Compliance by Nigerian financial institutions with United States FATCA: caught between a rock and a hard place?

The Foreign Accounts Tax Compliance Act is a United States legislation that requires non-U.S foreign financial institutions (‘FFIs’) to identify and disclose their United States financial account holders to the US Internal Revenue Service (IRS) or otherwise be subject to a punitive 30% US withholding tax with respect to any payment of U.S-source income. Although FATCA is aimed at combating offshore tax evasion and recouping tax revenues from United States citizens, it will have a direct and profound impact on any Nigerian “financial institutions” that have U.S proprietary investments, U.S account holders or U.S financial dealings.

Who is subject to FATCA?

The ultimate goal of the legislation is for the IRS to obtain information through participating FFIs with respect to offshore financial accounts and investments beneficially owned by United States taxpayers. The legislation applies a broad definition to foreign financial institutions by including: entities that accept deposits in the ordinary course of banking or similar business; entities that as a substantial portion of their business hold financial assets for the account of others; and entities that are engaged or hold themselves out as being primarily engaged in the business of investing, re-investing or trading in securities, partnership interests, commodities or any derivative interests therein.

What are the reporting requirements under FATCA?

The expansive effect of the legislation is that it requires FFIs to make disclosures to the IRS -about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest. To properly comply with these new reporting requirements, an FFI will have to enter into a special agreement with the IRS under which it will be obligated to:

undertake certain identification and due diligence procedures with respect to its account holders; report annually to the IRS on its account holders who are U.S. persons or foreign entities with substantial U.S. ownership; and withhold and pay over to the IRS, 30% of any payments of U.S. source income, as well as gross proceeds from the sale of securities that generate U.S. source income, made to (a) non-participating FFIs, (b) recalcitrant individual accountholders or (c) recalcitrant foreign entity account holders.

How does FATCA affect Nigerian Financial Institutions? 

The financial institutions in Nigeria that, by the definition parameters of the legislation, would fall within the ambit of FATCA include banks, insurance companies, fund managers, custodial agents etc and the impact of FATCA on these institutions could manifest in the following ways:

a. the disclosure requirements under FATCA would require the adoption of new protocols and information technology separate and distinct from existing KYC and anti-money laundering procedures prescribed under local law and regulation. This would require training, expertise and investment by these financial institutions;

b.the adoption of the reporting requirements and consequently designation of a Nigerian financial institution as a participating FFI may and indeed could raise potential conflict of law issues in relation to  both local law and local regulation. For instance, data disclosure of an account holder to the IRS without the account holder’s permission may be deemed a breach of data confidentiality and integrity. Also withholding of payments by the financial institution in compliance with a foreign law may not be enforceable in Nigeria;

c.Nigerian financial institutions that fail to comply may be less competitive as the punitive 30% withholding would apply to their U.S source income. Given the dollarization of the Nigerian economy and the recent attraction of Nigerian financial institutions (particularly commercial banks) to the U.S capital markets as a source of capital raising, adherence to FATCA will be a sine qua non for accessing the U.S markets;

d.typically offshore loan agreements contain copious representations on the status of a financial institution based on parameters set by FATCA i.e. whether the institution is a FATCA Obligor or otherwise, hence non- FATCA compliant Nigerian financial institutions keen on obtaining foreign loans would face potential exposures on those loan amounts if any repayment sums are from U.S sources.

Are there alternative solutions?

Rather than having Nigerian financial institutions report directly to the IRS, the Nigerian government can enter into an inter-governmental agreement (‘IGA’) with the U.S. The U.S Treasury Department has released two models IGAs under which reporting financial institutions would be deemed to have satisfied FATCA disclosure requirements by making the requisite disclosures to their government.

 Alternatively, FFIs can structure their business to ring fence US account holders in a different incorporated entity separate from all other subsidiaries and branches.

Conclusion

The reality of FATCA means that Nigerian financial institutions would need to start to structure their affairs based on compliance or non-adherence with FATCA. For those FFIs that hold substantial amount of U.S dollars, engage in significant trade with the U.S. or otherwise want to expand their commercial relationships with the U.S, non-adherence is not an option. It is important also for the regulators -Central Bank of Nigeria and Federal Inland Revenue Service – to also rise to the occasion by thoroughly evaluating the net effect of this U.S. centric law on local financial institutions and advocating constructive solutions that would be beneficial to all parties.