Efficient recording and management of customer data. That is what tax experts and operations executives believe will become a critical task for financial firms abroad when complying with U.S. legislation being proposed to curb tax evasion by Americans overseas.

That won't be easy, they say, because of the expected complexities of the rules-and unanswered questions about them.

Financial firms-banks, brokerages, offshore hedge funds and other types of investment funds-may need to establish new procedures to open accounts for U.S. investors in foreign assets and continually update and aggregate information on their holdings from multiple offices and databases. For foreign banks, the burden of compliance may be even greater than for U.S. banks operating abroad because of the lack of any procedures when opening accounts for U.S. investors.

"The bank or other foreign intermediary will need to know where the records of ownership of foreign shares of U.S. investors are kept and set up new and consistent procedures for account opening and updating," says Eric Bass, a principal with the business advisory services group Rothstein Kass, a Roseland, N.J. accounting firm. "With financial firms often depending on multiple repositories, the legislation could prove challenging."

While none of the dozen banks and brokerages contacted by Securities Industry News wanted to predict how much it will cost them to comply with the new measure, they will more than likely have to absorb the price tag.

"Tax changes always require adaptations to systems and procedures which we can never recoup from customers," says Paul Bodart, director of operations for Europe, the Middle East and Africa at The Bank of New York Mellon's asset servicing group in Brussels.

Considered far less stringent than what the Obama administration had initially proposed in its so-called green book proposals in May 2009, the proposed legislation called The Foreign Account Tax Compliance Act (FATCA) forces foreign financial institutions to sign an agreement with the Internal Revenue Service that they annually disclose the identities of direct and indirect U.S. investors in foreign assets and consent to some type of external auditing. Any foreign financial institution which fails to disclose all of its U.S. investors in foreign securities will be subject to a 30 percent withholding tax on all U.S.-sourced income and gross proceeds it receives.

About 5,000 or so banks have already developed extensive recordkeeping systems to categorize non-U.S. customers into different tax categories and either deduct the appropriate withholding tax themselves or send the information on the investors to yet another bank. That bank, typically a U.S. global custodian, then would deduct the correct tax amount.

However, even those banks-called qualified intermediaries or QIs-never had the obligation to reveal to the IRS the names of U.S. citizens or companies which invest directly in foreign assets. U.S. tax laws required the U.S. investor to disclose any accounts in foreign assets or voluntarily report any income earned on such accounts, but that did not always happen. The new legislation could bring in an estimated $30 billion in new revenues over the next decade.

"Banks have already found it difficult to comply with the QI status and they had several years to adapt their technology," says Bass. "The new proposed legislation will make it even more cumbersome so they will need to shore up their operations." The IRS adopted policies on qualified intermediaries in 2001- five years after it first floated the idea.

But nothing is signed into law yet. The FATCA was introduced by House Ways & Means Committee Chairman Charles Rangel (D-NY) and Senate Finance Committee Chairman Max Baucus (D-MT) last November, in the two chambers of Congress.

The measure has passed the House, but not yet the Senate. Even if passed there, the two versions must be reconciled and a final measure signed into law. Such a process, according to legal experts, could take three to four months to complete.

For now firms have one saving grace. The effective date of the legislation has been pushed back by one year to December 2012. Still, "the new effective data provides insufficient time for the massive amount of changes to IT and business operations that need to be completed and the IRS to sign up foreign financial institutions to participate," says John Staples, a partner with the Washington D.C., law firm Burt, Staples & Maner.

The new FATCA legislation comes after tens of thousands of Americans' offshore accounts in recent months were shut down by banks under pressure from the U.S. Treasury and requests to open new accounts have been denied.

Switzerland's financial services giant, UBS, for instance, decided to end offshore banking with U.S. customers in July after admitting that it assisted more than 50,000 U.S. citizens in evading U.S. taxes. About 14,000 Americans have so far come forward to disclose their overseas holdings to the IRS to avoid criminal prosecution.

