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Fatca requires proper due diligence of all financial accounts

When residing overseas and generating income, US citizens are required to file an annual tax return

The US is the sole major nation that imposes a tax on the income earned worldwide by its citizens and tax residents. The Philippines, North Korea, and Eritrea are the only other countries that tax the global earnings of their citizens and residents.

When residing overseas and generating income, US citizens are required to file an annual tax return with the Internal Revenue Service (IRS). Furthermore, US taxpayers with foreign accounts must disclose these accounts to the US Treasury Department.

To prevent tax evasion, the US government implemented the Foreign Account Tax Compliance Act (Fatca) in 2010. This legislation mandates that foreign financial institutions (FFIs) disclose details about financial accounts held by US taxpayers or by foreign entities in which US taxpayers have a significant ownership stake to avoid 30 per cent withholding tax on US source payments made to them.

Under the Fatca, a reportable person encompasses various categories, including US citizens or residents. Additionally, US entities that are deemed US taxpayers are also considered reportable persons under Fatca. Moreover, non-US entities that are substantially owned by US taxpayers fall within the scope of reportable persons, necessitating the disclosure of their financial accounts and assets to the IRS.

Fatca applies to a range of FFIs, including depository institutions such as banks, custodial institutions like mutual funds, investment entities like hedge funds or private equity funds, and specific types of insurance companies. These institutions are required to report information about financial accounts held by US taxpayers or by foreign entities in which US taxpayers possess a substantial ownership interest.

In general, the following categories of entities are exempt from Fatca requirements: most governmental entities, most non-profit organisations, certain small, local financial institutions, and specific retirement entities.

FFIs have the option to transmit this information either directly to the IRS by accessing their portal or through the competent authority of the relevant country where intergovernmental agreements (IGA) are established. A total of 113 jurisdictions, including China, have signed the IGA to adhere to Fatca, and the UAE is among those that have done so.

On June 17, 2015, the UAE signed an IGA with the US government (referred to as the US-UAE IGA). Acting as the competent authority, the Ministry of Finance in the UAE issued guidance regarding the UAE IGA on July 6, 2015. Within the IGA, both parties consented to the UAE gathering and sharing information about each US Reportable Account (financial account held by the US Person or non-US entity controlled by the US person) annually with the relevant US authority.

In accordance with UAE legislation, all entities operating within the UAE are required to adhere to the US-UAE IGA. These entities can be categorised as either financial institutions (FIs) and non-financial foreign entities (NFFEs).

FIs can be classified into reporting FIs and non-reporting FIs. Reporting FIs are required to identify and report information about financial accounts held by US persons (including individuals and entities). Non-reporting financial institutions are exempt from the requirement to report information about US account holders as they are deemed compliant with Fatca.

NFFEs can be divided into active NFFEs and passive NFFEs. An active NFFE is a foreign non-financial entity, which generate at least 50 per cent of its income from active sources; and hold at least 50 per cent of its assets to produce active income. A passive NFFE refers to a foreign entity that is primarily engaged in activities that generate passive income. The passive income generally includes dividends, interest, rents, royalties, and other types of income that are generally considered to be passive in nature. Only passive NFEEs are subject to Fatca requirements and are required to disclose information about their substantial US owners.

Regulated entities are supervised by their regulatory bodies. All entities under the jurisdiction of the economic department are overseen by the Federal Ministry of Economy, and all entities in free zones will be administered by the respective free zone authorities for Fatca compliance and enforcement.

Mahar Afzal is a managing partner at Kress Cooper Management Consultants. The above is not an official of Khaleej Times but an opinion of the writer. For any queries/clarifications, please feel free to contact him at mahar@kresscooper.com.