The realisation that an impending US law could see UK investments take a 30 per cent hit is starting to sink in – but not fast enough. The Foreign Account Tax Compliance Act, or Fatca, is extensive and far-reaching, impacting IFAs, platforms and fund managers – not to mention banks, administrators and custodians.
In November, I discussed the implications of the Fatca on UK retail investors and looked at how US law could lead to investment losses, increased compliance and costs and, at its most extreme, the ability to do fund management business.
Fatca requires any foreign financial institutions, such as IFAs and fund managers, sign an agreement that they will provide the US Internal Revenue Service with information on any US taxpayers they deal with. The penalty for non-compliance is a 30 per cent withholding tax, imposed on a pro rata basis and levied on the gross proceeds of any US assets. That means more than just capital returns, interest or dividends but also cashflows, including losses.
However, it doesn’t stop there. The viral-like nature of Fatca means for UK fund investors, it affects more than just US portfolios but can apply to all mutual funds. Fatca involves a chain of financial institutions and if even one member of that chain fails to comply, it impacts on the compliance of the others. As a result, some groups may chose not to do business with them or use the option of ’passing through’ the withholding tax.
For example, say the provider of a UK fund with UK assets and 100 per cent owned by UK investors opts to ignore the US law in the belief that it has nothing to do with them. The administrators or custodians, who likely do have US assets, must prove everyone they deal with is Fatca-compliant. As it is impossible to do so in this case, that provider could be deemed too high a risk and refused business, leaving the fund incapable of continuing.
The contagion effect also extends to IFAs. Not only are they forced to report any clients who are US taxpayers, they must report those who are not. They have to prove the negative, says Jonathan Willcocks, global head of sales at M&G. If they fail to do so, there are a number of potential consequences and they could find some providers will no longer deal with them or that their clients are inadvertently disadvantaged.
Take the example of a client in a UK occupational pension scheme, also caught by Fatca. As it stands, all schemes have to contact members to get them to declare whether or not they are a US taxpayer. In the case of a final salary scheme, they would even have to declare the status of their beneficiary.
Steve Lynam, head of taxation at the IMA, says investors can often be lax in responding to investment comm-unication but if they, or their IFA, do not provide the information, their pension returns may be cut. Most occupational schemes have US asset exposure and so unless it can prove none of the members are US taxpayers, the scheme would be subject to the 30 per cent withholding tax penalty, thereby reducing distributions.
The US law has been in place since March 2010 but details concerning the final regulations are still being negotiated. Trade bodies such as the IMA and the European Fund and Asset Management Association are actively lobbying to moderate Fatca’s measures.
However, those who believe the situation will go away completely are wrong, as the political will behind it is very strong, says Lynam. The best the UK can hope for is to push for amendments that will soften the blow. Such action has already happened to a degree in relation to mutual funds, he says.
Fatca initially applied to US taxpayers who invested any amount but it now encompasses investments of $50,000 or higher. According to the IMA, based on data from one of the UK’s biggest administrators, there are at least 7.7 million accounts of US taxpayers held in UK funds but approximately 85 per cent of these do not exceed the new $50,000 limit.
But while the high threshold reduces the number of retail investors the platforms, IFAs or fund managers must report on, they still need to report – even if it is to say they have nil exposure. If they fail to report the fact they are unaffected, they are caught and the contagion moves back up the chain.
Another potential softening of the rules lies with a recent edict issued in the spring, in the form of IRS notice 201134. This is aimed at local banks and while it might not exempt them from Fatca, it does offer a lighter-touch form of the law, says Lynam, adding that what exactly this means has yet to be clarified. He says a similar option could potentially be offered to fund distributors, at least as far as B2C platforms are considered. IFA-centric distributors may be more problematic but the IMA and EFAMA are still pushing the case forward.
Considering the current lack of clarity on issues such as what lighter-touch involvement will constitute, the deadline for Fatca’s implementation looks tight. Like the retail distribution review, it takes effect from January 1, 2013 and while critics are harsh on the late timing of the FSA’s final RDR regulations due out this summer, Fatca’s final regulations will be even later – at the end of the year or the start of 2012.
That is both good news and bad, says Lynam – good in that it provides an opportunity for continued lobbying efforts but the tight deadline may mean companies have insufficient time to implement the necessary system changes.
The ramifications of Fatca are a massive concern for all UK financial institutions, including IFAs, and yet the issue has been simmering away on the back burner in the year since it was announced. That has since changed. Willcocks notes that Fatca has moved well up the agenda for most companies in recent months and today there is greater unification in lobbying efforts across the industry.
Still, unless more is done to promote understanding that this is an issue concerning everyone in financial services, the consequences are grave. A worst-case scenarios is that groups will suddenly see too much risk associated with US assets and unilaterally dump exposure to the region. The impact of that – and any subsequent, protectionist backlash – will effect all investors.