Private equity firms have been under increasing investor pressure to tweak language in the partnership agreement that prevents all LPs from suffering withholding tax should one fail to comply with the US Foreign Account Tax Compliance Act’s (FATCA).
The possibility of withholding tax on large sums of cash has put FATCA “on investors' radar”, said Matthew Saronson, a tax partner at law firm Debevoise & Plimpton. “They are seeking? assurances that funds will be FATCA-compliant and that FATCA withholding or other costs attributable to non-compliance by other investors will be born solely by the non-compliant investors.”
IRS: sparking LPA talks
FATCA requires foreign firms with any US citizens to send tax information on their US accounts to the Internal Revenue Service (IRS), or via their own local tax authority who can send the information to the US on their behalf. Those that fail to comply suffer a 30 percent withholding tax on payments travelling out of the US.
The fund agreement should have the proper mechanics to trace withholding to a particular LP and reduce only that LP's distributions or capital account, said Scott Jones, a tax partner at law firm Proskauer. He adds most fund agreements already contain that language for traditional withholding taxes, but that fund managers are being asked to revisit it to ensure FATCA-related withholding taxes are covered as well.
Fund documents also need to give the GP the right to withdraw, redeem or require transfer of non-compliant interests to safeguard compliant investors, advise legal sources. This is because the GP must register with the IRS and agree to withhold on certain non-compliant LPs otherwise the entire fund could be subject to FATCA withholding.
Lastly, advisors recommend firms begin working out now what extra information they need from LPs to become FATCA-compliant. Sources say most partnership agreements allow the GP to request any information from LPs that is required for the firm to be meet various rules and regulations.