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Tuesday, February 12, 2013

Whitepaper: Impact of FATCA and FATF revised recommendations in the Middle East

Thompson Reuters - February 2013



A pdf version can be downloaded here -


Tax evasion is as widespread as tax avoidance in the Middle East. It is also not illegal in certain countries while others have zero tax regimes. When the OECD’s Financial Action Task Force (FATF) revised its 40 recommendations on combating money laundering and terrorist financing in 2012, adding serious tax crimes to the list of predicate offences, it was duly noted by the region’s authorities even if legislation did not change. But what has made Middle Eastern regulators and bankers really sit up and take notice when it comes to tax crime legislation are the looming deadlines to comply with the U.S.’ Foreign Account Tax Compliance Act (FATCA).
It is not publicly known how many Americans there are in the Middle East and North Africa (MENA) region. Or how many people in the region were born in the United States, have Green Cards, relatives in the U.S., U.S. telephone numbers or ZIP codes. Estimates indicate there are 40,000 to 50,000 American citizens in the United Arab Emirates, and 20,000 to 30,000 Americans in Lebanon, mostly dual citizens.
While reliable statistics would be useful, it will be up to MENA financial institutions to find out if clients may be liable for paying U.S. taxes. That could affect tens of thousands of people across the MENA region, or potentially hundreds of thousands. For foreign financial institutions (FFIs) to comply with FATCA it will certainly mean enhanced due diligence on thousands of account holders to find out about any connections to the U.S. Enacted in 2010, FATCA is essentially an expanded version of the U.S.’ Foreign Bank and Financial Accounts form, or FBAR, the ‘TD F90-22’ form must be completed by Americans with an aggregate of $10,000 or more in a foreign bank account at any time of a tax year. FATCA asks for similar information to FBAR but is focused on accounts above $50,000. The big difference is that unlike FBAR, which relies on individuals filing, FATCA uniquely requires FFIs to identify and report any American account holders to the Internal Revenue Service (IRS). As of 1 January, 2014, FATCA rules will impose a 30 percent withholding tax on certain payments of U.S. income to a FFI unless the institution reports specific information about U.S. Account holders. This has far reaching worldwide impact, as it applies directly to withholding agents, FFIs and non-foreign financial institutions (NFFEs).
Notably, FBAR was used by the U.S. Treasury to identify money laundering and terrorist financing under the Banking Secrecy Act, and the information was not passed on to the IRS. The motivation for FATCA is for the IRS to repatriate billions of dollars held outside the U.S. by American account holders that are evading tax. The U.S. has been cracking down on banks that have allowed Americans to evade the IRS, fining Swiss bank UBS $780 million in 2009, while in January 2012, Switzerland’s oldest bank, Wegelin, was fined $57.8 million for helping over 100 Americans evade tax on $1.2 billion in secret offshore accounts, and has since folded.
“FATCA is similar to FBAR except for one form, so it hasn’t increased the tax liabilities of American tax payers but provided increased control as there was no means to check or confirm tax declarations,” said Chahdan Jebyli, General Manager, Group Head of Legal and Compliance at Bank Audi in Lebanon. “The U.S. acquired very relevant experience from the UBS case on how taxpayers manage their tax obligations,” he added.
Middle Eastern FFIs are gearing up to be in compliance with FATCA, only too well aware that the region is in the eye of the storm when it comes to the U.S.-led fight on anti- money laundering (AML) and counter-terrorist financing (CTF), in addition to the economic sanctions slapped on Iran and Syria. What happened to the Lebanese Canadian Bank (LCB) is a case in point, which was labelled a “financial institution of prime money laundering concern” for carrying out transactions with U.S. designated terrorist organization Hezbollah and drug dealers by the U.S. Treasury’s Office of Foreign Assets Control (OFAC) in February 2011. 
The fallout resulted in LCB going under and a reevaluation of AML practices in Lebanon, one of the Middle East’s leading banking hubs with over 60 banks and $144 billion in cumulative assets as of 2012. Indeed, the LCB case followed by the U.S. sanctions on Syria has made Lebanese banks “paranoid” about falling foul of U.S. regulations, according to a senior source at the central bank, Banque du Liban (BDL). 
With two thirds of the money in Lebanon in dollars, 85 percent of loans in dollars and significant amounts of the banks’ money in U.S. bank accounts, Lebanon is a “dollar economy and has no choice” but to abide by the regulations, said Jebyli. Lebanese banks also have subsidiaries around the Middle East and Africa. “Countries, particularly Lebanon, cannot afford to swim against the international current, or want to for that matter,” added Jebyli.

