Background on FATCA
The Foreign Account Tax Compliance Act (“FATCA”) increases the U.S. tax compliance burden for foreign financial institutions (called “FFIs” in FATCA-speak). The FATCA rules are intended to assist the U.S. in identifying U.S. persons who fail to report their non- U.S. assets and income.
To enforce compliance, FATCA requires that FFIs (which generally includes non-U.S. private equity funds) become participating FFIs (“PFFIs”) by entering into an agreement with Treasury. Unless it qualifies for a specific exemption, a FFI that chooses not to become a PFFI will be considered a “non-participating FFI,” thereby exposing the FFI to potential U.S. withholding tax of 30% on certain of the FFI’s income.
The PFFI agreement requires, most notably, that a FFI deduct and withhold 30% from certain payments made to non-participating FFIs and “recalcitrant” account holders. A form of agreement for a PFFI is expected to be released by Treasury in the next two or three months. It is currently expected that, in order to comply with FATCA, the FFI will need to enter into a PFFI agreement with Treasury before July 1, 2013.(1)
Core Elements of FATCA for Private Equity Funds
For non-U.S. private equity funds, complying with FATCA means:
- entering into an agreement prior to July 1, 2013 to become a PFFI and avoid having U.S. taxes withheld on their income;(2)
- withholding on payments to investors that are non-participating FFIs and “recalcitrant” account holders; and
- obtaining information and certificates from investors to comply with the PFFI agreement and avoid having to do FATCA withholding on payments to its investors.
A U.S. private equity fund will not be required to enter into a PFFI agreement. However, a U.S. private equity fund will need to withhold on distributions made directly (or in certain cases, indirectly through other entities) to investors who are “non-participating FFIs” and “non-financial foreign entities” that do not identify their substantial U.S. owners or who are otherwise not exempt from FATCA withholding. Accordingly, like non-U.S. private equity funds, U.S. private equity funds will need to obtain information and certificates from certain of their investors to avoid having to withhold under FATCA on payments made to such investors.
Practical Implications for Funds
To comply with FATCA on a practical level, private equity funds will need to consider and address the issues listed below:
- Weighing confidentiality concerns and laws, sensitivity to investor relations, and costs of FATCA compliance (and non-compliance).
- Inability to comply with FATCA based on existing investor agreements as drafted and obtaining investors’ consent for any amendments to agreements that provide for FATCA compliance.
- Increased administrative burden of obtaining appropriate forms and certifications from investors (including a special Treasury-issued identifying number issued to investors that are PFFIs).
- Potentially seeking indemnification from investors for taxes (and other costs) imposed on the fund as a result of noncompliance with FATCA.
- Potentially requesting powers of attorney from investors to allow the fund to take actions to comply, or at least mitigate, FATCA issues.
- For non-U.S. private equity funds, potentially establishing a U.S. vehicle and transferring each investor that is unwilling, or unable, to provide the information required under FATCA to such a vehicle.
“… private equity funds (both U.S. and non-U.S.) may be required to expend substantial resources to establish practices and procedures to comply with FATCA”
FATCA can have broad implications for all private equity funds and requires the prompt attention of both U.S. and non-U.S. private equity funds to determine their approach to FATCA compliance. As a result of FATCA’s additional withholding and information reporting and gathering requirements, private equity funds (both U.S. and non-U.S.) may be required to expend substantial resources to establish practices and procedures to comply with FATCA.