Treasury calls for FATCA exemptions on eve of proposals

HM Treasury is pressuring the US government to "carve out" low-risk institutions from FATCA, ahead of a draft paper due this week.

The move may help them avoid a punitive 30% withholding tax for non-compliance with the new rules.

A Treasury source said the difficulties in implementing FATCA (the Foreign Account Tax Compliance Act) are considerable, as the legislation goes further than anything the UK has had to deal with before.

However, it is understood to be seeking a ‘country to country’ solution which may build on the existing tax treaty the UK has with the US. It is hoped this will reduce the systems UK institutions will have to introduce, and minimise the burden on industry.

Last summer the Investment Management Association (IMA) was lobbying for changes which would see funds using local distributors exempt from FATCA rules.

The IMA’s submission to the IRS read: “A solution for the UK funds industry would be to afford platform operators similar treatment to that of ‘certain local banks’, ie for provisions to be extended to include local distributors. Such a change would see funds treated as ‘deemed compliant’ foreign financial institutions.”

Even with a country to country agreement, UK institutions still face significant financial and administrative hurdles to impose the systems FATCA requires.

According to the latest estimates, complying with FATCA will cost each large institution $100m (£64m), and will bring in $7.5bn of revenue for the US Treasury over 10 years.

A major problem with FATCA is it assumes a UK financial institution would be willing or able to levy a tax on behalf of a foreign government.

The source said HM Treasury will not allow any legislation which undermines the UK’s own national sovereignty and tax framework.

UK banks are also understood to have raised concerns over FATCA, which may conflict with existing money laundering rules, as well as the Data Protection Act, raising the prospect of legal challenges.

Submissions from the banks and the UK authorities have put Congress under pressure and it has toned down its original FATCA proposals, but sources suggest they will not be relaxed much further before the final paper is published in the summer. This is largely a political issue, the party in power, the Democrats, would not want to be seen as a friend to tax evaders.

Foreign financial institutions (FFIs) will not be able to avoid FATCA even if they have no US customers, as they must have systems in place to identify future US clients. Plus, any transactions made with US-investing firms will be subject to FATCA under pass-through payment rules.

The Foreign Account Tax Compliance Act was designed by the US Internal Revenue Service to prevent offshore tax evasion. The regime will force individual investors in funds holding any US assets to prove they are not US citizens or face a 30% witholding tax on US-sourced returns.

Originally set to come into force in January 2013, certain aspects of FATCA have been postponed until 2014 and 2015. FFIs, including banks and asset managers, will have to register with the IRS by June 2013.