Americas > North America > United States > US foreign tax act in Africa

United States: US foreign tax act in Africa

2013/04/13

Following the passing of the US Foreign Account Tax Compliance Act ("FATCA") in January, compliance in Africa will be a challenge

At the same time as the US Department of the Treasury and Internal Revenue Service issued the final Foreign Account Tax Compliance Act ("FATCA") regulations in January, there was a sigh of relief that the financial services industry in Africa could begin to analyse its FATCA's obligations. However, experience and comments from the industry suggest that compliance remains a challenge.

While a variety of African jurisdictions each face unique obstacles with FATCA compliance, a lot of in the industry share a general unease with FATCA's scope, inclunding scepticism that FATCA's rewards (estimates range from $1 billion to $8 billion in additional tax revenue annually) justify its expenses. Generally, FATCA attempts to combat US tax evasion by requiring that non-US financial institutions statement the identities of US shareholders or customers, or otherwise face a 30% withholding tax on their US source gain. However, FATCA compliance obligations apply even where there is very little risk of US tax evasion and it impacts amount payers, inclunding foreign payers of “withholdable payments” made to any foreign entities affecting deposit accounts, custody and investments. With an estimated 6.3 million Americans living abroad and only 171,000 of them in Africa - while the number may be higher to include additional people that are born US but live in Africa - US taxpayers evidently make up a small percentage of total financial accounts in Africa. However the key issue for any financial institution is not how a lot of US customers it has, but rather whether it chooses to be compliant with FATCA or not. Non-compliance has critical consequences for any institution with US source gain.

Even concerns about privacy abound. FATCA requires that financial institutions statement to the IRS certain data about US persons. In some jurisdictions, investment funds and insurance companies are permitted to disclose data with client consent. In other jurisdictions, such disclosure is prohibited without further changes to domestic law. For this reason, negotiations are under way to implement FATCA on a bilateral basis via a series of “intergovernmental agreements” ("IGAs"); IGAs are being put in place so that institutions could instead statement data to their local tax authority rather than the IRS. The process to make necessary changes locally will involve time and effort.

"Deemed compliance" in Africa

FATCA contains partial exemptions (i.e. "deemed compliance") and as well exceptions for certain financial institutions that are less likely to be used by US tax evaders. It still has to be seen to what extent these exemptions have applications in Africa. For example, the regulations include an exemption for retirement funds and as well partially exempt "restricted funds" — funds that prohibit investment by U.S. persons. Although a lot of non-U.S. funds have long restricted investment by U.S. persons because of the U.S. federal securities laws, this exemption could be less useful than it prime appears. It should be pointed out that the exemption as well requires that funds be sold exclusively to limited categories of FATCA-compliant or exempt institutions and distributors. These categories are themselves difficult for African institutions to qualify for. For example, a restricted fund may sell to certain distributors who acknowledge not to sell to US persons ("restricted distributors"). But restricted distributors must operate solely in the country of their incorporation, a authentic obstacle in smaller markets such as Botswana or Namibia where a lot of distributors must operate regionally to attain scale. In order to make the exemption viable, restricted distributors should instead be permitted to operate regionally in Africa.

Other permitted distribution channels for restricted funds are "local banks," which are not allowed to have any operations outside of their jurisdiction of incorporation and may not advertise the availability of US dollar denominated investments. However, investors in Africa routinely make US dollar investments, while a number of African investment funds are either denominated in US dollars or have US dollar share classes. Chris Sickle, a Partner and leader of the Investment Management Sector for Africa at Ernst & Young adds: “South Africa is used as a gateway into Africa by a lot of investors. As investment managers, and their investment funds, are due impacted by FATCA, they as well do business with various financial institutions in the price chain, and should someone in the manager’s business model refuses to be compliant, the manager needs to review their business, and potentially disengage from some of their third parties and/or customers. Furthermore, managers may be required to carry out actions on behalf of the investment funds.”

Challenges in FATCA compliance in Africa

Financial institutions will have to consider what steps to take to prepare for FATCA compliance and take into account other FATCA obligations, such as account due diligence and withholding against non-compliant financial institutions. The core of FATCA is the process of reviewing customer records to search for "US indicia" — that is, evidence that a customer may be a US person. FATCA as well generally requires financial institutions to look at their entity customers' and counterparties' ownership to find "substantial US owners" (generally, certain US persons holding additional than 10% of an entity). In South Africa and most other nations, existing anti-money laundering legislation generally requires that financial institutions look through entities only at the same time as there is a 20% beneficial owner, leaving a gap between data that may be needed for FATCA compliance and existing procedures. Even how to transaction with non-FATCA compliant financial institutions and whether to completely disengage business ties with them, remains a concern. This may be addressed should the jurisdictions enter into an IGA.

What next for financial institutions in Africa?

Implementation of FATCA is approaching on 1 January 2014 and a lot of local financial institutions have either not started or are just at the early planning stages of addressing the potential impact of FATCA. In South Africa, only few of the leading banks and financial services groups are completing impact assessments and by presently optimizing solutions. Investment managers are only starting to tackle the assessment. Ghana, Kenya, Mauritius, Nigeria and Zimbabwe have only started engaging relevant government and industry stakeholders. In the rest of Africa, FATCA is mainly unheard of. In Europe and the Middle East, a lot of of the large and world financial institutions have completed their FATCA impact analysis and are in the design phase of what needs to change to be compliant with FATCA.

Financial institutions choosing to comply with FATCA will need to appoint a “responsible officer” for FATCA and register with the IRS, identify and categorize amount customers, and from presently on statement U.S. persons to the IRS or to local tax authorities. “Institutions will as well need to consider implementing a host of other time-consuming operational tasks, inclunding revamping certain electronic systems to capture applicable accountholder data and/or to accommodate the new reporting and withholding requirements, enhancing customer on-boarding processes, and educating both customers and staff on the new regulations. Where possible, financial institutions should seek to achieve these tasks through enhancing existing initiations so as to minimise the cost and disruption to the business,” says Mike Kane, a Partner and FATCA services leader for Africa at Ernst & Young.

Conclusion

The breadth of issues faced by the financial services industry in Africa suggests that FATCA can be implemented efficiently with necessary changes to existing local laws or equally significant accommodation from the IRS and Treasury. But the timeline for FATCA compliance remains tight — financial institutions must enter into "foreign financial institution agreements" by presently formerly the end of 2013.Inter-governmental cooperation in IGAs with African nations may not come any minute at this time enough to beat that deadline. The best approach may be for African industry groups to continue their dialogue with the IRS and Treasury, while African financial institutions start to assess the impact of FATCA on their business and prepare for compliance.

Eugene Skrynnyk is a senior manager and specialist for the investment management industry in the Africa Sub-Area at Ernst & Young in Cape Town, South Africa

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