In 2010, the United States Congress enacted the Hiring Incentives to Restore Employment Act, which included provisions known as the Foreign Account Tax Compliance Act, or FATCA. The purpose of FATCA is to prevent U.S. persons from evading U.S. tax through the use of non-U.S. entities, by requiring such entities to disclose U.S. account information to the relevant governmental authorities. U.S. and non-U.S. investment funds will be impacted by FATCA and will potentially be subject to U.S. withholding tax under FATCA unless they comply with certain requirements, including requirements relating to investor due diligence and the reporting of U.S. account information to the relevant governmental authorities. As part of their FATCA compliance processes, non-U.S. investment funds must first determine their classification under FATCA, and assess whether they need to register their FATCA status with the U.S. tax authorities and the deadlines for registration. The FATCA classification of a non-U.S. investment fund is critical as this in turn drives the manner of FATCA compliance for such fund. FATCA classification analyses should be completed as soon as possible for non-U.S. investment funds and before July 1, 2014, when FATCA withholding begins.
What the FATCA rules say
FATCA (which is codified in Sections 1471 through 1474 of the United States Internal Revenue Code of 1986, as amended, and the U.S. income tax regulations promulgated thereunder) imposes a 30% U.S. withholding tax on "withholdable payments" made to non-U.S. entities that do not comply with certain due diligence and reporting requirements prescribed by FATCA. "Withholdable payments" consist of (i) certain U.S.-source income, such as U.S.-source dividends, interest and rents, paid after June 30, 2014, and (ii) certain U.S.-source gross proceeds paid after December 31, 2016.
For FATCA purposes, non-U.S. entities are categorized as (i) foreign financial institutions (FFIs) or (b) non-financial foreign entities (NFFEs). The distinction is relevant as that in turn drives the manner of FATCA compliance. An NFFE is an entity that is not an FFI.
An FFI is broadly defined and includes, for example, any non-U.S. entity that (i) holds as a substantial portion of its business financial assets for the benefit of another or (ii) holds itself out as a collective investment vehicle, mutual fund, exchange traded fund, private equity fund, hedge fund, venture capital fund, leveraged buyout fund, or any similar investment vehicle established with an investment strategy of investing, reinvesting, or trading in financial assets. "Financial assets" are defined to include stock, partnership interests, notes, bonds and commodities. As discussed above, FATCA requires the reporting by non-U.S. entities of U.S. account information to the relevant governmental authorities.
A U.S. account includes a depository account (i.e. any commercial, checking or savings account, an account evidenced by a certificate of deposit, or any other instrument for placing money in the custody of an entity engaged in a banking or similar business for which such institution is obligated to give credit), (ii) a custodial account (i.e. an arrangement for holding a financial instrument, contract, or investment for the benefit of another person) and (iii) non-publicly traded equity or debt interests.
An FFI can avoid FATCA withholding if it registers its FATCA status with the Internal Revenue Service (IRS) to obtain a special FATCA identification number called a Global Intermediary Identification Number (GIIN), and (i) agrees to report U.S. account information directly to the IRS or (ii) if the FFI is in a jurisdiction whose government has executed a “Model 1” FATCA intergovernmental agreement with the United States, such FFI reports U.S. account information directly to its own government instead of to the IRS (note, however, that an FFI located in a jurisdiction that has executed a “Model 2” FATCA intergovernmental agreement with the United States will be required to report U.S. account information directly to the IRS).
An NFFE can avoid FATCA withholding if it provides to a withholding agent or to the IRS information regarding its “substantial U.S. owners” (i.e. certain U.S. persons that own 10% or more of the NFFE). Additionally, both FFIs and NFFEs may avoid FATCA withholding if they fall within prescribed categories of persons that are treated as exempt from withholding under FATCA (i.e. certain non-U.S. pension trusts).
FATCA compliance involves a multi-layered process that consists of registration, due diligence and reporting requirements:
FFIs (and NFFEs under certain circumstances) are required to register their FATCA status and obtain a GIIN. Registration can be done by filing a paper registration form (IRS Form 8957) or through a web portal established by the IRS. It is strongly recommended that FFIs register their FATCA status using the web-site portal as opposed to the paper registration form, as the latter method may result in processing delays.
The IRS is expected to publish monthly lists of FFIs and their GIINs (FFI Lists) beginning June 2014. The first FFI List is expected to be published by June 2, 2014 (June 2014 List), and the second FFI List is expected to be published by July 1, 2014 (July 2014 List), when FATCA withholding begins. A purpose of the FFI Lists is to enable withholding agents to satisfy their obligations to verify the FATCA status and GIINs of non-U.S. entities claiming to be FFIs. The deadline for an FFI to register and obtain a GIIN in order to be published on the June 2014 List was May 5, 2014.
Although this deadline has passed, an FFI can nevertheless get onto the July 2014 List (and thus before FATCA withholding begins) if it registers by June 3, 2014. Notwithstanding the above deadlines, however, the FATCA rules provide that FFIs in jurisdictions that have entered into Model 1 FATCA intergovernmental agreements are not required to provide withholding agents with GIINs until January 1, 2015. To that end, the FATCA guidance further provides that such FFIs have until December 22, 2014 to register their FATCA status and obtain a GIIN, in order to ensure inclusion on an FFI List by January 1, 2015.
FATCA due diligence requires obtaining and verifying tax information and documents (i.e. IRS Form W-9, applicable IRS Forms W-8) from payees to determine whether a payee is required to be reported to the relevant tax authorities under FATCA. Due diligence is required for holders of pre-existing accounts (i.e. accounts maintained by (x) individual holders as of June 30, 2014 and (y) entity holders as of December 31, 2014) and new accounts (i.e. accounts held by (x) individuals that are opened on or after July 1, 2014 and (y) entities that are opened on or after January 1, 2015). The FATCA rules require onboarding procedures to be implemented for new accounts. The deadline to complete FATCA due diligence pertaining to pre-existing accounts is generally June 30, 2016.