Reporting issues

Over the past year MENA financial institutions have been scrambling to get themselves prepared for FATCA, with numerous conferences and summits held to discuss the best ways to be in compliance and how to report to the IRS, whether through an inter-governmental agreement (IGA) or FFI agreements directly with the IRS.
“Every bank that says it is committed to following international best practice has to automatically say, I’ll comply – it is a question of principles. We settled by applying the regulations and being committed to transparency,” said Jebyli. “The question is, what is the best way to implement FATCA? And it is very much a question of details.”
The region’s institutions have been struggling with the details as much as anywhere in the world, primarily due to the regulations not finalized until 17 January, 2013. This prompted the IRS in October 2012, to extend the deadlines for complying with certain FATCA deadlines by six to 12 months. (The certification process for new customers was January 1, 2013, now January 1, 2014; the certification process for existing customers that are intermediates was extended from the end of 2013 to June 30, 2014; the certification process for all other existing customers from December 31, 2014 to December 31, 2015; high value accounts (over $1 million) by 31 December 2014 or one year after FFI Effective Date; and controlled foreign corporations (CFCs) agreements with the IRS from July 1, 2013 to January 1, 2014.)
“The final regulations have provided some much needed clarity, and FFIs can progress confidently in establishing processes for new customer onboarding and the review of existing accounts, and in providing self- certification documentation tools to establish their customers’ tax residency,” said Laurence Kiddle, Commercial Director, FATCA, at Thomson Reuters. “At the same time there remains some areas of uncertainty – in which jurisdictions will enter into IGAs, for example, and looking into the future, to withholding on pass-thru payments and gross proceeds. But there is enough now known to get moving.”
The delays have enabled financial institutions to get more clarity on FATCA guidelines. “As the deadlines are extended it’s a good time for banks to step back and look at what the regulations are all about and the implications attached to that. Because of the evolving nature of FATCA there are definitely some areas that are challenging. For instance, gaining an understanding of the FATCA Foreign Entity classification such as participating FFI, non-participating FFI, deemed compliant FFI, and exempt FFI,” said Kauzal Rizvi, Director, Risk Consulting and Head of Department, Forensic Services at KPMG in Dubai (* caveat).“Certain guidelines require more clarification, and some countries and financial institutions are seeking it. Financial institutions need to be proactive, and engage with regulators.”
The issue is particularly pressing as to whether governments sign an IGA (Model 2) which would mean central banks would report on behalf of financial institutions to the IRS, or if it is left to the FFIs (Model 1). Either way requires a different model for reporting to the IRS on an annual basis.
The U.S. Treasury stated in November 2012, it has engaged with 50 jurisdictions to conclude and explore options on IGAs, and so far has signed bilateral agreements with the UK, Denmark, Mexico and Ireland. In the same month, the U.S. Treasury published the Model Intergovernmental Agreement for Cooperation to Facilitate the Implementation of FATCA (Model 2).
“What is the better model? It depends, the IGA model may reduce the cost element and amount of work required by institutions, and ultimately the relevant government authority would be responsible for compliance rather than individual institutions. To my understanding this seems more logical,” said Rizvi. “If more countries adopt the model of inter-governmental agreements I think it will extend to others as well, while some may wait to see what is more productive and beneficial.”
The final regulations provide more clarity on the registration process, with a registration portal to be accessible as of 15 July, 2013. The portal will allow FFIs to complete and maintain their chapter 4 registrations, agreements and certifications, including for selected group members. Model 1 FFI’s that registered are deemed-compliant FFIs. Under the IGA Model 2, ‘Reporting FI’ may register so long as the jurisdictions is on an IRS published list treated as having an IFA in effect even if the ratification has not been completed. The IRS intends to issue a Global Intermediary Identification Number (GIIN) to FFIs whose registration is approved; GIINs are to be signed no later than 15 October, 2013, according to the IRS.
On the U.S. Treasury’s list only two Middle Eastern countries were involved in negotiations, Israel for an IGA, and “exploring options” with Lebanon. In December 2012, Lebanon opted for the FFI agreement.
Elsewhere in the region reporting is still being decided, and there does not appear to be any resistance to comply with FATCA, unlike certain jurisdictions such as Hong Kong which have voiced concerns. “There is some speculation that the Gulf Cooperation Council (GCC) as a whole may look to do something multilaterally with the U.S.,” said Kiddle.
A U.S. Treasury backed FATCA symposium hosted in January by the Qatar Central Bank (QCB) for Gulf officials and financial institutions was intended to provide further information on the act and IGAs. The opening speech by the QCB governor, Sheikh Abdullah bin Saoud al-Thani, touched on the UK having signed an IGA, indicated that Qatar and other GCC countries are likely to go along with FATCA for reputational risk reasons, and ended by saying there is still a way to go to address legislative issues. Qatar itself will have to work out reporting and oversight as the country has two financial regulators – the QCB and the Qatar Financial Centre Regulatory Authority (QFCRA) – that oversee financial institutions conducting domestic business.

