Aligning FATCA with the AML compliance regime

By Christine Duhaime | August 10th, 2014

It has been noted by US officials that the Foreign Account Tax Compliance Act (“FATCA“), 26 USC Ch. 4, is not only one of the most significant pieces of US legislation for financial institutions, asset managers and foreign residents, it is also one of the most legally complex and technical that “will spawn significant enforcement activity not seen before.”

Now that amendments to the Income Tax Act, R.S.C. 1985, c.1, are in effect to implement the Inter-Governmental Agreement (“IGA“) with the United States, Canadian financial institutions are working to address the new due diligence and reporting requirements.

The Canadian IGA, similar to most other IGAs such as the one in Australia, is anti-money laundering law (“AML“) dependent and allows US foreign financial institutions (“FFI“) to rely upon existing AML compliance regimes, thereby saving millions of dollars in onboarding and ongoing compliance costs.

IGA provisions subject to compliance by Canada & FFIs

In Canada the IGA is operative for FFIs if:

(a) Canada complies with the IGA; and

(b) FFIs comply with §4 of the IGA.

Pursuant to the IGA, if FFIs are non-compliant, the IGA does not cover their activities.

Together, the IGA and Bill C-31 make at least two material changes to FATCA in Canada: (i) by eliminating many categories of institutions included as FFIs; and (b) by eliminating the concept of a “substantial US owner” to exclude all foreign entities banking through Canadian systems, wherever incorporated, that have a substantial US owner whose interest is in the range of 10% – 50%.

Compliance Differences with AML & FATCA

In Canada, while the IGA allows FFIs to leverage former AML procedures to carry out pre-existing account due diligence, changes needed to underlying infrastructure should be identified, together with detailed legal and operational requirements of the IGA to take into account variances brought about by the IGA to determine how to adjust the infrastructure to accommodate new regulatory requirements.

Existing AML procedures and processes will have to be expanded to accommodate the wider range of recording and reporting obligations. There will also need to be thorough employee training on the IGA  to ensure that new obligations in respect of collecting and collating information and documents from customers, and reviewing of legal documentation governing products and client relationships, are compliant.

In cases where AML procedures are not consistent across business lines, or are inconsistently implemented or enforced, additional enhancements will have to be made by FFIs and to certain business lines that tend to be more high risk, such as private banking and correspondent banking relationships, which demand more detailed customer information for compliance.

There are some fundamental differences between information collected for AML purposes and for IGA purposes that will need to be reconciled. For example, legal and beneficial share ownership pursuant to AML laws is usually triggered at 25% based on the Financial Action Task Force 2012 Recommendations, whereas the IGA imposes a different threshold for such determinations.

Onboarding of new clients will require that FFIs ensure that they have the necessary information to determine if a person or entity is a US tax obliged person and that will require having data fields to capture the indicia for certain high value accounts.

FFIs will need to continually monitor relationships to capture clients who, in the subsequent period, become a US tax obliged person. Monitoring systems is one area where leveraging off existing AML systems will be cost effective.

FFIs should also evaluate how the IGA will affect their risk assessment processes both their enterprise AML risk assessment (geographies, customers, and products) and their customer risk assessment models and processes for persons and entities. However, the IGA, like some parts of AML compliance (such as PEPs and listed terrorist identification), are obviously not risk-based.

Similarities with AML & FATCA Compliance

AML procedures for payment filtering and asset freezing, such as used for transactions in which a payee or payor is a listed terrorist or that involve a sanctioned entity or country, can be used for IGA compliance requirements.

FFIs can also leverage compliance personnel for the IGA in that the Chief AML Officer, with requisite training and education, can also be the responsible officer in most circumstances.

However, the responsible officer may have personal liability for compliance errors, including errors in respect of what constitutes a US tax obliged person.

FinOps has an article here on whether there is personal liability of responsible officers functioning under IGA countries like Canada. It suggests that internal FFI employees (with the most at stake in terms of financial exposure) may consider declining to act as responsible officers for FATCA purposes because of potential personal liability and queries whether IRS certifications should be delegated to external third parties.

Sound Risk Management Practices

Sound risk management requires identifying and managing all aspects of compliance risk, and the prospect of new exposure and significant civil and criminal penalties and fines for failure to comply with the IGA falls in that domain.

FFIs with significant assets under management should act now to designate and articulate compliance oversight before regulators visit. Boards need to ask themselves what their compliance risks and exposures are today and what they are doing about their institution’s risk exposures to make sure they are headed toward effective IGA compliance risk management.

FFIs should be making adjustments to compliance regimes, and undertaking the systems changes and employee training now to obtain the requisite level of legal comfort. For Canadian FFIs, that means having sufficient, competent evidence that will withstand the scrutiny of an IRS audit, or from a national regulator.

Six Basic Preliminary Steps

As a preliminary measure towards compliance, FFIs should undertake the following:

  1. Adopt procedures to address the objectives of FATCA (curbing tax evasion).
  2. Assess infrastructure to determine if the FFI can identify US persons and US-sourced income.
  3. Assess exposure – how many US investors are there and how large are their holdings; how much of portfolio investments will result in US-sourced income.
  4. Modify systems for compliance and consider issues such as who will bear the cost of compliance.
  5. Amend fund, asset management and precedent FFI agreements to allow for compliance and minimization of liability exposure to FFI (in other words, risk shifting to clients in all investment and client agreements and prospectuses where relevant).
  6. Train internal staff on IGA and appoint person responsible for making FATCA-related certifications and filings.

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