20 Mar 2013

FATCA – IS IT AN ATTEMPT AT U.S. INTERVENTION IN THE UAE DOMESTIC BANKING REGIME?

Authored by: Lori-Ann Campbell

FATCA – IS IT AN ATTEMPT AT U.S. INTERVENTION IN THE UAE DOMESTIC BANKING REGIME

In an era of increased domestic pressure from regulators upon banks and financial institutions to become more transparent, the requirement for full due diligence upon account holders and “know your customer” checks has come under the spotlight.   The implementation of the U.S. Foreign Account Tax Compliance Act (“FATCA”) however, takes such compliance to the global stage.  In this article Lori-Ann Campbell explains the aims of FATCA and discusses its implications for the UAE.

In brief:

  • The aim of FACTA is to tackle U.S. tax evasion by either making those U.S. taxpayers having earnings on undisclosed foreign accounts, disclose such accounts voluntarily, or by forcing Foreign Financial Institutions (“FFI”) holding such accounts to disclose details of these directly to the Internal Revenue Services (IRS).
  • There is a wide array of reporting requirements for U.S. citizens and residents under FATCA ranging from individuals, corporations, trusts, partnerships and estates. The willful failure to comply can be prosecuted as a criminal offence and/or result in fines and tax penalties.
  • The UAE has yet to agree to an intergovernmental agreement with respect to the imposition of reporting requirements by UAE licensed banks and financial institutions although it has appointed a FATCA team of senior compliance heads from select banks under guidance from the Central Bank to consider FATCA and its implications.
  • Cost implications of implementing the terms of FATCA may be an additional burden on banks and financial institutions and could have an impact on internal policy decisions.

What is FATCA?

FATCA was first introduced under the benign auspices of the Hiring Incentives to Restore Employment Act, P.L.111-147 in 2010 but its implementation has been periodically postponed.  Most recent notifications from the U.S. Internal Revenue Services (“IRS”) make it effective on a phased basis from 1 January 2014. It has far reaching implications. Its aim is to tackle U.S. tax evasion by either making those U.S. taxpayers having earnings on undisclosed foreign accounts, disclose such accounts voluntarily, or by forcing Foreign Financial Institutions (“FFI”) holding such accounts to disclose details of these directly to the IRS. Failure of the FFI to disclose or comply with the reporting requirements may result in a 30% withholding tax by the IRS on FFIs U.S.-source investment income and any proceeds from sale.  Indeed not only can this 30% withholding tax be imposed on FFIs on funds due to them, but it can also be imposed upon certain customers or “Recalcitrant Account Holders” who refuse to disclose requested details or consent to a waiver of their privacy rights. The criteria to apply the withholding tax is quite wide and may be levied by the IRS against any  U.S. source interest, dividends, rents or other profits and income payable to a FFI or any gross proceeds the sale of any property, including stocks held by U.S. persons that could produce dividends or interest payable in the U.S.

A detailed review of the terms of FATCA is outside the scope of this article but in summary FATCA aims to compel FFIs (which term is widely defined to include any foreign entity that accepts deposits, holds financial assets or trades or invests in financial assets which would extend to banks, hedge funds, insurance companies and Islamic finance structures) to disclose certain details (such as name, address, taxpayers identification number) in relation to accounts holding US$50,000 or more and to annually update the IRS in relation to these with regards to withdrawals, dividends and interest payable.

There is a wide array of reporting requirements for U.S. citizens and residents under FATCA ranging from individuals, corporations, trusts, partnerships and estates. The willful failure to comply can be prosecuted as a criminal offence and/or result in fines and tax penalties. Non-financial foreign entities who are not engaged in commercial activities must also report any U.S. owner holding an interest greater than 10%.

Does FATCA apply to the UAE?

