Update on FATCA Compliance for Alternative Investment Funds
The long-awaited final Foreign Account Tax Compliance Act (FATCA) regulations have been issued, and the timelines for fund compliance have been set. Accordingly, sponsors of private investment funds must now take steps necessary to comply with these new rules. This Client Alert focuses on the specific FATCA compliance issues for hedge funds and other alternative investment funds that are organized under non-U.S. law. Sadis & Goldberg's tax partners are available to answer your questions on these and any other FATCA developments.
What is FATCA?
FATCA is the 2010 tax legislation that is designed to reduce evasion of U.S. tax by U.S. citizens and residents who hold offshore assets. To accomplish this objective, FATCA requires "foreign financial institutions" (FFIs) (which term includes most offshore private investment funds) to register with the Internal Revenue Service (IRS) and undertake the responsibility to perform due diligence to identify their U.S. accounts and report the income earned by them to the IRS. The FFI's compliance obligations will be set forth in in a compliance agreement (FFI Agreement) with the IRS (or, in the case of FFIs domiciled in certain jurisdictions, the terms of an "intergovernmental agreement" as discussed below). An FFI that does not comply is subject to 30 percent U.S. withholding from any payments of most types of U.S. source investment income and the gross proceeds of sales of U.S. stock and debt instruments.
Which Offshore Funds are FFIs?
Pursuant to FATCA, an FFI includes, among others, an entity that is "engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest (including a futures or forward contract or option) in such securities, partnership interests, or commodities." Therefore, most funds organized under non-U.S. law, including hedge funds (e.g., offshore master funds, stand-alone offshore funds and offshore feeder funds), fund of funds, venture capital funds and private equity funds, will be classified as FFIs.
Offshore Management Companies are also FFIs. The definition of "financial institution" in the final FATCA regulations ("Final Regulations") has been expanded to include entities that provide investment management services on behalf of customers. This means that investment managers organized under non-U.S. law that receive fees for investment management services now will be treated as FFIs and required to enter into FFI Agreements (absent an applicable exemption). Further, the Final Regulations provide that an entity that does not have professional managers will not be treated as a financial institution under FATCA.
What about Onshore Funds?
Funds organized under U.S. law (e.g., as Delaware limited partnerships or LLCs) are not classified as FFIs and thus are not required to register under the FATCA rules. However, such onshore funds will be classified as U.S. financial institutions and thus will be required to withhold payments to non-U.S. entity investors in such funds that refuse to provide the information and documentation required by the IRS under FATCA.
Overview of FATCA Compliance Obligations for Foreign Funds that are FFIs
FFIs will be required to:
1. register with the IRS via the IRS' secure online web portal (described in the following paragraph);
2. enter into a compliance agreement (the FFI Agreement) with the IRS to conduct due diligence on account holders or comply with the terms of an applicable intergovernmental agreement (IGA) (discussed below);
3. annually disclose certain information about U.S. account holders and account holders that are foreign entities in which U.S. persons hold a substantial ownership interest;
4. withhold on payments to certain account holders (beginning January 1, 2014); and
5. undertake additional compliance obligations set forth in the Final Regulations or such IGA.
Those FFIs that comply with these requirements will be considered "participating foreign financial institutions" (PFFIs). FFIs that have registered will be issued a Global Intermediary Identification Number (known as a "GIIN").
Streamlined Registration Process for FFIs
The IRS has established the FATCA Registration Portal ("Portal"), a secure online portal for FFIs to register and enter into an FFI Agreement to become PFFIs. The Portal will be accessible to financial institutions beginning no later than July 15, 2013, and will be used to manage registration information, to make representations required for specific status under FATCA, and to facilitate communication between the IRS and FFIs. The assignment of identification numbers (i.e., GIINs) is intended to start no later than October 15, 2013. The IRS plans to publish a monthly list of PFFIs that withholding agents can use to verify an FFI's FATCA status, starting December 2, 2013. It is expected that counterparties will begin asking foreign funds for their GIINs in order to verify their status as "participating FFIs" exempt from FATCA withholding once the first IRS list is issued. Consequently, we strongly advise foreign funds to register early to ensure that they will appear on the IRS' first monthly list of PFFIs.
The Final Regulations do not contain a draft of the FFI Agreement. It is anticipated that the IRS will release a draft sometime in the next few months.
The online registration process will require each FFI to designate a "FATCA responsible officer" who will typically sign the FFI Agreement on behalf of the FFI. The FATCA responsible officer will be able to delegate full FATCA registration duties (including signing) to another in-house individual or an authorized U.S.-licensed tax professional.
Impact of the Final FATCA Regulations
While retaining much of the substance and clarifying some of the details of the Proposed Regulations, the Final Regulations incorporate some important changes in the wake of comments from the business community and tax professionals. The Final Regulations extend the dates by which withholding is required for certain payments and expand the definition of "grandfathered obligations" which are exempt from FATCA withholding.
Perhaps the most significant revisions in the Final Regulations for sponsors of offshore investment funds are the final rules relating to due diligence requirements. The Final Regulations exempt from review all preexisting accounts held by individuals with a value of $50,000 or less. The threshold is raised to $250,000 for preexisting accounts held by entities. Participating FFIs may determine whether any preexisting accounts with a value of $1,000,000 or less are held by U.S. individuals based solely on a search of electronically searchable data for certain U.S. indicia of ownership set out in the Final Regulations.
