House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon J. B. Hockey MP)

Chapter 1 - FATCA

Outline of chapter

1.1 Schedule 1 to this Bill amends Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) to require Australian financial institutions to collect information about their customers that are likely to be taxpayers in the United States of America (US) and to provide that information to the Commissioner of Taxation (Commissioner) who will, in turn, provide that information to the US Internal Revenue Service (IRS).

1.2 These amendments give effect to the Australian Government's commitments as set out in the Agreement between the Government of Australia and the Government of the United States of America to Improve International Tax Compliance and to Implement FATCA (the FATCA Agreement).

Context of amendments

The Foreign Account Tax Compliance Act

1.3 The Foreign Account Tax Compliance Act (FATCA) is a unilateral anti-tax evasion regime enacted by the US Congress as part of the US Hiring Incentives to Restore Employment Act 2010. FATCA is aimed at detecting US taxpayers who use accounts with offshore financial institutions to conceal income and assets from the IRS. The relevant provisions are contained in the US Internal Revenue Code (IRC) 1986 and are supplemented by extensive US Treasury Regulations that were issued on 17 January 2013 (and have been subject to subsequent amendment).

1.4 The substantive FATCA requirements for financial institutions generally start on 1 July 2014.

1.5 From that date, FATCA will require all foreign (that is, non-US) financial institutions, including custodial institutions, depository institutions, investment entities and specified insurance companies, to conclude individual agreements with the IRS under which they will periodically report certain information about their account holders who are US citizens or US resident individuals (or individuals who fail to rebut a presumption of being a US citizen or US resident individual) or specified entities established in the US or controlled by US persons.

1.6 In order to comply with their reporting obligations, these financial institutions will need to follow specific due diligence procedures in identifying all relevant accounts.

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The level of due diligence required depends on whether the account is held by an individual or an entity and whether or not the account was opened prior to 1 July 2014.

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For example, the due diligence requirements generally do not apply to accounts held by individuals unless the aggregated account balances exceed USD 50,000.

1.7 Financial institutions that do not comply with FATCA will be subject to a 30 per cent US withholding tax on their US source income.

1.8 A broad range of Australian financial institutions, including banks, some building societies, some credit unions, specified life insurance companies, private equity funds, managed funds, exchange traded funds and some brokers (generally those brokers maintaining Custodial Accounts) will be subject to FATCA. As most major Australian financial institutions operate or otherwise invest in the US, the US withholding tax creates a strong commercial incentive for these entities to comply with FATCA.

1.9 This means that those Australian financial institutions that intend to comply with FATCA would need to commence relevant due diligence procedures from 1 July 2014 in anticipation of reporting to the IRS. However, Australian privacy laws generally prevent compliance with these US-based obligations and some Australian State and Territory anti-discrimination laws could also prevent the interrogation of customer accounts based on US citizenship.

1.10 In recognition of the fact that many countries' domestic laws would otherwise prevent foreign financial institutions from fully complying with FATCA, the US has developed an intergovernmental agreement approach to manage these legal impediments, simplify practical implementation, and reduce compliance costs for relevant financial institutions. The US has signed a number of intergovernmental agreements with a range of jurisdictions including Austria, Belgium, Bermuda, Canada, the Cayman Islands, Chile, Costa Rica, Denmark, Estonia, Finland, France, Germany, Gibraltar, Guernsey, Honduras, Hungary, Ireland, the Isle of Man, Italy, Jamaica, Japan, Jersey, Luxembourg, Malta, Mauritius, Mexico, the Netherlands, Norway, Spain, Switzerland and the United Kingdom of Great Britain. A complete list of countries with intergovernmental agreements with the US is available on the US Department of the Treasury's website.

Signing an intergovernmental agreement with the US

1.11 On 28 April 2014 the Treasurer, on behalf of the Australian Government, and the US Ambassador to Australia, on behalf of the US Government, signed the FATCA Agreement.

