• Foreign financial institutions must perform due diligence to identify their U.S.-owned accounts and report them to the IRS, as well as act as a withholding agent for payments to other foreign entities. Those "FFIs" that do not comply with these Foreign Account Tax Compliance Act (FATCA) requirements could face a 30% withholding tax.
  • Some FFIs will need to register with the IRS and sign a Participating FFI Agreement. The deadline has been extended from April 25, 2014 to May 5, 2014.

  1. Background and Status: The Foreign Account Tax Compliance Act ("FATCA") requires foreign financial institutions ("FFIs"), including most non-U.S. investment funds, to engage in specified due diligence procedures to identify their U.S.-owned accounts, report their U.S.-owned accounts to the Internal Revenue Service ("IRS"), and act as a withholding agent for payments to other foreign entities. If the FFIs fail to comply with FATCA requirements, beginning July 1, 2014 they may face a 30% withholding tax on certain U.S.-source payments and certain non-U.S. source payments that are made to them. FATCA also requires non-financial foreign entities ("NFFE"), under the threat of the 30% withholding tax, to identify and report certain information about their substantial U.S. owners.

U.S. payors, including investment funds, will bear an increased burden of enforcing FATCA by acting as withholding agents and withholding 30% on payments to individuals or entities that fail to provide forms establishing their FATCA compliance.

On December 26, 2013, the IRS unveiled the eagerly awaited final agreement for FFIs to sign up for direct reporting of their U.S.-owned accounts under FATCA ("Participating FFI Agreement"). The final Participating FFI Agreement is largely similar to the draft version the IRS issued in October.

Since FATCA was enacted, the U.S. has been involved in negotiating intergovernmental agreements ("IGAs") with dozens of jurisdictions. Many jurisdictions have already finalized and signed an IGA, and on November 29, 2013, the United States and the Cayman Islands signed a Model 1 IGA.

The IRS released two general versions of IGAs – Model 1 IGA and Model 2 IGA. Under Model 1 IGAs, FFIs would report the information to their own governments, which then would share the data with the IRS. In contrast, Model 2 IGAs generally provide for a version of direct reporting to the U.S. FFIs located in Model 1 IGA countries generally are required to identify U.S. accounts pursuant to due diligence rules adopted by the IGA partner country and to report specified information to the relevant governmental authorities of the IGA partner country. This information should be automatically exchanged by the IGA partner country with the IRS.Thus, in order to avoid FATCA withholding, most FFIs in Model 1 IGA countries like the Cayman Islands will be required to register with the IRS and obtain a global intermediary identification number ("GIIN"), but should not be required to enter into agreements directly with the IRS. In contrast, FFIs in Model 2 IGA countries, just like FFIs in countries without an IGA, must register and enter into an agreement with the IRS, or find an applicable exemption, to avoid FATCA withholding.

The IRS has announced that a jurisdiction will be treated as having an IGA in effect if such jurisdiction has signed an IGA or reached an agreement in substance with the IRS regarding an IGA even if the IGA has not yet been brought into force by local law. An FFI that resides in a jurisdiction with an IGA in effect can register on the FATCA registration website either as a registered deemed-compliant FFI (a "Reporting FFI") if it is required to report under a Model 1 IGA (like Cayman's) or as a participating FFI ("PFFI") if it is required to report under a Model 2 IGA.

  1. Next Steps and Required Analysis: Each fund should review its subscription documents, operating agreements, offering memoranda, vendor agreements and loan agreements to determine if they are compliant with the obligations imposed by FATCA. The subscription agreement and the operating agreement should enable the fund managers to obtain and disclose to tax authorities the documentation required under FATCA to establish the FATCA status of each payee. The operating agreement should enable the fund to withhold 30% on distributions to investors who are not FATCA compliant, expel non-compliant investors, and allocate withholding as appropriate. The offering memorandum should accurately describe the documentation required and withholding tax consequences for non-compliance. For non-U.S. funds, it may be necessary to hold a board of directors meeting to authorize any required amendments to the fund operating agreements. Vendor agreements should provide for due diligence assistance as necessary. The lending agreements should require the non-U.S. lender to supply the fund or IRS with information as to its U.S. investors and account holders and should shift the responsibility for FATCA non-compliance to the lender, and not require the fund to "gross-up" for FATCA withholding taxes resulting from the lender's failure to comply with FATCA.
  2. Compliance for Non-U.S. Funds: If you are a non-U.S. investment fund or investment adviser, it is likely that FATCA will apply to you. Therefore, you need to analyze your reporting status and obligations in preparation for the legislation coming into effect, including the following steps:
  1. Determine if there is an applicable IGA. If the entity is in a jurisdiction to which an IGA applies, then it will need to review its obligations under the IGA and the applicable local laws. Generally, under a Model 1 IGA agreement an FFI will need to report to its local authorities and will not need to report directly to the IRS. A Reporting FFI required to report under a Model 1 IGA will need to register with the IRS and obtain a GIIN.

