Paul Thurston, chief executive of global retail banking and wealth management at HSBC, appeared before the US Senate permanent subcommittee on investigations last month, and tried to explain the bank’s failure to apply anti-money-laundering controls in the mid to late 2000s and to stop drug dealers and account holders from rogue states moving billions of dollars through the bank.
The tales of how difficult the bank found it to recover account files from branches around Mexico when law enforcement agencies requested them, and the details of minimal documentation on thousands of accounts opened in a virtual branch in the Cayman Islands, must have had HSBC executives around the world squirming in embarrassment.
Aside from the unquantifiable but substantial damage to HSBC’s reputation and the potential for large financial penalties to be imposed, the revelation of its weaknesses are a reminder to all international banks of the looming challenge of complying with the Foreign Account Tax Compliance Act (Fatca).
This is the law the US Congress passed in 2010 in response to the revelation of how certain private bankers at UBS had helped wealthy US citizens avoid paying tax.
Rather than pursue many separate investigations and settlements against other banks suspected of similar activities, the US authorities decided instead to seek a comprehensive solution. Foreign banks will be required to identify individual US citizens holding accounts and investing in US markets offshore directly and indirectly through controlled organizations.
The banks will be required to confirm the identity of all account holders, and also to supply information on balances and payments through accounts held by US citizens, including corporate organizations where a US citizen might hold as little as 10% beneficial ownership.
The US authorities decided to wield a hefty stick to compel compliance. Any foreign bank failing to sign an undertaking with the US tax authorities to identify US account holders and report account information will be charged a 30% withholding tax on all US source income and payment flows.
At one stage, there was even a suggestion that the US would seek to impose a withholding tax on non-US sourced revenues as well, although this threat has now been reserved for possible implementation in 2017.
However, the deadline for compliance in identifying US account holders phases in soon, from January to July. Foreign banks will then need systems to identify withholdable payments and calculate tax liability on US accounts in 2014.
There’s a gamble here by the US authorities. Some small foreign banks might decide the cost of compliance is too great and simply forgo having anything to do with US financial markets. The original legislation carried a medium-term revenue estimate of around $8 billion from forcing reluctant US citizens hiding their investments in offshore hedge funds and private banks to start paying their US taxes.
If Fatca should cause foreign banks to abandon the US financial markets to such a degree that it forces up rates and the cost of mortgages, that $8 billion might not look like such a great return.
However, the US authorities have tapped into a global mood of anger against tax avoidance. When banks pointed out that supplying account information to a foreign government might contravene local privacy laws, the Internal Revenue Service announced agreements with the governments of France, Germany, Italy, the UK and Spain, whereby banks in those countries would supply information to their own governments, which would then pass it on to the US. It looks as if Switzerland and Japan will also sign up.
Banks have grumbled about the substantial cost of compliance, often put in the low hundreds of millions of dollars for a large international bank. One joke is that it might be cheaper for the big global banks to club together and hand the IRS a cheque for $8 billion than to comply with the new requirements.
Banks need to do more than just ask account holders if they happen to be US citizens. If there is any indication they might be so – owning a home in the US, having a US phone number, for example – then banks must seek clear evidence they are not US citizens or report them as such.
Banks need to verify, then monitor existing and new account holders, especially those with more than $1 million, and any failure to do so will potentially open senior bank executives to criminal charges.
Banks are due to get first sight of the agreement they will have to sign with the US tax authorities later this summer. It will be a pivotal moment.
Large, complex global banks such as HSBC will have to ensure that each legal organization within the group is Fatca-compliant or risk the dreaded 30% withholding tax being applied across the group. Failure to do so carries substantial reputational risk, for those with good reputations left intact.
Some foreign banks have quietly suggested that they might allocate the group-wide cost of Fatca compliance to their US subsidiaries, thereby reducing the US tax take. However, the US authorities are in no mood to be threatened, no doubt especially since the revelations at HSBC.
Fatca might force substantial changes in some banks’ business portfolios. If they have operations in countries where it proves especially difficult to obtain from account holders proof of nationality and waivers from liability under local privacy laws against disclosing account information, banks might even have to withdraw from those countries.
That might be a good thing, after listening to Thurston’s evidence before the Senate sub-committee. Establishing Fatca compliance is a daunting undertaking. It would not have been such a burden for banks had they been more careful all along genuinely to know their customers.