US Withholding Agents Face the FATCA Music

The US Internal Revenue Service is spreading its love for the Foreign Tax Compliance Act (FATCA) to US shores.

US tax operations and corporate tax directors at US banks and broker-dealers serving as US withholding agents must now deal with the IRS’ request for more information on their compliance with FATCA. If they haven’t done so already, US withholding agents could face audits if their onboarding, withholding and reporting for FATCA-related payments don’t pass muster, warn panelists and attendees at a recent tax withholding and information reporting conference in New York hosted by the Loscalzo Institute, a Kaplan company.

The IRS’ interest in how US withholding agents are doing their jobs is nothing new. The US tax agency has simply expanded the scope of its so-called 1042 audits. “The IRS will review US withholding agents’ policies and proceudres along with their due diligence, applicable withholding and reporting obligations associated with FATCA,” says Cyrus Daftary, a principal in the information reporting and withholding group for global consultancy KPMG in New York who spoke at the Loscalzo-hosted event.

Other panelists representing the IRS say that withholding agents shouldn’t be surprised if the tax agency comes knocking at their doors. They’ve had fair warning in a new Internal Revenue Manual (IRM) released in September, explaining that US withholding agents must report on Form 1042 and Form 1042S any withholdable payments with respect to FATCA. “Although this IRM section deals principally with NRA [non-resident alien] withholding, FATCA withholding also needs to be considered as part of an integrated audit,” says the IRS in the ARM. “Auditing Form 1042 information should include both NRA and FATCA withholding.”

Adopted in 2010, FATCA is aimed at ensuring foreign financial institutions help catch US persons evading US taxes. Foreign financial institutions whose countries have signed Model 1 intergovernmental agreements (IGAs) with the IRS’ parent, the US Treasury, have to disclose any US persons and account information to their local tax authorities. By contrast, FFIs whose countries have signed Model 2 IGAs with the US Treasury must give the IRS the data directly.

Under Chapter 3 of the US tax code, US withholding agents were typically responsible only for withholding tax on foreign investors holding US assets based on their country of residence and type of financial instrument. Now under an additional Chapter 4, US banks and broker-dealers also have to withhold a 30 percent tax on US-sourced payments made to foreign financial institutions or non-financial foreign entities that do not provide the appropriate information required by FATCA and/or information regarding their underlying US owners to US withholding agents. The foreign branches of US financial institutions are also considered US withholding agents and must comply with the same reporting and withholding requirements at their US parents.

Why Now?

Why is the IRS suddenly interested in how US withholding agents are handling their FATCA requirements? It has taken some heat from the Treasury Inspector General for Tax Administration (TIGTA) , which in July 2018 criticized the IRS’ lax enforcement of FATCA. Although the Treasury’s recommendations on improving compliance with FATCA focused entirely on greater oversight of foreign financial institutions, the IRS has decided to also hold US withholding agents accountable. US banks and broker-dealers must be prepared to show that they have implemented the requisite controls and compliance procedures to satisfy FATCA’s requirements.

Incorrect information at the time of customer onboarding, charging too little withholding tax or failing to report the correct information to the IRS are just some of the shortcomings US withholding agents must now correct. Among the errors panelists at the Loscalzo-hosted event highlight as being the most worrisome were missing data on W8 or W9 forms that the FFI or non-FFI must accept from its customers, such as the names of beneficial owners of foreign companies and tax identification numbers. In some cases a PO Box instead of a physical street address is listed or the type of entity subject to withholding tax is incorrectly classified. In highlighting the ineffectiveness of the IRS’ enforcement of FATCA, the TIGTA says that in 2015 about 62,398 Form 1042S had incorrect TINs, reporting more than US$7171 million of which only US$47 million in tax was withheld.

Ensuring accurate data at the time of customer onboarding won’t be enough to keep the IRS at bay. “Even if US withholding agents have started off with the right client information, they might not be adequately keeping track of changes in circumstances or the details related to the client’s tax status which would change the amount of withholding tax and the information reported to the IRS,” cautions William Sheridan, executive director of CTI Tax Solutions at IHS Markit, a financial technology and information firm in New York.

Technological inefficiencies will also lead to errors with FATCA compliance. Ideally, US withholding agents will rely on a single customer onboarding system that is linked to a single tax withholding system and a single tax reporting system. However, the norm looks more like a Tower of Babel — a multitude of disparate unconnected systems. The greater the number of platforms the higher the potential for error.

“US withholding agents may have either licensed or developed in-house platforms for different business lines when different tax rules were in effect,” says Nelson Suit, tax counsel and director of regulatory compliance at tax technology firm Scivantage in Jersey City, New Jersey. “Systems originally coded for reporting and withholding tax for foreign investors might also not be correctly programmed to handle FATCA.” These different systems still need to talk to each other.”

