This question has been given due consideration by a significant number of persons holding management responsibility for, or acting in an advisory capacity to, Cayman Islands registered or incorporated entities.
However, due to the extremely broad scope of what is commonly known as the Foreign Account Tax Compliance Act ("US FATCA") and its accompanying reporting and due diligence obligations as implemented in the Cayman Islands, there have been instances where management and advisors alike have mistakenly concluded that US FATCA is of no relevance to their Cayman Islands entity. It is important to note that US FATCA applies to all Cayman Islands Financial Institutions regardless of whether such entities have US based shareholders or receive US sourced income.
Pursuant to Cayman Islands domestic law1 (the "Cayman Regulations"), all Cayman Islands Reporting Financial Institutions (each, an "RFI") must make an application for registration with the US Internal Revenue Service (the "IRS") before 31 December 2014.
Following the 31 December 2014 deadline, an entity that is an RFI that has failed to register with the IRS is likely to have any future receipt of US sourced income subject to a 30% withholding by the payer under US law. In addition, failure to register may also result in financial penalties and a possible custodial sentence being imposed against the entity, its directors and/or other officers under Cayman Islands law.
With the above in mind, management and advisors to Cayman Islands entities need to carefully consider whether their Cayman Islands entity is an RFI for the purposes of US FATCA. The Cayman Regulations define an RFI as a "Financial Institution which is not a Non-Reporting Financial Institution"2. This update focuses only on whether an entity is a Financial Institution. The scope of the Non-Reporting Financial Institution definition has been considered in prior updates.
What is a "Financial Institution" for the purposes of US FATCA?
The Cayman Regulations import many of the definitions and concepts from the framework intergovernmental agreement entered into between the United States and the Cayman Islands (the "US IGA"). The term "Financial Institution" is defined in the US IGA very broadly to mean "…a Custodial Institution, a Depository Institution, an Investment Entity, or a Specified Insurance Company."
Each of the subcategories of the Financial Institution definition are then separately defined within the US IGA with further clarification on the meaning of such definitions being provided in the recently published Guidance Notes on the International Tax Compliance Requirements of the Intergovernmental Agreements between the Cayman Islands and the United States of America and the United Kingdom (the "Guidance Notes")3.
This is any entity that earns a substantial portion (at least 20%) of its gross income from the holding of financial assets for the accounts of others and from related financial services.
Related financial services include services relating directly to the holding of assets by the institution, such as clearance and settlement services, custody and account maintenance services.
Brokers, custodial banks, trust companies and clearing organisations would each typically be regarded as a Custodial Institution. The Guidance Notes confirm that insurance brokers will generally not fall within the scope of the definition as they do not hold assets on behalf of clients.
This is any entity that accepts deposits in the ordinary course of a banking or similar business. The Guidance Notes further specify that such entity must also regularly engage in one or more of the following activities:
- Provision of credit through personal, mortgage, industrial or other loans or other extensions of credit;
- Purchases, sells, discounts or negotiates of accounts receivable, instalment obligations, notes, drafts, cheques, bills of exchange, acceptances, or other evidence of indebtedness;
- Issues letters of credit and negotiates drafts drawn thereunder;
- Provides trust or fiduciary services;
- Finances foreign exchange transactions; or
- Enters into, purchases, or disposes of finance leases or leased assets.
The Guidance Notes confirm that insurance brokers will not be regarded as a Depository Institution.
The definition of Investment Entity for US FATCA purposes has received widespread publication. A copy of our prior US FATCA update discussing such definition can be viewed from the following link:
For current purposes, it is sufficient to note that the definition includes, "any entity that conducts as a business (or is managed by an entity that conducts as a business) one or more of the following activities of operations for or on behalf of a customer:
- Trading in money market instruments (cheques, bills, certificates of deposit, derivatives, etc.); foreign exchange; exchange, interest rate and index instruments; transferable securities; or commodity futures trading;
- Individual and collective portfolio management; or
- Otherwise investing, administering, or managing funds or money on behalf of other persons."
Whilst it is clear that the vast majority of investment funds (including hedge and private equity funds), administrators, investment managers and investment advisors will be picked up by such definition there are certain other less obvious types of entities that may also fall within its scope. For example, the activities of some treasury management operations within larger corporate groups may be regarded as an Investment Entity.
Specified Insurance Company
This is any entity that is an insurance company (or the holding company of an insurance company) that issues, or is obligated to make payments with respect to, a Cash Value Insurance Contract or an Annuity Contract (each such terms as defined in the US IGA).
Insurance companies that only provide general insurance or term life insurance should not be Financial Institutions under this definition and neither will reinsurance companies that only provide indemnity reinsurance contracts.
In addition to the above, it is also important that consideration be given to the potential application of the United Kingdom's own version of US FATCA ("UK FATCA"). Whilst UK FATCA does not impose a requirement to register with Her Majesty's Revenue & Customs (as with US FATCA) there is, pursuant to Cayman Islands law, the potential for penalties and a custodial sentence to be imposed for non-compliance.
UK FATCA has a similar scope and adopts similar definitions to US FATCA. We would therefore encourage management and advisors of Cayman Islands entities to have regard to both UK and US FATCA.
For further information on UK FATCA, please see our previous update which can be accessed from the following link: