Implementing the UK-US FATCA Agreement. STEP Response to consultation issued on 18 September 2012

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1 Implementing the UK-US FATCA Agreement STEP Response to consultation issued on 18 September 2012 Main Points STEP welcomes the UK Government s initiative to conclude an Intergovernmental Agreement (IGA) with the US authorities. Even under the IGA, the burdens imposed on UK practitioners will remain very substantial, and some important practical issues remain to be resolved. 176,500 trusts made a self-assessment return to HMRC in The great majority of UK trusts, however, do not receive income or make any chargeable gains and do not need to file a UK self-assessment return. Nevertheless these may, on the current proposals, still have to register as FIs. We believe that this is an unintended consequence of regarding any trust with a "professional manager" as an FI. It would be considerably easier, more practical and, in our view, would in no way jeopardise the integrity of reporting if all trusts, whether or not they have professional trustees, were regarded as NFFEs with the primary obligation for reporting falling on any associated TCSP or FI acting in connection therewith. The major difficulties in calculating the required information for reporting are likely to relate to the need to calculate an account value for a trust. Any requirement to value property (such as real property) or businesses held within the trust annually could significantly add to compliance costs. For many trusts it would ease compliance considerably if valuations could be tied into the Inheritance Tax 10 year charge valuations they are also required to do alongside a requirement to report annually known significant changes. In terms of attributing a value within the trust fund to a particular beneficiary, in practice most TCSPs are likely to simply report the value of the trust fund rather than attempt to attribute it to the settlor and particular beneficiaries since this is often not possible, particularly where there are discretionary or contingent beneficiaries. A clarification that this is acceptable, as has been given on a similar basis in the case of reporting requirements for holders of joint accounts, would help limit compliance concerns.

2 Implementing the UK-US FATCA Agreement STEP Response to consultation issued on 18 September The Society of Trust and Estate Practitioners (STEP) is the worldwide professional body for practitioners in the fields of trusts and estates, executorship, administration and related issues. STEP members help families secure their financial future and protect the interests of vulnerable relatives. STEP aims to promote the highest professional standards through education and training leading to widely recognised and respected professional qualifications. STEP internationally has over 18,000 members, with more than 6,500 members in the UK. Over 4,500 students worldwide are currently studying for STEP qualifications and in the UK STEP supports an extensive regional network providing training and professional development. 2. STEP welcomes the UK Government s initiative in concluding an Intergovernmental Agreement (IGA) with the US authorities. In the absence of an IGA the FATCA proposals from the US would have imposed an enormous burden on UK practitioners and in some areas appeared wholly impractical in the UK context. Even under the IGA, the burdens imposed on UK practitioners will remain very substantial, and some important practical issues remain to be resolved. We agree, however, that that the IGA provides a framework to establish a more practical reporting mechanism for UK trusts and trust service providers. 3. The areas covered by FATCA, the IGA and the associated consultation document are clearly extremely wide. The following comments are therefore focused wholly on the issues raised in the IGA that we feel are of particular relevance for trusts, families using trusts and trust service providers. Trusts - background information 4. Trusts are very widely used in the UK. Some of the most common family situations where trusts are used (often in conjunction with a will) are: To provide for a husband, wife or partner after death while protecting the interests of any children. To protect the inheritance of young children until they are old enough to take responsibility for their own affairs. To provide for a vulnerable relative who is unlikely to be able to look after their own affairs. To help succession planning in family businesses.

