Alternative Investment Management Association Representing the global hedge fund industry
On 12 September 2012, HM Treasury announced that the UK Government had signed an agreement with the United States to improve international tax compliance and implement FATCA. This new agreement is part of the continuing initiative to make FATCA more sensible and palatable to the non-US market and is a welcome step for investment firms already under huge time and cost pressure to incorporate new global regulatory changes.
The UK-US agreement follows the Joint Statement made on 26 July 2012 by the governments of France, Germany, Italy, Spain, the United Kingdom and the United States, announcing the publication of the Model I Intergovernmental Agreement (IGA) to implement FATCA.
The agreement has now been laid before the UK Houses of Parliament and will undergo a 21 sitting day scrutiny period as part of the ratification process. Alongside the publication of the signed IGA, HM Treasury also published on 18 September a UK consultation paper on the implementation of the agreement. Firms were given until 23 November to respond to a series of implementation questions posed in this consultation. Ultimately, the legislation will be included in the 2013 Finance bill, draft clauses of which are anticipated in early December, along with draft HMRC guidance.
The UK is clearly ahead of the pack in terms of negotiating and signing their FATCA IGA with the other G5 countries reported to be some way off concluding their own equivalent agreements.
Benefits of the IGA
HM Revenue & Customs (HMRC) has summed up the benefits of signing the IGA as follows:
· The legal barriers to compliance with FATCA, such as those related to data protection, have been addressed.
· Withholding tax will not be imposed on income received by UK financial institutions.
· UK financial institutions will not be required to withhold tax on payments they make for example to recalcitrant account holders.
· The due diligence requirements under the IGA are more closely aligned to the requirements under the existing anti-money laundering rules.
· There is a wider scope of institutions and products effectively exempt from the FATCA requirements
· HMRC will receive additional information from the US Internal Revenue Service (IRS) to enhance its own compliance activities.
The first point specifically means that information on UK investors will not be shared with the IRS unless there is evidence of them being US citizens avoiding US tax.
Impact on alternative investment managers
All very well then, but alternative investment managers could be forgiven for asking “what does this have to do with me anyway?” On the face of it, the impact of the UK/US IGA on the alternatives sector will be fairly minimal, given that funds generally reside outside of the UK. However, this has been followed by announcements from the governments of Guernsey, Jersey and the Isle of Man that they are to negotiate similar agreements with the USA, with other jurisdictions likely to follow.
This serves to apply pressure on the Cayman Islands, the dominant offshore financial centre for the alternatives sector. If Cayman does not follow the lead of the authorities in the Channel Islands in concluding an IGA of its own, its attractiveness as a fund domicile will likely suffer as a result. The threat of withholding tax, largely eliminated if a foreign financial institution’s (FFI) investors are in partner countries with an IGA in place, can only be expected to grow in importance as a factor in determining fund structures in the future.
In response to this, a FATCA task force was established in Cayman in May 2012 to evaluate the suitability of such a government-to-government reporting arrangement with the USA. At the time of writing, feedback from the task force suggested that it will continue to monitor developments such as the release of the Model 2 IGA, which is currently in development and is likely to be more suitable for smaller countries, before making a decision whether to move forwards with a similar arrangement.
The Model 2 IGA will follow the FATCA implementation approach announced in a joint statement by the US Treasury, Japan and Switzerland in June 2012. Under this approach, FFIs will be required to report information directly to the USA, as opposed to their own governmental authorities.
This means that the Model 2 IGA is likely to be suitable for other jurisdictions that are also looking at the feasibility of entering into a direct treaty with the USA. One such example, the British Virgin Islands, had flagged the increase in the administrative burden on its tax authority under the Model 1 framework as a dissuasive factor in introducing an IGA. Building the necessary systems to process information being sent by 100,000+ FFIs is a task beyond the budgetary constraints of many smaller territories that serve as fund domiciles, meaning that the release of the second model is even more keenly anticipated by the industry.
Are you (and, more importantly, your administrator) ready?
Regardless of fund jurisdiction, the readiness of fund administrators will be of paramount consideration for alternative investment managers. Because of the focus placed by FATCA on linking KYC and payments information together, the responsibilities of reporting will fall upon fund administrators in their role as transfer agents in the hedge fund industry. Consequently, FATCA-readiness has become a key factor in the administrator selection process.
Until final regulations are issued and decisions are made by respective governments as to whether or not to enter into a reporting arrangement with the USA, FFIs will have to prepare for all eventualities. This includes entering into an FFI agreement with the IRS, which would be superfluous in the event that an IGA under the Model 1 framework has been concluded.
This, as well as other uncertainties over the implementation of FATCA, gives rise to the need for greater flexibility of administrators’ systems. Administrators will not only have to be ready to report directly to the USA, but also local jurisdictions should a Model 1 IGA be implemented. There is also the need for greater adaptability in KYC information gathering processes, given that the requirements under a Model 1 IGA differ from the FATCA Proposed Regulations for new individual accounts. So currently, an administrator’s systems must be able to cater for:
· Funds with investors impacted by Model 1 IGA.
· Funds with investors impacted by Model 2 IGA.
· Funds with investors not impacted by either model but are FATCA compliant.
· Funds outside the FATCA universe completely.
Consideration must also be given to the capabilities of administrators’ systems to manage the adoption of future legislation similar to FATCA by other jurisdictions in the future. A report published in August 2012 by the UK House of Commons International Development Committee made it clear that the UK is strongly considering this, with the report also recommending that “the Government should also use its influence (via the OECD Tax and Development Task Force, and similar avenues) to persuade other governments to follow suit”. If the right groundwork is done now, the industry will be spared a real headache as other countries join the information-sharing bandwagon.
What should you do?
· Firstly, bear in mind that the discussion above has not touched on the other various global regulatory changes also occurring simultaneously, specifically the Alternative Investment Fund Managers Directive (AIFMD). The picture can get very complicated. Note also that none of these key regulations have yet been announced at a granular level, so the situation could easily change again.
· You must have strong communications with your fund’s administrator and, if necessary, consider thorough due diligence over their state of readiness.
· Ensure that responsibilities in relation to FATCA implementation, such as obtaining additional due diligence information from investors and new reporting requirements, have been properly set out to your administrator.
· Be clear of the cost implications of your administrator’s FATCA-readiness programme and how this will impact upon the fund.
· More so than ever, you must have a strong compliance/risk oversight of the administrator and be sure that issues can be resolved quickly.
· It is vital to work with your administrator to get to the right result now. Changing administrators can take 18 months to implement, so this will not be a ‘quick fix’ for potential future issues.