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Expert View: The Latest Facts On FATCA
Mike Laveman
EisnerAmper
29 January 2013
Editor’s note: The saga of how the controversial US FATCA Act (Foreign Account Tax Compliance Act) affects – or is said to be affecting – the delivery of financial services to expat US citizens has been a major talking point over the past couple of years. The exact way in which this mix of rules will affect people in different countries continues to evolve. Earlier this month, the US tax collection authority produced new rules on how FATCA is intended to work regarding entities such as investment funds. At US accounting firm EisnerAmper, one of its senior figures, Mike Laveman, has issued guidance. As ever, these views are not necessarily endorsed by this publication, which has printed them here with permission, but it is pleased to share details on this issue. Readers reactions are always welcome. To view the entire report, including tables, click here. On January 17, the Internal Revenue Service released long-awaited final regulations on the Foreign Account Tax Compliance Act. These regulations reflect the emerging prominence of Intergovernmental Agreements as a means for foreign funds and their investors to become FATCA compliant and a “risk-based” approach that attempts to balance FATCA’s policy objectives with the associated costs and burdens. We present below the key aspects of FATCA which are relevant to investment funds in 2013. How does FATCA impact investment funds? Investment funds organised outside the US - as one type of foreign financial institution or FFI - will generally have to become FATCA compliant in order to avoid 30 per cent withholding on US source FDAP (interest, dividends, etc) and gross proceeds from the sale of investments that could give rise to such US source income. A foreign fund will become FATCA compliant by either (a) entering into an FFI Agreement with the US Internal Revenue Service to perform FATCA withholding and reporting directly to the IRS or (b) complying with the requirements of the IGA in its local country and registering its status as such with the IRS. Foreign funds will have to be documented by their US withholding agents (such as prime brokers, other funds, etc) as being FATCA compliant. Both US and foreign investment funds will also have to document the FATCA status of their investors as being compliant or otherwise. There are 2 types of IGAs: Under a Model 1 IGA, the foreign fund or FFI investor reports to its local government, which then reports to the IRS on an automatic basis. The foreign fund or FFI investor must comply with registration and other requirements of the foreign country, as well as provide its US withholding agents with the amount of the FATCA withholdable income it receives that is allocatable to its investors who are not FATCA compliant. Under a Model 2 IGA, the foreign fund or FFI investor enters into an FFI Agreement with the IRS, under which it reports directly to the IRS, with such reporting supplemented by the local government reporting to the IRS information regarding certain recalcitrant account holders. To date, the IRS has signed a Model 1 Agreement with the UK, Denmark, Mexico, Ireland, Norway, and Spain, and a Model 2 Agreement with Switzerland. In addition, the IRS is in negotiations with 50 countries – including the Cayman Islands, as discussed further below – to sign other Model 1 or 2 Agreements. The final FATCA regulations refer to an entity that enters into an FFI Agreement or is covered under a Model 2 IGA as a “participating foreign financial institution”. An entity that is covered under a Model 1 or Model 2 IGA (a “Model 1 FFI” or a “Model 2 FFI”) and has registered with the IRS is referred to as a “registered deemed-compliant foreign financial institution” (RDCFFI). By what dates do funds have to document the FATCA status of their investors? 1) Investors admitted on or after 1/1/14: upon admission 2) Investors that were admitted prior to 1/1/14: · “Prima Facie FFIs” (as defined) must be documented by 7/1/14. · All others must be documented by 1/1/16. In connection with these requirements, US and foreign funds generally have to implement new account opening procedures conforming to the FATCA documentation requirements by 1/1/14 or, in the case of a foreign fund entering into an FFI Agreement, the effective date of its FFI Agreement. (An FFI Agreement entered into prior to 2014 will have an effective date of 12/31/13.) The same timelines apply for a fund itself. For example, if a foreign fund has an existing account with its US withholding agent (such as a prime broker) prior to 1/1/14, the US withholding agent will have until the dates noted above (7/1/14 if the fund is a Prima Facie FFI, 1/1/16 if it is not) to document the fund’s FATCA status. If the foreign fund opens the account on or after 1/1/14, the US withholding agent will have to document the fund’s FATCA status upon opening the account. When does FATCA withholding begin in respect of non-FATCA compliant funds and investors? Withholding on US Source FDAP (interest, dividends, etc, but not gross sales proceeds): 1) Investors admitted on or after 1/1/14: upon admission 2) Investors that are Prima Facie FFIs admitted prior to 1/1/14, whose FATCA compliant status is undocumented: 7/1/14 3) Other foreign entities admitted prior to 1/1/14, whose FATCA compliant status is undocumented: 1/1/16 4) If the FATCA status of a fund or investor has been documented as non-compliant – for example, by its furnishing to a withholding agent a Form W-8BEN-E indicating that it is a non-participating FFI – then withholding begins as of the date of that documentation, even if earlier than the dates noted above. Withholding on Gross Sales Proceeds: 1) 1/1/17 except as noted immediately below 2) Foreign entity investors who are non-compliant with FATCA and are invested in foreign funds covered under a Model 1 IGA are not subject to withholding on gross sales proceeds (as these IGAs are currently drafted). How and when will foreign funds and investors register with the IRS? The IRS FATCA Registration Portal will be accessible online no later than 7/15/13 for the following purposes: · Foreign funds will be able to enter into an FFI Agreement; the IRS and Treasury Department will publish a FATCA revenue procedure containing all terms and conditions prior to 7/15/13. · Foreign funds will be able to register as FATCA compliant pursuant to their respective countries’ IGAs. · IRS intends to issue a Global Intermediary Identification Number (GIIN) to foreign entities