FATCA: A Project Audit

Awareness of the implications of the U.S. law, FATCA (Foreign Account Tax Compliance Act) is growing.  For FATCA supporters the past few weeks has seen both domestic (US) opposition to reciprocity and the Intergovernmental Agreements (IGAs), and yet another delay in implementation.  For FATCA detractors this is good news but it's too soon to tell where this is all going and I wouldn't break out the champagne just yet.

Whenever there is a lull in the action, smart strategists take the time to reassess.  FATCA, the law, is a reality.  It was passed by the U.S. Congress and, come hell or high water, the U.S. Treasury and the IRS have to come up with some way to make it stick.  That's their job.  But what began as a law to force foreign banks to disclose their U.S. Person account holders has become something else altogether.  

What we are seeing right now is the creation of a very complex worldwide financial reporting system - what Marvin Van Horn has dubbed "GATCA" (Global Account Tax Compliance Act).  Is this what the U.S. Congress had in mind back in 2010?  I really doubt it. U.S. lawmakers are not terribly concerned about other countries and their problems with tax compliance.  Some are even horrified that their very own foreign investors might be deemed another country's tax evaders and they are resisting any attempt to make U.S. banks report those accounts to their respective governments.

Allison Christians made this very pertinent observation the other day on her blog, "It's really, really difficult to get an international tax regime going on a unilateral basis. There is a story in this about the difference in making a unilateral rule first, and then repeatedly changing it to fix all the problems that inevitably arise, versus sitting around in international networks trying to make sure the rule will work first, before trying to implement it internationally."

My background is in the management of large information systems for multi-nationals.  What Professor Christians  is describing feels a lot like some of the global projects I've worked on where company HQ decides unilaterally to impose a new system on its subsidiaries around the world.  What appears  straightforward, logical and necessary to the home office in Houston or Paris is often completely illogical and unworkable when it hits the ground in Tokyo or Sao Paulo.  When a multi-national company tries to run a project in this manner, it inevitably has to make many changes and the end result is all too often a system that is overly complex, late, and costs far more than HQ ever intended to spend.

A much better way is to gather the requirements ahead of time and build a core model that takes local conditions and perspectives into account.  Equally important in the "Gather Requirements" phase is what I call "evangelization" - building support for the project one country or region at a time.  Yes, all this takes time but it's worth it because implementation will then go much more smoothly and the project is much more likely to be a success.

Whatever the merits or demerits of FATCA the law,  it's worth looking at FATCA/GATCA from this perspective.  If this were an IT or engineering project and a consultant was asked to do an audit, what might he or she say about it?

Failure to identify all the stakeholders:   FATCA was originally thought of as something between foreign banks and the U.S. government.  But at every stage of implementation new stakeholders keep popping up:  foreign governments and their tax authorities, the compliance industry, U.S. Persons abroad and so on.  Now the World Council of Credit Unions is chiming in as well as regional authorities like the European Union.  As the final system takes shape some U.S. lawmakers have become major stakeholders as well.  Yes, Treasury did ask for comments when preparing the final regulations and did take them into account.  However, this did not suffice as a forum for discussing all of the concerns and questions.  This has led to mounting criticism and both legal and political challenges which are slowing down the implementation and might even stop it.

Failure to do a proper assessment of the impact and the risks:  FATCA has already had many unintended consequences that could have been foreseen.  A few (like banking discrimination) were considered but then set aside as unlikely to occur.  Surprise!  The cost issue was raised pretty much after the fact and the U.S. Congress never asked for, to my knowledge, any estimate of how much FATCA would cost to implement, nor was there any realistic cost/benefit analysis.  For the money spent building the system, not to mention the recurring support costs, just how much net revenue will the U.S. get in the end? No one knows.  Even today there are only vague promises of "putting a halt to tax evasion" but there are no hard numbers from a credible source.

