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Hong Kong – Entering Intergovernmental Agreement With The US To Implement FATCA Locally.

22 May, 2014

 

Legal News & Analysis – Asia Pacific – Hong Kong – Tax

 

Hong Kong and the US have substantially concluded discussions regarding an intergovernmental agreement regarding FATCA compliance (the “HK IGA”), though there are still some legislative procedures to be complied with before it will come into effect. This follows the enactment of a tax information exchange agreement (“TIEA”) with the US in March of this year. Having reached an “agreement in substance”, Hong Kong will be treated as having an agreement in place until the end of year and Hong Kong financial institutions (“HKFI”) will therefore be able to register with the US tax authority on that basis notwithstanding that the IGA is not yet effective.

 

The IGA will require HKFIs to register with the US tax authorities and to report information directly to the US tax authority. It is expected to make it easier for Hong Kong financial institutions to become FATCA compliant and therefore not be subject to withholding tax.

 

What Is FATCA?

 

A brief summary of the thinking behind the FATCA legislation is useful in order to understand the significance of the HK IGA. The FATCA legislation is complex US anti avoidance tax law aimed at stopping US citizens and taxpayers ‘hiding’ income offshore. It is potentially very wide in application and has significant extra territorial scope.

 

The principal aim of the FATCA rules is to force all non-US ‘Foreign Financial Institutions’ (“FFIs”) to report to the US Internal Revenue Service (“IRS”) information on those ‘Financial Accounts’ maintained by the FFI that are ‘US Accounts’. The ‘stick’ to be used by the IRS in the case of ‘non-compliant’ FFIs is the threat of 30% withholding tax imposed on ‘US Source Withholdable Payments’ (ie payments including US source dividends, interest, rents, salaries, and gross proceeds from sale) made to such FFIs. This is known as the ‘basic FATCA charge’. However, withholding in respect of the basic FATCA charge will not arise where the FFI signs up to a ‘FATCA Agreement’ (an agreement with the IRS to annually report information on its US shareholders, policyholders, account holders etc), nor where the FFI is otherwise ‘deemed’ FATCA compliant.

 

For completeness, an FFI which signs up to a FATCA Agreement may also be required to withhold, again at 30%, from payments it makes (i) to other FFIs that have not entered into a FATCA Agreement, and (ii) to holders of Financial Accounts who fail to provide information as to their status. This is the so-called ‘passthru payment’ regime. Beyond making this point, this briefing does not focus on the passthru regime.

 

The basic FATCA charge will come into force on 1 July 2014. The commencement date for the passthru regime is unknown but it is not expected to be before 2017.

 

Model IGAs

 

Prior to FATCA implementation, an important question was whether an FFI has the ability to comply with FATCA as a matter of law as well as of practice without breaching domestic law rules which are binding on the FFI, such as rules relating to privacy, data protection and confidentiality. In recognition of such difficulties, the US entered into discussions with various governments, to define by agreement how FATCA compliance may be achieved.

 

The results of these discussions are the Model 1 IGA and the Model 2 IGA. Hong Kong has entered into a Model 2 IGA. This means that HKFIs will need to register and report information directly to the IRS and will need to agree to comply with the terms of a FATCA Agreement as modified by the Model 2 IGA.

 

This is in contrast to a Model 1 IGA which requires FFIs to report all FATCA-related information to their own governmental agencies, which would then report the FATCA-related information to the IRS. FFIs from Model 1 jurisdictions are also not required to enter into FATCA Agreements.

 

To date, the Model 1 IGA has been the preferred option for the majority of other jurisdictions, including Australia, Indonesia, South Korea and Singapore. However, Japan has entered into a Model 2 IGA.

 

In both cases, the compliance burden is reduced if an FFI is from a jurisdiction with an IGA in place. Certain entities may also benefit from been “deemed compliant” under an IGA. The HK IGA will also provide for the passing of information between tax authorities under the TIEA recently entered into between Hong Kong and the US.

 

Having reached an agreement in substance with the US, Hong Kong will now be treated as having an IGA in place for the remainder of the year (notwithstanding that legal formalities have not yet been completed). HKFI’s will therefore be able to register on this basis prior to the fast approaching 1 July 2014 implementation date.

 

herbert smith Freehills

 

For further information, please contact:

 

Isaac Zailer, Partner, Herbert Smith Freehills

isaac.zailer@hsf.com

 

Richard Norridge, Herbert Smith Freehills

richard.norridge@hsf.com

 

Casey O’Hara, Herbert Smith Freehills

casey.ohara@hsf.com

 

Homegrown Tax Law Firms in Hong Kong 

 

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