1.12 The text of the FATCA Agreement is set out in the Australian Treaty Series (currently [2014] ATNIF 5) which is accessible through the Australian Treaties Library on the AustLII website ( www.austlii.edu.au ). A copy of the FATCA Agreement is also available online on the Australian Department of Foreign Affairs and Trade's Australian Treaties Database and on the Australian Treasury's website.

Summary of new law

1.13 These amendments insert a new Division, 'Division 396 - FATCA', into 'Part 5-25 - Record-keeping and other obligations of taxpayers' in Schedule 1 to the TAA 1953.

1.14 To ensure consistency with the FATCA Agreement, these amendments adopt meanings and concepts used in that agreement.

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This means the substantive amendments apply to 'Reporting Australian Financial Institutions' that maintain at least one 'U.S. Reportable Account' in a calendar year.

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In addition, transitional obligations apply to 'Reporting Australian Financial Institutions' that make payments to 'Nonparticipating Financial Institutions' in 2015 and 2016.

Comparison of key features of new law and current law

Detailed explanation of new law

The FATCA Agreement with the US

1.15 The FATCA Agreement establishes a framework for reporting by Australian and US financial institutions of some financial account information to their respective tax authorities (the Australian Taxation Office (ATO) and the IRS). Article 25 (Exchange of Information) of the Convention between the Government of Australia and the Government of the United States of America for the Avoidance of Double Taxation and Prevention of Fiscal Evasion with respect to Taxes on Income (which has the force of law under subsection 5(1) of the International Tax Agreements Act 1953) requires each country's tax authorities to automatically exchange that information.

1.16 The FATCA Agreement consists of four parts.

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(1) The Agreement that:

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defines specific concepts used in the Agreement - per Article 1;

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requires Australia to obtain information about 'Reportable Accounts' - per Article 2;

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sets out the process for exchanging information with the US - per Article 3;

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specifies how 'Reporting Australian Financial Institutions' will be treated under FATCA - per Article 4;

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provides for compliance and enforcement mechanisms - per Article 5;

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articulates a mutual commitment between Australia and the US to enhance the effectiveness of information exchange and transparency - per Article 6;

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grants Australia the benefit of more favourable terms under Article 4 or Annex I provided by the US to other jurisdictions - per Article 7;

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allows for consultation and amendment of the agreement and specifies the terms of the agreement - per Articles 8 and 10; and

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incorporates Annex I and Annex II as integral parts of the agreement - per Article 9.

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(2) Annex I that requires Reporting Australian Financial Institutions to apply specific due diligence procedures in identifying 'U.S. Reportable Accounts' and accounts held by 'Nonparticipating Financial Institutions'.

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(3) Annex II that deems specific Australian 'Entities' to be complying with or exempt from FATCA or specific Australian accounts to be excluded from the definition of 'Financial Accounts' for the purposes of FATCA.

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(4) The Memorandum of Understanding to the Agreement.

1.17 Paragraph 4 of Article 5 of the FATCA Agreement requires Australia to implement measures, as necessary, to prevent financial institutions from adopting practices designed to circumvent the relevant reporting obligations. Although the Australian Government does not propose to introduce a specific anti-avoidance rule at this stage, it has given an undertaking to the US that it will do so if it becomes apparent that Reporting Australian Financial Institutions are adopting practices designed to circumvent their reporting obligations.

1.18 It is important to note that a Reporting Australian Financial Institution that complies with all of its reporting obligations under these amendments will still need to comply with additional obligations directly imposed by the IRS to avoid becoming subject to a 30 per cent US withholding tax on its US source income. These additional obligations are contained in subparagraphs (1)(c), (d) and (e) of Article 4 of the FATCA Agreement.

