FATCA favourites

The latest FATCA proposals take some measured steps to address industry concerns, but compliance will undoubtedly remain a burden. However, GPs in some tax-transparent jurisdictions look set to have it easier than most.

Finally, after a series of pushbacks and delays, the US Treasury released its latest round of proposals to the Foreign Account Tax Compliance Act (or FATCA). 

And for the most part, the industry’s preliminary response has been of a positive nature. The refined proposals provide a welcome ‘phased approach’ to building a FATCA compliance programme and push back certain deadlines that would have been difficult to meet under the original proposed timeframe – for example extending the deadline of withholding on so-called passthru payments until 2017.

That’s not to say compliance will be easy, though. As a way of combating offshore tax evasion, FATCA requires foreign financial institutions, including private funds, to disclose the account details of their US clients or suffer a 30 percent tax penalty on certain US-connected payments. 

As such private equity firms should be reviewing now, today, how they identify and document fund investors. To the industry’s benefit, the updated proposals make it easier for GPs to rely on already existing know-your-customer and anti-money laundering rules to determine investors’ tax status. But funds’ distribution models, internal IT systems, and relationships with third-party service providers (such as fund administrators) will all still need reviewing. 

Investors will want clarity around what happens if one LP were to hold out. Nothing short of a way to isolate the tax burden to the violating LP will be a satisfactory response

Moreover, firms should begin thinking about amending their limited partnership agreements to obligate LPs to comply with FATCA rules. To that end, investors will want clarity around what happens if one LP were to hold out. Nothing short of a way to isolate the tax burden to the violating LP will be a satisfactory response. 

Then there is to consider the ongoing industry grievances that FATCA will bring significant administrative costs and potentially force firms to violate local data privacy laws.To address those concerns, US Treasury signalled it was open to the idea of implementing FATCA under an “intergovernmental approach” whereby foreign governments relay account disclosures on local firms’ behalf. The benefits of doing so would be obvious: foreign firms could submit information under more familiar reporting systems within a domestic legal framework. 

However, some in the industry question whether this bilateral (or maybe multilateral) solution could be extended to relatively opaque offshore financial centres like the Cayman Islands. The first round of countries to have emerged as “FATCA partners” (France, Germany, Italy, Spain and the United Kingdom) all already exhibit a high level of tax transparency and information exchange with US tax authorities. US Treasury said it was open to forming relationships with other countries, including reportedly Cayman, but presumably only if the foreign government were to introduce significant reforms around tax transparency and sign a substantive bilateral tax treaty. 

If Cayman, and other popular fund domiciles, are unable or unwilling to enter into this type of relationship with US tax authorities, it seems fund managers caught by FATCA in those jurisdictions will be stuck with the less appealing individual reporting arrangements, in effect boosting the appeal of “FATCA partner” locales. 

Final FATCA regulations are expected later this summer.  No doubt the financial services industry at large will be hoping the US government continues to formulate rules with the still lingering aforementioned concerns in mind.