Lack of success criteria:  One of the signs of a very poorly conceived project is that the original objectives were either fuzzy to begin with or become completely lost in the frenzy to get the project in.  What exactly would have to happen for FATCA to be considered a "success"?    To date the only scorecard we are seeing is the number of intergovernmental agreements signed.  But the original project goal wasn't about making these kinds of agreements - in fact the IGAs are something that came into the game rather late.  The fact that they are now being used as a measure of success should trouble everyone.    A perfect example of "mission/scope creep" and one could argue that Representative Posey's letter to Treasury and Senate opposition is just the Steering Committee (such as it is) trying to rein in the project team's attempt to broaden the scope of the original project objectives.

An out of control Core Model:   FATCA was originally a few pages in the 2010 Hire Act. Today it has become a monster with over 500 pages of regulations and eight signed intergovernmental agreements. In the recent announcement by the IRS that FATCA is once again being delayed, they say, "The Department of the Treasury (Treasury Department) and the Internal Revenue Service (IRS) intend to incorporate the rules described in this announcement in final regulations under sections 1471 through 1474."   As I understand it, as the IGAs are signed, changes are fed back into the Core Model (the regulations).  Since only a few countries have actually signed IGAs to date, this raises the question of what future changes may have to be included as Treasury negotiates with the remaining 180+ countries in the world.

This not only increases both the uncertainty about what the final system will look like, it adds to the complexity and the costs.  Today one can see the outline of what the system will look like but is that good enough for those who must modify processes, laws and information systems?  As my friend JJ says:   “Walking on water and developing software from a spec are easy if both are frozen.”   Trying to deploy a Core Model without having the vast majority of the requirements already taken into account, and making ad hoc changes during implementation and deployment,  is a recipe for disaster.  If I were an IT manager running a FATCA compliance project I would be very very nervous because the ice looks pretty thin to me.

Complexity:  FATCA begets GATCA and as the system becomes more and more complex with more and more components (people, processes, information systems, legal and political systems) it is rapidly becoming a bowl of spaghetti the kids are trying to eat on a white couch.   Charles Perrow, author of Normal Accidents, has a lot to stay about high-risk systems and "inevitable accidents."   It's not so much about original design flaws as it is the way the components interact in new and surprising ways as the system starts working and doing what it was meant to do.  

"We start with a plant, airplane, ship, biology laboratory, or other setting with a lot of components (parts, procedures, operators).  Then we need two or more failures among components that interact in some unexpected way.  No one dreamed that when X failed, Y would also be out of order and the two failures would interact so as to both start a fire and silence the fire alarm."   

And that's why the house burns down or the system crashes.  Efforts to make the system safer and more robust only add to the complexity thus making it,  Perrow says, even more likely to fail.

FATCA is becoming such a system;  highly complex and more and more "tightly coupled" (a change or failure in one component means sending ripples through the entire system).   More components mean more danger.  A good example of this are the IGAs - an attempt to make a poorly-written, dangerous and unworkable law "safer" and less likely to have catastrophic consequences.  

But are they really making the system more secure or have they introduced new risks?    If Treasury cannot get the IGAs signed in sufficient numbers by next year then the choices are 1.  Start the 30% withholding which could be interpreted as starting a financial war with the rest of the world;  2.  Step back and get the law revised or delayed yet again;  3. Give up.   

If Treasury succeeds, on the other hand, it could be even worse because no one really knows what is going to happen when the system goes live in July of 2014.  Already other countries are looking at the opportunities inherent in FATCA.  The U.S. could very well end up with the short end of the stick if other countries use it to for their own ends - ends that are in direct opposition to U.S. interests.  

Any one of these outcomes would be a huge blow against the credibility and prestige of the U.S.   Stepping back and looking at it very coldly, FATCA may represent one of the riskiest projects the U.S. has ever tried to push on the international stage.

Can this project be saved?  As someone who would be more than happy to see it fail, I am not well-placed to objectively answer that question. 

What is clear is that no one - not the proponents or opponents of this law or the lawmakers and bureaucrats around the world making policy or even the average person mindlessly cheering on the "fight against tax evasion" - has any idea of what the FATCA/GATCA landscape will look in the years ahead and if it will be a deemed a great victory or a catastrophic failure. 

Perhaps both.   Because, as every experienced project manager knows, "If you don't know where you're going, any road will take you there."