1.19 How each Reporting Australian Financial Institution chooses to comply with these additional obligations will be a matter for that institution and the IRS. Although the ATO has a role in acting as an intermediary between Reporting Australian Financial Institutions and the IRS, the formal obligations on the ATO under Article 5 of the FATCA Agreement are limited to applying Australia's domestic taxation laws, where applicable, to resolve any non-compliance. Accordingly, these obligations on the ATO will only apply in situations where the non-compliance has led to a contravention of Australia's domestic taxation laws.

1.20 The FATCA Agreement permits Australia to allow Australian Financial Institutions to elect to apply alternative definitions as well as alternative procedures specified in the Agreement. The Government has prepared these amendments so that Australian Financial Institutions are permitted to make any of the elections contemplated by the FATCA Agreement.

The reporting obligation - U.S. Reportable Accounts

1.21 Reporting Australian Financial Institutions that maintain one or more U.S. Reportable Accounts at any time during a calendar year will need to give a statement to the Commissioner in relation to each of those accounts. This statement must contain all of the necessary information about those accounts that would allow the Australian Government to fulfil its obligations under the FATCA Agreement. [Schedule 1, item 2, subsections 396-5(1) and (2) of Schedule 1 to the TAA 1953]

1.22 Implicit in this obligation is the requirement that such a Reporting Australian Financial Institution will need to collect the relevant information. Of note, an entity subject to the Australian Privacy Principles in the Privacy Act 1988 that collects personal information about an individual must, under Australian Privacy Principle 5, take reasonable steps either to notify the individual about a range of matters relating to this personal information or otherwise ensure the individual is aware of these matters. These matters are set out in Australian Privacy Principle 5.2.

1.23 A Reporting Australian Financial Institution that does not maintain any U.S. Reportable Accounts in a calendar year does not need to provide such a statement to the Commissioner.

1.24 The concepts of Reporting Australian Financial Institutions and U.S. Reportable Accounts are defined in Article 1 of the FATCA Agreement. However, generally speaking:

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banks, some building societies, some credit unions, specified life insurance companies, private equity funds, managed funds, exchange traded funds and some brokers (generally those brokers maintaining Custodial Accounts) will typically be Reporting Australian Financial Institutions; and

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U.S. Reportable Accounts will typically include cheque and transaction accounts, savings accounts, term deposits, debt interests and equity interests (including derivatives), and certain annuity contracts.

1.25 Australian retirement funds, including superannuation entities (which includes self-managed superannuation funds), public sector superannuation schemes, constitutionally protected funds or pooled superannuation trusts, will generally not be Reporting Australian Financial Institutions as they are treated as Non-Reporting Australian Financial Institutions and as exempt beneficial owners for the purposes of sections 1471 and 1472 of the US IRC under Section II of Annex II of the FATCA Agreement. Government entities will also generally not be Reporting Australian Financial Institutions under Section I of Annex II of the FATCA Agreement.

1.26 Article 2 of the FATCA Agreement sets out Australia's obligations in relation to the collection of information about U.S. Reportable Accounts. This includes collecting the following information, for example, in relation to each U.S. Reportable Account:

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the name, address and U.S. Tax Identification Number of each Specified U.S. Person that is an Account Holder (or each Specified U.S. Person that is a Controlling Person, as well as the name, address and U.S. Tax Identification Number of the controlled Non-US Entity);

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the account number or equivalent;

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the name and identifying number of the Reporting Australian Financial Institution;

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the account balance or value at the end of the calendar year or other appropriate reporting period (or, if the account was closed during the year, immediately before its closure);

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the total amount of income generated by the account (such as interest or dividends) and paid into the account (or with respect to the account) - but only with respect to 2015 and subsequent years; and

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in some cases, the total gross proceeds from the sale or redemption of property paid or credited to the account during the calendar year - but only with respect to 2016 and subsequent years.

1.27 Further to paragraph 1.20, paragraph 7 of Article 4 of the FATCA Agreement allows Australia to permit Australian Financial Institutions to use a definition in the relevant US Treasury Regulations in lieu of a corresponding definition in the FATCA Agreement where the application of such a definition would not frustrate the purposes of the Agreement.

