Press Room: Tax Release
Special FATCA Update
As the time for compliance with the requirements of the Foreign Account Tax Compliance Act (FATCA) approaches and FATCA-related developments occur almost daily, we think this is an appropriate time to survey the FATCA scene to date. We note that these matters are of particular concern to the alternative investment fund (AIF) community and review at this time is important, as there may be action required at a future date.
As you may be aware, in 2010 the U.S. Congress enacted provisions of FATCA to prevent tax evasion by U.S. taxpayers using non-U.S. financial accounts. To accomplish this, FATCA generally imposes a 30% withholding tax on non-U.S. entities with respect to U.S.-source income and gross proceeds from the sale of property that can produce U.S.-source income (such as U.S. corporate stock or debt), unless non-U.S. entities disclose their U.S. ownership or are otherwise exempt from FATCA.
All funds with U.S. investments will be subject to FATCA, either as a U.S. withholding agent, if the fund is organized in the United States, or a "foreign financial institution" (FFI), if organized outside of the United States.
In either case, each fund with U.S. investments will have to obtain information from each of its investors in order to avoid FATCA withholding. An investor who does not provide the necessary documentation will be subject to FATCA withholding and may be required to withdraw from the fund. Each investor will be required to analyze its own status under FATCA (and determine what, if anything, it must do to be exempt from FATCA withholding) and provide the necessary documentation to the fund.
Proposed U.S. Treasury Regulations were issued under FATCA on February 8, 2012 (the Proposed Regulations). These Proposed Regulations have not yet been finalized and are therefore subject to change. In addition, the U.S. Internal Revenue Service (IRS) issued an announcement on October 24, 2012, that extends some of the deadlines set forth in the Proposed Regulations. Accordingly, based upon current IRS guidance, FATCA withholding is required to begin on January 1, 2014, with respect to U.S.-source income (e.g., interest and dividends) and January 1, 2017, with respect to gross proceeds from the sale of property that can produce U.S. source income (e.g., U.S. corporate stock or debt).
In order to avoid FATCA withholding on January 1, 2014, FFIs that are required to register with IRS must do so by June 30, 2013. You should also note that FATCA requires the appointment of a responsible officer of the FFI who will be required to make compliance certifications and manage the registration of the FFI.
FATCA Requirements for Investors
Below is a general summary of the various FATCA requirements for different types of investors. This summary is based in part on the Proposed Regulations. All references herein to IRS W-8 forms are to drafts dated May 31, 2012 and August 13, 2012, which have not been finalized and are therefore subject to change. The instructions to these forms have not yet been released by IRS.
A U.S. investor generally will have to provide an IRS Form W-9 with its U.S. taxpayer identification number to the fund.
An investor who is a non-U.S. individual generally will have to provide the fund an updated IRS Form W-8BEN.
Non-U.S. Pension Funds Generally
The Proposed Regulations contain exemptions for non-U.S. pension plans that: (1) qualify for benefits under a tax treaty between their country of residence and the U.S.; (2) qualify for tax exemption in their country of residence and meet requirements regarding their funding and the maximum percentage interest of any beneficiary; or (3) qualify as certain small local pension funds. Exempt non-U.S. pension funds generally will have to provide the fund an IRS Form W-8BEN-E. In some cases, non-U.S. pension plans may also be required to provide their organizational documents to the fund.
If an investor is a FFI that does not fall within one of the various exempt categories defined under the Proposed Regulations, it will have to enter into an FFI agreement with IRS to avoid the 30% U.S. withholding tax described above. Participating FFIs generally will have to provide the fund an IRS Form W-8BEN-E, or an updated IRS Form W-8IMY, as applicable.
Non-Financial Foreign Entities
Non-U.S. entities that are not FFIs and do not fall within other special FATCA categories (such as pension funds or charities) generally are treated under FATCA as "non-financial foreign entities" (NFFEs). An investor who is an NFFE generally will have to provide the fund an IRS Form W-8BEN-E, or an updated IRS Form W-8IMY, as applicable.
The Proposed Regulations also contain exemptions for non-U.S. charitable and other non-profit organizations that satisfy specific requirements. Exempt non-profit organizations generally will have to provide the fund an IRS Form W-8BEN-E.
As described above, the foregoing is a general summary of FATCA classifications that may apply to investors, but there are many other possible FATCA classifications, including certain exemptions for non-U.S. governmental entities (e.g., sovereign wealth funds) that may apply to a particular investor. It is also possible that other information, in addition to IRS forms outlined above, will be required to avoid FATCA withholding for certain investors.
Effect of Intergovernmental Agreements
Running parallel with the FATCA regulatory regime (described above), the U.S. government has as of this date entered into two intergovernmental agreements (IGAs), one with the United Kingdom and one with Denmark, that effectively eliminate the application of the Proposed Regulations with regard to FATCA compliance. In addition, the Treasury has announced that it is in dialogue with over 50 countries regarding FATCA implementation and that many foreign governments are interested in developing IGAs.
While some of the compliance procedures may vary under an applicable IGA, even under an IGA, FFIs must still perform the onerous identification procedures to search for U.S. account holders. One benefit of an IGA, however, is that Annex II to the IGA names country-specific institutions and products that will have reduced obligations or will not be subject to FATCA reporting requirements.
Increased documentation and due diligence will be required relating to account opening and maintenance. For example, the W-8 BEN-E has increased from 2 to 6 pages and W-8s must be obtained annually (unlike the three-year life applicable to regular Section 1441 withholding). In addition to the administrative burden imposed on a fund, substantial confusion is to be expected for the investors required to file the new forms.
The good news is that most alternative investment funds will outsource the FATCA compliance obligations to their transfer agent or other third party provider. The bad news is that, despite such delegation, the fund continues to remain liable for any failure to comply with FATCA.