Lifting secrecy

Lebanon opted for FFI reporting for a number of reasons, most notably due to its banking secrecy laws and that since 2008 Beirut has been an offshore center. Lebanon’s decision may be repeated by other MENA countries that have offshore and tax free zones, while how it has handled banking secrecy in relation to FATCA will be multilaterally noted given Beirut’s role as a regional legal service provider.
“Banking secrecy presented some problems in how to handle clients, as FFIs have to report to a foreign jurisdiction, so a client could sue the bank for illegal disclosure,” said Paul Morcos, founder of law firm Justicia Beirut Consult and an adviser to Lebanese banks. “Contracts have had to be changed at banks to include an acknowledgement from the client that he accepts and recognizes FATCA regulations. It is a way to lift banking secrecy, otherwise banks will have to close the account.”
Finding out whether a client is liable to pay U.S. taxes is a prerequisite before signing a FATCA acknowledgement that could lift an account’s secrecy status. FATCA has adopted a drag net type of approach to determine any connection to the U.S. that could lead to being a tax payer – if a client is a citizen, was born in the U.S., has a Green Card, has a relative in the U.S., a U.S. phone number or ZIP code. With the first certification process deadline in 2014 requiring due diligence to be carried out on new customers, banks have to consider how to ascertain this information and what forms to use. “Banks need to look at the questions they ask - do you ask for ‘nationality’ or in the plural? If the client doesn’t declare at least you have asked the question. Whether that is regarded as an acceptable level of due diligence or not is something else, but on a $1 million account it becomes very relevant,” said Kiddle.
With Know Your customer (KYC) forms already in place for AML and CTF purposes, banks are now drawing up similar forms specific to FATCA. “It could be the same type of form as a KYC but split in two: those concerned with paying tax in the U.S. and those not concerned. Or make two separate forms. I’d opt for the double form and we are seeing banks go for this one,” said Morcos.
What will prove most cumbersome for FFIs financially and in terms of human resources is the requirement to screen intermediaries and old clients, which means thousands of accounts. “There is a big debate on the remediation exercise – how to remediate those accounts which were opened say 10 years back? This is a challenging area as has cost and resource implications,” said Rizvi.
Indeed, the incremental cost for FFIs to implement FATCA, are staggering. The European Banking Federation (EBF) and Institute of International Bankers (IIB) informed the U.S. Treasury that large institutions estimated “on a conservative basis that they will incur an incremental cost, on average, of $10 to properly identify and document each existing account for which they do not have documentation establishing non-U.S. Status.” With millions of clients, larger institutions could have incremental costs as high as $250 million. The EBF and IIB estimated the overall incremental cost to the industry of identifying and documenting existing accounts “will run at least several billion dollars.”
Getting reporting right is therefore a major concern, although complicated by the lack of clarity on certain aspects of FATCA. This extends to drawing up FATCA KYCs, to paperwork and hiring sufficient human resources. “FFIs may find staffing up difficult as there are no real FATCA experts, in the sense that no-one has been there and done it yet,” said Kiddle. “What we do know, is that FATCA is probably not the end-game; other jurisdictions will follow with similar legislation. Institutions have to do future policing – for example implementing a flexible technology framework - as they don’t want to go back and do this again, so should do the known knowns and anticipate the known unknowns.”

