China’s Relationship with the Contentious U.S. FATCA
For several years now, the United States has been preparing legislation under the Foreign Account Tax Compliance Act (FATCA), a complex reporting and withholding regime intended to enable the U.S. to better access offshore accounts, investments and income of U.S. citizens who have failed to rigorously report these holdings. Despite several nations’ embrace of the FATCA, China has continued to delay negotiations with the U.S. Treasury over whether or not to allow Chinese financial institutions to report U.S. taxpayer or U.S. firm information to the United States Government.
Under the FATCA, participating foreign financial institutions would be required to report to the IRS with information related to U.S. taxpayers, or foreign firms in which U.S. taxpayers hold substantial ownership.
Additionally, the U.S. would be able to impose a 30% withholding tax on “withholdable payments” to foreign persons at the highest levels unless it identifies U.S. interest holders or owners and disclose the required tax information to the United States. The FATCA will require those withholdable payments to be reported annually to the Internal Revenue Service (IRS) regardless of whether withholding from the payment has been required or completed.
To date, while most major economies are currently engaged in negotiations concerning how the FATCA will be applied to businesses within their borders, China has repeatedly refused to discuss the FATCA directly, and will likely continue to do so for the time being. Reports last September that Beijing and Washington had agreed to reach an intergovernmental agreement (IGA) on the FATCA before January have proven unfounded, with no such negotiations or agreement in sight despite the U.S. Treasury announcing a six-month extension on FATCA implementation last July in anticipation of an IGA with China.
So far, the Chinese have referenced the FATCA in only two notable instances. First, in a joint fact sheet released by the U.S. Department of the Treasury and PRC Ministry of Foreign Affairs (MOFA) in July that discussed both sides’ commitment to “make best efforts to reach an intergovernmental agreement on the implementation of the FATCA in advance of the January 2014 deadline in the legislation” and second in a press release from the MOFA that mentioned the FATCA discussions in one clause.
Despite China’s refusal to follow Japan and other nations’ embrace of the FATCA, the legislation will continue to apply to companies with a U.S. nexus. This means U.S. companies with subsidiaries in China and Chinese companies with subsidiaries in the U.S. should be cognizant of the FATCA’s current implications, and potential future implications if the China were to sign an IGA with the U.S. Treasury.
While China does stand to gain considerable insight into Chinese citizens’ offshore holdings if it signs an IGA, China’s leadership would also face potentially embarrassing disclosures about wealth stashed overseas. A recent report by the Guardian about the substantial offshore holdings of China’s top political and military leaders is one of several in recent years on the topic.
At the present time, the U.S. has several IGAs regarding the FATCA with Britain, Germany, Japan, Switzerland, Norway, Ireland and Spain (among others) with several more set to follow. While some foreign governments initially viewed FATCA legislation as U.S. encroachment on their sovereignty, others have embraced the opportunity to receive more tax information on their citizens’ offshore holdings from the United States. Currently, the Hong Kong SAR is engaged in negotiations with the U.S. Treasury regarding an FATCA IGA.
Should Beijing ultimately sign an IGA with the United States, all mainland financial institutions and many other firms there such as trust companies and pension fund managers will need to comply with the FATCA’s due diligence and disclosure requirements. If a non-U.S. financial institution refuses to comply with the FATCA, it faces a 30 percent withholding tax on gains on the U.S. investments in its portfolio – regardless of whether the assets are held for U.S. taxpayers or other parties such as Chinese nationals. If this happens, non-compliant mainland banks will be violating not just the FATCA, but also domestic laws as an FATCA IGA would require non-U.S. jurisdictions to pass legislation making the FATCA a part of local law.
While most countries will not risk refusing to comply with FATCA (because not doing so means they would not be able to invest in the United States) China has significant bargaining power in this respect as the United States vies for Chinese investment. As such, a Chinese statement proclaiming China’s opposition to the FATCA would have the potential to derail the entire endeavor. If and when China seeks to negotiation an IGA deal with the United States, it will for this reason also likely seek to extract other concessions such as exemptions for smaller Chinese banks from the FATCA.
Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.