While much of the industry's focus has been on the OECD’s Automatic Exchange of Information (AEOI), private banks in Singapore and Hong Kong have also been contending with heftier tax obligations for US clients.
Private banks in Asia have mostly weathered the storm brought on by the 2014 Foreign Account Tax Compliance Act (Fatca) – either by determining the tax liabilities of US citizens or by ditching them entirely.
But now, according to experts, some private banks are beginning to think again, booking their clients in the US to avoid the reporting burdens.
These requirements typically include identifying the client and filing annual returns providing the name, address and taxpayer identification number of each account holder, in addition to the account balance or value at year-end, gross dividends, interest and any other income paid or credited to the account.
‘They book them under the US business, which is Fatca-exempt,’ says Ishali Patel, associate director at tax consultancy firm Buzzacott. ‘I've heard of a few private banks that have acquired US wealth management teams, who are looking to take on Americans as well.
‘There is a big [US private bank] here where people from New York are sitting in Asia.’ However, this is still the exception rather than the rule, she says.
David Snelling, founder and director of external asset manager Strabens Hall, agrees. ‘Some of the biggest private banks in Hong Kong have been actively closing investment accounts related to US citizens. I think the headache of Fatca has presented too much risk for their appetite,’ he says.
Fatca came into effect in 2014 to prevent US citizens from abusing the tax system through the use of offshore accounts. The rules require foreign financial institutions (FFIs) to provide the Internal Revenue Service (IRS) with information on US citizens using accounts outside of the US. Certain non-US entities must also provide information about any US owners.
If foreign financial institutions do not comply with Fatca, a 30% withholding tax is imposed on the firm’s US income. This penalty on certain incomes and gross proceeds began in January last year. FFIs are required to close any accounts where US customers have not provided information to be collected.
Aside from private banks and private wealth management firms, certain trusts and family arrangements also qualify for Fatca.
Patel highlighted two areas where dealing with US clients is particularly burdensome: the heightened costs and improved systems needed to bring new clients on board, and the difficulty of actually exchanging information with the IRS.
For example, Hong Kong operates under a Model II intergovernmental tax agreement with the US, which puts the burden of reporting to the IRS squarely on the shoulders of the financial institution itself.
Singapore, however, is a Model I country and requires banks to report to the local tax authority, which then deals with the IRS on their behalf.
Building the perfect beast
The obvious answer for US clients living in Asia might seem to be investing in non-US domiciled funds.
However, the US applies additional taxes and reporting obligations for US taxpayers who invest in so-called ‘passive foreign investment companies’. This includes any foreign corporation with 75% or more of its gross income coming from passive income, or with 50% or more of its assets deemed to be producing passive income.
Generally, any non-US mutual fund, collective investment scheme or investment wrapper falls into this category.
An annual income tax at the top rate of 35% is levied on the income and even on unrealised gains. This compares with US-domiciled mutual funds, where capital gains tax, at a maximum of 20%, is chargeable only when the gain is realised.
‘Most US clients don’t know about this tax trap, presuming they do not need to declare tax on non-US domiciled investments until gains are actually realised. As such they do not declare the annual deemed gains and start to accrue a tax balance, penalties and interest,’ Snelling says.
Instead, in an effort to reduce their tax burden, US clients are increasingly using wealth management firms in Asia and elsewhere that are registered with the US Securities and Exchange Commission. This enables them to buy funds on US platforms from the likes of Fidelity and Charles Schwab.
‘For a lot of Americans in Asia, the best answer for them is to go for one of these US-registered wealth managers who can put them into domestic funds,’ Patel says.
Building a portfolio of offshore ETFs is also typically more tax efficient for the US taxpayer in comparison with holding an offshore mutual fund, Snelling adds.
Looking ahead, it will be interesting to watch how the dynamic unfolds between the US and the OECD’s Automatic Exchange of Information, to which the US is not a signatory.
Singapore and Hong Kong will undertake the first exchanges under the AEOI in 2018. However, there is a chance that a loophole could be exploited by investors in Asia, Snelling says.
An investor could potentially open a custodian account in the US but appoint a European or Asian fund manager. As custody would be in the US, the investor would not fall under AEOI disclosure requirements.
‘Specific states in the US have also been touted as being interesting for clients to go to [to set up companies] in order to reduce their [Common Reporting Standards] obligations,’ he says.
This article appeared in the November issue of the Citywire Private Wealth magazine.