Kenyans receive a significant sum of money from abroad and that number is set to grow annually. According to the Central Bank of Kenya, the country received approximately $1.3 billion in 2013 from remittances.
Approximately $630 million was received from North America and $350 million from Europe; that is close to $980 million from just two continents.
Now, imagine a worst case scenario where 30 per cent of these payments are withheld as a result of Kenyan banks not complying with the Foreign Account Tax Compliance Act (FATCA) regulations.
The FATCA regulations have been designed to counter offshore tax avoidance by US individuals and entities as well as to improve tax transparency.
The regulations were finalised and issued on January 17, 2013. The first registration deadline was May 5, 2014 and the first set of compliance requirements come into effect on July 1, 2014.
FATCA will be administered by US-based financial institutions (USFIs) and foreign financial institutions (FFIs).
In order to comply with these regulations, foreign banks will need to register and enter into an agreement either directly with the US Internal Revenue Service (IRS) or through an Intergovernmental Agreement (IGA).
Through these pacts, foreign banks agree to comply with the FATCA regulations and undertake certain obligations including customer due diligence, withholding on certain payments and reporting.
If financial institutions do not comply, they will be subject to 30 per cent withholding on certain payments from either US financial institutions or other complying Non-US financial institutions.
Given that the majority of Kenyan financial institutions have correspondent banks that are either US- based or likely to be participating FFIs, this makes FATCA a very real problem for the financial services industry.
Let’s take an example of David, a Kenyan living and working in the US who sends $1,000 to his parents back in Kenya on a regular monthly basis. David’s bank will use a correspondent bank to send money to his parents’ local bank.
While the transaction is being processed, the correspondent bank notes that the local bank is not registered for FATCA (and is effectively non-compliant) and withholds $300 (30 per cent). The local bank needs to refund the full remittance to David’s parents and as a result have to fork out the withheld $300 from its own reserves.
Financial institutions could choose to simply ignore this regulation and incur the withholding penalty. But this may have an adverse impact on a bank’s balance sheet as well as its liquidity due to the reimbursements of the 30 per cent withholding to their customers.
Non-compliance may also make it difficult to do business with other financial institutions that are compliant with FATCA.
In addition, other countries are also keen to pursue similar tax initiatives. On July 20, 2013, the G20 supported OECD proposals that would essentially transform FATCA into GATCA— a Global Account Tax Compliance Act. This is expected to come into effect in 2016.
FATCA impacts financial institutions and their customers worldwide and therefore financial institutions in Kenya need to understand the extent of the impact and what they need to do to comply — it’s not just a problem for US- based financial institutions!
FATCA in practice will impact banks, investment companies, investment or fund managers, brokers, certain insurance companies as well as affiliated financial institutions (50 per cent shareholding within a group structure).
FATCA also impacts US persons, for example an account holder or customer who is a citizen or resident of the US or an entity formed under US law.
US- owned foreign entities are also impacted. This includes any foreign entity which has one or more “substantial US owners.”
“A ‘substantial US owner” is a specified US person (individual or entity) who directly or indirectly owns more than 10 per cent (stock/interest) of a foreign entity.
With less than three months to go when the first compliance requirements kick in for new customer on boarding on July 1, 2014, financial institutions require a pragmatic, focused and cost effective approach to ensure minimum compliance and minimal operational disruption.
FATCA does allow for an intergovernmental agreement (IGA) between Kenya and the US and this could simplify certain requirements and obligations.
A co-ordinated effort is taking place between the Kenya Revenue Authority, the Central Bank and the Kenya Bankers Association; however given the short timeline to the registration deadline, financial institutions may need to register directly with the IRS before an agreed IGA is in place.
Financial institutions need to undertake an analysis of their legal entities, products and customers to determine FATCA scope and enable classification for the purposes of FATCA registration.
In addition, the financial institutions will need to consider what their FATCA governance structures will be including options for consolidated compliance groups, expanded affiliated groups and responsible officers.
This information is required for registration and is even more important for financial institutions that are present in multiple countries and/or with complex legal structures.
The next focus for financial institutions should be the first set of compliance requirements for FATCA registration and new customer on boarding.
Financial institutions should undertake an impact assessment to determine appropriate solution options; which could include manual or tactical options to start off with.
The rest of the FATCA requirements are phased in up to 2017 and financial institutions will similarly need to undertake an impact assessment to determine appropriate solution options to meet these requirements.
The writers are from the Financial Services Group at EY.