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Anti-money laundering officers face greater burdens and risks because of the 2010 U.S. imposition of the cross-border, automatic sharing of financial information (FATCA) which in turn led to the global agreement among over 100 countries to adopt more expansive information sharing through an OECD Common Reporting Standard (CRS). FATCA and CRS require an enhanced customer identification program (CIP) and know your customer program (KYC), leveraging the AML customer due diligence (CDD) system, to take into a customer’s compliance with national and foreign tax reporting obligations. The lack of previous relationship of AML compliance and tax compliance led to nearly 100 non-prosecution agreements (NPA) against Swiss financial institutions since the initial 2009 UBS NPA along side scores of successful criminal prosecutions of bank officers and their clients.
To grossly simplify the impact of FATCA, FATCA has pushed the burden of collection and validation of tax identification self-declarations for U.S. purposes unto all financial institutions and financial firms of the 244 countries and dependencies of the world recognized by the United States. That is – pursuant to FATCA and its accompanying regulations, nearly all financial institutions, both U.S. and foreign ones, must obtain a signed tax self-declaration from the owner or owners of an account. Foreign individual must fill in and sign a Form W-8BEN and foreign entities a Form W-8BEN-E. U.S. taxpayers must complete and sign a Form W-9.
In addition to the FATCA requirement to collect signed tax self certification forms, over 100 countries governments have agreed to require a similar tax self certification form be collected pursuant to the OECD developed Common Reporting Standard. In general, financial institutions are now combining the U.S. form requirements with those of the OECD to create one form to collect the information necessary to comply with both.
Thus, a financial institution must by 2018 collect from the ultimate beneficial owners several self declaration forms, including FinCEN’s, a W-8 series or W-9, and the additional information to comply with CRS. The form W-8BEN-E and its OECD equivalent, at 12 pages, can be quite difficult for many taxpayers and their representatives to complete and thus contain numerous mistakes. The U.S. Treasury has agreed with over 100 countries through intergovernmental agreements (called IGAs) that allow variances in definitions for completing the required tax self certification forms. These variances are contained not in the IGA itself but in foreign revenue department’s “controlling” guidance, which adds another level of complexity and thus challenge for compliance officers.
Correspondingly these forms require substantial validation time for compliance officers. To put the numbers in perspective, industry is currently estimating that 900 million tax self-certifications need collecting and validating by compliance officers around the world by 2018 when nearly all the old forms on file and in data systems will have expired. Since the original 10 pages of the year 2010 enactment of FATCA, the U.S. Treasury has issued 2,000 pages of regulations and guidance in the form of the actual FATCA regulations, FATCA notices, the instructions for the new W-8 series, the 112 IGAs and the 2 FATCA competent authority agreements (CAAs).
Moreover, compliance officers must have a working knowledge of the equivalent amount of pages for the OECD CRS and foreign government guidance. By example, the determination of the status of an entity for FATCA compliance with the W-8 series is proving to be difficult because FATCA contains 129 new terms that can apply to this determination, many terms requiring definitions within U.S. or foreign regulations to explain what a term means and how it should be applied by a compliance officer.
The U.S. is a self-reporting and assessment system whereby each year over 150 million taxpayers file Form 1040 and its attachments that require the reporting of worldwide income, interests in foreign entities, interests in foreign accounts and many types of assets. It is reasonably estimated by various government sources such as the State department and the Treasury department that 10 million of these taxpayers attract reporting obligations regarding either foreign income or foreign accounts. Separately, taxpayers must self-report interests in, and signatory authority for, any foreign financial account via the electronic filing of FinCEN Form 114 ‘Report of Foreign Bank and Financial Accounts’ (FBAR).
Less than 20 percent of Americans with international income or asset exposure are compliant with filing the FBAR form that requires reporting of signatory authority over accounts if the collective balance exceeds $10,000. Only approximately 800,000 FBARs were filed for the year 2012 for that group of potentially 10 million American taxpayers.
The 2013 IRS tax statistics validate the low level of tax compliance. U.S. persons only filed 470,000 returns claiming the foreign-income exclusion. But the U.S. State Department estimates that more than 7 million U.S. persons reside overseas. 7.5 million Americans claimed a foreign tax credit on their 2013 return in the total amount of over $20 billion dollars. Perhaps the tax credit explains the discrepancy? But the foreign tax credit requires either earning income from foreign assets or earning foreign income from employment.
800,000 FBARs is probably 90 percent beneath the required FBAR filings required. Moreover, the FBAR is required to be filed even if a U.S. person only has signatory authority for a foreign account and is not the account beneficial owner. By example, if two board members of a company are signatory on a foreign account that reaches the FBAR reporting requirement, then both must file an FBAR.
In the infamous words of Ronald Reagan, “Trust but Verify”, the U.S. tax system is not just based upon self-reporting. Congress has deputized financial institutions’ compliance officers to become information collectors and verification auditors of the tax self-certification forms such as the W-8 series, W-9 and new FinCEN CDD form. Compliance officers face their most significant challenge in the industry’s history.
By example, when the IRS Qualified Intermediary regime (known as the “QI” regime) was introduced in the early 2000s to require foreign financial institution compliance officers to report on their US clients – at that time, only 20 percent of W-8s in bank files were fit for purpose. It has been reasonably estimated that as of 2015 only 35 percent of W-8s are fit for purpose – not a substantial increase over a decade, leading the IRS to question the veracity of financial institution compliance officers. Based on interviews with bank chief compliance officers, large financial institutions on average requires between 5 and 7 months to obtain a new W-8 from a pre-existing customer when it is missing or has expired. From that point does the validation process begin. Finally, the IRS estimates the time to complete the new W8-BEN-E is 12 hours and 40 minutes of record keeping and another 8 hours and 16 minutes preparing and sending the form. That requires 21 compliance hours before verification of the information within the form against the AML system maintained by the financial institution.
Apply these estimate stats to the customer base for whom the compliance officer of a large institution must reach out to. Firstly, obtaining W8s or W9s and their equivalent substitutes under an IGA, secondly validating those withholding certificates, and thirdly repeating this process in the 65 percent of the cases where the W-8 submission turns out to be ‘invalid’, multiplied by 12 to 20 hours. Amazingly, a 2015 large survey by Paystream Advisors found that 71 percent of respondents did not have an automated system for collecting, validating and managing W-8 and W-9 forms. The size and scale of the challenge for compliance officers requires substantial department budgetary increase requests to the board.
Lexis Guide to FATCA Compliance contains over 1,800 pages of analysis of the FATCA and CRS compliance challenges, with in-depth, practical insights. The Guide to FATCA Compliance includes examples, charts, time lines, links to source documents, and compliance analysis pursuant to the IGA and local regulations for many U.S. trading partners and financial centers. The Guide to FATCA Compliance provides the financial enterprise’s compliance officer the tools for developing and maintaining a best practices compliance strategy. Visit the LexisNexis Store to learn more >>
Prof. William H Byrnes of Texas A&M University School of Law is the primary author and co-author of eight Lexis legal treatises including Money Laundering, Asset Forfeiture and Recovery, and Compliance- A Global Guide and Lexis Guide to FATCA Compliance. At Texas A&M University School of Law he is developing a risk management curriculum in cooperation with Texas A&M University Mays Business School.