3 5. 176,500 trusts made a self-assessment return to HMRC in , but there is no requirement to submit a self-assessment return or otherwise inform HMRC if a trust is not going to receive any income or make any chargeable gains (although for Inheritance Tax purposes the trust may still need to be reported). The great majority of trusts do not receive income or make any chargeable gains and on most estimates there are many hundreds of thousands (possibly over a million) such non-reporting trusts, often simply holding a share of the family home or some other family asset. Given house values, particularly in the South East of England, many of these trusts are nevertheless likely to be over the FATCA IGA de minimis reporting limits for account values. 6. The consultation document (paragraph 3.9) attempts to distinguish between family trusts and professionally managed trusts, suggesting that the former are out of scope in terms of the definition of Financial Institution for FATCA purposes. We would note initially that the term family trust has traditionally been used by HMRC to refer to the range of types of trusts typically used by families rather than to whether the trust is professionally managed or not. We would also note that many relatively modest family trusts (particularly will trusts) will have a professional acting as at least one of the trustees. Thus the HMRC website distinguishes between family trusts and non-family trusts on grounds of purpose, not in terms of who manages the trust. 1 Non-family trusts are defined as heritage, charitable or business related trusts, with business related trusts further defined as covering flat management company trusts, employee benefit trusts, investment trusts and unit trusts. The status of professional trustees 7. Many family trusts (i.e. trusts established to pass assets on within a family) are likely to have at least one professional trustee, who may often be the family solicitor or accountant, with the other trustees being family members. Professional trustees play an important role bringing specialist expertise to the administration of a trust although they may not always be paid directly for their services as a trustee, this being regarded as just one of a range of services provided by their firm. 8. This situation is covered by the normal term used in UK tax and anti-money laundering regulations, which is trust and company service providers (TCSPs). The Money Laundering Regulations 2007/2157 defines a TCSP as a firm or sole practitioner who by way of business provides any of the following services to other persons (c) providing a registered office, business address, correspondence or administrative address or other related services for a company, partnership or any other legal person or arrangement; 1

4 d) acting, or arranging for another person to act, as.. (i) a trustee of an express trust or similar legal arrangement; 2 9. While we discuss the position of trusts under the FATCA legislation in greater detail below, given the large number of trusts with a professional trustee among the trustees it is worth considering the practical implications if they are to be categorised as Financial Institutions. Many hundreds of thousands of families will be astonished to discover that their grandmother s or uncle s trust fund, in spite of often having little or no income and limited assets, now falls into the same category as a major investment bank or City institution. In these circumstances it will clearly be necessary for HMRC to mount a major public information campaign to explain the position to families and avoid widespread public concern at the imposition of major new registration and reporting requirements which are likely to give rise to significant compliance costs. The position of trusts under IGA 10. It remains unclear what a trust is under the FATCA IGA, not least because the Financial Action Task Force (FATF) definition of Financial Institutions excludes trusts. 11. A trust is clearly an Entity, as defined in Article 1.1.hh of the IGA: The term Entity means a legal person or a legal arrangement such as a trust. 12. If a trust has a relationship with a TCSP, the trust will fall within the definition of an Investment Entity, as defined in Article 1.1j. of the IGA: The term Investment Entity means any entity that conducts as a business (or is managed by an entity that conducts as a business) one or more of the following activities or operations for or on behalf of a customer: (3) otherwise investing, administering, or managing funds or money on behalf of other persons. 13. More problematic is the categorisation of a trust as a Financial Institution. Article 1.1.j notes that This subparagraph 1(j) shall be interpreted in a manner consistent with similar language set forth in the definition of financial institution in the Financial Action Task Force (FATF) Recommendations. The FATF Recommendations state: Financial institution means any natural or legal person who conducts as a business one or more of the following activities or operations for or on behalf of a customer: Otherwise investing, administering or managing funds or money on behalf of other persons. A trust is not a natural or legal person but a legal arrangement without legal personality. A trust is therefore not a financial institution under the FATF definition. 14. One of the practical results of a trust lacking legal personality is that it is extremely difficult to require a trust to perform various actions and enforce those requirements. Generally, 2

