Cayman Islands: FATCA: International Tax Compliance Implications For PRC And Hong Kong

The US Foreign Account Tax Compliance Act (FATCA) is in the vanguard of a global movement towards the automatic exchange of information on tax matters. The US enacted FATCA in 2010 to tackle the problem of tax evasion by US citizens and residents who under-report or fail to report income related to their foreign financial accounts.

FATCA will take full effect on 1 January 2015, following a six-month transitional period. FATCA provides for the exchange of information between the US and its partner jurisdictions.

Foreign financial institutions (FFIs) in these jurisdictions and US withholding agents (USWAs) are required to collect information on account holders, and in certain cases their controlling persons and beneficial owners, and report on anyone who is, or might be, a specified US person, or who otherwise fails to cooperate with the FATCA regime.

Foreign financial institutions

FFIs include investment entities, depositaries, custodians and specified insurance companies. FFIs are generally required to register with the US Internal Revenue Service (IRS) – to obtain a global intermediary identification number – and comply with various due diligence, withholding and reporting obligations in respect of their account holders. There are certain exceptions for FFIs that are considered to provide a low risk of tax evasion by US taxpayers.

FATCA withholding

A US withholding agent must follow a cascading series of presumptions if it does not have valid documentation to establish the FATCA status of an account by the end of 2014. The end result is that the account holder is treated as a non-participating financial institution (NPFI) and subject to a 30% FATCA withholding tax on US source fixed, determinable, annual or periodic income, and, from 2017, gross proceeds of sale or redemption of assets procuring US source dividends or interest.

Apart from terminating all future transactions, the only certain way for a non-US entity to avoid this treatment by its US counterparties and financial service providers is to provide valid documentation in the form of: IRS form W-9 for US persons; W-8BEN for non-US individuals; or W-8BEN-E, W-8IMY, W-8EXP or W-8ECI for foreign (non-US) entities.

Any entity providing an IRS Form W-8IMY which does not have FATCA withholding responsibilities with respect to the account/ payment must also provide an “IMY allocation” and withholding certificates and identification documents in respect of each beneficial owner of the account.

China and the Model 1 IGA

China is among many other jurisdictions that have an unsigned “agreement in substance” for a Model 1 IGA with the US. There are 98,354 FFIs from 97 jurisdictions, including 658 from China, which have registered with the IRS pursuant to their jurisdiction’s Model 1 IGA with the US.

These FFIs are required to annually report on reportable accounts to their domestic tax authority for transmission to the IRS. The domestic tax authority regulates these FFIs under their domestic law; they are not subject to an FFI agreement with the IRS.

Model 1 IGAs may be either reciprocal – requiring the US to share information on the partner jurisdiction’s taxpayers’ accounts with US financial institutions – or non-reciprocal, where information only flows from the partner jurisdiction’s competent authority to the IRS, and not the other way.

Hong Kong and the FFI agreement

Hong Kong signed a Model 2 IGA with the US on 13 November 2014. Thirteen other jurisdictions have also agreed to Model 2 IGAs with the US. Hong Kong FFIs that have registered with the IRS, and are subject to an FFI agreement, number 2,562 to date of press and include well known entities such as Hang Seng Bank and BOC Hong Kong.

In total, 23,837 FFIs from 129 jurisdictions have entered into FFI agreements directly with the IRS. The FFI agreements require FFIs to report directly to the IRS annually in respect of any withholding tax and reportable accounts. Unlike Model 1 IGA FFIs, they are each subject to US law and the jurisdiction of US federal courts. There are also 735 US financial institutions registered on the IRS FFI list, primarily as sponsoring entities, or leads or members of an expanded affiliated group.

The FFI agreement provides that Model 2 IGA FFIs generally only have FATCA withholding responsibilities in respect of NPFIs not resident in an IGA jurisdiction. The Model 2 IGA requires the partner jurisdiction to assist the US with enforcement. Model 2 IGAs are not reciprocal.

Due diligence

FATCA and the IGAs require USWAs and many FFIs to obtain documentation regarding the tax status and identity of their customers, clients, investors and counterparties. It does not matter whether those persons are US or non-US, or are individuals or entities such as companies, partnerships, trusts, government bodies or foundations. In every case, documentation on status is required, such as an IRS withholding certificate and government identification document.

Withholding tax and account closure

In addition to those due diligence obligations, USWAs and certain FFIs are required to deduct and pay FATCA withholding tax to the IRS on any US withholdable payment to a payee that is non-compliant with FATCA, either because it is an NPFI or “recalcitrant”, i.e. has failed to provide the USWA/ FFI with valid documentation.

FFIs are required to report on NPFIs, recalcitrants and “specified US persons”, i.e. not tax exempt. USWAs and FFIs will be personally liable to the IRS if they fail to deduct that tax from the withholdable payment and pay that tax to the IRS up to four times per month. Unlike FFIs, USWAs must close accounts of recalcitrants.

Chinese and Hong Kong entities and individuals that have accounts with certain financial institutions or receive US source payments should expect to comply with requests for documents regarding their tax status and identity very soon, if they have not done so already.

FFIs and USWAs must request and obtain these documents in order to comply with FATCA. Directors, managers, partners and trustees should understand their duties and liabilities will vary, depending on whether their FFI has an FFI agreement with the IRS or is regulated by domestic regulations of a Model 1 IGA jurisdiction