Clock ticks down on US tax compliance

Financial institutions in the UAE face challenges complying with the new legislation. But steps can be taken now to mitigate risk ahead of the deadline.

Legislation designed to ensure US citizens pay tax on international investments is looming, with potentially costly consequences. Silvia Razgova / The National

The new Foreign Account Tax Compliance Act (Fatca) introduced by the United States looks set to have a direct and profound impact on potentially thousands of foreign financial institutions (FFIs) with US investments around the world.

This could be magnified by the cascading of millions of international financial transactions flowing through global financial entities on a daily basis. But what exactly does Fatca legislation mean for the UAE in terms of scope and compliance, as we approach the looming deadline of December 31.

Fatca was enacted on March 18, 2010 with the intention of ensuring that US citizens pay the relevant US tax on their worldwide investments. It requires FFIs to sign an agreement with the US authorities and identify, classify and report details of their customers who are from the US and, in certain circumstances, withhold tax where appropriate. Both individual and corporate customers can be classified as US persons under the Fatca rules.

The incentive for FFIs to comply with Fatca is that otherwise a non-refundable 30 per cent withholding tax will be applied to US source income from January 1, 2014 and also to gross proceeds of sale of US investments from January 1, 2017.

While compliance could be burdensome, costly and may be in conflict with local laws, non-compliance is similarly risky from a funding, competitive and client-facing perspective. From a commercial standpoint, for FFIs who are dependent on raising funds in the US, there is no real choice but to comply.

As a result, before the negotiation of an intergovernmental agreement (IGA) approach, FFIs were facing an impossible position. Jurisdictional legal conflicts, which differ from country to country, meant that an FFI signing an agreement and complying with Fatca requirements would risk breaching local laws.

To date the US has entered into discussions with around 85 countries that will need to follow one of these model agreements. There is the potential that the UAE will enter into such an agreement and discussions are ongoing. While a number of differences exist in terms of the IGAs signed to date with various countries, these will ultimately be ironed out to achieve a global consistency in approach.

If the UAE enters into an IGA with the US, then FFIs will be obliged to comply with the domestic legislation introduced to implement the agreement. This effectively creates the obligation to comply with local law and an agreement helps to protect the FFI from exposure to the risk of Fatca.

In the absence of a UAE IGA at present, and given that Fatca withholding tax will be applied from January 1, there are a number of practical steps that can be taken to minimise future financial risk. Key steps include deciding who will take executive responsibility for Fatca compliance, ensuring that a project sponsor has been identified to lead the strategic decision-making process as well as consideration of the communication strategies you have in place to manage your Fatca programme.

Additional measures include ensuring your organisation has plans in place to train customer-facing teams to deal with customer inquiries, as well as conducting a thorough analysis which includes the mapping of subsidiaries and branches in other jurisdictions.

This will help to determine which compliance rules will be applicable to each business. Do you have joint venture arrangements and can you identify those subsidiaries where your ownership exceeds 50 per cent to determine who will be responsible for Fatca compliance?

It is worth considering whether any changes need to be made to terms and conditions to enable the FFI to comply with Fatca data collection, withholding tax and reporting.

Are there any strategic decisions that could be made that may help reduce the costs and risks associated with Fatca compliance, and where is the potential to "future proof" for the evolving legislative landscape, future Fatca-like laws and business change?

There are many challenges for financial institutions operating in the UAE in relation to complying with Fatca. But there lie opportunities in the coming months for organisations to mitigate risk, in terms of both the costs of compliance and the potential impact on customers, well ahead of the deadline.

Practical steps can be taken now to help mitigate risk and devise the best strategic and practical routes to compliance for FFIs. Given that Fatca withholding tax commences on US source fixed, determinable, annual or periodical payments, such as dividends and interest, from January 1, the clock is ticking for FFIs to ensure that they will be in the best position to manage the risks from that date.

Peter Somekh is office managing partner at DLA Piper Middle East