This article was authored by Karl J. Paulson Egbert, who is based in the Hong Kong offices of international law firm Dechert LLP, and appeared in the firm’s latest Financial Services Quarterly Report. |
Issues in Asia generally
Some comment letters suggested that cultural differences in Asia needed to be considered. In certain situations, FATCA requires that financial institutions ask a customer who was born in the United States to submit documents explaining why the customer abandoned U.S. citizenship or did not obtain it at birth. The Japan Securities Dealer Association ("JSDA") notes that "asking such a delicate and private question is not something Japanese financial institutions could ask to their customers" and requested "IRS understanding […] that the general perception relating to nationalities in Japan differs from the situation in the U.S. and/or Europe."5 Even apparently straight-forward requirements may pose challenges in Asia: FATCA requires that customers make representations about their identities "under penalty of perjury" in certain situations. But, as the JSDA notes, Japan has no custom of making legal oaths, so Japanese customers will be extremely reluctant to give them.
Even where cultural differences were not noted, concerns about privacy abounded. FATCA requires that financial institutions report to the IRS certain information about U.S. persons. In some jurisdictions, like Hong Kong, many funds and insurance companies are permitted to disclose information with client consent. But the organizational documents for these institutions might not include these provisions, and the process to change them is not easy. In other cases, such as in Japan or for Hong Kong’s mandatory provident plans (i.e., retirement funds), such disclosure is prohibited without further changes to domestic law.6 Proposed legislation in Singapore could ultimately have the same effect.
"Deemed Compliance" in Asia
The proposed regulations also partially exempt "restricted funds" — funds that prohibit investment by U.S. persons. Although many non-U.S. funds have long restricted investment by U.S. persons because of the U.S. federal securities laws, the comment letters suggest that this exemption is less useful than it first appears. Both the JSDA Comment Letter and the Hong Kong Joint Comment Letter pointed out the exemption also requires that funds be sold exclusively to limited categories of FATCAcompliant or exempt institutions and distributors. These categories are themselves difficult for Asian institutions to comply with. For example, a restricted fund may sell to certain distributors who agree not to sell to U.S. persons ("restricted distributors").
But restricted distributors must operate solely in the country of their incorporation, a true obstacle in smaller markets such as Hong Kong and Singapore where many distributors must operate regionally to attain scale. In order to make the exemption viable, comment letters suggested that restricted distributors instead be permitted to operate regionally in Asia.9 Other permitted distribution channels for restricted funds are "local banks," which are not allowed to have any operations outside of their jurisdiction of incorporation and may not advertise the availability of U.S. dollar denominated investments.10 But investors in Hong Kong routinely make U.S. dollar investments; Hong Kong’s currency is pegged to the U.S. dollar and over 90% of funds are either denominated in U.S. dollars or have U.S. dollar share classes. The Hong Kong Joint Comment Letter suggests that this requirement must be removed for the exemption to be workable.
When no exemption applies – Challenges in FATCA compliance in Asia
The core of FATCA is the process of reviewing customer records to search for "U.S. indicia" — that is, evidence that a customer might be a U.S. taxpayer. While the proposed regulations suggested that financial institutions could rely on their existing anti-money laundering procedures for this requirement, the comment letters noted that this might not always be possible. Under certain circumstances, FATCA requires financial institutions to look through their customers and counterparties’ ownership to find "substantial U.S. owners" (generally, certain U.S. persons holding more than 10% of an entity).11 In both Hong Kong and Japan, existing anti-money laundering legislation generally requires that financial institutions look through entities only when there is a 25% owner, leaving a gap between information that may be needed for FATCA compliance and existing procedures.12 Where customers fail to provide requested information to ascertain their U.S. status, FATCA eventually may require closure of their accounts. But in Asia, this mandate bumps into local legal requirements: comment letters from Japan, Singapore and Australia all noted that compulsory redemption was impermissible, impractical or a possible breach of contract. In the case of retirement plans where participation is mandatory, forced redemption would defeat the express purpose of the product.13 In Hong Kong, forced redemption may be allowed in retail funds, if it is expressly permitted in organizational documents. But many funds’ organizational documents never contemplated that compulsory redemption would be necessary, so costly shareholder approvals are needed before such funds can become FATCA-compliant.
Local law may also complicate compliance with FATCA’s withholding obligations. In some situations, an institution may be required to withhold 30% from payments that have no connection to the United States (e.g., with respect to pass-thru payments). The JSDA Comment Letter openly questioned whether Japanese law would permit such withholding and queried whether it would also violate customers’ property rights under Japanese law. In Hong Kong, retirement plan providers face a similar issue. The Mandatory Provident Fund Schemes Ordinance (1995) permits deductions from plans only for certain specified purposes, which do not include FATCA withholding.
The best approach may be for Asian trade groups to continue their dialogue with the IRS and Treasury, while Asian financial institutions begin to assess their FATCA burdens as they prepare for compliance.