The IRS and Treasury released a comprehensive set of final regulations relating to the implementation of the Foreign Account Tax Compliance Act (“FATCA”) this winter. While the final regulations further delayed the implementation of certain FATCA provisions, the time to begin preparing for full FATCA implementation is now.
FATCA generally imposes gross-basis withholding at a 30 percent rate on payments of certain types of U.S.-source income (generally, dividends, interest, royalties and other similar “passive” types of income), as well as on the gross proceeds from the sale of, or a return of capital or principal from, investments that generate such U.S.-source income (the “Withholding Tax”). The Withholding Tax applies with respect to payments to certain foreign financial institutions (“FFIs”) unless the relevant FFI enters into an agreement (an “FFI Agreement”) with the IRS pursuant to which the FFI agrees to determine which of its accounts is directly or indirectly owned by U.S. individuals or entities (“U.S. Holders”), and ultimately, to provide information on such U.S. Holders and their account balances, income and withdrawals, to the IRS.
The definition of an “FFI” includes not only banks and broker dealers, but also entities whose principal business is investing in securities, commodities and partnership interests (including derivatives of such interests). Therefore, the FATCA provisions are applicable to many investment entities organized outside the U.S. (e.g., hedge funds, private equity funds, CLOs, and mutual funds, among others).
WHAT NEEDS TO BE DONE IN 2013?
Investment managers of offshore hedge funds should begin now to prepare their funds to comply with the FATCA requirements. Actions that must be taken this year include:
- Enter into an FFI Agreement with the IRS. The IRS has not yet released the form of FFI Agreement. However, they have indicated that the agreement will be available to be entered into starting July 1, 2013, and must be entered into by offshore hedge funds no later than October 25, 2013 to be effective January 1, 2014 (the “kickoff” date for FATCA), so as to avoid the Withholding Tax.
The IRS plans to create a secure online web portal by July 15, 2013 so that FFIs can register with the IRS and receive a “Global Intermediary Identification Number” (“GIIN”).
Investment managers should consider whether to register as a “sponsoring entity” for multiple funds under advisement, pursuant to which they agree to manage diligence and FATCA compliance for those funds.
Managers should appoint a “responsible officer” (an “RO”) who will oversee compliance with FATCA requirements. The RO will complete the fund’s registration, must periodically certify to the IRS as to compliance with the FFI Agreement and must make an initial certification to the IRS that, to the best of the RO’s knowledge, there were no formal or informal practices or procedures in place at any time from August 6, 2011 through the date of the certification to assist account holders in avoiding FATCA.
- Prepare New “On-Boarding” Procedures. Offshore hedge funds that enter into FFI Agreements will be required to ascertain the FATCA status of all new investors admitted on or after January 1, 2014 as part of their standard account-opening procedures.
- Generally, this will require obtaining a Form W-9 or revised Form W-8BEN from all new investors, and, in the latter case, matching the information on that form against other information obtained pursuant to the account opening procedure, including the AML-KYC process, and, in the case of U.S. investors, obtaining a waiver of any applicable local-law limitations on the release of information to the IRS.
- Fund documentation, including subscription agreements, applicable partnership agreements, disclosure, etc., should be reviewed and revised as necessary to allow for this documentation to be collected, for any FATCA withholding required, for mandatory redemptions if a waiver is not obtained, etc.
- Alert Existing Investors to Need for Diligence. FFIs will be required to perform due diligence with respect to their existing (i.e., pre-January 1, 2014) investors in order to ascertain the FATCA status of those investors, and may need to seek additional information from them. FFIs will be required to examine their records, identify investors having certain indicators of U.S. status, and obtain additional information (Form W-8BEN, passport, etc.) as necessary to ascertain whether such investors are U.S. or non-U.S.
WHAT NEEDS TO BE DONE IN 2014?
- Implementation of new on-boarding procedures for new investors.
- Withholding begins January 1, 2014, with respect to U.S.-source income (other than gross proceeds income), unless either the investor or the investment is “grandfathered” under the applicable rules. Essentially, for new investors, and post-2013 investments, withholding begins unless the investor has provided the information necessary to comply with FATCA or is otherwise exempt.
- Diligence on pre-2014 investors that are prima facie FFIs (i.e., that possess external characteristics of FFIs as prescribed by regulations) must be completed by July 1, 2014.
WHAT IS COMING UP POST-2014?
- Diligence with respect to all large investors (in excess of $1 million) must be completed by 2015. Diligence on all smaller, non-”prima facie FFI” investors must be completed by the beginning of 2016 (assuming FFI agreement first effective January 1, 2014).
- Reporting on identity of U.S. account holders for 2013 and 2014 begins in 2015. Reporting on certain types of income recognized by such persons starts in 2016 (for 2015). Full reporting, including gross proceeds, starts in 2017 (for 2016).
- Withholding with respect to the gross proceeds of investments that generate U.S.-source income begins in 2017.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:Bogle-CharlesCarbone-AnthonyGouwar-James