Curbing Tax Evasion: Do You Know Where Your Data Is?

January 25, 2010
Chris Kentouris

Efficient recording and management of customer data. That is what tax experts and operations executives believe will become a critical task for financial firms abroad when complying with U.S. legislation being proposed to curb tax evasion by Americans overseas.

That won't be easy, they say, because of the expected complexities of the rules-and unanswered questions about them.

Financial firms-banks, brokerages, offshore hedge funds and other types of investment funds-may need to establish new procedures to open accounts for U.S. investors in foreign assets and continually update and aggregate information on their holdings from multiple offices and databases. For foreign banks, the burden of compliance may be even greater than for U.S. banks operating abroad because of the lack of any procedures when opening accounts for U.S. investors.

"The bank or other foreign intermediary will need to know where the records of ownership of foreign shares of U.S. investors are kept and set up new and consistent procedures for account opening and updating," says Eric Bass, a principal with the business advisory services group Rothstein Kass, a Roseland, N.J. accounting firm. "With financial firms often depending on multiple repositories, the legislation could prove challenging."

While none of the dozen banks and brokerages contacted by Securities Industry News wanted to predict how much it will cost them to comply with the new measure, they will more than likely have to absorb the price tag.

"Tax changes always require adaptations to systems and procedures which we can never recoup from customers," says Paul Bodart, director of operations for Europe, the Middle East and Africa at The Bank of New York Mellon's asset servicing group in Brussels.

Considered far less stringent than what the Obama administration had initially proposed in its so-called green book proposals in May 2009, the proposed legislation called The Foreign Account Tax Compliance Act (FATCA) forces foreign financial institutions to sign an agreement with the Internal Revenue Service that they annually disclose the identities of direct and indirect U.S. investors in foreign assets and consent to some type of external auditing. Any foreign financial institution which fails to disclose all of its U.S. investors in foreign securities will be subject to a 30 percent withholding tax on all U.S.-sourced income and gross proceeds it receives.

About 5,000 or so banks have already developed extensive recordkeeping systems to categorize non-U.S. customers into different tax categories and either deduct the appropriate withholding tax themselves or send the information on the investors to yet another bank. That bank, typically a U.S. global custodian, then would deduct the correct tax amount.

However, even those banks-called qualified intermediaries or QIs-never had the obligation to reveal to the IRS the names of U.S. citizens or companies which invest directly in foreign assets. U.S. tax laws required the U.S. investor to disclose any accounts in foreign assets or voluntarily report any income earned on such accounts, but that did not always happen. The new legislation could bring in an estimated $30 billion in new revenues over the next decade.