FATCA Compliance Deadlines Postponed Again – Implications for Alternative Investment Industry

IN GENERAL

On July 12, 2013, the Internal Revenue Service announced that various Foreign Account Tax Compliance Act (FATCA) compliance deadlines would be postponed for six months. The original deadlines were established under the final regulations for the FATCA issued by the U.S. Treasury Department on January 17, 2013.

FATCA was enacted in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act, and is intended to improve tax compliance for financial assets held by U.S. persons in bank accounts and other financial vehicles outside the United States.

FATCA requires foreign financial institutions (FFIs) to register with the IRS and perform due diligence to identify U.S. accounts and report certain income to the IRS. An FFI that does not comply is subject to 30 percent withholding tax on most types of U.S. source investment income and the gross proceeds of sales of U.S. investment properties. To avoid withholding, FFIs that are not exempted or deemed-compliant must generally enter into FFI Agreements with the IRS. FFIs located in foreign jurisdictions that have entered into Intergovernmental Agreements (IGAs) will also be exempt from withholding. The Model 1 and 2 IGA procedures, which differ significantly, are described below.

The U.S. Treasury has published two model IGAs, referred to as the Model 1 IGA and the Model 2 IGA. In general, under the Model 1 IGA, FFIs would report information about U.S. accounts to their local government without entering into FFI Agreements. The local government, in turn, would report such information to the IRS. In contrast, under a Model 2 IGA, FFIs would be required to enter into FFI Agreements and comply with the FATCA reporting requirements as modified by the specific terms of the Model 2 IGA. FFIs that are in compliance with an applicable IGA generally will not be subject to withholding under FATCA.

As of July 15, 2013, the United States has signed Model 1 IGAs with seven jurisdictions: Spain, the United Kingdom, Denmark, Mexico, Norway, Ireland, and Germany; and the Model 2 IGAs with Switzerland and Japan. In March 2013, the Cayman Islands announced that it would enter into negotiations with the U.S. government with regards to entering into a Model 1 IGA. The British Virgin Islands, Bermuda, Luxembourg and many other countries are also in negotiations with the United States regarding IGAs.

IMPLICATIONS ON ALTERNATIVE INVESTMENT INDUSTRY

Both U.S. and non-U.S. hedge funds, private equity funds and other similar investment vehicles will have to undertake substantial work and overcome significant implementation challenges to comply with the FATCA regulations. Failure to take necessary actions could result in significant business risks.

U.S. funds will be required as U.S. Withholding Agents (USWAs) to conduct enhanced due diligence and obtain documentation with respect to their payees who receive withholdable payments. They will also be required to comply with enhanced reporting and withholding responsibilities.

Non-U.S. funds must determine if they fall under the FFI definition. The final regulations define investment entity as an entity that primarily engages in a business of trading financial products for customers, performing portfolio management, or investing, administering, or managing funds, money or financial assets on behalf of customers. As a result, investment management companies, investment advisers, general partners, professional managed investment funds, mutual funds, collective investment vehicles, exchange traded funds, or similar investment vehicles organized under a non-U.S. jurisdiction are generally considered FFIs subject to the FATCA rules. However, passive foreign entities that are not professionally managed will generally not be treated as FFIs.

Foreign holding companies and treasury centers that are formed in connection with a hedge fund, private equity fund, or any similar investment vehicle will generally be considered FFIs.

Exceptions to FFI Status

The final regulations exclude certain entities from FFI status (and thus excluded from FATCA reporting). Below are some exceptions or deemed-compliant FFI categories that are helpful to the alternative investment industry:

1. The “sponsored investment entity” deemed-compliance category applies to investment entities that have contracted with a registered sponsoring entity (e.g., an investment manager) to comply with FATCA on their behalf. This category also allows investment funds to engage third party sponsors to deal with FATCA on their behalf.
2. The “sponsored, closely held investment vehicles” category applies to an investment entity FFI that has contractual arrangements with certain sponsoring entities registered with the IRS that agree to fulfill all the sponsored FFI’s FATCA responsibilities. However, this category is limited to sponsored vehicles that have twenty or fewer individuals owning all of the debt and equity interests in the FFI.
3. The “excepted inter-affiliated FFI” category includes certain dormant entities within an FFI group with activities limited to group members.
4. The “nonreporting member of a participating FFI group” deemed-compliance category allows an FFI to transfer the U.S. accounts it identified to an affiliate. This category can be useful for private equity and hedge funds by transferring all reportable accounts to an affiliate that is a participating FFI, reporting Model 1 IGA FFI or U.S. financial institution within the group that can perform the FATCA reporting requirements.

Key Considerations For Fund Managers

To comply with FATCA, fund managers and general partners should take immediate actions including, but not limited to the following:

• Appoint a responsible officer to ensure compliance with all FATCA certifications and requirements;
• Determine the final FATCA characterization of each of their investment entities;
• Prepare to register their non-U.S. funds by April 25, 2014 in order to have the funds appear on the IRS’ first published list of FATCA compliant FFIs;
• Consider amendments to the investor onboarding process to comply with the FATCA final regulations or an applicable IGA;
• Review existing investor data and perform a gap analysis to determine what additional data needs to be collected;
• Consider the allocation of responsibilities between investment managers and their service providers;
• Consider updating critical legal documents, including fund offering documents (and more importantly, subscription documents), corporate charters or partnership agreements, and service provider agreements;
• Include provisions in the new funds’ operational and organization documents to address the FATCA requirements; and
• Identify which payments may give rise to withholding and prepare for FATCA compliance documentation.

New and Revised IRS Forms

In April 2013, the IRS issued a draft revised Form 1042 to include FATCA withholding requirements in addition to the existing withholding requirements for U.S. source interest and dividends paid to non-U.S. payees (the Chapter 3 withholding rules). In May 2013, the IRS also issued revised draft Forms W-9, W-8BEN and W-8EXP to similarly include FATCA documentation requirements. The IRS split the existing W-8BEN into two forms for claiming foreign status, beneficial ownership of income, and reduced withholding, if applicable. Form W-8BEN is for foreign individuals, who are reporting their foreign status for Chapter 3 withholding. New FormW-8BEN-E is for foreign entities under both Chapters 3 and FATCA. In August 2012, the IRS issued revised draft Form W-8IMY to include FATCA documentation requirements.

FATCA COMPLIANCE DEADLINES (AS REVISED ON JULY 12, 2013)

Notice 2013-43 issued by the IRS on July 12, 2013 postpones various FATCA compliance deadlines that were originally listed in the preamble to the FATCA final regulations issued on January 17, 2013.

As per Notice 2013-43, the FATCA registration online portal will be accessible by the financial institutions from August 19, 2013. However, the final registration submission will not be processed until after January 1, 2014. The IRS will electronically post the first IRS FFI list by June 2, 2014 and will update the list on a monthly basis thereafter. FFIs that intend to be included on the IRS’ first FFI list will need to be registered with the IRS through this online portal by April 25, 2014. The IRS will start issuing Global Intermediary Identification Numbers (GIINs) on January 1, 2014. FFIs are required to have processes and procedures in place to identify and categorize non-U.S. payees for FATCA purposes, report withholdable payments and potentially withhold 30% tax beginning July 1, 2014. Other withholding and reporting requirements will phase in from 2015 through 2018.