Model 1 IGA allows entities that are listed in the Annex II of the IGA to be classified as Non-Reporting FFIs. Non-Reporting FFIs generally do not have the same due diligence and reporting obligation, and, with some limited exceptions, do not need to register with the IRS. Instead, Non-Reporting FFIs from Model 1 IGA jurisdictions will need to self-certify with withholding agents to evidence their status and avoid the imposition of the 30% withholding.

In contrast, under the Model 2 IGA the partner jurisdiction will agree to enable all relevant FFIs located in the jurisdiction to report specified information about their U.S. accounts directly to the IRS, and the FFIs in that jurisdiction will need to sign a Participating FFI Agreement with the IRS to become PFFIs.

  1. Determine if the relevant entity is an FFI, and what kind of FFI it is. Consider all entities and consider which entities are members of an expanded affiliated group ("EAG") and obtain information and monitor developments regarding IGA (if any) of the country of tax residence of each entity. FFI is a very broad definition and includes most types of investment entities. If the entity in question is an FFI, what kind of FFI is it? The regulations define the following types of FFIs: (a) a PFFI, (b) a deemed-compliant FFI (registered or unregistered), (c) a restricted distributor, (d) an exempt beneficial owner, (e) a nonparticipating FFI, and (f) a territory financial institution.

FATCA includes numerous exemptions from the definition of FFI. For example, certain holding companies, treasury centers, and captive finance companies that are part of a larger non-financial group of companies are exempt from the definition of FFI. Exemptions are also available for certain non-financial start-up companies, non-financial companies in the process of liquidation or bankruptcy, tax-exempt and charitable entities, and certain inter-affiliate FFIs whose activities are limited to transactions with other members of their PFFI affiliated group.

Other FFIs are treated as deemed-compliant FFIs to which only limited FATCA rules apply. This exemption is available for sponsored investment entities for which another entity (e.g., fund manager) agrees to take responsibility for complying with FATCA obligations. In addition, there are categories of "collective investment vehicle" and "restricted fund," as well as others, which may be available to certain investment funds and investment managers. Each category of deemed-compliant FFIs has numerous qualification requirements which need to be reviewed very closely by a qualified U.S. counsel.

  1. Determine if it is necessary to sign a Participating FFI Agreement. If an FFI qualifies as an unregistered deemed-compliant FFI, a restricted distributor, an exempt beneficial owner, a territory financial institution, or a Non-Participating FFI under an IGA then the FFI can avoid signing the Participating FFI Agreement. Otherwise, it should register and sign the Participating FFI Agreement by May 5, 2014 (recently extended from April 25) in order to avoid being subject to withholding.
  2. Register with the IRS. The FATCA registration period began on January 1, 2014. PFFIs or Reporting FFIs should begin finalizing their registration information, either on the FATCA Registration System or by paper on Form 8957. As registrations are finalized, such institutions will receive notice of registration acceptance from the IRS and will be issued GIINs. Those institutions that are FATCA compliant will be included in the IRS's "FFI List," the first of which is to be released electronically in June 2014. The list is to be updated monthly. To ensure inclusion on the June 2014 FFI List, financial institutions should finalize their registrations with the IRS by May 5, 2014. Further, the IRS believes it can ensure registering FFIs that their GIINs will be included on the July 1 IRS FFI List if their registrations are finalized by June 3, 2014.

Withholding agents, however, are not required to verify GIINs on payments made prior to January 1, 2015, where the payee is a typical FFI in a Model 1 jurisdiction such as the Cayman Islands. Accordingly, some Reporting FFIs in Model 1 jurisdictions may self-certify their status to withholding agents after July 1, 2014 to avoid FATCA withholding and could register with the IRS on or before December 22, 2014 to be included on the IRS FFI list by January 1, 2015. Consult counsel regarding any decision to wait. We encourage FFIs to register with the IRS by the May 5, 2014 deadline. While most funds subject to a Model 1 IGA are not required to provide a GIIN to a withholding agent until January 1, 2015, certain withholding agents may decide as a practical matter to withhold on any FFI that does not provide a GIIN on or after July 1, 2014 (even though the IRS has reiterated that is not required until January 1, 2015). In such situation, because withholding is not required, the FFI would be able to claim a refund or request a credit, but this would require additional actions on the part of the FFI. Accordingly, it may be prudent for an FFI in a Model 1 IGA jurisdiction to register for a GIIN by May 5, 2014. Note: The IRS has reminded withholding agents that they will have an additional 90 days to verify that the GIIN of a payee appears on the GIIN list, before they will be treated as having reason to know that the status of the payee is unreliable or incorrect.

