Hong Kong banks face global tax woe

Hong Kong’s banks, in the midst of adapting to the new US Foreign Account Tax Compliance Act (FATCA), are now facing a tax headache on a global scale.

In July, the month where FATCA became a reality for the region, the OECD published guidelines on the adoption of a much broader and more ambitious set of rules.

Common Reporting Standards (CRS), or GATCA as the rules have been dubbed, effectively require all participating countries to share tax information with each other.

Unlike FATCA, no timeframe has been given for adoption — Hong Kong has yet to sign up — but there is a similar level of confusion; and the burden on the city’s regulators and banks has intensified.

“When I talk to the market there is the same lack of awareness as three years ago with FATCA, which is worrying,” Tim Clough, PwC’s risk and control solutions assurance partner, told FinanceAsia. “Banks have taken their foot off the pedal after FATCA and, bang, they are faced with an even bigger hurdle that will have a bigger impact,” he added.

Hong Kong was relatively late to the game on FATCA; only agreeing an inter-government agreement (IGA) with Washington in May, just ahead of the first hard deadline for tax reporting on July 1.

The city agreed to a Model Two IGA, which requires banks to report direct to the IRS in the US; and CRS is based on FATCA’s Model One IGA, which requires banks to report to their local authority.

A small detail perhaps but the logistical difference could be immense; for banks and the Hong Kong authorities.

“Those who adopted the Model One framework will already have a system in place on which to build. Hong Kong will still need to develop this and pass legislation giving effect to CRS. So the Hong Kong government will have a lot to do,” Charles Kinsley, principle, tax, at KPMG told FinanceAsia.

Bad news for banks

This could be bad news for banks in the city, which were forced to wait for the government to thrash out its FATCA IGA before they had clarity on what was expected of them.

Although Hong Kong has double tax agreements with other countries, which could help facilitate the process (about 30), this is short of the expected number of CRS participants – currently about 70 but expected to be closer to 100, according to Kinsley.

Kinsley said that most of Hong Kong’s banks are still “bedding down” FATCA and have not turned to CRS.

“Recognising the Hong Kong government will have a large part to play, I think a number [of banks] will sit on the sidelines until it gives a sense of its acceptance and what it plans to do,” he said.

The Financial Services and the Treasury Bureau, the Hong Kong body negotiating both CRS and the city’s Model Two FATCA IGA, could perhaps control the collection and sharing of the data in-house, which would require a sizeable bulking up of staff and IT systems.

Or the government could set up a separate body to do all this, which would be a significant undertaking on its own, even before factoring in the need for all the city’s banks to co-ordinate with it.

Either way, Kinsley said early discussions between the Hong Kong government and the city’s financial services community should start now. The lesson learned from FATCA is that to build certainty you have to keep people informed, said Clough.

The FSTB told FinanceAsia it was studying CRS and would respond to the OECD “when we are ready to do so”. But it also suggested the undertaking was huge.

“It is highly challenging to implement automatic exchange of information in Hong Kong, which constitutes a fundamental policy change and an overhaul of our tax regime, particularly given local concerns on data privacy and confidentiality,” it said.

The Hong Kong Association of Banks, which effectively acts as an intermediary between government and the city’s banking industry, said it expected more detail to be released by the OECD in due course.

“The OECD common reporting standards are relevant to Hong Kong as a major financial centre,” the HKAB told FinanceAsia, without elaborating.

Well, yes. That role, however, is perhaps not as concrete these days, with Hong Kong and its banking industry going through something of a soul searching period.

Headhunters are seeing a reduction in activity, the initial public offering market is struggling to return to levels of a few years ago and HSBC in July downgraded its investment outlook for Hong Kong equities.

HSBC cited Occupy Central, the protest movement campaigning for universal suffrage, as a factor and the tensions were evidenced by the record crowd at the July 1 democracy march to the heart of the business district (left).

Meanwhile, Moody’s holds a negative stance on Hong Kong’s banking system, citing its exposure to mainland borrowers, and ANZ said it had noticed the “rising risk of political tension and its possible impact on economic fundamentals”.

That said, according to a KPMG survey of the top 10 locally incorporated banks, released at the end of July, their profitability increased by 39 per cent last year compared to 2012.

Nevertheless the requirements of the likes of FATCA, CRS and Basel III are heaping additional pressure on the industry at a sensitive time.

The issue of most importance perhaps is the handling of customer data.

“Dealing with the volume of data, its security, storage and analysis will be much more challenging than FATCA,” Florence Carr, APAC FATCA lead at EY, told FinanceAsia.

Data

Instead of merely reporting those customers that are American, banks in theory will be reporting on all their customers, and to the local authority or other body as part of local law.

This puts a strain on the on-boarding of new customers, not to mention the identification of existing customers and the IT systems needed to support it.

Early adopters of FATCA should find their IT solutions somewhat similar for CRS and, if banks leverage the work already done, the costs involved should not be punitive, according to Clough.

“However, in some cases, this may even require fundamental changes to existing FATCA systems. In effect, we could be looking at CRS having a reverse effect on FATCA systems, ultimately creating a ‘rewrite’ of FATCA based systems to accommodate CRS and FATCA,” Neil Ramchandran, India and Hong Kong head of Capco, a global business and technology consultancy with a focus on financial services, told FinanceAsia.

The lack of a formal timetable does little to help the situation, with human nature suggesting much will be left to the last minute, whenever that is.

FATCA’s July 1 deadline acted as a lightning rod for financial institutions, which ensured appropriate prioritization, said Clough. Until there is a clear timetable on CRS, they will more than likely defer action, he added.

Early adopters that have already signed up to CRS in principle are expected to be ready by 2016. For the rest, including Hong Kong, the progress and success of FATCA will no doubt be important.

“I expect the Hong Kong government to be pressured on its participation at the OECD global forum in October. As a global financial centre it will not be allowed to sit on the sidelines,” said KPMG’s Kinsley.

To be fair, there is no suggestion that Hong Kong would sit on the sidelines but the city’s banks are waiting.

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