Countdown to FATCA Reporting: Will IT Glitches Mar Good Efforts? (Updated)

UPDATE: Following the publication of this article, the IRS announced it will offer another testing window from March 10 at 2AM EDT to March 12 at 5PM EDT. The test will be open to financial institutions and tax administrations which enrolled in the IDES by March 5 at 5PM EDT.

With about a month left to comply with reporting requirements before the controversial US legislation aimed at catching tax dodgers overseas takes effect, IT departments are now in the hot seat.

Assuming compliance and operations peers have provided a correct accounting of US accountholders subject to the Foreign Account Tax Compliance Act (FATCA), the tech staff are responsible for the last step in the reporting process — shoehorning the potential gigabytes of data into the IRS format and shipping the data according to IRS protocols. It’s not a risk-free process.

The IRS has published detailed guidance for the data fields and formats, data compression and encryption requirements. It is language computer geeks love, with one exception. As with any complex formatting and digital coupling project, there is a lot that can go wrong. If all goes well, the IRS will email a confirmation the transmittal has been successful.

If IT experts miss any single detail, the transmission could fail and the IRS won’t receive all of the required information or won’t be able to read what was submitted. IT staffers might not get praised for a job well-done, but they will get blamed by compliance, operations and C-level executives for any glitches, even if they were outside their control.

“The IRS has provided the necessary technical specifications but the timetable to prepare is still pretty short,” says Roman Ipfling, director at the Cayman Islands-headquartered DMS Offshore Investment Services, a FATCA compliance specialist. “Our IT department is making certain we can follow the IRS’ instructions on file transmittal.”

Now or Never

To test transmission protocols, the IRS offered foreign financial firms or their service providers only a two-day window from February 18 at 2AM EST until February 20 at 5pm EST to send test files. If they missed that window, they take their chances and hope for the best in their first transmission. The IRS offered no information on just how many FFIs, short for foreign financial institutions, took advantage of that opportunity or how successful their testing was.

Making the testing process even more time-constrained, testing was limited to firms that signed up with the IRS’ International Data Exchange Service (IDES) before February 17 at 2AM after completing the necessary paperwork, including receiving a tax ID number and certificate from a third party. Although the IRS did publish its initial specifications in January, it was not until February 17 that it released its final revised set of guidelines and sent off an email with a link to the IDES test website application

Of five fund management firms contacted by FinOps Report, only two had registered with the IRS in time to send test files. One had not attempted. The remaining two are using third-party reporting providers, and are awaiting news of the success of their transmissions.

The results of those two that did participate in testing: one succeeded and the other failed in having their test files accepted. Ipfling says that his firm did not participate in the two-day test period, but its IT team has conducted its own internal testing on the IDES the US Treasury wants to know whether or not US persons — either individuals, corporations or other types of entities — have US-sourced income they may not be declaring to the IRS to avoid US taxes. In the case of Model One agreements, the IRS will allow the FFI to transmit the data to its own tax agency which will then transmit it to the IRS. When it comes to Model Two agreements, the IRS expects the information sent directly.
The IRS might not penalize financial firms for technology glitches, but as one technology specialist tells FinOps it means going over all the laborious steps to determine what went wrong.’ guidelines for several weeks and has been in contact with the IDES help desk to sort out questions.

Queued-up Deadlines

Investment fund management firms and other financial firms, such as banks and broker-dealers domiciled in countries which have signed so-called Model Two Intergovernmental Agreements (IGAs) with the IRS must report by March 31 on any US persons opening accounts in those foreign financial institutions, or FFIs after July 1, 2014. FFIs in Model Two IGA countries — such as Bermuda, Switzerland, Hong Kong, Austria and Japan among others — also have to attest that they have not helped any individual close his or her account after July 1, 2014 — that is, they didn’t help anyone evade paying US taxes. The next deadline: June 30, 2015 to report on individual holders of pre-existing accounts opened before July 1, 2014. FFIs can correct any mistakes by June 30, 2015 and do the final reporting in 2016.

