Industry organizations in each country submitted comment letters toward the proposed regulations on U.S. Foreign Account Tax Compliance Act (FATCA), which was released on February 8, 2012. The comments seem to indicate that financial institutions are hesitant to commence their action for FATCA given the demands by the Internal Revenue Service (IRS) to design institutional arrangements and to clarify the details described in their comments letters. A joint statement from the United States and five European countries; France, Germany, Italy, Spain, and the United Kingdom, were released simultaneously with the Proposed Regulations and the draft of the Japanese government statement have not specified exact timelines. It is unclear that such intergovernmental agreements would be effective prior to FATCA implementation deadlines. But the intergovernmental agreements has been characterized as “remarkable progress” in a comment letter by the Japanese Bankers Association, as these agreements would clear most of the current legal restrictions for compliance with FATCA. Repeal of the obligation on withholding recalcitrant account closures shall make reaction of FATCA a more realistic issue for foreign financial institutions (FFIs). There are four categories of classifications in FATCA:
- Identification of entity that must comply with FATCA;
- Identification of account; both current and new;
- Reporting; and
The following is a recommended course of action for identification of accounts; current and new, which FFIs are able to initiate at this moment as an answer to the question: “What should FFIs tackle right now?”
New Account Opening Procedure Under Terms of the Revised Act on Prevention of Transfer of Criminal Proceeds (Revised Act)
The demand to minimize chaos at the business scene by simultaneous parallel consideration on KYC for compliance to both the Revised Act and FATCA was well known before the release of the proposed regulations. The proposed regulations focus on AML/KYC procedures; and seem to have some consideration to minimize chaos caused by requirements under the Revised Act; however, KYC procedures for FATCA might be substantively added to the current AML/KYC process. We would interpret that FFIs can rely on AML/KYC procedures required in FATF-compliant countries and have to implement detailed rules on KYC; including the document to be obtained outlined in the proposed regulation. In their comment letter the Japanese Bankers Association indicated they would like confirmation and clarification that financial institutions can just rely on AML/KYC procedures and that there is no need of additional FATCA KYC processes needed. Therefore, we recommend that you closely monitor development of the following six items mentioned in the comment letter, acknowledging the difference between the Revised Act and FATCA.
- Types and scopes of documentary evidence
- Expiration period of documentary evidence and procedures to renew the identification process
- Timing of identification,
- Transactions subject to identification procedures (financial accounts)
- Obligation to retain a copy of documentary evidence
- Standard for identification of U.S. substantial owners
Clarification of the Range to be Aggregated
Aggregation by each account holder is needed on the premise of certain threshold usage on account KYC procedures. The proposed regulation states that aggregation “to the extent that the FFI’s computerized systems link the accounts by reference to a data element such as client number or taxpayer identification number” is acceptable. Therefore, when a customer is assigned a different client number by each branch, those accounts cannot be aggregated under such a requirement. Meanwhile most of Japanese banks accommodated such an aggregation when they implemented “payoff,” which means only a deposit of JPY 10,000,000 and its interest shall be protected under the Japanese Deposit Insurance Act, but accounts subject to aggregation are limited. FATCA covers accounts, which are not applicable to payoff rule; such as foreign currency deposits. FFIs have to confirm additional measures when they may not establish a system to conduct aggregation of same client number.
Procedures to Conduct Electronic Research on U.S. Indicia of a Preexisting Individual Account
The KYC process for individual accounts in the proposed regulations require FFIs to search information to indicate if the account holder is a U.S. person, hereinafter referred to as US indicia, in accordance with certain search conditions. However, such information searches would not produce any result, under the current system of KYC procedures and client data input and database maintenance. In such a case, there is a method to document certification of no extraction results instead of searching. When the above mentioned documentation process is troublesome for FFIs, they may arrange extraction conditions, conduct a search and keep a record of no results.
