We know, we know. It’s a whole load of anagrams at once! It can all get a bit confusing, especially if you’re trying to work out which regulations apply to you, and what the differences are between all of the major tax regulations across the US, EU and OECD. Today’s blog is going to be a brief overview of what they are, the differences between them and when each one might come into play.

FATCA

Financial institutions are often faced with the challenge of working out the sheer number of regulations they’re subject to, which means they rarely communicate with their investors about the complexity of those regulations or the hoops they have to go through to be compliment. Given that the most common compliant at onboarding is about the number and types of documentation needed just to open an account, we can say this with some confidence. Which is why financial institutions need to be clearer in their communications with investors.

Onboarding is a particularly difficult time to financial institutions anyway. Not only are they subject to the Know Your Customer regulations (or KYC), but they use this opportunity to gather other documentation and data that they will need to support their client’s ongoing needs. If the client intends to invest or open a deposit account, they will almost certainly need tax documentation because they’ll be subject to US tax regulations – namely FATCA and even potentially QI. It’s important to remember that tax documentation is NOT a part of KYC, though there are valid arguments for institutions taking that approach.

What a client usually don’t understand is that FATCA is what’s called a negative proof system. After all, the purpose of FATCA is to identify and report Americans with financial accounts outside the US. The problem is, it’s not enough to prove what your client is not – you have to prove what the are. In terms of US tax classifications at any rate. If it was really that simple, most financial institutions would just use tick-boxes that their client could use to confirm that they’re not Americans!

So the financial institution has to do some due diligence on each client to figure out how they should be classified for FATCA. That’s pretty simple for individuals, but it can get far more complex for entities, because entities are much more likely to be used for US tax evasion, so the IRS wants much more information than just ‘we’re not American’.

And that’s just one regulation! Let’s look at a few of the others.

FASTER and TRACE

You might also have heard of FASTER and TRACE

FASTER is an EU directive that’s due to come into force in 2030. TRACE is an OECD tax initiative that has so far only been implemented by Finland. The difference between FATCA, FASTER and TRACE is simple. FATCA is an anti-tax evasion regulation that’s implemented through the transposition of inter-governmental agreements into domestic legislation. TRACE and FASTER on the other hand are both tax relief at source regulations that are implemented (or will be) by domestic legislation. The only tax applied in FATCA is a 30% penalty for non-compliance. The taxes imposed under FASTER and TRACE are the lower treaty rates of tax on cross border investment income that apply due to double tax treaties.

We’ve got a few years before FASTER comes into force, but don’t be fooled! That time will fly by, and there’s an enormous amount of work to do between now and then. Finland, of course, is in a special position because it’s an EU Member State that will be subject to the FASTER directive, but it also already has the TRACE tax relief system in place. So the big question for Finland is whether the TRACE regulation it uses at the moment will be considered to be a ‘comprehensive relief at source system’ as defined in the FASTER directive.

Twenty-two of the thirty-eight (58%) members of the OECD are also members of the European Union. So while the TRACE system is voluntary for OECD members, the FASTER directive is (or will be) mandatory for EU member states. Unless the OECD can establish an equivalence for TRACE within the EU, it’s unlikely that TRACE will be adopted by any other EU member state. And whatever that equivalence is, it will be important for Finland.

So, there you have it. FATCA, FASTER and TRACE. Three sets of regulations that affect financial institutions and investors, each with different components (documentation, due diligence, withholding and reporting) that will affect how financial firms onboard new clients. It’s not just about KYC anymore. Financial firms will have to adapt, mainly because of that communication gap we talked about earlier. Investors, for the most part, don’t know much about all of this, let alone why it’s being done, which is why they’re likely to complain about too much paperwork and too much duplication of effort when the same questions are asked over and over again. Happily, most of the more recent regulation has allowed for more standardisation and automation. For the forward-looking firms, this is a great opportunity to look for and implement new digital systems that make client journeys a lot smoother. And dare we say it, faster!

If all of that sounds a bit complicated, or you need some help working out where your institution fits in all of this, then we are here to help. Just get in touch with the team today to book your free, no obligation consultation with one of our subject matter experts.