Because the legislation has not been passed, neither the Treasury nor the IRS have suggested any guidelines for implementation of the new rules, banks and other financial firms may be at a loss for how to prepare technologically. But as Bass notes, it's best to set up a task force, in advance.

"Although it is unlikely that a financial firm could quickly consolidate such information in a single repository, it still has to set up a centralized virtual committee to determine the procedures required and consistent basis," asserts Bass. He suggests such a committee consist of operations, technology, tax and compliance experts. The group should also seek outside counsel on interpreting the potential legislation.

"We're at the preliminary stages of assessing just what the new measure means but have created a FATCA committee," says Bodart. The committee consists of representatives involved with technology, operations, product management, tax, and compliance across all of its business lines.

At the very least, financial intermediaries will be required to track down and report information on direct and indirect U.S. investors in all of the foreign accounts held at all of its affiliates which would keep their records in separate databases.

Most large global banks maintain separate databases on investors and investments made. These can be databases for each branch office or for each type of investment made, such as equities, fixed-income products or derivative securities. On average, say data experts, a global bank would easily have at least a dozen or so counterparty repositories holding information on customers and their investments. And the information may be inconsistent and incorrect. Branch offices also may have different policies reflecting legal requirements in their home markets.

Complicating matters: some foreign banks may not have established procedures for opening accounts for U.S. investors in foreign securities.

While the measure does exempt the accounts of U.S. individuals with "low balances"-those not exceeding $50,000 in value-most large foreign financial institutions are unlikely to rely on such exceptions. That's because it is unclear if the affiliates must be treated as part of a single institution when determining whether the account exceeds the threshold. The financial institution's computer systems may not be able to aggregate account balances for a particular individual across jurisdictions and affiliates, by the time the legislation passes.

The proposed legislation also does not indicate exactly how and when the threshold is measured. That means it could be below the threshold for a given day during the calendar year or the reporting date or the average of the closing balances for each month.

Technical issues aside, there are also legal quagmires involved with the potential legislation.

By requiring financial institutions and investment funds to disclose information about certain accounts to the U.S. government, the foreign firm may be required to obtain a valid waiver from the account holder. That means if the account holder has accounts in several countries multiple waivers may be required. If they cannot be obtained, the financial firm is required to close out the account.

"Some countries do not allow investors to waive their privacy rights and if a firm is forced to close the account what happens if the account itself is subject to legal or contractual restrictions regarding its closer," says John Taylor, a U.S. tax attorney in London with King & Spaulding. "FATCA defines non-publicly traded debt or equity issued by the financial institution itself as an account, so how does a firm comply if the account is a non-callable financial instrument?"

Just as difficult as consolidating information on ownership of foreign shares by U.S. investors will be figuring out how to determine "indirect ownership." Foreign firms have never had to "look through" the ownership of the account to determine whether a U.S. investor has a ten percent-and in some cases even less-ownership stake in an offshore entity.

"It's not clear what business procedures a firm would have to undertake to determine non-direct ownership," says Tay;or. "It is more than simply a technological issue and it could impact the division of responsibilities between financial institutions, investment funds and their customers.''

Depending on how the IRS interprets FATCA, firms around the world could be required to more diligently keep track of the U.S. ownership in an account, when it is opened and throughout its lifetime.

Bodart says BNY Mellon's FATCA committee is determining how the bank will obtain information from its transfer agent clients in Europe on U.S. direct and indirect ownership of shares and how it will adapt its two European transfer agency platforms to add information on U.S. direct and indirect ownership in the funds.

For many foreign funds and even banks, the most difficult decision will be whether or not it makes sense to keep their U.S. customers or even stay invested in the U.S. market. "FATCA is counting on the fact that foreign banks don't want to forgo their business in the U.S. capital market," says Staples. "However, it will simply come down to a single cost-benefit calculation as to whether putting all the systems and procedures in place will cost less than the anticipated profit from having either U.S. customers or staying in U.S. securities.

This article can also be found at SecuritiesIndustry.com.

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