Foreign Account Tax Compliance Act

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21 Aug, 2024

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The Foreign Account Tax Compliant Act (FATCA) refers to a United States law requiring specific taxpayers, including every foreign financial institution, to report about assets held by the US account holders. It aims to prevent US persons from utilizing financial institutions to park funds outside the nation to avoid taxation.

Per the requirement of this law, US residents and citizens living abroad or at home must file yearly reports on their foreign account holdings, if any. Moreover, according to this law, foreign financial institutions must determine if their clients are US citizens. FATCA came into effect in 2010 after Barrack Obama, the former US President, signed it into law.

What Is Foreign Account Tax Compliance Act (FATCA)?

The Foreign Account Tax Compliance Act (FATCA) refers to a law introduced by the United States government that requires financial institutions to carry out the identification of their US accounts via improved due diligence reviews before reporting the same to the IRS or any appropriate government authority.
A key difference between FBAR and FATCA is that the latter has less complicated reporting thresholds.
The primary Foreign Account Tax Compliance Act's purpose is to prevent US persons from evading tax via foreign financial accounts.
Some critics argued that the law would obstruct foreign investment in the US market.

Foreign Account Tax Compliance Act Explained

Foreign Account Tax Compliance Act refers to a law that the US Government introduced in reply to the perception that United States persons do not report their entire income generated outside the country either because of intentional actions of specific foreign entities or tax standards.

The Foreign Account Tax Compliance Act's purpose is to require financial institutions outside the US to report the total revenue paid to US taxpayers. This allows for automatic data cross-verification with the taxpayers’ declarations. Thus, simply put, the main objective of FATCA is to get rid of American businesses and individuals earning, operating, and investing taxable income in a foreign country.

Although it is not unlawful to keep an offshore account, it is illegal for one to not disclose their account to the federal tax agency as the government taxes citizens’ assets and income on an international scale.

How To Comply?

US taxpayers having financial assets of at least $50,000 must file Form 8938 to fulfill the requirements of FATCA. Note that such assets can be in bank accounts. Also, they may be in bonds, stocks, and any other financial instrument. That said, note that there are specific exceptions. For example, a noteworthy one is the exclusion of assets that a US person holds in a US institution’s overseas branch or a foreign institution’s United States branch.

One must keep in mind that the American taxpayers who file Form 8938 may include individual taxpayers who live in the United States and abroad. Also, they may include foreign financial institutions (FFI). For compliance, such foreign institutions must disclose the identities of those United States citizens along with their accounts and total asset value in such accounts to the Foreign Account Tax Compliance Act Intergovernmental Agreement or the federal tax agency.

Examples

Let us look at a few Foreign Account Tax Compliance Acts to understand the concept better.

Example #1

Suppose David is a US citizen living abroad. He files an income tax return every year as required by the US federal law. On the last day of the assessment year 2022, the value of his total foreign financial assets was over $500,000. According to the requirements of the Foreign Account Tax Compliance Act, he had to file Form 8938 to report his foreign financial assets to the federal tax agency. If he failed to file the form, he had to pay significant penalties.

Example #2

On May 24, 2023, the Belgian Data Protection Authority (DPA) issued an important decision about the exchange of information according to the Foreign Account Tax Compliance Act. The decision declared that the information reporting needed from the Belgian financial institutions and Belgian tax authority under FATCA was illegal. This is because it violated the protection and privacy rights provided to Belgian residents under the General Data Protection Regulation or GDPR.

Moreover, it violated the rights to the protection of personal details that the European Union’s Charter of Fundamental Rights guarantees, besides the rights to private life.

Penalties For Non-Compliance

The Internal Revenue Service (IRS) can ask US persons to pay a fine of $10,000 if they fail to report their financial assets and foreign account holdings exceeding $50,000 in a given year by filing Form 8938. Note that the federal tax agency can also levy a maximum fine of $50,000 in case the guilty person chooses to not file the form even after receiving the IRS’s notification. Moreover, one may be subject to a 40% penalty if they understate taxes that are applicable in the case of non-taxable assets.

The statute of limitations gets extended to 6 years once an organization files the form for an income exceeding $5,000, which is because of an unreported financial asset. Moreover, in case a party is unable to report any asset on the form correctly, the extension of the statute of limitations concerning the tax year takes place for 3 years past the time when that party gives the necessary information.

If a rational reason for failure exists, the extension of the statute of limitations occurs only concerning the items or the item associated with this kind of failure rather than for the whole tax return.

Remember that there is no levy of penalty in case the party’s failure to disclose turns out to be reasonable. However, whether or not a person has to pay a penalty varies from case to case.

Criticism

One can go through the following points to understand the criticism of the Foreign Account Tax Compliance Act of 2010:

According to a few critics, the cost of executing the act was too significant a load on overseas financial institutions. Moreover, it could even lead to them divesting their assets.
Per Reuters, FATCA made the businesspersons and banks angry; they termed the act ‘imperialist.’ Different financial institutions protested the expectation of reporting on US clients or withholding 30% of the dividends, investment payments, and interest payable to the clients. Moreover, they opposed the sending of funds to the IRS.

Additionally, some critics said that the act would discourage foreign investment in the United States market.

Foreign Account Tax Compliance Act vs FBAR

Some key differences between the Foreign Account Tax Compliance Act of 2010 and the Report of Foreign Bank and Financial Accounts (FBAR) are as follows:

The Foreign Account Tax Compliance Act requires financial institutions as well as individuals to adhere to the rules by filing Form 8398. On the other hand, only individuals file FBAR reports.
FBAR is due on April 15 after the reported calendar year. That said, the due date for filing the FATCA form is the same as a person’s annual tax return filing due date.
In the case of FATCA, the reporting thresholds are comparatively more complex than FBAR.

Frequently Asked Questions (FAQs)

What is a US reportable account under the Foreign Account Tax Compliance Act?

A US reportable account refers to a financial account that a Reporting Indian Financial Institution maintains. Also, a non-United States entity having one or multiple Controlling Persons who are Specified US Persons may hold the financial account. Alternatively, one or multiple US Persons may hold the account.

How do I know my Foreign Account Tax Compliance Act status?

US taxpayers can know their FATCA registration status by signing into their FATCA account and looking at the account status found on the home page.

Is the Foreign Account Tax Compliance Act required for Indian citizens?

From January 2016, it became compulsory for all Indian and non-resident Indian or NRI investors, irrespective of new or existing, to file FATCA self-declarations. Note that the details may vary slightly with different financial institutions.

Which countries don't use the Foreign Account Tax Compliance Act?

There are over 90 nations worldwide that do not have FATCA agreements with the United States. A few examples of such countries are tax havens, such as Argentina, Belize, and Monaco.