whose registration is approved no later than 10/15/13. A foreign fund or (foreign entity) investor will use its GIIN for satisfying its reporting obligations and to identify its status as FATCA compliant to withholding agents. · The IRS will electronically post the first list of FATCA compliant entities on 12/2/13 and intends to update this list monthly. A foreign fund or investor must register with the IRS by 10/25/13 in order to be included on the December 2013 list. If a fund has a valid pre-FATCA Form W-8 from an investor, will it have to obtain a new Form W-8 now? The IRS plans shortly to release revised Forms W-8 on which foreign funds and investors certify their FATCA status. However, in response to industry concerns that withholding agents will have to solicit these new forms within a compressed time frame, the final regulations temporarily allow continued reliance on pre-FATCA Forms W-8, to be supplemented with additional information regarding FATCA status, under certain circumstances. Six months after the IRS releases the new Forms W-8, a withholding agent cannot rely on a newly-furnished old version of FormW-8. However, the discussion here is regarding a situation in which the fund already has a valid (pre-FATCA) Form W-8 on file. What are some of the other key provisions in the final FATCA regulations which are of interest to investment funds for 2013? · Expansion of grandfathered obligations - Payment from (or the disposition of) an “obligation” (for example, a debt instrument, a derivative transaction between counter-parties under an ISDA Master Agreement, etc, but not an equity instrument) held on 1/1/14 will not be subject to FATCA withholding. - FATCA withholding applies not only to US source FDAP and gross sales proceeds from instruments that could give rise to such payments, but also to “foreign pass-thru payments”, payments that are “deemed to be attributable” to such payments (such as a Cayman Limited fund receiving US source FDAP that it immediately distributes to its investors). The IRS has not yet defined the term “foreign pass-thru payment” but has indicated that such a payment will not be subject to withholding prior to 1/1/17. The final regulations provide that any obligation executed on or before the day that is six months after future regulations define the term “pass-thru payment” will not be subject to FATCA withholding. - The IRS has yet to issue regulations regarding dividend equivalent payments under Internal Revenue Code S 871(m), which are treated as US source FDAP and generally subject to FATCA withholding. Under the final regulations, a dividend equivalent payment will not be subject to FATCA withholding if it is paid in connection with an obligation that is executed on or before six months after the date on which obligations of its type are first treated as giving rise to dividend equivalents. - Payment pursuant to an agreement requiring a secured party to make a payment with respect to, or to repay, collateral to secure a grandfathered obligation will also not be subject to FATCA withholding. · Reliance on the “eyeball test”: Funds documenting the FATCA status of entity investors that have “incorporated” or “corporation” or a similar term as part of their names will be able to rely on this in certain circumstances in lieu of obtaining Forms W-9. · PFFIs (foreign funds entering into an FFI Agreement and Model 2 FFIs) will report FATCA information to the IRS on Form 8966, FATCA Report. This form must be filed electronically by 31 March of the year following the end of the calendar year to which the report relates (an automatic 90-day extension will be available by filing Form 8809). · The final regulations provide that PFFIs will be able to report to the IRS for both 2013 and 2014 calendar years on or before 31 March 2015. · The final regulations clarify that an account held by a disregarded entity is treated as held by the person owning the entity. · Offshore fund management companies are treated as FFIs under the final regulations – consistent with their treatment under IGAs – and in order to become FATCA compliant they will have to either enter into an FFI Agreement or comply with the local country IGA. - Observation: Consideration should be given to their need to become FATCA compliant: Will they receive payments subject to FATCA withholding? Alternatively, are they part of an “expanded affiliated group” (as defined) which includes funds or other entities that need to be FATCA compliant? If so, all FFI members of the expanded affiliated group must be FATCA compliant in order for any of them to be FATCA compliant. · Private equity funds often set up a tiered entity structure with foreign entities to invest in a target company. The final regulations provide that “inter-affiliate FFIs” – members of a PFFI group which do not maintain financial accounts, hold accounts, or receive or make payments outside the expanded affiliated group- are not FFIs (and therefore may not need to be FATCA compliant). What significant FATCA developments should investment funds anticipate in 2013? · With respect to the Cayman Islands, where many funds and investors are organised, on 11/8/12 the US Treasury Department announced that it is actively engaged in a dialogue towards signing an IGA. If and when a Model 1 IGA is signed, Cayman funds and investors will be able to evaluate and definitively determine (a) if they will become FATCA compliant under that IGA (most likely), rather than entering into an FFI Agreement with the IRS and (2) what the process for Cayman Islands registration entails (which will be determined by the Cayman Islands Government) and how they will prepare for it and move forward with their FATCA action plan. · The IRS is expected to release new Forms W-8 (designed for FATCA compliance) with detailed instructions, which will enable funds to evaluate if, when, and how they will solicit them from their investors (please note our discussion further above regarding reliance on pre-FATCA Forms W-8), as well as how they will assure that they are appropriately completed and can be relied upon in accordance with the rules. · A draft of new Form 8966 and revised Forms 1042 and 1042-S are expected to be released soon. The IRS expects final versions of Form 8966 and Form 1042-S, including XML-based schemes for electronic filing, to be released later in 2013 or in early 2014. Reviewing these new forms and their instructions will provide funds with an opportunity to get a better sense of what information they will need and start thinking about the most efficient way to compile and report it.