Following international discussions, intergovernmental agreements have been established between the U.S. and various countries in relation to the implementation of FATCA and two reporting models have been agreed upon. Either the FFIs can report directly to the IRS or the FFIs will report to their own government authority who will then in turn report to the IRS. No exemptions from FATCA have been contemplated for any jurisdiction. The Alternative Investment Management Association has reported in January 2013 that the U.S. is in the process of completing outreach work with all G.C.C. members with respect to the implications of FACTA.

The UAE has yet to agree to an intergovernmental agreement with respect to the imposition of reporting requirements by UAE licensed banks and financial institutions although it  has appointed a FATCA team of senior compliance heads from select banks under guidance from the Central Bank to consider FATCA and its implications.  No U.A.E. legislation promulgating FATCA has been published however potentially as a first step towards reporting compliance generally, the Ministry of Finance has been authorized by virtue of Cabinet Resolution No 17 of 2012 to “gather and exchange information and data” relating to all persons (both natural and legal) licensed to work in the UAE.

How have UAE banks reacted to the imposition of FATCA?

Within the market there appears to be a mixed reaction to FATCA. Some UAE licensed banks appear to have confirmed in the press that they have taken steps to ensure that they are compliant with the reporting requirements, whereas certain other banks have reportedly ceased offering certain accounts to U.S. 
persons, citing the costs of upgrading and maintaining compliance with regards to citizens of certain nationalities, including the U.S., as the main reason.

In practical terms the cost implications of implementing the terms of FATCA will certainly be an additional burden on banks and financial institutions where account opening is already viewed as unnecessarily cumbersome and administratively burdensome. As a result the implementation of FATCA may sway internal policy decisions to withdraw from the U.S. client market in smaller banks or financial institutions on a commercial basis where the benefits are not deemed to outweigh the costs. A recent survey published in the U.S. revealed that as of January 2013, 65% of FFIs are struggling to complete the client identification and reporting requirement imposed by FATCA due to the inadequacies of their existing internal data retention systems.  Certainly the cost of implementing and integrating IT systems to capture the FATCA required data is viewed as unnecessary additional costs to local banks and financial institutions, particularly where the overall percentage of U.S. customers are small. However the message from the U.S. is clear; banks and finance institutions must comply with FATCA or risk having 30% of payments due on any income or proceeds from their investments in U.S. financial assets withheld as a penalty.

Clearly there are benefits of FATCA for the U.S. administration. The U.S. Association of Certified Financial Crime Specialists claims FATCA is expected to raise revenues of approximately US$800 million per year for the U.S. Treasury; however, the costs of implementation are more difficult to estimate and critics argue that the implementation and maintenance costs will far outweigh the predicted revenues.

Is FATCA an intervention by the U.S. into the U.A.E. banking regime? 

At first glance FATCA appears an attempt by the U.S. of extra-territorial regulation.  Without direct implementing legislation or an intergovernmental agreement with the UAE, it is difficult to reconcile the legal grounds for the imposition of a U.S. law dictating a 30% withholding tax regime upon UAE banks, particularly where the domestic regime is absent of local withholding tax laws.
 
However FATCA cannot be so easily dismissed as merely a U.S. tax compliance process.  At a micro level commentators note that FATCA benefits the banking system as it marks the first positive step towards true transparency of accountholders and the detailed reporting requirements under FATCA can be useful as a basis for FFIs in developing and upgrading their existing internal anti-money laundering policies.

At a macro level, it would appear that FATCA, although widely objected to initially, may become the benchmark or framework for similar reporting regimes internationally. The UK has already adopted a similar type arrangement with respect to UK accountholders having offshore accounts.  As of 19 February 2013 the UK entered into an intergovernmental agreement with the Isle of Man with respect to the disclosure of information on UK tax payers annually to the UK taxing authority. With similar reporting legislation currently being discussed in Germany, France and Italy, it appears that like it or not, FATCA has paved the way towards increased global banking transparency.

This article, including any advice, commentary or recommendation herein, is provided on a complimentary basis without consideration of any specific objectives, circumstances or facts. It reflects the views of the writer which may, in some cases, differ from those of the firm, especially in the develop jurisdiction of the UAE.