The Foreign Account Tax Compliance Act imposes registration and reporting and obligations on hedge funds, due to come into effect in just over three months, says Kathleen Celoria

What is Fatca and how does it impact me? The Foreign Account Tax Compliance Act (Fatca) is a new US Treasury regulation that takes effect this July. Allowing the Internal Revenue Service (IRS) to collect financial account information on US citizens living outside of the country, Fatca requires foreign financial institutions (FFIs) to report on these foreign account balances, gross proceeds and dividends.

To ensure that no one escapes the broad arms of the law, the IRS also requires FFIs to provide information on recalcitrant account holders – those account holders who may be found to be US taxable earners with a little digging. Non-participating financial institutions (NPFIs) – those institutions that aren’t playing ball with the IRS’ new Facta regime – will also be documented and reported.

This means that foreign depositories, custodians and investment entities will be required to lift the veil. The IRS will now have a bird’s eye view into not only US citizens’ foreign accounts but also foreign accounts held by those who could possibly be US-taxable parties. The Congressional Research Service produced a report on international tax avoidance and evasion in 2013, stating that tax losses to the US amount to $1 trillion over a decade and the IRS intends to get that back. The IRS believes that Fatca will expose tax evasion by the wealthy – those accounts with more than $50,000.

What does Fatca mean to US and FFIs? Fatca not only impacts FFIs but also their US counterparties. With the entire focus of Fatca being locating unreported taxable income and retrieving it, a withholding requirement will be expected from US institutions such as banks or prime brokers that do business with FFIs. Starting in July, US counterparties will have their own set of responsibilities to comply with their IRS obligations.

Fatca supplements the existing US withholding regimes that apply to US financial institutions. A new requirement to withhold 30% on certain US source payments to non-compliant FFIs means these counterparties will find themselves acting as informal agents of the IRS. Where and how is Fatca being implemented? The long arms of the law reach around the globe. Any international jurisdiction wanting to remain in good favour with the US has signed or will sign an intergovernmental agreement (IGA) with the US government.

Fatca IGAs are a welcomed addition for FFIs in partner jurisdictions. They help FFIs streamline compliance with Fatca procedures, stretch out some deadlines and layer local regulation and reporting. Additionally, a reduction in withholding requirements and some clearer definitions can usually be found in an IGA’s Annex II.

Cayman – as well as many other popular offshore markets – has opted for the Model 1 IGA. FFIs in Model 1 IGA jurisdictions will register the FFI with the IRS and then report to the local tax authority in which the FFI operates, whereas FFIs in Model 2 IGA jurisdictions will not only register but also report directly to the IRS.

In the absence of an IGA, FFIs wanting to remain in good grace with the US government will take on the burden of full Fatca compliance with no local easing.

How will Fatca be implemented for an FFI in terms of registration? To register, the FFI must authorise a director or officer who will ensure Fatca obligations are met. This Fatca-responsible officer (FRO) certifies to the IRS that they will ensure the FFI becomes and remains compliant.

To jump-start the process, the FRO will register the FFI online through an IRS portal and obtain a unique global intermediary identification number (Giin). Giins will be provided to counterparties as of July 1 for the FFI to prove they have accepted their Fatca obligations and that the counterparty has no need to withhold any of the payment as a corrective measure.

Registration is critical because prime brokers and others that the IRS will have act as withholding agents do not want to be found failing to withhold on a FFI that is not compliant with Fatca. From some counterparties’ perspectives, an FFI’s Giin is the only assurance that the FFI is deemed compliant.

In fact, industry research conducted through the recent DMS/SEI Fatca Readiness Survey found that half of the investment managers who responded have already spoken with their prime brokers about Fatca requirements. Nearly 80% of these reported that their prime brokers have advised they will require FFIs to provide their Giin as of July 1, 2014 even for FFIs established in a “Model 1 IGA” jurisdiction.

How will an FFI make Fatca reports? All of the work registering the FFI and implementing a compliance programme is required to prepare for accurate reporting. By allowing the IRS to cross-reference its records with newly obtained international account information, tax evasion will be revealed and penalties will ensue.

Depending on the FFI domicile, registered deemed-compliant FFIs will be required to report either to their domestic tax authority or to the IRS directly. Either way, the information will find its way home to the IRS. Should the IRS or local tax authority have queries and take enforcement action, the FRO will take the lead with resolving.