Model 1 and Model 2 FATCA intergovernmental agreements executed between the United States and various jurisdictions contain FATCA due diligence requirements. An FFI located in a jurisdiction that has entered into a Model 1 or Model 2 FATCA intergovernmental agreement with the United States will generally be required to comply with the due diligence requirements set forth in the subject intergovernmental agreement.
FATCA requires the reporting of U.S. account information to the relevant tax authorities. An FFI in a jurisdiction that has entered into a Model 1 FATCA intergovernmental agreement will be required to annually report U.S. account information to the governmental authorities in its jurisdiction rather than to the IRS, in the manner required by the subject intergovernmental agreement and any implementing FATCA legislation enacted by the governmental authorities in the FFIs jurisdiction. An FFI in a jurisdiction that has entered into a Model 2 FATCA intergovernmental agreement, or in a jurisdiction that has not entered into a FATCA intergovernmental agreement, will be required to annually report U.S. account information directly to the IRS. An NFFE will be required to disclose its substantial U.S. owners (or certify that it has no substantial U.S. owners).
Implications for investment funds
The first step in FATCA compliance for an investment fund organized outside the United States is to ascertain whether it is classified as an FFI or NFFE.
Non-U.S. investment funds will generally be treated as FFIs under FATCA, but an investment fund should nevertheless carry out the requisite analysis to confirm its FATCA classification, as the classification drives the manner of FATCA compliance.
The FATCA classification exercise is also critical if an investment fund is part of a chain of entities, because the activities and assets of the other entities in the chain will need to be considered when determining the FATCA classification of the investment fund. Furthermore, if the chain of entities consists of one or more entities linked by common control in the form of more than 50% vote and value, such entities would form an expanded affiliated group (EAG) under FATCA.
Under the FATCA rules, every FFI in an EAG must be FATCA-compliant, such that if one FFI in an EAG were non-compliant, this would taint all the other members in the EAG. Accordingly, the FATCA classification of an investment fund necessarily requires looking at the investment fund’s entire organizational structure.
If a non-U.S. investment fund determines that it is classified as an FFI for FATCA purposes, FATCA compliance requires that such investment fund register its FATCA status and obtain a GIIN. If the investment fund is part of an EAG, the registration process requires that a member of the EAG be designated the “lead financial institution” for FATCA registration purposes, and such member must initiate the registration process for all the other members in the EAG.
It will also be important to determine whether an investment fund is located in a jurisdiction that has entered into a FATCA intergovernmental agreement with the United States. If the fund is in a jurisdiction that has entered into a Model 1 FATCA intergovernmental agreement, it has until the end of 2014 to register and obtain a GIIN. If the fund is located in a jurisdiction that has entered into a Model 2 FATCA intergovernmental agreement, or in a jurisdiction that has not entered into a FATCA intergovernmental agreement, it should register its FATCA status before FATCA withholding begins on July 1, 2014.
Investment funds that determine they are NFFEs technically are not required to register their FATCA status with the IRS. Such investment funds will need to provide a certification to a withholding agent as to their substantial U.S. owners (or a certification that they do not have any substantial U.S. owners). However, if an investment fund does not wish to provide U.S. owner information directly to a withholding agent, it may instead provide such information directly to the IRS. In such instance, the investment fund would need to register its FATCA status.
As discussed above, FATCA compliance includes the satisfaction of due diligence and reporting requirements. Investment funds (whether U.S. or non-U.S.) will need to conduct FATCA due diligence on, and obtain the requisite tax information from, their investors. As part of FATCA due diligence, investment funds should modify, amend, expand and/or supplement their investor onboarding procedures and policies. Investment funds will also have FATCA reporting obligations with respect to U.S. accounts or U.S. owners. The satisfaction of the due diligence and reporting requirements under FATCA by a non-U.S. investment fund will be largely driven by whether such fund is an FFI located in a jurisdiction that has entered into a FATCA intergovernmental agreement.
The IRS recently announced (in Notice 2014-33) that it will treat 2014 and 2015 as a transition period for purposes of FATCA enforcement and administration. Under Notice 2014-33, withholding agents and FFIs that act in “good faith” to comply with their FATCA obligations should be entitled to relief from IRS enforcement of the FATCA rules. Although Notice 2014-33 does not clarify what is considered “good faith”, it does provide that the IRS will take into account whether reasonable efforts during the transition period were made to modify account opening procedures and practices to document the FATCA status of payees. Accordingly, an example of good faith efforts arguably could be inferred from Notice 2014-33 to include the modification of account opening procedures. Note, however, that notwithstanding the transitional relief in Notice 2014-33, the official commencement date of FATCA withholding remains at July 1, 2014.
Investment funds will undoubtedly be impacted by FATCA, and the steps to FATCA compliance must include an assessment of an investment fund’s FATCA status, the performance of appropriate FATCA due diligence, and the reporting of U.S. account/owner information. All investment funds (whether U.S. or non-U.S.) should modify their investor onboarding procedures and policies to account for FATCA and to ensure that they obtain the appropriate information from investors. All investment funds (whether U.S. or non-U.S.) should carry out pre-existing account due diligence to determine if sufficient documentation is associated with each pre-existing account. Investment funds that are organized in non-U.S. jurisdictions must assess whether they are FFIs or NFFEs and register their FATCA status as necessary, keeping in mind that the deadline for registration is the end of 2014 for FFIs in jurisdictions that have entered into Model 1 FATCA intergovernmental agreements, while all other FFIs should register as soon as possible and before FATCA withholding begins on July 1, 2014.