Asset Management Intelligence - February 2015 - FATCA’s Major Impact on Domestic and Foreign Funds

Published: Feb 6, 2015
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The Foreign Account Tax Compliance Act (“FATCA”) is a U.S. law aimed at foreign financial institutions (“FFIs”) and other financial intermediaries to prevent tax evasion by U.S. citizens and residents through the use of offshore accounts. The FATCA provisions were included in the Hiring Incentives to Restore Employment (“HIRE”) Act, which was signed into U.S. law on March 18, 2010.

The impact of FATCA on U.S. and offshore funds is extraordinary. Almost every asset management fund will have to comply with FATCA and will either be considered a U.S. withholding agent or an FFI.

The U.S. has entered into Model 1 intergovernmental agreements (“IGAs”) (agreement between a foreign jurisdiction and the IRS) with several jurisdictions, including the Cayman Islands. Under a Model 1 IGA, investment funds must register with the IRS but will not be required to enter into an FFI Agreement. Instead, they will be obligated to comply with the local rules issued by the IGA partner country for the implementation of FATCA. Under a Model 2 IGA, an FFI Agreement is necessary and reporting is done in the U.S.

FATCA will apply in different ways to domestic and foreign funds.
Fund requirements under FATCA can be broken down into four categories: account documentation; due diligence; withholding; and registration and reporting. To the extent funds are established in the Cayman Islands, the Cayman Islands-U.S. IGA and the Guidance Notes the Cayman Islands have issued will govern the above obligations of funds.

DOMESTIC FUNDS (INCLUDING DOMESTIC FEEDERS)

To comply with FATCA, domestic funds must:

Confirm that foreign funds and other investment entities in which a fund invests are taking steps to become FATCA-compliant.
Identify U.S. withholding agents to which the fund and investors will need to provide new FATCA documentation and confirm that documentation has been provided where requested by the U.S. withholding agent. Generally, this will be the prime broker for hedge funds and portfolio companies for private equity funds.
Confirm that the fund has received affirmative confirmation that the agent will withhold in accordance with the fund’s expectations.
Confirm the fund has valid Form W-9s and W-8s for all its investors. (See discussion of forms below.)
U.S. funds are generally not required to register with the IRS. However, if a U.S. fund chooses to be a lead FFI or a sponsoring entity, or if it seeks to maintain “qualified intermediary” status with respect to its foreign branch(es) or if it has a foreign branch in a Model 1 IGA jurisdiction, it is required to register.

FOREIGN FUNDS (INCLUDING FOREIGN FEEDER FUNDS AND MASTER FUNDS)

Similarly, foreign funds need to be concerned with FATCA.

Foreign funds should have registered by now on the IRS website and have obtained a Global Intermediary Identification Number (“GIIN”). They will also have to review accounts and obtain appropriate documentation from investors. If the foreign fund has not yet registered as an FFI, it should take the necessary steps to register now.¹
Confirm who is responsible for due diligence procedures for new and pre-existing accounts. For hedge funds it will generally be the administrator or other third-party service provider. For private equity funds it may be the administrator or in-house personnel depending on the size and complexity of the fund. (See discussion on due diligence below.)
Review the rules governing the FFI depending on where it is organized (IGA or non-IGA country).
For Cayman Islands funds they will in general be governed by Cayman Island Guidance Notes. (See below.)

COMPLIANCE UNDER THE CAYMAN ISLANDS GUIDANCE NOTES

The Cayman Islands Tax Information Authority (“TIA”) issued Guidance Notes on Cayman Islands FATCA in July 2014. The TIA issued a second version on December 15, 2014 which replaces the previous version and provides additional guidance on a number of issues.

Investment managers, general partners and investment funds located in the Cayman Islands need to have arrangements in place to allow them and the funds that they operate or sponsor to comply with Cayman Islands FATCA.

Filings with the TIA begin on May 31, 2015 with respect to U.S. Reportable Accounts.² If an FFI establishes that it has no U.S. Reportable Accounts, then it must still make a nil filing with the TIA as noted above. This will be through an online portal which is yet to be released. We expect that the TIA portal will be online in the early part of the first quarter of 2015.

However, if a fund concludes that it is a reporting FFI, notification to that effect together with name classification and any GIIN must be given to the TIA by March 31 of the year in which the first report is due.

The above is a high-level summary of the actions which U.S. and foreign funds must take to become compliant with FATCA. We used the Cayman Islands as an example because of the number of funds established in the Cayman Islands and the fact that the Cayman Islands has developed guidance notes, unlike some of the other jurisdictions in which funds are located.

The above discussion is limited to FATCA compliance by funds; other U.S. tax withholding and reporting rules continue to apply.

DUE DILIGENCE

Due diligence is required for holders of pre-existing accounts and new accounts. The time frame for applying due diligence procedures is generally upon opening for new accounts and as follows for preexisting accounts.

December 31, 2014 for accounts held by “prima facie” FFIs,
June 30, 2015 for “high value” accounts, and
June 30, 2016 for all other accounts.

Preexisting accounts are:

Individual accounts opened and existing as of June 30, 2014.
Entity accounts opened and existing as of December 31, 2014.

New accounts are:

Individual accounts opened on or after July 1, 2014.
Entity accounts opened on or after January 1, 2015.

REPORTING

FATCA requires reporting of U.S. account information to the relevant tax authorities.

A fund located in a Model 1 IGA jurisdiction will have to report the information required by the IGA to the governmental authorities in that jurisdiction rather than to the IRS. Those governmental authorities will in turn report that information to the IRS.
A fund located in a Model 2 IGA jurisdiction or in a jurisdiction where there is no IGA will be required to annually report the U.S. account information directly to the IRS (Form 8866).

Note that Cayman funds subject to reporting must report by May 31 of each year starting in 2015.

FORMS

Confirm that all Form W-9s for domestic partners are valid. Note a Form W-9 does not expire but a new Form W-9 was released by the IRS in August 2013. The new Form W-9 has two new exemption codes to:

claim exemption from backup withholding if you are a U.S. exempt payee.
certify that you are exempt from FATCA reporting.

Confirm that Form W-8s for foreign partners are valid and have not expired. Generally the Form W-8 will expire 3 years after it is submitted to a withholding agent. However, the IRS has extended the term of the 2010 Form W-8s that would otherwise have expired in 2013 through December 31, 2014. If the Form W-8 has expired or is about to expire, the new Form W-8BEN for individuals and the new Form W-8BEN-E for entities should be collected by the fund.
Form W-8IMY was revised in April 2014 and is the current version of the form for use by foreign intermediaries, such as foreign partnerships and trusts. The old version (dated February 2006) can only be used through December 31, 2014. Generally Form W-8IMY is valid until the status of the person whose name is on the certificate is changed in a way relevant to the certificate or if there is a change in circumstances that makes the certificate no longer correct. The Form W-8IMY must be updated as often as necessary to enable the withholding agent to withhold at the appropriate amount.

^{1 Under transitional relief, certain non-U.S. investment funds, including Cayman Islands funds that qualify as FFIs, have been permitted to certify their status under FATCA without registering with the IRS to obtain a GIIN. As of January 1, 2015, this relief no longer applies, and, going forward, all FFIs should expect FATCA withholding agents to require withholding tax forms that include a GIIN.

2 The term “U.S. Reportable Account” means a financial account maintained by a reporting financial institution and held by one or more specified U.S. persons or by a non-U.S. entity with one or more controlling persons that is a specified U.S. person.}

Asset Management Intelligence - February 2015