The U.S. Internal Revenue Service (“IRS”) and U.S. Department of Treasury (“Treasury”) released a comprehensive set of final regulations and notices relating to the implementation of the Foreign Account Tax Compliance Act (“FATCA”) last winter and fall.1 While the final regulations and notices further delayed the implementation of certain FATCA provisions, Asia-based managers should now be preparing for full FATCA implementation.
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 U.S.-source interest and dividends (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.
Where foreign law prevents an FFI from complying with the FATCA requirements, the United States may enter into an intergovernmental agreement (“IGA”) with the foreign government (the partner jurisdiction) to remove the impediments to FATCA reporting. The Treasury has developed two alternative model IGAs, Model 1 IGA and Model 2 IGA.2 Under Model 1, the partner jurisdiction agrees to direct and enable all nonexempt FFIs in the partner jurisdiction to identify U.S. accounts in accordance with due diligence rules adopted by the partner jurisdiction and report specified information about the U.S. accounts to the partner jurisdiction; the partner jurisdiction then transfers that information to the IRS on an automatic basis. Under Model 2, the partner jurisdiction agrees to direct and enable all nonexempt FFIs that are located within it to register with the IRS and report specified information about U.S. accounts directly to IRS in a manner consistent with FATCA, except as expressly modified by the Model 2 IGA.
According to Treasury guidance, a jurisdiction will be treated as having in effect an IGA if the jurisdiction is listed on the Treasury website as a jurisdiction that is treated as having an IGA in effect. In general, Treasury and the IRS intend to include on this list jurisdictions that have signed but have not yet brought into force an IGA. The list of jurisdictions that are treated as having an IGA in effect is available at the following address: http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA-Archive.aspx.
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, mutual funds, trustees, custodians, investment managers, securitization vehicles and listed investment companies, among others).
SINGAPORE, HONG KONG, JAPAN and the CAYMAN ISLANDS
The Singapore government intends to conclude a Model 1A IGA with the Treasury, pursuant to which financial institutions in Singapore must report information on U.S. accounts to Inland Revenue Authority of Singapore who will then exchange this information with the IRS.
Hong Kong’s Securities and Futures Commission has stated that the Hong Kong government has been in discussions with the Treasury “with the objective of concluding an IGA designed to facilitate compliance with FATCA by FFIs in Hong Kong in a manner that reduces their overall reporting burden”. However, no such IGA has been announced yet. It is envisaged that Hong Kong will enter into a Model 2 IGA.
On June 11, 2013, the U.S. and Japanese governments concluded a Model 2 IGA on the implementation of the provisions of FATCA by Japanese financial institutions and the IGA became effective on the same date.
On November 29, 2013, the Cayman Islands government signed a Model 1 IGA with the Treasury, which requires the Cayman Islands government to enact laws requiring the identification and reporting of information about U.S. accounts to the standards set out therein. Unless there is an available exemption, Cayman FFIs subject to the IGA will be required to identify U.S. accounts and report specified information about those US accounts to the Cayman Islands Tax Information Authority, which would then pass such information on to the IRS on an automatic basis annually. Cayman FFIs that comply with the laws implemented pursuant to the IGA will be treated as satisfying the due diligence and reporting requirements of FATCA. Such FFIs will not need to comply with the specific provisions of the FATCA Regulations and will instead be ‘deemed compliant’ with the requirements of FATCA and not be subject to withholding tax.
WHAT NEEDS TO BE DONE NOW?
Fund managers should begin now to prepare themselves and their funds to comply with the FATCA requirements. Actions that must be taken include:
Many fund administrators are offering additional services to assist funds in performing due diligence on pre-existing and new investors. Such services will need to be agreed upon and implemented well in advance of the relevant deadline, particularly since the administrator’s terms of appointment and responsibilities may need to be amended. In respect of the other FATCA obligations, fund managers will typically perform such obligations on behalf of the funds they manage
WHAT NEEDS TO BE DONE IN 2014?
WHAT IS REQUIRED POST-2014?
Charles Bogle, Partner, Tax and Employee Benefits
Anthony Carbone, Partner, Tax and Employee Benefits
James Gouwar, Partner, Tax and Employee Benefits
Anne-Marie Godfrey, Partner, Financial Services
Thomas Gray, Counsel, Tax and Employee Benefits
Circular 230 Disclosure: Internal Revenue Service regulations provide that, for the purpose of avoiding certain penalties under the Internal Revenue Code, taxpayers may rely only on opinions of counsel that meet specific requirements set forth in the regulations, including a requirement that such opinions contain extensive factual and legal discussion and analysis. Any tax advice that may be contained herein does not constitute an opinion that meets the requirements of the regulations. Any such tax advice therefore cannot be used, and was not intended or written to be used, for the purpose of avoiding any federal tax penalties that the Internal Revenue Service may attempt to impose.
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1 It should be noted that the timeline discussed in this alert may be further delayed pursuant to future Treasury and IRS guidance.
2 Model 1 IGAs can either be reciprocal agreements (the U.S. will also report information on residents of the other jurisdiction to that jurisdiction’s tax authorities) or non-reciprocal agreements. A reciprocal agreement is referred to as a Model 1A IGA and a non-reciprocal agreement is a Model 1B IGA.
3 Note that with respect to funds formed in the Cayman Islands, Bermuda and other jurisdictions that an IGA in place, such funds will not have to enter into an FFI Agreement because of the IGA entered into between those governments and the United States. These funds will still have to register for a GIIN. FFIs formed in Hong Kong will have to enter into an FFI Agreement at least until Hong Kong enters into an IGA.
4 A participating FFI is an FFI that enters into an FFI Agreement to (a) perform due diligence to identify accounts it maintains for U.S. persons, (b) verify compliance with the agreement, (c) report information on its U.S. accounts to IRS, (d) withhold on withholdable payments and foreign passthru payments to recalcitrant account holders and nonparticipating FFIs, (e) comply with requests from IRS for additional information on its U.S. accounts, and (f) under certain circumstances, close, block or transfer accounts of recalcitrant account holders.
5 This deadline may be further delayed, but any such delay should not be counted on to occur.
This article was originally published by Bingham McCutchen LLP.