FFIs can further enhance their search results by paying attention to client accounts with standing instructions or periodic fund transfer instructions. There would be various methods to input data and to maintain a database of such instructions for example, some FFIs can directly conduct their search of periodic fund transfer instructions data while others can search fund transfer data in their transaction records with the transaction records being linked to the account. Therefore, FFIs are required to sufficiently perform a feasibility study prior to actual screening and implementation of the search/screening policies.
In addition, the Japanese Bankers Association’s comment letter highlighted the clarification of the definition of standing instruction, which demands that only frequent and large amount fund transfers should be regarded as U.S. Indicia. If this comment is reflected in the finalized regulation and extraction results are narrowed down, it is possible for FFIs to decrease their procedures after conducting a client account review. In this case, FFIs need to evaluate the frequency and the amount in their extraction condition.
Targeted Information on Customer Database
Copies of passport and drivers licenses which are acquired as paper-based identification and stored electronically do not seem to be required to be included in the screening process. The proposed regulation defines “electronically searchable information” as information that an FFI maintains in its tax reporting files, customer master files, or similar files, and therefore, is stored in the form of an electronic database against which standard queries in programming languages, such as Structured Query Language, may be used. Information, data or files are not electronically searchable merely because they are stored in an image retrieval system, such as portable document format (PDF) or scanned documents. Furthermore, FFIs who have outsourced overseas remittance operations only need to search their own database, although there is an issue to what extent do they maintain data related with remittance upon receiving such applications from clients.
Identification of Certain Insurance Product Types
The proposed regulations exclude insurance contracts that provide pure insurance protection, such as term life, disability, health, and property and casualty insurance contracts, from the definition of a financial account. These contracts are not required to be examined. However, funding insurance policies that provide coverage against damage but also savings-based do not seem to fall under the category of pure insurance protection. The definition of term life insurance in FATCA is a contract in which equal periodic premiums are payable annually or more frequently during the period of the contract and single premium life insurance does not equate to term life insurance. Accordingly, FFIs need to consider the premium payment frequency to determine their examination coverage.
Holder of the Insurance Account
FFIs are required to pay attention to whether the contract holder or the beneficiary should be regarded as holder of the account. The proposed regulations set forth that an insurance or annuity contract that is a financial account is treated as held by the contract holder if such person can access cash value of the contract, for example, through a loan, withdrawal, or surrender, or change a beneficiary under the contract. However, if the contract holder cannot access cash value or change a beneficiary then the contract is treated as held by each beneficiary under the contract. Therefore, in most instances for Japanese insurance companies, the contract holders are treated as holders of the account. But once the amount of reimbursement is fixed at contractual maturity, the holder of the account would be changed from contract holder to the beneficiary in accordance with the contract. FFIs have to revise KYC procedures on beneficiary of maturity repayment to be compliant with FATCA.
Formulation of Process and Internal Control Cover Internal Validation
The proposed regulations require the FFI to conduct periodic reviews of its compliance with FATCA policies and procedures. The responsible officer of the FFI must periodically certify to the IRS compliance with FATCA requirements. FFIs are further required to record their execution processes and results of KYC procedures for subsequent validation to conform with the requirement. To satisfy this requirement, FFIs might apply a pilot method through which the FFIs only conduct identification of U.S. account ad referendum — taking no account of ex post facto validation — and putting the procedures to be conducted in writing prior to full-scale implementation. After full-scale implementation, execution results could be documented more easily in accordance with the written procedures, which might be a more efficient way than targeting ex post facto validation at one time.
This covers the common issues, with or without intergovernmental agreement, for both participating FFIs and registered deemed-compliant FFIs to conduct further analysis regarding their compliance with pending FATCA implementation. However, even registered deemed-compliant FFIs need to keep in mind that they have a shorter period of time remaining because they are required to complete their implementation policy to preclude non-resident U.S. person and identification of preexisting account by July 1, 2013. It is also necessary to tackle the FATCA timeline by watching further development of intergovernmental agreements, public announcements of additional guidance, and the finalization of the Proposed Regulations.