-Deloitte: FATCA compliance a challenge for financial institutions in the Middle East

19 March, 2013 – By the end of 2013 the United States’ Foreign Account Tax Compliance Act (FATCA) will require all foreign financial institutions (FFIs) to enter into disclosure compliance agreements with the U.S. Treasury. According to Deloitte, significant effort is required to meet this challenge in the Middle East while assessing and navigating the impact of FATCA requires a flexible approach grounded in solid expertise. Deloitte designed a series of workshops to help businesses in the Middle East address the developments of FATCA and prepare for them.

“FATCA is one of the most important and challenging projects for global financial institutions this year. Every CEO and Board of Directors needs to understand the legalities behind it and know where they stand. Ultimately, that is where the responsibility rests,” said Joseph el Fadl, partner in-charge of Global Financial Services Industry for Deloitte in the Middle East.

FATCA requires not only all foreign (non-US) banks but also other foreign financial institutions (mutual and hedge funds, insurance companies, trusts and Islamic finance structures) to disclose all US account holders to the US Internal Revenue Services (tax authority). The operative mechanism is that if any affected entity wants to do business with or invest in the United States, it has no choice but to comply with FATCA, irrespective of whether it has a U.S. branch, office, or other presence. Otherwise, its U.S. portfolio is subject to 30 percent tax on income as well as capital proceeds.

“We are working closely with our clients across the region to ensure full compliance with FATCA, as this is one of the most critical commercial issues currently faced by banks and financial institutions around the world. A series of deadlines have been set by the US Treasury by which various procedures need to be in place, and covers areas such as due diligence, monitoring, reporting, and withholding, Financial institutions need to put in place an effective plan to ensure that these requirements will be met,” said Humphry Hatton, Chief Executive, Deloitte Corporate Finance Limited.

In 2012 the US Treasury unveiled two models for intergovernmental agreements (IGAs) under FATCA. Recently further clarification has been provided around these two types of IGA and this has been shared by Deloitte in its series of workshops in the Middle East.

“IGA is the least worst option. It affords many benefits over the IRS direct route including the removal of the withholding requirement and it also provides a protective buffer to the domestic banking industry. Negotiating an IGA is a complex and protracted process. You need to know what to ask for, we are in discussions with banking associations and governments” said Ali Kazimi, Managing Director and Deloitte Middle East FATCA Leader.

Deloitte FATCA experts explained that Model I would require the local government to take a much wider role in FATCA enforcement. In this case FATCA regulations will not explicitly apply to financial institutions (FIs), instead the local regulations will supersede. Local legislation would therefore need to be introduced, and approved by the government. In this case FFIs will not be required to enter into agreements, and only registration will be required with the US Treasury. All FFIs within a given participating jurisdiction will be considered as being participants and all reporting will be to the local authority, who will then report information to US authorities. Such an IGA will not cover the branches and subsidiaries of the entity which are based outside of that IGA jurisdiction.

Model II IGA, which Deloitte FATCA experts clarified was introduced as an alternative for jurisdictions where Model I would not work. It would see a reduced role of the local government as each financial institution would have to enter into an agreement directly with the Internal Revenue Service (IRS). In this case non-confirming/recalcitrant accounts or accounts who have not agreed to a banking secrecy waiver would need to be reported to the local authorities, who would then share this information with the U.S.

Countries with information exchange/bilateral tax treaties with the US have been negotiating IGAs, pointed out Deloitte FATCA experts. However, the US government is considering allowing countries who do not have such treaties in place to still be able to have an IGA set-up. In recent months the total number of countries currently in discussions with the US on IGA increased from 50 to 60. According to the US Treasury there is still time for countries that have not already initiated discussions with the US Treasury on IGAs, to do so. It should be noted though, that despite discussions, it is believed that there is at present no government in the MENA region close to entering into an agreement with the IRS, therefore local banks and financial institutions need to be preparing to be subject to the full FATCA requirements.

Kazimi added that chief compliance officers, tax reporting heads, and other key players within financial institutions will need to evaluate the potential impact of these regulations and develop a plan for managing and remediating any potential risk associated with FATCA non-compliance. In some instances, in the view of Deloitte FATCA experts, there is a lack of awareness about the extent of Responsible Officer (RO) requirements, where a senior member of the FFI will certify to the IRS on behalf of the board of directors, that the FFI is compliant with the FATCA regulations to the best of their knowledge. It is possible that US tax authorities may criminally prosecute a false document case under various laws which may apply – this is clearly an area for concern and further discussions and clarifications are to be expected.

The provisions of FATCA are complex and will operate so as to make it difficult for any financial institution to operate unless it complies with the FATCA regime by registering with the IRS. Such institutions will need to do this as other US and FATCA compliant institutions may consider not to pursue further and discontinue banking operations with a non FATCA registered institution. Operationally this will mean that all financial institutions will need to enhance their customer due diligence procedures in order to capture additional data required for FATCA compliance and also modify systems to cope with the FATCA compliance requirements.