1.28 In complying with this reporting obligation, an Australian Financial Institution may elect to use such an alternative definition as it is within the meaning of the FATCA Agreement and its use allows the Australian Government to fulfil its obligations under the Agreement.

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Copies of US Treasury Regulations are available on the US Treasury website.

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In addition, the US Department of the Treasury typically publishes binding notices in anticipation of US Treasury Regulations.

[Schedule 1, item 2, section 396-20 of Schedule 1 to the TAA 1953]

1.29 An entity must have made any relevant elections by the time it gives the statement to the Commissioner. The way the entity has prepared the statement provides sufficient evidence of any elections it may have made. There is no need to provide the Commissioner with an additional, specific notification of any elections made.

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However, an entity that provides a statement to the Commissioner has an obligation to keep necessary records about the procedures used in determining the information given to the Commissioner (including any elections made).

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Paragraphs 1.50 to 1.53 provide further information about this obligation.

1.30 The statement to the Commissioner must be given in the 'approved form'. The concept of approved forms is used in the taxation laws to provide the Commissioner with administrative flexibility to specify the precise form of information required and the manner of providing it. [Schedule 1, item 2, subsection 396-5(4) of Schedule 1 to the TAA 1953]

1.31 Section 388-50 of Schedule 1 to the TAA 1953 provides the legislative basis for the use of approved forms. Subsection 388-50(2) allows the Commissioner to combine more than one statement in the one approved form and paragraph 388-50(1)(c) allows the Commissioner to require any necessary additional information. [Schedule 1, item 2, subsection 396-5(5) of Schedule 1 to the TAA 1953]

1.32 Each statement is due to the Commissioner by 31 July of the following year to which the information relates.

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However, section 388-55 of Schedule 1 to the TAA 1953 allows the Commissioner to defer the time that entities must lodge a statement in the approved form.

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This means Reporting Australian Financial Institutions may lodge these statements by a later date where that has been approved by the Commissioner.

[Schedule 1, item 2, subsection 396-5(6) of Schedule 1 to the TAA 1953]

1.33 The ATO has published a range of information and guidance about how the Commissioner administers the approved form provisions. In particular, practice statement PS LA 2005/19 provides information about the processes for approving an approved form and practice statement PS LA 2011/15 provides information about general lodgement obligations and the process for seeking to defer these obligations.

The requirement to follow specific due diligence procedures

1.34 In effect, complying with this reporting obligation will require all Reporting Australian Financial Institutions that maintain Financial Accounts (within the meaning of the FATCA Agreement) to determine if they maintain any U.S. Reportable Accounts. This requires applying the due diligence procedures specified in the FATCA Agreement to determine the information to be reported. [Schedule 1, item 2, subsection 396-5(3) of Schedule 1 to the TAA 1953]

1.35 Annex I to the FATCA Agreement specifies these due diligence procedures, including circumstances where Australia may permit a Reporting Australian Financial Institution to elect to apply alternative due diligence procedures. These include:

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Section I.C of Annex I which allows Reporting Australian Financial Institutions to rely on the procedures described in relevant US Treasury Regulations to establish whether an account is a US Reportable Account or an account held by a Nonparticipating Financial Institution;

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Sections II.A, III.A, IV.A and V.A of Annex I which allow Reporting Australian Financial Institutions to make elections in relation to different types of Accounts; and

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Section VI.F of Annex I which allows Reporting Australian Financial Institutions to rely on the due diligence procedures performed by third parties to the extent provided in relevant US Treasury Regulations.

1.36 Further to paragraph 1.20, a Reporting Australian Financial Institution may elect to use any of the alternative procedures allowed by the FATCA Agreement in complying with the due diligence obligations required under the Agreement. [Schedule 1, item 2, section 396-20 of Schedule 1 to the TAA 1953]

Consequences of not complying

1.37 Australia's domestic taxation laws contain a range of sanctions for entities that do not comply with their reporting obligations. Specifically:

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Division 284 of Schedule 1 to the TAA 1953 sets out the penalties that apply to entities that make false or misleading statements about tax-related matters; and

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Division 286 of Schedule 1 to the TAA 1953 sets out the penalties that apply to entities that fail to lodge statements on tax-related matters in time.

