• The mother of all US legislation that is sending shockwaves through the global financial services sector is FATCA (the Foreign Account Tax Compliance Act).
• This law mainly aims to curb tax evasion by US citizens holding financial assets abroad.
• This law seeks to force non-US foreign financial entities, including banks, insurance companies and brokers, to help the US government to collect taxes from its citizens with assets abroad or non-citizens working in the US.
• This means that if a bank in Kenya is not compliant, 30 per cent of the amount being sent to that bank from a US bank will be held.

The US government has recently passed new laws with potentially far-reaching impact on the corporate world.

Whether one is talking about Sarbanes Oxley Act that was passed after the accounting scandal that led to the collapse of America’s energy giant Enron and accounting firm Arthur Andersen the pipeline for legislation targeting corporate malfeasance and economic crimes has been consistently busy.

The impact of this legislation is being felt in corporate boardrooms across the world — especially its key provisions that introduced major changes to the regulation of financial practice and corporate governance.

Yet the mother of all US legislation that is sending shockwaves through the global financial services sector is FATCA (the Foreign Account Tax Compliance Act). This law mainly aims to curb tax evasion by US citizens holding financial assets abroad.

The law requires non-US financial institutions (foreign financial institutions or FFIs) and other vehicles to report certain relevant US persons’ information to the US tax authority — the Internal Revenue Service (IRS).

Simply put, this law seeks to force non-US foreign financial entities, including banks, insurance companies and brokers, to help the US government to collect taxes from its citizens with assets abroad or non-citizens working in the US.

FATCA is now in full swing as some compliance milestones and reporting requirements have passed while others are fast approaching.

While complying with this complex US tax law is costly, the financial institutions have only one option; to comply. The penalty for non-compliance is devastating.

Failure to provide the required documentation or enter into an agreement to provide information on a US person will attract 30 per cent withholding tax on payments made to that person.

This means that if a bank in Kenya is not compliant, 30 per cent of the amount being sent to that bank from a US bank will be held.

Kenya’s financial institutions and especially banks are exposed. This is because diaspora remittances from Kenyans in North America account for more than 45 per cent of all remittances. These funds are mostly transmitted through banks.

So it is fair to assume that most, if not all, banks in Kenya have US persons account holders.

All Kenyan banks have corresponding banking arrangements with US-based banks. The only way Kenyan banks can gain access to the US financial system is through correspondence with US-based banks.

All the US dollars sent from whichever part of the world have to go through a US correspondent bank before they are routed to a local bank in Kenya. As such they are exposed and will have to comply.

The two questions that have been arising revolve around who is a US person or FFI and the reporting requirement.

As expected, the FATCA definition of a US person is very broad. The two broad categories of Kenyans who may be considered US persons are the US citizen whether residing in the US or not and US green card holders.

This means that even if you are a Kenyan with US citizenship and doesn’t reside in US, you are a US person and ought to be paying US income tax.

As a US citizen, your worldwide income is subject to US income tax, regardless of where you reside. It is worth noting that it is only US and Eritrea that base their taxation on citizenship rather than residency.

If you spend a considerable amount of time in the US every year, you may be construed to be a US person. In some instances, even having a US telephone number or correspondence address can be used as a justification of your US status. Another category of the US persons are US corporations.

The second biggest question has been the definition of the FFIs that are supposed to be registered and be doing the reporting to the IRS.

The US government has been trying to avoid local privacy laws through implantation of intergovernmental agreements (IGA).

This kind of collaboration with the local government is aimed at minimising the reporting burden on local banks. The US Treasury department gave two intergovernmental frameworks through which financial institutions can become FATCA compliant.

The first option also called Model 1 IGA may involve the Kenyan government enacting laws that require the local financial institution, say a bank, to identify and report the relevant information on US persons to the Kenya Revenue Authority (KRA).
Subsequently, the KRA will directly share that information with the US tax authority.

This would have been the most efficient compliance route because it removes the 30 per cent withholding tax exposure from Kenya’s financial institutions.

The Kenya government will also benefit since the US government will reciprocate by automatically sharing the same information with the KRA. Unfortunately, Kenya has not concluded the signing of the intergovernmental agreement with the US.

The second option, also called Model 2 IGA, requires local financial institutions or FFIs to register with the IRS and report a US person’s relevant information directly to the IRS.

The big question that will need to be clarified is which financial institutions in Kenya fall under FFIs and as such have an obligation to register and subsequently do the reporting to the IRS.

The emphasis has been so much on Kenyan banks registering with the IRS while not highlighting other financial institutions that may fall under the definition of FFIs.

The IRS has broadly defined FFIs as any non-US entities that accept deposits, custodial institutions, investment entities and specified insurance companies.

Kenyan banks fall under depository institutions and have been registering with the IRS directly after realising the government is taking time to conclude the signing of the intergovernmental agreement with the US government.

Going by the above definition, banks, investment entities, some insurance companies, brokers, custodians and trusts may be viewed as FFIs.

Entities that are in the portfolio management business like investment banks may fall into this category too. Some of them may be exempted by virtue of their size.

Kenyan investment banks that are not affiliated to deposit-taking banks may need to assess if they are FFIs as per FATCA definition.

Some insurance companies will fall under FFIs if they are obligated to make payments under cash value or annuity insurance contracts exceeding $50,000 (Sh5 million) at any time during the calendar year.

Insurance companies making payments below that threshold may be excluded from the definition of FFIs. Thus, insurance companies will have to assess if the life policies that they issue can trigger the need to be registered under FATCA.

Insurance companies that do business with US insurers may be exposed if they are FFIs and fail to register.

A scenario can occur if a US Insurance company or a broker is paying insurance premium to a local Kenyan insurance company.
If it happens, the Kenyan insurance company is not registered as an FFI, then the US insurer or broker has an obligation to withhold 30 per cent of the premium payable.

FATCA has not laid down any additional tax reporting obligations to the US persons.

They will be required to continue filing their annual tax returns with the IRS that includes their worldwide income as they have been doing.

It will become more beneficial for Kenyans who are also US persons to file their returns with the KRA and the IRS once Kenya enters into double taxation agreement with the US.

This article is not intended to be relied upon for tax advice, and concerned readers should consult their tax professional for specific advice.

Mr Kiragu is a tax expert-based in Canada