IRS draft Form 8966 or some modified version of it will be submitted for each account holder starting in 2015. This will give the IRS information on the account number, currency code, balance, interest, dividends and gross proceeds of account holders This information will be required not only for accounts owned by a US person, but also for errants.

What does it take for an FFI to establish a Fatca compliance programme? Establishing and executing a Fatca compliance programme takes time and money but is necessary to ensure an FFI meets its ongoing compliance obligations.

To set up for success, the FFI will go back and review pre-2014 account holders and classify them into categories such as US specified persons, recalcitrant account holders and NPFIs. Reviewing current documentation, enquiries to relationship managers and conducting electronic searches for US indications – looking for things like green cards, birthplaces, addresses, standing instructions for transfer of funds and others that may trigger paying US taxes – help the FFI ensure that accurate records are in place and account holders are appropriately classified. This due diligence is often referred to as the ‘heavy lifting’ of FFI Fatca preparations.

If necessary, the FFI will need to take remedial action where there are documentation gaps and questions. Know-your-client processes will be followed to ensure updated tax documents, such as W8s and W9s, are on file. Where the status of the account holder cannot be confirmed, the FFI will ultimately cut the account.

Who is going to be the FRO and what are they signing up for? The FRO is a specialised role that carries new responsibilities, oversight and risks. Taking responsibility for establishing an effective Fatca compliance programme and communicating with FFI operators, staff and relevant service providers are among the first tasks the FRO faces. But the obligation does not end there. The FRO will monitor the effectiveness of the programme and make necessary revisions. As the overseer, the FRO will report on behalf of the FFI and respond to inquiries from the IRS and/or the FFI’s domestic tax authority.

Not only will the FRO need to be familiar with the US Fatca regime, they will also monitor and implement developments in the local regulations and reporting requirements of an IGA country.

What is more, Fatca is expected to grow in scope. The US is only the first of the Group of Eight (G-8) countries to roll out a Fatca-type programme. Tax information exchange obligations are likely to become more complex as the UK has committed to leverage its G-8 presidency to “move us rapidly to a new global system of multilateral automatic exchange of information”. The Cayman Islands and UK crown dependencies have already pledged a commitment to the UK initiative and it is highly likely that commitments will also be made to the remaining G-8 jurisdictions as well as new countries joining the initiative.

What does Fatca mean for FROs in terms of personal liability and tax filing? At first blush, it may appear the role is simply an addendum to a job description. It goes much further and the unintended consequences of this type of legislation will fully be realised in time. Some that are clear are the personal liability and, in some cases, personal tax filings triggered by being an FRO.

Once authorised, the FRO takes the first step for the FFI by registering the entity on the IRS’s internet portal, which is the electronic version of the paper version called Form 8957. Through the process, FROs accept formal responsibility for the Fatca programme and their obligations to the IRS. The IRS states it is a Federal felony to “willfully aid or assist in, or procure, counsel, or advise the preparation or presentation any document under the US internal revenue laws which is fraudulent or is false as to any material matter”. The information submitted should be accurate and complete, and the role taken seriously.

Personal tax filing requirements for FROs may include Form 5471: an information return of US persons with respect to certain foreign corporations. Used by certain US citizens and residents who are officers, directors or shareholders in certain foreign corporations, generally all US persons described in the form’s categories of filers must complete the schedules, statements, and other information. At a minimum, FROs who are US citizens or residents should understand the triggers that require the filing and monitor for any such occurrences. When does Fatca go live and what are the upcoming deadlines? The IRS portal opened August 19, 2013 and the ‘click to send’ button was made available January 1, 2014. Applications are being submitted and the first application window closes April 25, 2014 for those FFIs wanting to have their Giin when Fatca goes live in July. The IRS will electronically post the first IRS FFI list by June 2, 2014 and will update this list on a monthly basis thereafter.

An FFI’s compliance programne should be in place by July 1, 2014. The programme must address the FFI’s obligations outlined by the country in which it operates, which will be clearly stated in the jurisdiction’s IGA and the corresponding IGA-enabling legislation. Account onboarding under the new Fatca regime also commences July 1, 2014. FFIs must maintain accurate records and take reasonable steps to ensure that records are complete. This includes conducting an electronic record search for US indications in respect of each pre-existing individual account exceeding $50,000 as of June 30, 2014.

Risk.net  March 13 2014