Foreign Account Tax Compliance Act (FATCA) Implication and Impact on Malaysia

The IRS introduced the FATCA (Foreign Account Tax Compliance Act) in 2010 to prevent tax evasion by U.S. taxpayers holding accounts abroad.

Although FATCA is a U.S. law, it impacts countries like Malaysia because of its global reach. Malaysia signed an Intergovernmental Agreement (IGA) with the U.S. to comply with FATCA. This is so that Malaysian financial institutions report the details of all accounts held by U.S. taxpayers or entities related to all withholding tax payments.

To understand the act and its impact in Malaysia, we have brought this guide for you that will cover the following:

• What is FATCA withholding tax
• How FATCA is different from CRS
• Key aspects of FATCA in Malaysia
• FATCA’s impact on Malaysia
• FATCA regulations in Malaysia

FATCA Meaning and Overview

FATCA, or Foreign Account Tax Compliance Act by the IRS was passed to prevent tax evasion by U.S. citizens who might hide their financial assets in foreign countries. Under this act, foreign financial institutions (FFIs), such as banks and investment companies, must report details about accounts held by U.S. persons. This includes: 

• U.S. citizens
• permanent residents
• foreign entities with a significant U.S. ownership
• account balances
• interest earned
• other income linked to U.S. taxpayers.

Objectives of FATCA

The primary goal of FATCA is to:

• Detect unreported income by U.S. taxpayers.
• Reduce global tax evasion through enhanced transparency.

FATCA in Malaysia

Malaysia formally committed to FATCA compliance through a Model 1 Intergovernmental Agreement (IGA) with the United States on June 30, 2014. Under this agreement, Malaysian Financial Institutions (MYFIs) report FATCA-related information to the Inland Revenue Board of Malaysia (IRBM), which in turn exchanges this information with the U.S. Internal Revenue Service (IRS).

Key Requirements under Malaysia’s FATCA Compliance

The implementation of FATCA in Malaysia mandates Malaysian Financial Institutions (MYFIs) to comply with stringent due diligence, reporting, and withholding tax obligations.

 Below are the core requirement under Malaysia's FATCA compliance framework:

Due Diligence Requirements

MYFIs must identify and classify accounts with potential U.S. ownership through:

• Preexisting Individual Accounts: Accounts active before June 30, 2014, are reviewed for signs of U.S. ties, such as citizenship or residency.
• New Accounts: FATCA-compliant onboarding ensures proper identification for accounts opened after July 1, 2014.
• Entity Accounts: Ownership and control in businesses are examined to identify U.S.-connected entities.

Account classification is based on balance thresholds:

• High-Value Accounts: Enhanced reviews for balances exceeding USD 1 million.
• Lower-Value Accounts: Standard reviews for balances between USD 50,000 and USD 1 million.
• Small Accounts: Accounts below USD 50,000 are generally exempt from review.

Reporting Obligations

MYFIs are required to report FATCA-related information annually to the Inland Revenue Board of Malaysia (IRBM), which forwards the data to the U.S. Internal Revenue Service (IRS). The reports include:

• Year-end account balances.
• Income generated, such as interest and dividends.
• Identifiable details of U.S.-related account holders or entities.

Obligation to Deduct Withholding Tax

MYFIs must deduct a 30% withholding tax on U.S.-sourced income paid to:

• Non-compliant account holders who fail to provide their FATCA status.
• Non-participating foreign financial institutions (NPFFIs).

Scope of Implementation in Malaysia

The FATCA framework applies to:

1. Financial Institutions (FIs): These include banks, insurance companies, investment firms, and similar entities operating in Malaysia.
2. Account Holders: Malaysian residents who are U.S. citizens, permanent residents, or entities with significant U.S. ownership.
3. Financial Transactions: U.S.-sourced income, such as dividends, interest, or royalties.

Reporting Framework

Under Malaysia’s FATCA implementation:

• MYFIs must register with the IRS to obtain a Global Intermediary Identification Number (GIIN).
• MYFIs must perform due diligence to identify and classify U.S.-related accounts.
• Non-compliance with FATCA obligations, either by account holders or MYFIs, can result in withholding penalties or reputational damage.

What is FATCA Withholding Tax?

FATCA imposes a 30% withholding tax on U.S.-sourced income paid to foreign institutions that fail to comply with the rules. This tax encourages foreign institutions to follow FATCA's reporting requirements.

Many people mistakenly think FATCA only impacts U.S. citizens, it actually requires financial institutions in Malaysia to identify and report on accounts held by U.S. persons, such as U.S. citizens or those with significant U.S. ownership.

FATCA withholding tax is applied to U.S.-sourced income, such as:

• Dividends
• Interest
• Royalties
• Rent
• Other types of U.S.-sourced income such as proceeds from the sale of U.S. property or other investments.

FATCA Classification: Understanding the Key Categories

FATCA is applicable to the following categories:

FATCA Exempted Entities

Certain entities are exempt from reporting their FATCA details. They include:

Key Differences Between FATCA and the Common Reporting Standard (CRS)

Just like FATCA, Common Reporting Standards (CRS) is also an international tax compliance frameworks developed by the OECD. Let’s understand their difference in detail:

Conclusion

By entering into a Model 1 Intergovernmental Agreement (IGA) with the U.S., Malaysia has aligned its compliance framework with international standards, requiring Malaysian financial institutions (MYFIs) to identify, report, and, if necessary, withhold taxes on U.S.-linked accounts. This initiative aims to combat global tax evasion and improve financial transparency.

FATCA's implications extend beyond financial institutions to individuals and businesses, creating new compliance obligations and operational challenges. Key requirements include identifying U.S. reportable accounts, implementing robust due diligence procedures, and adhering to strict reporting timelines. Additionally, the distinction between active and passive Non-Financial Foreign Entities (NFFEs) ensures accurate classification and reporting under the agreement.