Impact of Intergovernmental Agreements
The Final Regulations endeavor to coordinate their requirements with the intergovernmental agreements (IGAs) that some foreign governments are negotiating with the U.S. as an alternative to FATCA compliance. The Treasury has provided two types of IGAs. Under the Model 1 IGA, an FFI organized in the applicable jurisdiction will report tax information to their home government, which will then automatically transmit the information to the IRS. The Final Regulations confirm that FFIs in jurisdictions that have entered into the Model 1 IGA will not need to enter into FFI Agreements in order to be FATCA compliant. On March 15, the Cayman Islands Government announced its intention to enter into a Model 1 IGA with the U.S. in response to FATCA and stated that final negotiations on such IGA are expected to be concluded "in the short term". Thus, Cayman Island funds will be required to be registered with the IRS and obtain a GIIN, but will not be required to enter into an FFI Agreement, if, as expected, the Cayman Islands enters into the IGA.
Under the Model 2 IGA, an FFI must report directly to the IRS. FFIs in Model 2 jurisdictions will still need to apply the Final Regulations and enter into an FFI Agreement, except to the extent modified by the Model 2 Agreement. This will require the foreign government to enact legislation that permits resident FFIs to comply with FATCA and report information directly to the IRS, notwithstanding bank secrecy laws.
As of the date of this Alert, the U.S. has only signed or initialed IGAs with eight jurisdictions: the United Kingdom, Denmark, Mexico, Switzerland, Ireland, Italy, Spain and Norway. It has been reported that at least 50 jurisdictions have expressed an interest in entering into such an IGA. Jurisdictions that are engaged in negotiations or other discussions with the U.S. include the Cayman Islands, the British Virgin Islands and Bermuda. Sponsors of funds organized in such jurisdictions should monitor developments relating to IGA negotiations.
FATCA Provisions in Fund Documents
New foreign funds should include provisions in their operational and organizational documents to address the FATCA requirements. In particular, a foreign fund's documents should:
- Permit the fund to enter into and comply with an FFI Agreement or an applicable IGA.
- Require the fund's direct and indirect owners to provide FATCA-related information to the fund (generally on revised Forms W-8 and W-9).
- Permit the fund to remove investors, if necessary under FATCA or an applicable IGA.
- Include waivers from investors of any provisions of foreign law that would prevent the fund from complying with the FFI Agreement or an applicable IGA.
Existing foreign funds should review their governing documents to determine whether the fund documents need to be amended to include any of such provisions.
Fund sponsors should be aware that some fund investors may seek assurances from a foreign fund that the fund will enter into an FFI Agreement and comply with its terms (or the terms of an applicable IGA). In addition, investors may inquire as to whether the fund will be indemnified for failures caused by any party that results in the imposition of a FATCA tax on the fund.
ACTION PLAN FOR SPONSORS OF PRIVATE INVESTMENT FUNDS
The principal tasks for fund managers include the following:
- Determine the final FATCA characterization of each of their investment entities;
- Prepare to register their non-U.S. funds by October 25, 2013 (in order to have the fund appear on the IRS' first published list of FFIs that have registered);
- Consider what changes should be made to the investor onboarding process in order to satisfy the requirements of the Final Regulations or an applicable IGA;
- Review existing investor data in light of the due diligence standards set forth in the Final Regulations or an applicable IGA, including several new provisions that permit reliance on existing documentation in certain circumstances;
- Consider whether certain FATCA compliance matters should be handled by third party service providers; and
- Consider updating critical legal documents, including fund offering documents, corporate charters or partnership agreements, etc. and service provider agreements.
REVISED FATCA COMPLIANCE TIMELINE
As a result of the revisions made by the final FATCA regulations, the revised timeline for FATCA compliance is now as follows:
July 15, 2013
- IRS online registration portal will be available no later than this date.
October 25, 2013
- Offshore funds and other FFIs must be registered by this date to be included on the IRS' first list of FATCA compliant FFIs.
December 2, 2013
- IRS will publish its first list of FATCA compliant FFIs. Withholding agents may generally rely on this list, which will be updated monthly, to verify an FFI's FATCA status.
December 31, 2013
- This is the effective date for FFI Agreements entered into in 2013. For FFI Agreements entered into after this date, the FFI Agreement will be effective as of the date the IRS issues the FFI its GIIN (identification number).
- This is also the last date by which most grandfathered obligations may be issued.
January 1, 2014
- This is the date FATCA withholding on U.S. - source interest, dividends, rents, royalties and other fixed or determinable annual or periodic ("FDAP") income begins.
- New account opening procedures for withholding agents, PFFIs, and registered FFIs begin.
March 31, 2015
- Information reporting for U.S. accounts for calendar years 2013 and 2014 are due.
January 1, 2017
- FATCA withholding on U.S.-source gross proceeds begins.
- FATCA withholding on passthru payments begins on the later of this date or six months following publication of Treasury regulations defining foreign passthru payments.