FATCA over FATF

Morcos calls FATCA “an extra-territorial and supra-national law,” and by complying banks are “doing the IRS a favor – for free.” However, FATCA is being taken more seriously regionally than FATF’s revised recommendations to list serious tax crimes as predicate offences. “Everyone is declaring to the IRS as they are afraid. There is a psychological impact in addition to the material impact,” said Morcos. “The IRS has earned billions of dollars already because of the psychological impact.”
Morcos added that Gulf and Arab investors in the U.S. are worried about their investments and looking to pull out, especially if American citizens or Green Card holders. Furthermore, account holders in the MENA are already looking at ways to evade FATCA and find exceptions to the regulations, whereas the same cannot be said of evading the local tax-man. “Middle Eastern banks learned and applied AML regulations 10 years ago, but now the fight against money laundering has been extended and the banks given a new role: to fight tax evasion, for the U.S. Government specifically,” said Morcos. “Banks have a role to play in fighting tax evasion but it is not on the agenda.”
MENA regulators have been slow to implement FATF ‘s revised recommendations on tax evasion. In Lebanon for instance the law has been drafted but not yet enacted by parliament. Other jurisdictions are facing set-backs to implementing an effective AML and CTF regime yet alone adopting the revised recommendations, whether due to governments being in transition following the Arab uprisings over the past two years or internal turmoil, while Syria and Iran’s central banks are under international sanctions. FATF has concerns with several MENA jurisdictions over strategic AML/CTF deficiencies, such as Iran, Syria, Yemen and Turkey, and others with lesser strategic AML/CTF deficiencies such as Algeria and Kuwait. Last year Iraq failed a Mutual Evaluation Report by FATF’s regional body, MENA-FATF. “A number of MENA countries have struggled with applying previous recommendations, and I think certain countries will not have enough support or services. We have to be mindful of the fact that most countries are members of MENA-FATF, so will be applying previous recommendations and will receive more clarity on the new ones,” said Rizvi. “There is a will at the top level – except countries with issues going on – to comply with all these requirements. But some countries will struggle from an implementation point of view; there are certain challenges for sure.”
Tax crimes and other predicate offences should be more seriously implemented. Global Financial Integrity (GFI) research published in December 2012, showed that outwards flows of illicit capital from the MENA had increased 26.32 percent from 2001 to 2010, and accounted for 10.28 percent of the $5.86 trillion the developing world lost in illicit outflows over the decade. Trade mispricing accounted for 80.1 percent of cumulative illicit outflows over the decade, while in the MENA it was 37 percent, the remainder attributed to corruption, bribery and kickbacks. One solution GFI put forward was to “harmonize predicate offenses under AML laws across all FATF cooperating countries” and “strongly enforce” regulations.


* - Note - “Kauzal Rizvi is a Director in Forensic practice of KPMG in UAE. Views expressed herein are those of Kauzal Rizvi and not necessarily those of KPMG. Due to the complex nature of the topic, professional advice must be sought in the context of specifics of each case.”

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