5 therefore, UK tax and AML obligations are imposed on the trustees or TCSP who must act on behalf of the trust. 15. Thus the legal status of a trust as a legal relationship raises problems in the context of, for example, paragraph 3.13 of the consultation document, which notes that for investment funds (which in many respects the IGA seems to regard as analogous to trusts): We consider that as the fund holds the assets, it is appropriate for the fund to be treated as the Financial Institution and therefore it will be the fund that has the responsibility for ensuring the obligations under the Agreement are carried out. In the case of a trust, the trustees, not the trust, hold the assets and the trustees are the only persons in a position to be able to ensure that reporting obligations under the IGA are fulfilled. 16. The IGA does not specifically identify what trusts (including those arising on intestacy) which have no professional managers are. They are Entities (Article 1.1.hh of the IGA), although they do not appear to be either Investment Entities or Financial Institutions. They are generally assumed to be an NFFE, which is defined (Annex 1.VI.B.2 of the IGA) as: Any Non-U.S. Entity that is not an FFI as defined in relevant U.S. Treasury Regulations, and also includes any Non-U.S. Entity that is resident in the United Kingdom or other Partner Jurisdiction and that is not a Financial Institution. These are then reported on by any FFI they transact business with. 17. It would be considerably easier, more practical and, in our view, would in no way jeopardise the integrity of reporting if all trusts, whether or not they have professional trustees, were regarded as NFFEs (non-financial foreign entities) with the primary obligation for reporting falling on any associated TCSP or FFI acting in connection therewith. TCSPs already have a duty to disclose their status under the latest FATF guidance, which imposes a requirement that: All countries should take measures to ensure that trustees disclose their status to financial institutions and DNFBPs (designated non-financial businesses and professions) when, as a trustee, forming a business relationship or carrying out an occasional transaction above the threshold. A similar reporting mechanism, placing a clear disclosure requirement on the TCSP in respect of the trusts for which it acts may be sensible in the context of FATCA reporting. In this scenario, all trusts would be NFFEs and while they would need to self-certify on an equivalent of IRS Form W8 or 9, this would significantly reduce the numbers needing to go through the much more cumbersome registration and reporting procedures which FIs have to comply with. It would, however, not in any way diminish the quality of the reporting to HMRC and therefore the IRS. 18. TCSPs would then have to determine if a trust was an active or passive NFFE. It would be useful if the term passive income were defined more fully in Annex 1, but we assume that most trusts are likely to be passive NFFEs. Trusts whose main asset is a (family) business may, however, fall into the definition of Active NFFEs. Annex 1.VI.B.4, states : An Active NFFE means any NFFE that meets any of the following criteria:.. Substantially all of the activities of the NFFE consist of holding (in whole or in part) the outstanding stock of, and providing

6 financing and services to, one or more subsidiaries that engage in trades or businesses other than the business of a Financial Institution. A great number of family businesses are held within a trust structure but they would not be regarded as subsidiaries of the trust if the definition of subsidiary is the one used in Section 1159 of the Companies Act This issue will therefore require greater clarification. The information to be reported for trusts under the IGA the term value. 19. We assume that the relevant definition of account for those with an interest in a trust is provided by Article 1.1.v of the IGA which states: In the case of a trust that is a Financial Institution, an Equity Interest is considered to be held by any person treated as a settlor or beneficiary of all or a portion of the trust, or any other natural person exercising ultimate effective control over the trust. A Specified U.S. Person shall be treated as being a beneficiary of a foreign trust if such Specified U.S. Person has the right to receive directly or indirectly (for example, through a nominee) a mandatory distribution or may receive, directly or indirectly, a discretionary distribution from the trust. 20. We would note that the IGA does not explicitly state that an Equity Interest is a form of account. Neither does it state how to treat an interest in a trust which is an NFFE. It would be preferable in the interests of consistency if an interest in a trust which is an NFFE was also categorised as an Equity Interest, but clarification on all these points would be useful. 21. Article 2.2. of the IGA then states that for all Reportable Accounts: The information to be obtained and exchanged is (4) the account balance or value (including, in the case of a Cash Value Insurance Contract or Annuity Contract, the Cash Value or surrender value) as of the end of the relevant calendar year or other appropriate reporting period or, if the account was closed during such year, immediately before closure;. (7) in the case of any account not described in subparagraph (5) or (6) of this paragraph, the total gross amount paid or credited to the Account Holder with respect to the account during the calendar year or other appropriate reporting period with respect to which the Reporting United Kingdom Financial Institution is the obligor or debtor, including the aggregate amount of any redemption payments made to the Account Holder during the calendar year or other appropriate reporting period. 22. Again we assume that an Equity Interest falls into the category of account referred to in Article 2.2.a.7 of the IGA although it would be useful to make this explicit since it is not an account in the conventional sense. 23. The major difficulties in calculating the required information for reporting are likely to relate to the need to calculate an account value for each Reportable Account under Article 2.2.a.4. of the

