Scratched by the FATCA

American tax law

Congress creates a bureaucratic nightmare for fund managers

Paperboarding

CATCHING tax cheats is well and good in theory. Achieving that feat in practice is another matter. As fund managers are finding, the latest effort from the American authorities to root out those of their citizens who have been hiding their assets overseas is creating a bureaucratic nightmare around the world.


The operation of the Foreign Account Tax Compliance Act (FATCA) has already been postponed for a year because of the immense problems that it is going to cause global investors. The law requires that foreign financial institutions (a category that seems to include everybody from financial advisers to pension funds) register with the Internal Revenue Service by June 30th 2013. If they do not register, they will then be regarded as “non-participating”. In that case a 30% withholding tax will be applied to all their income on American assets from 2014 as well as to the proceeds from the sales of these assets from 2015.
Since the American equity and bond markets are the biggest in the world, the vast majority of foreign fund managers will feel obliged to register. But that is where their problems will start. Managers will then have to tell the IRS whether their clients are American citizens. To do that they will have to find out a lot more than whether the client has an American address. They will need to check, for example, whether the client was born in the United States or whether interest or dividends are transferred to a bank account there.
This creates a whole bunch of problems. For a start, managers would have to report information about their clients to the IRS; a requirement that would cause some of them to fall foul of their own country’s data-protection laws. Second, there may be several layers of intermediation between the fund manager and the client. For example, the investors in a mutual fund will often include private banks and financial advisers, who are acting on behalf of other clients; sometimes these clients might be private companies. The fund manager will need to look through all these layers to find the end client.
Even when fund managers are able to contact their clients directly, there is no guarantee that they will reply. Much paperwork already goes unread and unanswered. “Many people will just put the form in the bin,” says Julie Patterson of the Investment Management Association, the lobby group for British fund managers. But if the client doesn’t fill in the right forms, they will be dubbed a “recalcitrant account holder” by the IRS, on the ground that they might be an American trying to evade tax (rather than, say, a forgetful old lady in Stuttgart).
If the fund manager has recalcitrant account holders, or cannot provide enough information to satisfy the IRS, it will have to apply the withholding tax on their share of its American assets. Fund rules will prohibit it from applying this charge to the affected clients, so the effect will be to penalise all investors, American or not. Clients from Aberdeen to Zagreb will be funding America’s fiscal deficit.
The rule will also apply to company pension funds, even though it seems unlikely that many Americans would go to the lengths of joining corporate pension schemes to evade taxes. Pension funds will have to assert not only that their members are not Americans but that their potential beneficiaries (spouses, children) are not so either, a Herculean task.
Fund managers still hold some hope that the costliest provisions of the legislation can be negated. “The US authorities have been listening to the concerns of the market,” says Fiona Bantock of the European Fund and Asset Management Association. The IRS is expected to issue a clarification of the rules by the end of the year.
If the process is not made simpler or less costly, fund managers may be forced to take drastic measures. One approach would be to bar Americans from investing in their funds, or to require them to own separate classes of shares.
Another approach would involve some global funds avoiding American assets entirely. That can hardly be what Congress had in mind.