed by several dozen foreign governments, the phrase responsible officer is never explicitly mentioned. Does that mean one doesn’t have to be appointed in a Model I country? Well, not exactly.

In order to receive a GIIN or a specific identification number from the IRS as being a foreign financial institution (FFI) compliant with FATCA rules, an FFI in either a Model I or Model II jurisdiction must appoint a responsible officer to fill out the paperwork. The obligations of the officer dotting the Is and crossing the Ts appear to be a bit above purely administrative, He or she must certify having the authority to answer all of the IRS’ questions. Still, such tasks are a far cry from the separate IRS definition of a FATCA responsible officer, which carries personal legal liability. The IRS has muddied the waters by using the same terminology to apply to both sets of individuals.

Just How Liable?

So what happens if something goes wrong? The IRS does say that the documentation to obtain a GIIN either through its portal or physical paperwork must be filled out correctly and it can penalize individuals for willful perjury with a financial fine of US$250,000, up to three years in jail, or both. So honesty is the only policy allowed. Still, to some legal experts, it is unclear just how much the IRS’ jurisdiction extends overseas and how it will differentiate between willful perjury versus accidental clerical errors.

Then comes the even more difficult part. Even financial firms in countries which have signed Model I agreements with the IRS will need to appoint someone to be responsible for complying with FATCA. The only difference: it can fulfill its tasks under its own set of local rules.

Opinions vary when it comes to just how legally liable such administrative officers will be under Model I IGAs. "There is no responsible officer as defined under the FATCA regulation, and the local laws of each IGA country may be used to ensure that an individual assigned to help comply with FATCA follows proper procedures,” says Lewin. "However, I am not aware of any Model I IGA country that has spelled out in official guidance that noncompliance may result in personal liability.”

Others are not quite as sanguine. "FATCA leads in Model I jurisdictions should take their responsibilities seriously and not be lulled into false narratives that their roles are inconsequential,” says Celoria.

Each Model I country will come up with its own definition of a responsible officer, because the documentation on who is and who isn’t a US person holding US sourced income will be sent to a local tax authority and not to the IRS. Therefore, offshore fund firms tell FinOps they are uncertain whether the job should be considered as paper-pushing or taken far more seriously.

Opinions vary, based on exactly where the fund was located. Case in point: a compliance officer at a Cayman Islands-domiciled fund tells FinOps "we won’t adhere to the US’ definition of responsible officer so there is no personal liability.” But his peers at investment funds in Luxembourg and Dublin didn’t agree with such a lackadaisical stance. "There will likely be some personal financial liability,” was their response.

Either way, the FFI is still on the hook for any errors and won’t take kindly to mistakes made by the "responsible” officer. His or her job will certainly be on the line, at the very least.

Rigid Rules

When it comes to a FRO in a Model II jurisdiction, there is no room for interpretation. The IRS is pretty strict about the responsibilities because all of the paperwork must be filed with the IRS directly, and not the local tax authorities. The FRO will need to set up a compliance program and verify — or certify — to the IRS every so often that the FFI is doing the job correctly. That means it has set up the correct procedures for tracking down and reporting on US persons. Those who don’t wish to be identified or the FFI can’t identify with certainty will automatically be hit with a 30 percent withholding tax.

The IRS will hold not only the FFI liable for any mistakes, but also the FRO. Just what does liability come to? The answer could depend on what the IRS considers a mistake. The IRS might overlook a situation in which an operational glitch causes withholding tax to not be applied to a handful of accounts, but won’t be happy if the errors are so egregious that the FFI is "non-compliant” or simply doesn’t know what its doing.

The FRO can be fined US$250,000 and even spend up to three yeasr in jail or both, or so the IRS’ own code says. The first outcome is a far more likely scenario than the second, as it is uncertain just how much the IRS’ legal arm can extend overseas.

Still no one should take any IRS threat lightly. Self-preservation is critical. For one, an FRO must insist on indemnification by the firm, so that the firm will pay for the FRO’s potential legal costs and penalties as well as its own. Beyond the financial fine and possible jail time, FROs could end up having to pay the IRS the entire 30 percent withholding tax owed for each account the firm cannot properly identify.

Offloading financial costs with indemnification will certainly help FROs breathe more easily. However, that doesn’t do anything for the extra administrative tasks they must oversee. Regardless of whether an FRO is in a Model I or Model II jurisdiction, the person must still plan on spending long hours to set up a workflow process of just who must do which operational tasks such as reporting to the IRS, setting up new account procedures and reviewing existing accounts for US indicia. Once all that information is in the FROs hands, the officer must then ensure its accuracy and certify the information is accurate to the IRS, in the case of Model II countries.

Internal Cooperation

Just how difficult setting up the entire compliance process will be will likely depend on a lot more than the number of business lines and offices involved. It may well come down to just how much cooperation the FRO or any designated official receives. The best course of action: ensure your CEO, CFO and COO have your back.

Even the most experienced chief compliance officers can’t necessarily be assured that each department will provide its utmost cooperation unless they receive a sign-off from management. "The buck stops with the FRO or any designated responsible officer, regardless of liability so its best that he or she receive a sign off from other senior level officials, particularly where it needs the cooperation of other departments,” says Mockler. "In the case of Model II countries, any instructions given also need to emphasize the FRO’s personal liability.”

In a best case scenario, the FRO or other administrative officer will receive all the information it needs on a timely basis to complete the necessary paperwork with its own tax authority or the IRS. In a worse case scenario, the FRO is unable to meet the compliance requirements and will have to hope that his or her firm provides sufficient indemnification.

Outsource or Not?

With the responsibilities of the FRO so weighty, it stands to reason that it would be best for the task to be outsourced. That’s just what some offshore investment funds are doing after on a thorough cost-benefit analysis. "When you add up all the administrative time it takes to learn about the requirements under FATCA, set up a compliance program and some certification, outsourcing the role might just be worth it,” says Celoria, whose firm offers outsourced FRO services.

Compliance officers at offshore investment funds insist they may get outside help with the investor due diligence work, but keep the FRO designation in house. "At the very least, it might make sense to have the due diligence in setting up customer onboarding and reviewing existing customer accounts outsourced,” says one compliance manager at a Luxembourg-based hedge fund.”

Regardless of just how much legal or financial liability an FRO or other administrative officer has in helping his or her firm comply with FATCA, there appears to be a rule of thumb. US citizens shouldn’t take the job at any cost.

As officers of their firms they will have to fill out a separate tax form with the IRS — Form 5471 — which could require them to not only reveal their designations as officers but also identify any individuals or corporations owning more than a 10 percent stake in the firm they work for. "It may be a time- consuming task for US citizens,” says Celoria.

Second qualm: "The IRS will likely have a lot more power to enforce possible jail time with US citizens who are FROs,” says Mockler. Foreign governments are far more likely to extradite US citizens to the US than their own, he believes. However, others insist that isn’t the case and even foreign citizens should be concerned about the IRS’ growing reach.

As is the case with many regulatory requirements, there is apparently a grace period. The IRS says it won’t penalize an FFI or its FRO if it makes a good faith attempt to comply with FATCA in 2014 and 2015. Of course, its anyone’s guess just what good faith means. At the very least, say some tax attorneys, the IRS will allow the FRO to issue "partial certifications” in case he or she isn’t certain it can pull off compliance. However, such partial certifications won’t last forever and the firm must ultimately meet the IRS regulation to the letter.

This article first appeared on finops.co.



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