ISDA Publishes Fatca Protocol For Derivatives Transactions

Terry Flanagan

The International Swaps and Derivatives Association (ISDA) has launched a new protocol intended to offer market participants an efficient way to amend the ISDA Master Agreement tax provisions to address the effects of the Foreign Account Tax Compliance Act (Fatca), which may impose a withholding tax on payments under derivatives transactions.

The protocol, formally titled the 2012 ISDA Fatca Protcol, will place the Fatca withholding tax burden on the recipient of the payment by eliminating this tax from the definition of “indemnifiable tax” in the ISDA Master Agreement.

The rationale is that the recipient is the sole party that has the ability to avoid the withholding tax by complying with the Fatca rules; therefore, the recipient should be the party burdened with the Fatca withholding tax if it chooses to not comply.

While Fatca, a 2010 U.S. law that targets tax dodgers using foreign accounts, contains a grandfathering rule with respect to transactions entered into before the end of 2012, that rule applies to individual transactions entered into under an ISDA Master Agreement and not the Agreement itself.

As a result, derivative transactions entered into after the end of 2012, or pre-existing contracts that are modified after 2012, could be subject to withholding tax under Fatca as early as January 1, 2014.

“Parties to a derivatives contract should consider signing up to the protocol by the end of the year so that counterparties can obtain certainty as to the legal provisions governing their transactions once grandfathering ends,” according to a statement issued on August 20 by accountancy firm PricewaterhouseCoopers.

ISDA, a trade body, is not setting a deadline for filing adherence letters, but it specifically recommends that parties get a head start and adhere to the protocol as quickly as possible, PwC noted.

Fatca requires foreign financial institutions (FFIs) to report information to either their home government or directly to the IRS regarding their U.S. account holders, after which the IRS can potentially withhold 30% U.S. tax on payments made to account holders or other FFIs.

“It’s true to say that most FFIs will have already begun the process of examining how their organizations’ processes, IT and people are geared up to handle this new, additional regulatory demand,” said Marc Murphy, chief executive of Fenergo, a provider of client onboarding software.

With client onboarding expected to bear the brunt of the new Fatca regulatory compliance and implementation, it is widely believed that the biggest challenge lies in client identification, data collection and documentation processes.

As a result, many institutions are looking at ways to streamline and automate as much as possible to cope with this additional regulatory pressure.

“The aim for most FFIs will be to ensure that the additional data collection and processing does not hamper or slow down the new client onboarding process,” said Murphy.

The quicker data is collected, clients classified (i.e. the appropriate withholding tax is applied) and reporting capabilities implemented, the quicker the bank becomes fully Fatca-compliant.

“By automating this process, the information collected can be automatically appended to the client’s record in the bank’s client database and fed downstream to corresponding systems—for example, compliance, legal, risk, tax etc—enabling the sharing of data and contributing towards the creation of a single, consolidated client view across the institution,” said Murphy.

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