FATCA: Why Financial Institutions in Nigeria Should Care

The final Foreign Account Tax Compliance Act (FATCA) regulations issued in the United States of America on January 17, 2013, outlined far-reaching new U.S. tax compliance obligations effective January 1, 2014 and potential legal conflicts that have been frightening financial institutions in the African region.

On July 12, 2013, the U.S. Internal Revenue Service (IRS) and Treasury Department announced a delay of key timelines for the implementation of many of the FATCA provisions affecting withholding agents, foreign financial institutions and non-financial foreign entities. With Nigerian banks in early stages with respect to FATCA readiness, a deadline extension on when certain non-U.S. institutions must register with the IRS is good news for the local financial industry.

The goal of FATCA is to reduce U.S. tax evasion by enabling the IRS to obtain information regarding worldwide income of U.S. persons. The legislation came in response to a series of cases in which some banks were alleged to have helped their clients evade taxes. As a result, financial institutions around the globe face a complex and onerous compliance burden in order to meet FATCA requirements. If financial institutions or their account holders are found to be non-compliant, they will be liable for a 30% withholding tax on certain payments received after 30 June 2014, including U.S. source interest and dividends, gross proceeds from the sale of assets that produce U.S. source income, and certain non-U.S. source income.

Effectively, FATCA will require many deposit or investment-taking banks, fund managers and investment funds, and certain insurance companies in Nigeria not only to enter into an agreement or register with the IRS, but to identify all U.S. account holders and investors, treat any non-cooperating investors as “recalcitrant,” and deduct a 30% withholding tax on U.S. source income from those who fall into the recalcitrant category.

Data Confidentiality
The global financial industry raised valid questions about data confidentiality, fairness, and broad application of the regulations. Following a great deal of lobbying, foreign governments have been negotiating with the U.S. Treasury to reduce the burden and delay implementation.

As a result, to ease some of the concerns, a series of intergovernmental agreements (IGAs), which rely on governmental cooperation to facilitate the exchange of FATCA information with the U.S.,  have already been signed by Denmark, Ireland, Mexico, Norway, Switzerland, and the United Kingdom. At least 80 other countries are currently in negotiations with the U.S. authorities.

Intergovernmental Agreements
Two types of IGAs exist: the Model 1 regime and the Model 2 regime. With Model 1, financial institutions will report details to their own governments, which will pass them on to the U.S. authorities (as the IGA becomes local law). However, because the U.S. authorities will have the required information, countries in the Model 1 regime will have limited circumstances when to apply withholding tax.

Under the Model 2 regime, financial institutions will report details on U.S. accountholders directly to the IRS.

Nevertheless, the IGAs raise some issues of concern. Banks operating in different countries may have to deal with multiple sets of regulations –IGAs versus full FATCA regulations. Questions also remain about whether financial institutions should sign individual agreements with IRS in countries that have either not yet signed IGAs or have not yet put local laws in place to implement them.

How Ready Are Financial Institutions in Nigeria?
Implementation of FATCA is less than a year away and many financial institutions in Nigeria have not started preparing for FATCA, even though they are well aware of this new regulation. In South Africa, the big banks are ahead of the game in completing an impact assessment and optimising solutions, while in the rest of Africa, FATCA is slowly falling on the radar. In Europe and the Middle East, a lot of the large and global financial institutions have either already completed their FATCA impact analysis or are already in the solution design stage.

Nigerian banks will have to register with the IRS by 25 April 2014 to ensure that potentially withholdable U.S. source income will not be reduced by the 30% withholding tax beginning July 1, 2014 on incoming withholdable payments to certain recipients. Implementation of FATCA provisions will have to commence in 2014, with additional provisions being phased in through 2017.

The key issue is not whether a financial institution has U.S. clients or exposure to U.S. investments but rather whether the institution decides to be a FATCA participating financial institution or not, and the implications of this choice. Consequently, the only way to avoid FATCA requirements is to either get rid of U.S. clients or not to invest in the U.S.

Gaining Full Understanding of FATCA
Although FATCA is a U.S. law, it will undoubtedly place a hefty burden on financial institutions outside of U.S. borders. Local financial institutions should start engaging in the strategic and operational issues the law raises. Institutions need to gain a full understanding of FATCA and the effect the law will have on the current state of operations. In particular, an institution will need to consider whether or not its legal entities, business divisions and products are in scope, analyse existing customers and on-boarding processes, as well as educate both internal stakeholders and customers about the new law.

Furthermore, institutions will have to come up with plans to implement a host of other time-consuming operational tasks, including revamping certain electronic systems to capture applicable customer information and/or to accommodate the new reporting and withholding requirements.

Pain for U.S. citizens
Financial institutions are not the only ones to feel the pain of FATCA. Millions of U.S. citizens or U.S. residents abroad are being forced to either face bureaucracy/privacy invasion or reconsider their nationality. Many, if not most, do not even know about these requirements. However, they will face fines and penalties for not complying –even if they have no U.S. bank account, own no U.S. property or assets, owe no U.S. taxes and have not lived there in years, if ever. It could well be the case, that for some Nigerians, who are dual citizens of Nigeria and the U.S. and whose lives are only in Nigeria, this type of taxation reporting could prove costly, onerous or force them to give up their U.S. citizenship.

FATCA requires significant support from multidisciplinary teams across the organisation, including business operations, Information Technology, marketing, compliance and risk management, to name but a few. FATCA is unlikely to be considered a matter of choice for top tier banks and other financial institutions in Nigeria but rather a matter of necessity that is essential to continue to participate in an increasingly connected global market and have access to U.S. markets. By developing an informed and carefully planned response to FATCA now, financial institutions in Nigeria can reduce disruption to their businesses with greater compliance cost efficiency.

Report by Eugene Skrynnyk, a Senior Manager and FATCA Specialist for the Africa Sub-Area at EY, South Africa.