7 IGA. There are two issues. First, there may well be difficulties around the calculation of the value of the trust fund. Second, it may well be impossible in practice to attribute a value within the trust fund to the settlor or any particular beneficiary. 24. In terms of valuing the overall fund, the difficulties relate principally to valuing annually property (e.g. real property) or businesses that might be held within the trust. For example, those trusts subject to the Inheritance Tax relevant property regime maybe subject to a tax charge on every tenth anniversary of the date the trust was set up depending on the nature of the trust property and its value. This requires a valuation of relevant property within the trust to be carried out every 10 years, an exercise which can be expensive and time consuming if professional valuations are needed. Article suggests that a similar exercise will now need to be undertaken annually for all reportable accounts (even if there is only one US beneficiary). It would significantly reduce compliance costs if only a periodic full valuation was required (particularly of property and businesses) akin to the Inheritance Tax 10 year charge requirements and perhaps using the same valuation information. [Alongside this could be an obligation to report known significant changes in value annually. Concern has also been expressed around the degree of flexibility in terms of reporting valuations as of the end of the calendar year or other appropriate reporting period (article 2.2.(4)). It would be useful to clarify the meaning of other appropriate reporting period and, in particular, confirm that it will be acceptable for accounts produced, for example, on a UK tax year basis to be used for IGA reporting purposes for the calendar year in which the end of the relevant UK tax year falls. 25. In terms of attributing a value within the trust fund to any particular beneficiary, in practice most TCSPs are likely to simply report the value of the trust fund rather than attempt to attribute it to particular beneficiaries since this is often not possible, particularly where there are discretionary or contingent beneficiaries. As reports will need to be filed for other controlling persons, such as the settlor and the trustees, the same capital sum in the trust could be reported for many individuals. Given the terms in which the IGA is drafted there are significant concerns that this is not an issue that can be simply left to HMRC Guidance. We note that Annex 1 VI.C.1 of the IGA gives a clear statement that each holder of a jointly held account should be attributed the entire value of the jointly held account for aggregation purposes. It would be useful to have a similar statement regarding interests in a trust. Due diligence obligations with respect to trusts. 26. We note the discussion in paragraph 4.13 of the consultation document regarding the intention to negotiate a standard self-certification form (equivalent to IRS Form W-8) on a multinational basis. STEP would strongly support such a multi-national approach as this will significantly reduce the potential for inconsistent certification procedures when trustees in one jurisdiction are dealing with financial institutions in another jurisdiction.

8 27. The issue of the role of a relationship manager (Question 20) in the context of a typical trust designed to pass assets safely between generations can be complex. It is common for the individual in a financial institution with the strongest link to the trust settlor and perhaps some of the beneficiaries to serve as trustee. This will make him (or her) one of the controlling persons alongside the settlor and beneficiaries. We see no reason in principle why the same individual could not be both the relationship manager as well as being a controlling person even if this implies a degree of circularity in as much as the relationship manager would have to report on himself as a controlling person, but this is another issue where clarification would be useful. STEP 23/11/2012