Precautionary Steps

Given the potential for error is so high, good housekeeping is now in order. A cleanup or data reconciliation is recommended for starters. The IRS will likely be matching up the consoldiated information on the Form 1042 it received from a US withholding agents about tax withheld for all FATCA-related payments with information on individual Form 1042S on FATCA-related withholding tax for each FFI or other customer. If the numbers don’t add up, the IRS will be prompted to do a deep dive inquisition about policies and procedures.

US withholding agents must do far more than just a perfunctory dusting to fulfill their legal responsibilities. Some heavy-duty scrubbing will be required. “Sample testing of withholding tax and reporting capabilities as part of an overall internal health check is the most likely critical to detect any deficiencies before an audit takes place,” says Daftary. A quick remediation of any errors is also recommended as is a written compliance program, he adds.

Spilling the beans on errors and taking immediate corrective steps is the best approach to avoiding hefty IRS fines, according to IRS officials speaking at the Loscalzo-hosted event. Confessions should be a lot longer than saying the problem has been fixed, they say. The IRS wants to hear the whole story.

The IRS might not penalize the US withholding agent for any errors that have already been corrected, but those left uncorrected won’t be forgiven. US withholding agents will be penalized for reporting errors and forced to fork over any underwithheld tax. Once interest is added, the fine could easily amount to over US$1 million, tax operations managers tell FinOps Report.

Determining whether compliance with FATCA is up to the IRS’ snuff won’t be easy. Internal audit departments, typically used to ensure regulatory compliance, aren’t always equipped to do the necessary health checks when it comes to FATCA. Neither are corporate tax departments which typically provide only high-level guidance. “Tax operations and IT managers are the ones with the most work to adjust systems and procedures,” says Sheridan.

Tax operations software providers and other tax expert firms, which displayed their wares at the Loscalzo-hosted event, offer some relief. The New York-based IHS Markit says its platform will keep track of the documentation US withholding agents accept as well as calculate the withholding tax and report to the IRS. Jersey City, New Jersey-based Scivantage, has just expanded its Maxit platform, which focuses on compliance with the IRS’ cost-basis reporting rules, to include reporting on NRA and FATCA subjects for Form 1042.

However, systems are only as good as the data received and any incorrect or incomplete information at the time of time of onboarding will likely affect results. It is unclear whether any data validation done by any platform will be sufficient to catch all of the potential data omissions which could lead to underwithholding and reporting errors.

Customer onboarding teams in multiple business lines will also need to be rigorously trained in checking up on discrepancies in client information. Although FATCA does allow financial firms to rely on self-certification or taking the client’s information at face value, no firm wants to be called to the carpet for even unintentional oversights related to customer onboarding and reporting. KMPG is among a handful of global consultancies that can assist with health checks, reviewing policies and procedures, and handling internal audits.

Representatives of US withholding agents who spoke at the Loscalzo event were eager to show they had gone the extra mile to win the IRS’ seal of approval. Kevin Sullivan, head of US information reporting and advisory services for Bank of America Merrill Lynch in Charlotte, North Carolina, says his firm has already completed a rigorous individual review of all of its US business lines and foreign offices. “We have an internal certification process with each business line and foreign office with designated responsible officers taking charge of the process,” he asserts.

Other panelists at the Locazlo Institute-hosted event didn’t hesitate to say they had undertaken “monumental training measures” and compared their financial firms’ preparations for FATCA to subcertifications often done to comply with the US Sarbanes-Oxley Act. Passed by the US Congress in 2002, the legislation requires US chief executives and financial officers to attest to the accuracy of their companies’ financials. Firms often do the attestation all the way down the line at each business unit to ingrain an enterprisewide culture of compliance.

US banks and broker-dealers who have already been audited when it comes to their responsibilities for withholding US tax for foreign investors will likely have an easier timewhen it comes to preparing for audits related to FATCA. For those facing the IRS for the first time, the process could not only be grueling, but expensive. External legal counsels and major global consultanties are expecting to clock lots of overtime to help client firms with their cleanup efforts and disclosures to the IRS.

Knowing where data is located, what procedures were used to uncover errors, how they were rectified and how they will be prevented will likely go a long way to mitigating mega-fines, say panelists at the Loscalzo-hosted event. Although executives at various banks and even IRS officials speaking at the event referred to the IRS’ requests for clarification on procedures related to correctly populating Form 1042 and Form 1042S as “love letters” it’s clear that there won’t be any love lost between the IRS and any US withholding agent it audits.