Sanctioned jurisdictions struggling with Fatca

Barriers to entry

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Complying with the Foreign Account Tax Compliance Act (Fatca) is no easy task and time is running out for foreign financial institutions (FFIs) that may not have started on their compliance programmes.

While many FFIs will be well on their way to implementing their programmes, some are struggling to understand in what capacity they can even begin to engage with Fatca compliance. In particular, for FFIs in jurisdictions that have sanctions against them, Fatca is posing a very tricky question indeed. And, worryingly, there doesn't seem to be an easy answer.

The problem doesn't just involve FFIs headquartered in sanctioned countries. FFIs headquartered in non-sanctioned jurisdictions with subsidiaries in sanctioned jurisdictions are also asking questions as to how they can comply with Fatca.

In the Middle East and North Africa, for example, many institutions headquartered in non-sanctioned jurisdictions have subsidiaries or associates in sanctioned jurisdictions such as Syria or Sudan. This is causing such concern that in September the Union of Arab Banks wrote to the US Internal Revenue Service (IRS) to ask for clarity on this point.
"These countries are under US sanctions. The Fatca regulations do not clarify whether banking entities in such countries will be allowed to register under Fatca and to comply with the requirements under Fatca," the letter says.

It goes on to ask whether the parent company would be affected if the IRS - or the local government - did not permit its subsidiary to register under Fatca. "Would the sanctioned entities operating in a sanctioned country like Sudan and Syria be allowed to register as a limited FFI?" it asks.

This is a common concern, according to Rachel Sexton, partner in forensic investigations and compliance at KPMG UK. "Banks located in sanctioned countries like Syria and Sudan are the main ones that I've been hearing about," she says. "How are they going to be compliant with Fatca? We're talking to clients a lot about how things are going to be done under Fatca and we don't know if you can just say this one subsidiary is a non-participating FFI."

She explains that, when the draft regulations came out, they detailed that organisations should go through their corporate structure and identify the entities that have to register as a participating FFI. But the question of having an entity in a sanctioned jurisdiction means that such entities simply don't know if they can register as a participating FFI or not. "So the response to the letter from the Union of Arab Banks is really important," she says. "What comes out of that is going to determine a lot of this, so our clients are eagerly waiting to see what the US government decides."
This is because, as things stand, sanctions legislation states that the US financial system cannot be used by or made available to sanctioned countries. Allowing such jurisdictions to register as a participating FFI conflicts with this, Sexton says, as it would mean a relationship between the entity and the US. "It will be very interesting see how [the US] deals with that conflict," she adds.

Frédéric Boulier, Paris-based director of compliance for Europe, the Middle East and Africa at Nice Actimize, is less concerned about this question. "By definition the sanctioned entities will have so few ties with the US from a transaction standpoint that whether or not they comply with Fatca is irrelevant anyway," he says.

But Dan Neidle, a London-based tax partner at law firm Clifford Chance, thinks that as things stand, institutions with entities in Syria, for example, are in trouble. "If you are a Lebanese bank with operations in Syria what do you do? From how I understand Fatca works, a Lebanese bank in this situation is in serious trouble.

Iranian convolution

Another jurisdiction of interest where sanctions and Fatca compliance might clash is Iran. According to Boulier, Iran is simply off the Fatca radar. "They won't comply, they won't strike an agreement with the US IRS and they are simply just going to stay out of scope," he says. "Any clients of these institutions that may have US dollars and denominated assets or anything are simply out of scope."

But Sexton is not so sure. She says there is a complication for Iranian banks in that there are many Iranians holding dual Iranian-US citizenship. If they live in Iran they will need to report their worldwide assets and income as stated under Fatca. "If they have those accounts with a bank in Iran, how is that going to work if that's a non-participating FFI?" she asks.
Boulier says the question is academic because Fatca is not relevant to these institutions as they are not doing any transacting with the US or with respect to US dollar-denominated assets. "It doesn't mean they will ask for an exemption to the IRS, it just means that there won't be any shortcoming from a US standpoint, whatever dealings they may be doing."

And there is another element to add to the confusion. Boulier points out that not all institutions in Iran are sanctioned. The country is under an embargo and all state-owned banks are sanctioned, but that leaves a handful of non-state-owned banks that are not. "This is important to understand as these few are deemed as not necessarily that close to the powers that are sanctioned," he says. "They might have dealings with the sanctioned institutions, but I would think the local Iranian authorities would not be paying much attention to the sanctions programme."

Assuming that these non-sanctioned Iranian banks sign an agreement with the US IRS, any dealings that they have with the sanctioned institutions may well result in the 30% withholding tax under Fatca, as Dean Rowan, chief risk officer for Gulf One Bank in Bahrain, explains.
"Let's say that a dual nationality Iranian customer deals with a domestic bank in Iran (Bank 1) which in on the UN sanction list. Bank 1, as part of its normal interbank cash management, places interbank money in domestic currency with another domestic Iranian bank (Bank 2) and Bank 2 (which is a non-sanctioned bank) has 5% of its assets in US dollars. Technically the non-sanctioned Iranian bank (Bank 2) - if it is a Fatca participating bank - has two issues. First and foremost it is in breach of UN regulations, but even if there were no sanctions and Fatca was the sole question, then any interest payments and other US-denominated flows at an interbank level between the two banks would be subject to the Fatca regulations."

However, he is clear that the sanctions question comes first. "The sanctions take priority so they shouldn't be having the relationship anyhow."

Clifford Chance's Neidle believes that any non-sanctioned entity with a branch in Iran "faces serious challenges".

The sanctions and Fatca compliance question stretches to jurisdictions such as China as well. According to Sexton, a large amount of trade finance is done between China and Iran. On top of this, a lot of Chinese banks clear US dollar transactions for Iran. "Working through these things is a real conundrum," she says. "I think China will struggle with this because they continue to have dealings with Iran. They will need to work out how they will unpick that and become compliant with Fatca when they are dealing with a sanctioned country."

And China will also have to deal with the North Korea question. According to Boulier, it is generally acknowledged that the two jurisdictions have a financial relationship, meaning China may have to find a way to resolve yet another question relating to Fatca compliance and sanctions. "Chinese financial institutions have ties with North Korean financial institutions," he says. "But this again is a sanctions discussion rather than a Fatca issue."

But Sexton is not so sure. She thinks the IRS faces difficulties where sanctioned jurisdictions are concerned. "I think the sanctions question could become quite a headache for the IRS next year because they won't be able to do something that contradicts the sanctions legislation. They're going to have to find a way to work within it [where Fatca is concerned], so I'm very interested to see how they resolve the issues and what their stance is on it."

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