The IRS recently issued proposed regulations under the Foreign Account Tax Compliance Act (FATCA)1 that provide additional FATCA guidance on due diligence, withholding and reporting obligations, carve-outs and exceptions to FATCA’s applicability, and a new timeline for implementation. This advisory highlights the most relevant aspects of these proposed rules for Alston & Bird’s private fund clients. For a more detailed discussion of the FATCA proposed regulations and their potential impact across various industry segments, please consult our March 15, 2012, International Tax Advisory, “Summary of Proposed FATCA Regulations,” available online at www.alston.com/summary-of-the-proposed-fatca-regulations.
In general, the new FATCA withholding and reporting rules are designed to ensure disclosure of U.S. persons who may be attempting to evade U.S. tax by holding income-producing assets through offshore accounts. FATCA divides offshore accounts into two general categories: (i) accounts held at foreign financial institutions (FFIs) and (ii) accounts held by other non-financial foreign entities (NFFEs). The proposed regulations provide separate rules regarding due diligence, withholding, reporting and implementation deadlines depending on whether the foreign entity is an FFI or an NFFE.
Private funds employing traditional structures and strategies will generally be classified as FFIs for FATCA purposes. A fund will be treated as an FFI if (1) at least 50 percent of its gross income for the prior three-year period (or the period of its existence, if shorter) is attributable to investing, reinvesting or trading in securities, partnership interests, commodities, notional principal contracts (e.g., most swaps), insurance or annuity contracts, or financial derivative interests in these types of assets (e.g., via futures, forwards and options); or (2) the fund holds financial assets for the accounts of others as a substantial portion of its business (“substantial portion” meaning at least 20 percent of the fund’s gross income attributable to the holding of financial assets and related services for the shorter of the prior three-year period or the period of its existence). While the remainder of this summary assumes an alternative investment vehicle will be treated as an FFI, fund managers should review our more-detailed “Summary of the Proposed FATCA Regulations” document, which contains additional information on FFI and NFFE classification.2
The FATCA regime imposes a 30 percent withholding tax on “withholdable payments” made to FFIs that do not enter into “FFI Agreements.” With certain exceptions, withholdable payments are defined as payments of (i) interest, dividends, rents and other fixed or determinable annual or periodical gains, profits, and income (collectively “FDAP income”), if such payment is from U.S. sources and (ii) gross proceeds from the sale or other disposition of any property of a type that can produce interest or dividends from U.S. sources. Substantial penalties can apply to any FFI that fails to comply with its tax withholding and reporting obligations under FATCA.
To avoid this tax withholding obligation, an FFI must generally enter into an “FFI Agreement.” As part of this agreement, the “participating FFI” will be obligated to perform certain customer account due diligence, report annually to the IRS on its account holders who are U.S. persons or foreign entities with substantial U.S. ownership and, in certain cases, withhold and pay over to the IRS a 30 percent tax on “passthru payments.”3 The FFI Agreement will also require, among other things, that a participating FFI (i) adopt written policies and procedures governing its compliance with its responsibilities under the FFI Agreement; (ii) conduct periodic internal reviews of its compliance; and (iii) periodically provide the IRS with a certification and certain other information that will allow the IRS to determine whether the participating FFI has met its obligations under the FFI Agreement.
FFIs qualifying as “deemed compliant” under the proposed regulations will not be required to enter into an FFI Agreement in order to avoid FATCA’s withholding obligations. However, deemed compliant FFIs will still be obligated to collect and report certain information to the IRS to obtain and maintain their “deemed compliant” classifications. The proposed regulations divide “deemed compliant FFIs” into the following categories: “registered deemed compliant FFIs,” “certified deemed compliant FFIs” and “owner documented FFIs.” Two designations within the category of registered deemed compliant FFIs are intentionally aimed at investment funds;4 namely, the designations of “qualified collective investment vehicles” (QCIVs) and of “restricted funds.”
To be a QCIV, the fund must (i) be “regulated”5 in its country of incorporation or organization as an investment fund; (ii) the holders of the fund’s equity and debt in excess of $50,000 must be participating FFIs, other registered deemed compliant FFIs, exempt beneficial owners or certain U.S. persons (e.g., publicly traded companies, tax-exempt organizations, banks, REITs, mutual funds, broker/dealers and the U.S., state and local governments); and (iii) if the fund is part of an expanded affiliated group, all other FFIs in the group must be either participating FFIs or registered deemed compliant FFIs.
By comparison, a “restricted fund” must (i) be incorporated or organized in a FATF compliant jurisdiction and be regulated by such jurisdiction as an investment fund; (ii) interests in the fund may only be sold through certain distributors6 or redeemed directly by the fund; (iii) the fund’s documents governing the distribution of its interests must prohibit sales of such interests to U.S. persons, nonparticipating FFIs or passive NFFEs with substantial U.S. owners, and the fund’s prospectus and marketing materials must indicate such prohibition; (iv) if the fund’s distribution agreements and marketing material did not contain an explicit prohibition on the issuance of shares to U.S. entities and residents, the fund must review its preexisting accounts held directly by the ultimate beneficial owner to identify any accounts held by nonparticipating FFIs and must provide a certification to the IRS that no such accounts were identified (or if identified, that such accounts will be either redeemed or withheld and reported on as if the fund were a participating FFI); (v) prior to registering as a deemed compliant FFI, the fund must implement certain policies and procedures designed to ensure that either (a) the fund does not open or maintain an account for prohibited U.S. persons, nonparticipating FFIs or passive NFFEs with substantial U.S. owners; (b) that such an account will be closed within 90 days of the account’s opening or the date the fund had reason to know the account holder was a non-permitted U.S. person, nonparticipating FFI or passive NFFE with substantial U.S. owners; or (c) the fund will withhold and report on such account as if it were a participating FFI; and (vi) if the fund is part of an expanded affiliated group, all other FFIs in the group must be either participating FFIs or registered deemed compliant FFIs.
Important FATCA Implementation Dates
January 1, 2013
- IRS will begin accepting electronic FFI applications; and
- obligations outstanding on January 1, 2013, and gross proceeds from the sale of such obligations are “grandfathered” and not subject to FATCA.
June 30, 2013
- FFI applications submitted before June 30, 2013, will have a July 1, 2013, effective date; all other FFI applications will be effective on the date they are entered into. January 1, 2014
- FATCA withholding on U.S. source FDAP payments begins;7 and
- FFI reporting of the name of account holders and account balances begins.8