One of the most far-reaching US Tax legislation, the Foreign Account Tax Compliance Act (Fatca) which has greatly impacted global financial institutions is slowly being implemented. Financial institutions all over the world are feeling its heat.
The transition grace period of light compliance deadline expired. The affected institutions that have been adopting a wait and see stance safely imagining that “Time is on their side” may easily find themselves in very hot soup, and quite unpleasant territory.
From January 1, 2017, US Treasury department through Internal Revenue Services (IRS) will start slapping withholding tax penalty to non-compliant financial institutions.
The law requires some foreign financial institutions (FFIs) like local banks to report some US persons who have bank accounts to the US tax authority.
It also requires certain non-US entities to provide information about any US owners. This law mainly aims to curb tax evasion by US persons s holding financial assets abroad directly as individuals or indirectly as corporate persons.
One of the key milestones occurred on March 31. Kenyan- based banks and hopefully some insurance companies filed their returns with the IRS.
In implementing some of the compliance milestones, some FFIs encountered several challenges. One of the key challenge emanated from the fact that some FFIs didn’t know whether they are covered by the Fatca rules.
Some institutions and especially insurance companies covered by Fatca may have missed the reporting milestone. Insurers that are obligated to make payments with respect to cash value insurance or annuities are subject to Fatca rules. The threshold of cash value payment is any amount greater than $50,000 (Sh5.1 million).
Another class of FFIs that will need to assess if they are supposed to be registered for Fatca purposes are deposit taking microfinance institutions.
Some of Kenya’s microfinance institutions are as big as tier 3 banks. They may be required to register with Fatca if they have account holders who are US persons.
Investment entities like brokers, investment banks and fund managers may not have registered for lack of clarity on their eligibility to register.
Fatca definition of FFIs is very wide since it aims to bring as many institutions as possible in the tax net. As such, there could be some Kenyan investment based institutions that may have missed the reporting deadline.
Such institutions are supposed to be Fatca compliant if they have US persons s holding investment with them.
Most of the banks if not all of them were registered and submitted their returns on time. Commercials banks stakes for being compliant are high since they directly do business with US banks through correspondent banking relationship.
Failure to register will expose them to the possibility of being shut off from the global banking system. Global banks are not willing to do business with Fatca non-compliant banks.
An additional penalty of non-compliance will result in 30 per cent withholding tax from US source of income like dividends and interest.
For instance, if we have a Kenyan investor who invests in US Treasury securities that generate interest income, that interest income will be subjected to a 30 per cent withholding tax if it’s sent to Fatca unregistered Kenyan bank from a US lender.
The slapping of the 30 per cent withholding penalty from non-compliant firms is set to become effective on January 1, 2017. This will definitely impact their profitability if they expect huge dollar inflow from the US.
The biggest challenge that banks faced was the identification of US persons . One of Fatca’s key foundation is the ability of the FFI to identify US persons who are account holders or counter parties.
The strict Fatca customer classification guidelines require firms to report on some US persons ’ account holders either directly or indirectly to the IRS.
The law requires financial institutions to sift through their database of bank accounts and identify any of their clients who have any slight US connections commonly known as US indicia. The banks are supposed to share that information with the IRS.
The definition of US persons is very wide in case of individual bank account holders. You may be a US person if you hold a US passport or you are a US permanent resident (green card holder).
Other US status indicators that financial institutions are supposed to look at are: A US residential address, a US birth place and a US telephone number.
It is worth noting that it is not necessarily true that any account that has any of these indicators are owned by a US person.
What it means is that the bank is supposed to give it a much closer scrutiny, or as some may put it, look at such accounts with a hawk’s eye. The bank is supposed to contact the customer and try to update the indicators.
For instance, a Kenyan customer who has a US telephone number can provide documentary evidence that establishes the account holder’s non-US status thus no need to be reported under Fatca.
This remediation process avoids unnecessary reporting of persons who don’t meet the definition of US persons. The deadline for FFIs to complete remediation on existing banks accounts was June 30.
The US government guidance on the role of FFIs in the identification of US persons is very clear. The foreign banks are supposed to get new customers to self-certify themselves and confirm whether or not they are US persons before they start the banking relationship.
Banks are not supposed to open a bank account without that certification. The guidance indicates that banks are supposed to close any accounts for those customers who fail to self-identify their US status.
Most of the banks are struggling to identify US person transactions from their customers’ databases.
Fatca regulation requires the financial institutions to report payments made from the start of 2013. The gruesome exercise of trying to sieve banks’ client database manually to identify US indicia may not capture all US persons indicators.
Electronic searches of clients database using commercially available software would give more accurate results.
Some financial institutions were also at a loss of how to treat a joint bank account which has one owner as a US person. Fatca requires such an account to be treated as a US person bank account and be reported.
FATCA oversight also has been an issue to most financial institutions. Just like the way Anti-Money Laundering laws require financial institutions to have Anti-Money Laundering Reporting Officer (AMLRO), Fatca requires the same institutions to have designated Fatca Responsible Officer (FRO).
The FRO is the eye of the IRS in the organisation and he/she is supposed to ensure that the institution has set up a compliance programme and to certify to the IRS that it’s being followed effectively. This is not a job to be taken lightly.
The person to be appointed as the FRO requires taxation expertise to avoid punitive action by the IRS for non-compliance. It is yet to be seen to what extent they will be held personally liable for non-compliance.
MrKiragu is finance and a compliance professional based in Canada, [email protected]