1.38 This means, for example, that:

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a Reporting Australian Financial Institution that makes a false or misleading statement because of an intentional disregard of the taxation laws may be liable to an administrative penalty of 60 penalty units - per table item 3A of subsection 284-90(1) of Schedule 1 to the TAA 1953;

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a Reporting Australian Financial Institution that makes a false or misleading statement through recklessness as to the operation of the taxation laws may be liable to an administrative penalty of 40 penalty units - per table item 3B of subsection 284-90(1); or

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a Reporting Australian Financial Institution that makes a false or misleading statement because of a failure to take reasonable care to comply with the taxation laws may be liable to a penalty of 20 penalty units - per table item 3C of subsection 284-90(1).

1.39 Similarly, a Reporting Australian Financial Institution that fails to provide a statement on time, or in the approved form, may be liable under subsection 286-80(2) of Schedule 1 to the TAA 1953 to a base administrative penalty of one penalty unit for each period of up to 28 days from when the document was due, up to a maximum of five penalty units (subsections 286-80(3) and (4) of Schedule 1 to the TAA 1953 increase these penalty amounts for some entities). This could include a Reporting Australia Financial Institution that fails to identify any U.S. Reportable Accounts that it maintains and lodge a statement with the Commissioner.

1.40 Section 4AA of the Crimes Act 1914 provides the value of a penalty unit. The current value is $170.

1.41 Division 298 of Schedule 1 to the TAA 1953 contains a range of machinery provisions relating to this penalty framework. This includes section 298-20 which allows the Commissioner to remit all, or part, of an administrative penalty and section 298-30 which allows entities to object to the Commissioner's penalty assessment.

1.42 The ATO has also published a wide range of information and guidance about the operation of this penalty regime. Relevant practice statements include PS LA 2012/4 which relates to false and misleading statements and PS LA 2011/19 which relates to failing to lodge.

1.43 It is important to note that a Reporting Australian Financial Institution that fails to comply with this reporting obligation may also be deemed by the IRS to be a Nonparticipating Financial Institution under subparagraph 2(b) of Article 5 of the FATCA Agreement regardless of any compliance action undertaken by the ATO using Australia's domestic taxation laws.

The reporting obligation - payments to Nonparticipating Financial Institutions

1.44 Reporting Australian Financial Institutions that make payments to Nonparticipating Financial Institutions in 2015 and 2016 will also need to provide information about these payments to the Commissioner.

1.45 Specifically, a Reporting Australian Financial Institution that makes a payment to a Nonparticipating Financial Institution holding financial accounts with the Reporting Australian Financial Institution in 2015 and 2016 will need to give a statement to the Commissioner in relation to each of these payments. Each statement must contain all of the necessary information about those payments that would allow the Australian Government to fulfil its obligations under the FATCA Agreement. [Schedule 1, item 2, subsections 396-10(1) and (2) of Schedule 1 to the TAA 1953]

1.46 Similar to paragraphs 1.27, 1.28 and 1.29, an Australian Financial Institution may elect to use any alternative definition in the relevant US Treasury Regulations in complying with this reporting obligation, provided the use of that definition does not frustrate the purposes of the FATCA Agreement. [Schedule 1, item 2, section 396-20 of Schedule 1 to the TAA 1953]

1.47 This statement is due to the Commissioner by 31 July of the year following the year to which the information relates and must be given in the approved form. Paragraphs 1.30 to 1.33 provide further information about approved forms. [Schedule 1, item 2, subsections 396-10(4), (5) and (6) of Schedule 1 to the TAA 1953]

