Tuesday, April 1, 2014

The Foreign Account Tax Compliance Act

FATCA stands for The Foreign Account Tax Compliance Act (“FATCA”) which was approved by the US Congress in March 2010. The law was scheduled to become effective from 1st January 2014, but the effective date has been postponed until 1st July 2014. This sweeping new law and its extraterritorial application is already influencing the behavior of Omani and other GCC banks and financial institutions and imposing structural, legal and commercial challenges on them to be compliant.

The American Congress enacted FATCA so that the Internal Revenue Service (“IRS”) could obtain information about offshore investments by US persons and thereby deter tax evasion. The FATCA tax gives the US revenue authority leverage to obtain information from foreign entities about offshore investments by US persons. Those foreign entities that do not provide the requisite information will be subject to the FATCA tax.

Obligations under FATCA Tax

FATCA requires US taxpayers having undisclosed foreign financial assets (including bank accounts) to disclose such accounts and forces Foreign Financial Institutions (“FFIs”) holding such assets to disclose details of them directly to the IRS.

Failure to report such information and disclose or comply with the reporting requirements can result in the following:

Individuals who fail to report

  1. a criminal prosecution and/or result in fines and tax penalties.
FFIs who fail to report
  1. a 30 per cent withholding tax (“FATCA tax”) levied against any US source income of the FFI such as interest, dividends, or other profits and income payable to an FFI or any gross proceeds deriving from the sale of any property including stocks that could result in such US source income.
An FFI that does not benefit by an Intergovernmental Agreement will be hit with the FATCA tax unless it becomes a ‘participating FFI’ by entering into an agreement with the US IRS pursuant to which it agrees to perform certain due diligence, reporting and withholding functions.

The definition of an FFI is intentionally very broad and encompasses a number of entities generally not considered to be financial institutions. It includes any foreign entity which accepts deposits, holds financial assets for the account of others or trades or invests in financial assets which would include foreign investment entities such as hedge funds, private equity funds and some Islamic finance instruments.

Intergovernmental Agreement (“IGA”)

The US has concluded government-to-government agreements (IGA) with a number of countries, such as Spain, UK, France, Germany and Italy, as an alternative to regular FATCA compliance for FFIs in those countries. This approach is intended to remove certain legal impediments to FATCA compliance and reduce some of the expected financial burdens of compliance for FFIs in participating countries.

Under the agreed framework, countries participating in the IGA (a ‘partner country’) would enact domestic legislation requiring FFIs in the partner country to collect information on US accounts and report it to their local tax authorities. The government of the partner country would then transmit this information to the United States.

Options of IGA Compliance

Consequently, there are two distinct types of IGAs that have been agreed between the US and various other countries:

Model 1 IGA
  1. FFIs can report directly to their own tax authorities who will provide the information to the IRS.
Model 2 IGA
  1. FFIs can report directly to the IRS.
The UAE and Qatar are the only GCC countries that are negotiating (or have negotiated) IGAs. These IGAs have not however been ratified by the countries and therefore they are not formally listed by the US Treasury as having an agreement in effect. In relation to the UAE, the Central Bank has agreed to adopt the Model 1 IGA, an agreement under which all FFIs in the Emirates will submit information about US accounts, assets or transactions to the UAE. The UAE in turn will provide the information to the IRS. Other countries with this model agreement in place include Cayman Islands, Isle of Man, Denmark, France, UK, Germany, Guernsey, Ireland, Italy, Malta and more. Model 2 IGA type agreements have been concluded with Bermuda, Japan and Switzerland.

The Capital Market Authority of Oman by Circular 2 of 2014, issued on 5th February 2014, has advised financial institutions to review their internal arrangements regarding accounts subject to FATCA. In particular, financial institutions should consider how they may do the following:
  1. Provide notice to all existing clients subject to the FATCA provisions;
  2. Seek customer consent when establishing new customer relationships; and
  3. Enhance due diligence and “Know Your Client” requirements.
Conclusion

Some banks have reportedly stopped offering certain types of accounts to US nationals citing the burdensome and costly compliance requirements as the main reasons for doing so. Account opening is already time consuming and administratively cumbersome in many GCC jurisdictions, including Oman. The cost implications of complying with FATCA reporting requirements will invariably require many institutions to have to undertake a cost benefit review of doing business with US persons. It has been reported that many FFIs are struggling to comply with the client identification and reporting requirements imposed by FATCA because their data retention systems will need to be upgraded at a cost that many local banks and financial institutions find unacceptable given the small US customer base.

FATCA is already having some ‘knock on’ effects in the market in the Gulf. Correspondent banks are already asking for the data for FATCA compliance via periodic questionnaires. Loan syndication parties are insisting on the FATCA status of the interested parties. The effect may be that non-participating FFIs will lose business opportunities. Local banks will undoubtedly have to begin FATCA training and awareness campaigns, developing FATCA policies and procedures, creating new customer on-boarding procedures from 1st July 2014, devising IT support systems for FATCA compliance, determining its impact on funds and credit card transactions and more. A recent seminar on FATCA, organised by KPMG and held under the auspices of the Executive President of the Central Bank in Oman, urged Omani financial institutions to register with both the FATCA and IRS websites to ensure compliance and to avoid the 30 per cent withholding tax.

Clearly the US will benefit from increased revenue from FATCA compliance. However, the high costs of implementation and maintenance needs to be assessed by banks in Oman and elsewhere in the GCC. While FATCA may be viewed by banks and other financial institutions as burdensome and costly at this time, it shows all the signs of becoming the benchmark for increased promulgation of banking transparency regulations – such as the recently enacted UK law with respect to UK account holders having offshore accounts.