  1. Appoint a Responsible Officer. PFFIs, Reporting FFIs, registered deemed-compliant FFIs, and other entities that need to obtain a GIIN must appoint a Responsible Officer, whose duties vary depending on the FATCA classification of the appointing financial institution. In general, a Responsible Officer will sign the Participating FFI Agreement, will oversee compliance with the Participating FFI Agreement or requirements for deemed-compliance, and will make certain periodic certifications to the IRS regarding the compliance with FATCA requirements.

The Cayman Islands government recently clarified the IGA signed between the Cayman Islands and the United States does not specifically require or envisage a Responsible Officer role. The concept of the Responsible Officer as expressed in the U.S. Treasury Regulations will not be imported into the Cayman Islands domestic legal framework.

While the Responsible Officer title is a feature of the IRS FATCA portal registration process, registration by a FFI in a Model 1 IGA jurisdiction does not invoke the US Treasury concept of a Responsible Officer. The purpose of the registration process for a Model 1 IGA FFI is to apply for a GIIN and to authorize one or more point of contacts fro the Reporting FFI.

The submission of the registration on behalf of an entity should be made by an authorized person who certified to the best of their knowledge and belief that the information is accurate and complete, and that the FFI will comply its FATCA obligations under the Cayman legislative framework.

  1. Implement due diligence procedures for new and existing customers. For PFFIs and Reporting FFIs, a due diligence program should be put in place to seek to identify direct and indirect U.S. investors and other payees. Certain Non-Reporting FFIs will also need to perform simplified due diligence procedures.
  2. Implement procedures for reporting. For PFFIs and Reporting FFIs, procedures should also be implemented so that the required information on any U.S. reportable accounts is reported within the prescribed time limits.
  1. Compliance for U.S. Funds: For U.S. funds the FATCA obligations will consist primarily of performing due diligence and acting as a withholding agent. A U.S. fund must obtain proper documentation to identify the FATCA status of each investor or lender in the fund, which will generally consist of obtaining a Form W-9 or W-8 from each investor. Under some limited circumstances, a U.S. fund may continue to rely on previously obtained forms W-9 or W-8; however, it may be more cost-effective to obtain new Forms W-9 and W-8 from all investors or lenders, rather than try to determine on a case-by-case basis whether the reliance on prior forms is permissible. If a U.S. fund is unable to document that the payee is exempt from FATCA withholding, then the U.S. fund must withhold 30 percent of U.S.-sourced payments made after June 30, 2014.

The obligations for U.S. funds with only U.S. investors are technically the same as the obligations for U.S. funds with non-U.S. investors. Nevertheless, U.S. funds with only U.S. investors will find it much easier to comply because their existing procedures should be sufficient to document the identity of their investors.

Unlike a fund organized as a foreign partnership, a U.S. fund will not provide investor forms to its U.S. withholding agents for review and reliance. Rather it is the U.S. fund itself that is responsible for FATCA withholding and that will bear any consequences for failure to withhold if its investor documentation does not conform to IRS regulations.

  1. Additional Upcoming Deadlines: The following FATCA action items have a deadline of June 30, 2014:
  1. Withholding agents will be required to begin withholding on payments with respect to obligations that are not grandfathered obligations, unless the payments can be treated as exempt.
  2. The last day outstanding obligations must be "in force" to be considered as grandfathered obligations.
  3. Withholding agents will be required to implement new account opening procedures by the later of July 1, 2014 or the effective date of the Participating FFI Agreement.

FFIs located in a jurisdiction that signed a Model 1 IGA will need to register and obtain a GIIN prior to December 22, 2014, in order ensure inclusion on the IRS FFI list on January 1, 2015.

FFIs will be required to report on March 31, 2015 with respect to the 2014 calendar year (U.S. accounts identified by December 31, 2014).

The FATCA rules are very intricate and extensive, with the final FATCA regulations consuming 543 pages.