China ends speculation over Fatca

After months of speculation, China has agreed in principle to comply with the US’s Foreign Account Tax Compliance Act (Fatca), just before its July 1 compliance deadline.

This means that, among others, mainland fund managers – many of which had thought they would not need to comply with the extra-territorial anti-tax evasion law – will have to start preparing to do so.

The US Department of the Treasury said on Friday that it had reached a model 1 intergovernmental agreement (IGA) “in substance” with China on Fatca. The model 1 IGA means non-US financial institutions will report client information to their national government (which then passes it to the US Internal Revenue Service) rather than directly to the US.

Foreign financial institutions are supposed to send account information on their US clients to the US IRS by tomorrow, July 1. Unless, that is, they have shown "good faith" in complying, in which case they have a transitional period of until 2016 to comply (although some argue it's not clear what "good faith" means here). If they fail to comply, they will be subject to a 30% withholding tax on US-sourced income.

By June 2, only 212 institutions based in China had registered to be Fatca-compliant (and many of them were foreign multinationals), while 1,700 in Hong Kong had registered as compliant.

For instance, compliance processes have barely begun for China-based fund houses, unlike for mainland banks, said Charles Kinsley, tax partner at KPMG in Hong Kong.

“A lot of them [asset managers] hold the view that since they don’t invest in the US and instead invest, for example in small-cap China companies or real estate in Asia, they don’t see the risk of the withholding penalty, because there is no US-sourced income,” said Kinsley. But Fatca compliance will now be local law, so they will have no choice but to fall in line.

While the agreement has come late, commentators argue China’s participation is no surprise. “If you look at China’s involvement with G20 countries, it was one of the countries that endorsed the principal of tax transparency,” said Al Wang, Shanghai-based senior manager for US tax consulting at PwC.

“In the eyes of many Chinese financial institutions, Fatca is an unreasonable demand from the US," he added. “But if you really calm down and look at what Fatca is doing, the demand is not all that unreasonable because this is a US domestic tax law that requires foreign financial institutions [FFIs] to participate in it if they want to get into the US capital market.

If FFIs choose not to participate but are in the US capital market, they will bear the economic consequences with regard to their income from the US capital market "pure and simple", said Wang.

Ultimately, non-compliance with Fatca would make it a lot more difficult for FFIs to do business with US entities and potentially even Fatca-compliant FFIs.

Given that China is due to sign a model 1 Fatca IGA with reciprocity, the US is expected also to send tax information on US-based Chinese persons to the mainland. And, with acknowledgment of the IGA now in place, China-based institutions will be deemed Fatca-compliant until December 31.

Meanwhile, in the past two weeks, Taiwan and Thailand have agreed in principle to a model 1 and model 2 Fatca IGA, respectively, said Kinsley.