The Foreign Account Tax Compliance Act (FATCA) is a US legislation which targets tax non-compliance by US persons in respect to their offshore assets and accounts. FATCA became law in March 2010 and will be effective at the end of this year. Under FATCA, financial institutions worldwide will be required to identify and supply the details of any US account holder. Once FATCA takes effect, financial institutions in the United Arab Emirates (UAE) will also be required to report information on financial accounts held by US persons.

Who is a US person for US tax purposes?

  1. A US citizen, including an individual born in the US but resident in another country, who has not renounced US citizenship;
  2. A tax resident of the US, including a US green card holder;
  3. A person who spends a significant number of days in the US each year;
  4. A non-US entity that is controlled by a US tax resident or US citizen;
  5. A US partnership, corporation, estate or trust.

Types of UAE financial institutions affected

FATCA will affect virtually all UAE financial institutions including banks, insurance companies, custodial institutions, hedge funds, mutual funds, superannuation funds, trustees, investment companies and managers, securitization vehicles, and private equity firms.

FATCA requirements for UAE financial institutions

The implementation of FATCA at the end of this year will require financial institutions to consider a range of commercial and practical issues which will affect their business.

  1. UAE financial institutions will be required to collect vital information to identify US persons who have invested in either non-US financial accounts or non-US entities.
  2. Financial institutions will be required to report mandatory information on US accounts to the US Internal Revenue Service.
  3. Financial institutions may also be required to withhold 30% on payments to those who refuse to declare their obligations to pay US tax.

If a UAE financial institution fails to comply with FATCA’s disclosure, reporting, and withholding requirements, it runs the risk of examination by US tax authorities or being declared “off-limits” to US businesses and banking institutions.

Key Considerations for UAE financial institutions

Becoming FATCA-ready now will allow UAE financial institutions to be in the best position possible to deal with FATCA, and to attract investors who want to invest through FATCA-designed structures. To be FATCA ready, financial institutions in the UAE should:

  1. Identify whether they will be subject to FATCA. Financial institutions must identify whether they will be subject to FATCA and if they are, prepare themselves for the implications of FATCA. Financial Institutions must continue to monitor developments including the impact under FATCA. If necessary, financial institutions must review their investment strategies of accounts that provide exposure to US sourced income or assets.
  2. Identify US account holders. Financial institutions must confirm whether their due diligence procedures are capable of identifying US persons and their internal systems are able to monitor the various disclosure thresholds provided for under FATCA. In this regard, UAE financial institutions will have to carefully review their Know Your Customer procedures to ensure compliance.
  3. Ensure any disclosure does not conflict with UAE laws. Disclosure requirements under FATCA may conflict with UAE privacy laws. Financial institutions must consider whether they will obtain the consent of US account holders before disclosing information which might contravene UAE privacy and confidentiality laws.
  4. Consider risk allocation. UAE financial institutions should consider who will bear the potential risk of FATCA withholding tax in legal documents. Financial Institutions should consider revising documentation to address risk allocation issues posed by the introduction of FATCA. In any case, it seems likely that legal documents should be amended to include representations and warranties which are aimed at providing protection to financial institutions against FATCA withholding tax.

Conclusion

FATCA is complex and challenging to say the least. However, the potential impact to financial institutions under FATCA should not and cannot be ignored. Also, if FATCA prevails, its reporting requirements will likely necessitate business systems changes that will take time to build and implement. Affected institutions should immediately determine whether the current processes are sufficient, and establish appropriate FATCA reporting systems on US account holders.

This regulatory regime is dynamic and subject to frequent changes in application and interpretation, therefore, we recommend that UAE businesses, particularly financial institutions, obtain advice on how the law will affect their UAE operations. We will continue to monitor the progress of FATCA and report on future developments.