When it comes to corporations or other financial firms — entities — holding accounts that signed up before July 1, 2014, the IRS is a bit more lenient. The US tax authority is allowing FFIs to correct any errors by June 2016 and report in 2017. So-called new account holders who are classified as entities must be reported by June 2016.

Model Two agreements are one of two types signed by foreign governments with the US Treasury, the agency controlling the IRS, to comply with FATCA. The other agreements — Model One — are far more popular having been signed by over 100 countries, including the UK, most of Europe, the Cayman Islands, and Asia-Pacific. Regardless of whether a foreign country has signed a Model One or Model Two agreement, the US Treasury wants to know whether or not US persons — either individuals, corporations or other types of entities — have US-sourced income they may not be declaring to the IRS to avoid US taxes. In the case of Model One agreements, the IRS will allow the FFI to transmit the data to its own tax agency which will then transmit it to the IRS. When it comes to Model Two agreements, the IRS expects the information sent directly.

Although compliance specialists at several non-US fund management firms tell FinOps that they prefer Model One IGAs for legal reasons — reporting through local regulators ensures no local data privacy laws are violated — IT specialists are more comfortable with Model Two IGAs. The reason: they already know exactly what the IRS wants. Not so with many foreign countries which have yet to specify the required data fields and test transmissions. “The IRS’ transmission guidelines are considered the guidepost for other markets,” says one IT expert at an offshore fund management shop.

Difficulty of Getting It Right

Knowing what the IRS wants isn’t always the same as making it happen, note IT specialists at several firms. The IRS might not penalize financial firms for technology glitches, but as one technology specialist tells FinOps it means going over all the laborious steps to determine what went wrong. That won’t be an overnight process.

“Gathering the reporting data is critical. It is another challenge to make certain it is rendered in the correct format,” explains Laurence Kiddle, managing director of tax and accounting for Europe, the Middle East and Africa at data giant Thomson Reuters in London. “The IRS schemas require some very specific validations.”

Of course, one hopes that the IRS has planned its capacity correctly for the potential onslaught of electronic transmittals. If the experience of the UK’s Financial Conduct Authority (FCA) provides an inkling of what can happen, the IRS has a lot to be worried about. Reportedly, the FCA was unable to receive for at least two days the required quarterly or annual financial reports from fund managers following the European Alternative Investment Funds Directive (AIFMD). The reports were due the weekend of January 31 and the technical glitches weren’t corrected until February 3, according to the FCA.

“We are currently receiving high volumes of data and some users may experience slow performance issues,” said the FCA on its website. “We recommend that you save your data regularly and avoid using the system during busy periods of the day such as mid-morning and mid-afternoon.” The regulatory agency declined to comment further on the matter.

Best Laid Plans

Even if the IRS is has its IT act together and financial firms have done their IT homework as well, there are always risks of last minute errors with no time to fix them. Such as occurred with AIFMD, financial firms may delay aggregating their data resulting in either incomplete or incorrect responses.

“There were some errors or omissions with calculations on regulatory assets under management, liquidity, counterparty risk and leverage,” explains Mario Mantrisi, senior adviser to the chief executive at the Luxembourg-headquartered regulatory reporting service firm Kneip. “In some cases, the errors were caught in advance, before any regulatory agency saw the report, while in other cases the regulator flagged the error.” The fund manager had to redo its homework.

So what are FFIs likely to overlook when it comes to filing their regulatory tax reports? How about the basics such as the full address of the reportable individual, or his or her full name, predicts Kiddle.

The good news: The IRS has said it will not penalize financial firms who make a “good faith” effort to file their reports correctly. The better news: chances are that if a non-US fund manager or other financial institution can get through the March 31 reporting period, it can also do so for most other tax authorities, two fund management IT specialists tell FinOps. Or so they hope.