The Alternative Investment Management Association

Alternative Investment Management Association Representing the global hedge fund industry

Time for action on FATCA

By Michael Regan, General Counsel

Citco Fund Services

Q2 2013

Whilst the Foreign Account Tax Compliance Act (FATCA) was enacted over three years ago, the final FATCA regulations were only published by the US Treasury and IRS in January this year. This article describes some of the ways the final FATCA regulations have attempted to reduce the administrative burden of complying with FATCA and highlights some of the issues managers of private investment funds need to evaluate in 2013 to ensure timely compliance with the FATCA regulations.


Overview of FATCA

The principal goal of FATCA is to prevent tax evasion by U.S. taxpayers through the use of foreign accounts and FATCA is designed to assist the IRS in identifying foreign accounts maintained by U.S. persons. Under FATCA, a private investment fund organized in a non-US jurisdiction will generally be classified as a foreign financial institution (FFI), and, unless covered by an Intergovernmental Agreement (IGA) as described below, must enter into a compliance agreement with the IRS (FFI Agreement) to conduct due diligence on account holders, annually disclose certain information about US account holders and withhold on payments to certain non-compliant account holders. A US domiciled private investment fund is not required to enter into an FFI Agreement, but may serve as a US withholding agent under FATCA, and thus would generally be required to withhold on withholdable payments made to any foreign investor that fails to provide the US fund with required documentation. Funds which do not comply with FATCA face a 30% withholding tax on US-source interest, dividends, rents, royalties, and certain other types of fixed or determinable annual or periodic income from 1 January 2014 and on gross proceeds derived from the sale of any property that can generate U.S. source interest or dividends from 1 January 2017.



Investor due diligence

The FATCA rules require FATCA-compliant funds (“Participating FFIs”) to follow certain due diligence procedures and standards to identify US accounts. The rules set out separate due diligence procedures with respect to individual accounts and entity accounts and for pre-existing accounts and new accounts.

For pre-existing (i.e. pre-2014) individual accounts exceeding $1 million (in aggregate), the prescribed due diligence procedures require a Participating FFI to complete an electronic search for certain prescribed “US indicia” followed by a paper record search if no US indicia is found via the electronic search by 31 December 2014 and an electronic search for “US indicia” in respect of pre-existing accounts below $1 million but above $50,000 by 31 December 2015. Pre-existing entity accountholders that are prima facie FFIs will need to be identified and documented by 30 June 2014 and for other pre-existing entity accounts exceeding $1m, it will be necessary to identify non-financial foreign entities (NFFEs) with substantial US owners by 31 December 2015. In addition a fund will need to implement new FATCA-compliant investor on-boarding policies and procedures by 1 January 2014 to process subscriptions from individuals or entities who were not investors prior to 1 January 2014. For all such new investors, the Participating FFI will be required to collect completed W-9 or W-8BEN forms.

It is likely that mangers of funds will want to engage the fund’s administrator/transfer agent to perform both the due diligence on the pre-existing investor accounts and to implement the new investor on boarding procedures with effect from 1 January 2014. Whilst the earliest deadline for completion of due diligence for pre-existing investors is 31 December 2014, it is advisable for any managers who wish to engage a fund administrator or other third party to assist in performing the due diligence on pre-existing investors to formally engage such party in 2013 so there is sufficient time to both identify any problematic investor accounts and work on a solution to remediate such accounts. Given the role fund administrators perform in processing subscriptions for funds, it is critical that fund managers actively engage with their administrators well in advance of 1 January 2014 to ensure all parties understand and agree on the additional due diligence which will need to performed in respect of new investors.


Sponsored FFI reporting

Another issue which managers should evaluate in 2013 is whether they wish to register as a “sponsoring entity” in respect of the funds which they manage. To reduce some of the compliance burdens created by FATCA, the final regulations introduce the concept of “sponsoring entities” and “sponsored FFIs”. This allows a sponsoring entity such as a fund manager to agree to perform the due diligence, withholding, reporting, and other required undertakings on behalf of the funds which it manages. In such circumstances, each sponsored FFI fund, once registered with the IRS, will be treated as a “registered deemed compliant FFI” and will not have to enter into an FFI Agreement with the IRS. The advantage is that it will avoid multiple reporting in relation to investors that invest across a range of funds managed by the same fund manager. Managers who register as sponsoring entities will need to provide sponsored FFI information and obtain registration numbers for each sponsored FFI no later than 15 October 2013 to avoid FATCA withholding from 1 January 2014.