1.48 Reporting Australian Financial Institutions that provide such a statement will need to apply the due diligence procedures required under the FATCA Agreement in determining the information to be contained in that statement. As noted in paragraphs 1.35 and 1.36 a Reporting Australian Financial Institution may elect to use any of the alternative procedures allowed by the FATCA Agreement in complying with this obligation. [Schedule 1, item 2, subsection 396-10(3) of Schedule 1 to the TAA 1953]

1.49 A Reporting Australian Financial Institution that does not comply with this obligation may be subject to specific sanctions under Australia's domestic taxation laws and may also be deemed by the IRS to be a Nonparticipating Financial Institution. Paragraphs 1.37 to 1.43 provide further details about these different sanctions.

The requirement to keep records of relevant procedures

1.50 Similar to Australia's income tax regime and the lodgement of income tax returns, the reporting obligations on Reporting Australian Financial Institutions will operate on a self-assessment basis. Under self-assessment, taxpayers typically perform certain functions and exercise some responsibilities that might otherwise be undertaken by the revenue authority. One consequence of a self-assessment approach is that whilst the Commissioner may initially accept an entity's statement at face value, the Commissioner may subsequently seek to verify the accuracy of that statement, particularly if there are potential compliance risks.

1.51 Accordingly, reporting entities will need to keep adequate records about the procedures they used in preparing the relevant statement to ensure the Commissioner can properly assess whether they have, in fact, complied with their reporting obligations. This record-keeping obligation is similar to other record keeping provisions in Australia's domestic taxation laws.

1.52 Specifically, a Reporting Australian Financial Institution that provides a statement to the Commissioner needs to keep records for five years (from the date of providing that statement to the Commissioner) that:

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correctly record the procedures by which it determined what information to include in the statement; and

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are in English, or are readily accessible and easily convertible into English.

[Schedule 1, item 2, section 396-25 of Schedule 1 to the TAA 1953]

1.53 This record-keeping obligation particularly applies in relation to the due diligence procedures followed by the Reporting Australian Financial Institution in identifying relevant accounts or payments as well as any elections made by the institution in relation to terms used in, or procedures required under, the FATCA Agreement. However, entities need not create specific records just to comply with this obligation. Internal guidelines or similar documents about the procedures relevant staff should follow, for example, may be sufficient, particularly if there is also evidence that staff do, in fact, routinely follow these guidelines.

Consequences of not complying

1.54 Section 288-25 of Schedule 1 to the TAA 1953 provides that an entity that fails to keep or retain records as required by the taxation laws is liable to an administrative penalty of 20 penalty units.

1.55 The ATO has published a practice statement, PS LA 2005/2, which provides further information about these record keeping obligations.

1.56 In addition, a Reporting Australian Financial Institution that fails to keep adequate records may be exposed to the possibility of being deemed by the IRS to be a Nonparticipating Financial Institution.

Consequential amendments

1.57 These amendments define the FATCA Agreement as the Agreement between the Government of Australia and the Government of the United States of America to Improve International Tax Compliance and to Implement FATCA. [Schedule 1, item 2, section 396-15 of Schedule 1 to the TAA 1953]

1.58 In addition, these amendments amend the definitions in section 995-1 of the Income Tax Assessment Act 1997 to incorporate a reference to the FATCA Agreement. [Schedule 1, item 1, subsection 995-1(1) of the ITAA 1997]

1.59 These amendments also insert relevant guide material for Division 396. [Schedule 1, item 2, section 396-1 of Schedule 1 to the TAA 1953]

Application and transitional provisions

1.60 These amendments commence on Royal Assent.

1.61 These amendments apply in relation to:

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all U.S. Reportable Accounts maintained by Reporting Australian Financial Institutions on or after 1 July 2014 [Schedule 1, item 3, paragraphs (1) and (3)]; and

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any payments made in 2015 or 2016 by Reporting Australian Financial Institutions to Nonparticipating Financial Institutions [Schedule 1, item 3, paragraphs (2) and (3)].