What will a Chinese Fatca mean for financial institutions?

Just as UK firms grasp the requirements of the US-led Foreign Account Tax Compliance Act (Fatca), China appears to be joining the ranks as another nation seeking to up its tax-take from citizens living abroad.

China has announced plans to implement a law that is similar to Fatca. This legislation requires financial institutions worldwide to disclose information on American taxpayers to the Internal Revenue Service (IRS).

The government of China has also decided to tax its citizens living abroad as part of a crackdown on both tax avoidance and tax evasion.

Ruffling feathers

Aimed mainly at wealthy citizens who stash money away in Hong Kong, the Chinese version of Fatca is expected to ruffle some feathers worldwide – although the precise details of the legislation are not yet known.

After Fatca was first announced in 2010, a number of financial institutions in the UK, under the burden of increased regulatory obligations, withdrew services for their American clients. Now with China implementing its own version, some firms may also opt out of servicing Chinese clients.

‘At present, Chinese nationals represent a smaller opportunity set for UK financial services firms than their American equivalent, although given the size of the country and the pace of wealth creation there is undoubtedly scope for this to grow in the future,’ said Richard List, director at Waverton Investment Management.

‘We suspect that firms would take a pragmatic approach to a Chinese equivalent of Fatca. Those businesses with the necessary language and legal expertise may well decide that the additional burden is worthwhile, although smaller firms could opt not to participate if the costs of so doing were unlikely to be matched by a corresponding increase in revenue.’

List believes the Chinese market will continue to be served by UK firms that have strong historic or cultural links to Asia and the Far East, possibly augmented by smaller specialist firms with the necessary expertise.

‘Other sections of the industry may choose not to accept Chinese clients if the cost of doing business becomes too onerous,’ he said.

Unintended consequences

Maseco, a wealth management firm that targets American and French expats, has had its share of dealing with worried clients over Fatca. Co-founder James Sellon believes there will be a lot of screaming voices concerning the Chinese regulation.

‘The unintended consequence is the cost to your average Chinese citizen living and working in a local jurisdiction who suddenly has to spend more time and effort considering their personal investments and taxation,’ he said.

‘They have to file two tax returns – a domestic plus a home country one. That adds to the complexity, time and uncertainty.

‘That also adds to an increase in professional service practices and professional accountancy practices to account for this. There will be a lot of advocates or groups that are set up to argue why citizen-based taxation is not a good idea.’

Sellon suggests that the regulation will make it more challenging to invest globally. However, he does not believe heads of compliance will turn down Chinese citizens until they are faced with the responsibility to report.

Further along the line, this could mean that products and services need to be tailored to account for citizen-based taxation.

‘I think that products and services would have to be redesigned for individuals of those jurisdictions. If the whole world goes to citizen-based taxation, the way investment products are structured would have to become more globally aligned than nationally aligned,’ he said.

‘They are now designed for local residents and sales are regulated locally. To cut through this, there seems to be a misalignment between taxation, regulatory sales and investment products.’

Burdens of US Fatca

Sellon said Fatca itself has not changed any requirements for US clients. It has only been an issue for the providers of investment products.

However, List paints a more difficult picture as the burden on US citizens resulted in 3,000 expatriations last year, according to official figures he cited.

‘We expect to see a sharp polarisation as US clients with more modest wealth find it much more difficult to access financial and wealth management services as the associated costs make them unviable for many firms.

‘Much change has already taken place, with a number of firms declining to act for US citizens and closing existing accounts,’ he said.

He believes that specialist knowledge is still required to meet the tax requirements of US investors who can shoulder any extra costs.

‘According to KPMG, the cost of regulation now accounts for 10% to 20% of a firm’s turnover and Fatca is yet another example of how the cost of doing business has escalated dramatically in recent years,’ he said.

Separately, the OECD and G20 nations have reached an agreement that would allow the automatic exchange of information to tackle tax evasion. Nations will automatically report information on accounts held by non-resident individuals and entities, including trusts and foundations to their tax administration. This is expected to be implemented by 2017 and 2018.