Intergovernmental Agreements (IGAs)

In recognition that foreign laws may have prevented an FFI’s ability to comply with the FATCA regulations, the US Treasury consulted with foreign governments to develop two model IGAs to facilitate the implementation of FATCA. The two model IGAs serve as the basis for concluding bilateral agreements with interested nations but the final negotiated IGAs may vary from country to country. A fund incorporated in a country which negotiates a Model I IGA with the IRS will be deemed compliant and will not be required to enter into an FFI Agreement or subject to FATCA withholding. Such funds will not be required to report information to the IRS and will instead report FATCA information to the taxing authority in their country of incorporation which authority will, in turn, share such FATCA information with the IRS. Funds formed in jurisdictions which enter into a Model II IGA will still be required to enter into an FFI Agreement with the IRS and generally must comply with the FATCA regulations and report information directly to the IRS.

The Cayman Islandsannounced on 15 March 2013 that it willenter into a Model I IGA with the IRS. This is a welcome development for managers as the Cayman Islands is the most prevalent domicile for offshore hedge funds. Managers will need to monitor the final form IGA entered into between Cayman Islands and the IRS but will be comforted in the knowledge that their Cayman funds will not need to enter into an FFI Agreement with the IRS or need to appoint an individual to act as a FATCA “responsible officer” for such funds (as described below).


Responsible officer

The FATCA Regulations do not require an annual audit of a fund to verify that the terms of an FFI Agreement entered into by a fund have been complied with. However, funds which are not formed in countries which have entered into a model I IGA with the IRS, will need to identify a responsible officer in the FATCA registration portal who will sign and verify compliance with the FFI Agreement entered into by the fund once every three years commencing with the effective date for the FFI Agreement. The responsible officer is also required to make an initial certification that, to the best of the responsible officer’s knowledge, there were no formal or informal practices or procedures in place at any time from 6 August 2011 through the date of certification that would have assisted account holders in the fund avoid FATCA withholding and reporting. Managers will need to consider which of their employees will act as responsible officer for any funds where it remains a requirement and where the manager intends to act as sponsoring entity.


Portal registration

The IRS is developing an online FATCA registration portal that will enable FFIs to enter into an FFI Agreement and facilitate communication with the IRS. The portal is expected to be operational by July 15, 2013 and, by no later than October 15, 2013, the IRS plans to assign to participating FFIs, registered deemed-compliant FFIs, and model I FFIs a newly created global intermediary identification number (GIIN) to be used for FATCA purposes. Although they are generally not otherwise required to comply with the final regulations or enter into an FFI Agreement, funds incorporated in Model I IGA jurisdictions will need to register with the IRS to obtain a GIIN.



Changes to fund documents

Managers should ensure that any new funds contain adequate FATCA provisions in the investor subscription documents, offering memoranda and organizational documents which will enable the funds to:(i) obtain the requisite FATCA due diligence information from investors; (ii) comply with FATCA disclosure and reporting rules and (iii) withhold on payments to recalcitrant or other non-compliant investors. Fund documents for new funds should also contain compulsory redemption provisions allowing the manager to redeem non-compliant investors and apportion related costs to such investors. Managers also need to review and, where necessary, amend existing fund documents so they contain similar provisions and need to consider which amendments to existing fund documents, if any, may require prior investor consent.



Whilst the final FATCA regulations and IGAs may partially reduce the administrative burden and simplify FATCA compliance for investments funds and their managers, investment funds still need to perform due diligence on pre-existing and new investors to identify and, where applicable, report US accounts. Accordingly, it is important that fund managers consider the issues identified in this article to determine as soon as practicable how they wish to ensure their funds will satisfy the reporting and compliance requirements imposed by FATCA.




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