FATCA requires private fund managers to disclose a mishmash of financial details on their US investors or stomach a 30 percent tax on certain US-connected payments. But is there a risk some types of LPs will not be able – or even willing – to disclose such data?
Charkin: Any LP with a fluctuating body of owners may have problems. Think of an investment trust, or other listed company that has a constantly changing shareholder base. That company wouldn’t necessarily hold all the details on each shareholder itself, but might instead outsource the work to a third party, and so, in effect, be unaware of who the actual owners are. While there are various “get outs”, including for some regularly traded entities, this won’t help everyone.
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Laura Charkin |
And in many jurisdictions the LP may not be legally permitted to disclose such information to the US authorities without violating local data protection laws.
As far as an investor being unwilling to cooperate, I suppose some investors may not be entirely comfortable submitting details to a foreign tax authority. It may be the case that the investor has a trust gap with their local tax authority; if so, disclosing their information to the IRS could be just as uncomfortable.
So what should a fund manager do if an investor is bound by local privacy laws?
It depends on the jurisdiction. The manager should check if the data protection laws allow certain disclosures if the LPs give their written consent. Or perhaps the law might allow an ‘opt-out’ structure so the GP can write to investors and say unless you tell us otherwise, we will disclose the information.
A big challenge here is that it can be quite difficult to get an effective consent, because the investor that signs up to the fund documentation is not always (and in fact in most cases is not) the same individual covered by data protection laws. So the LP you actually have contact with might not have the authority to disclose information with regards to its ultimate beneficial owners.
And if no solution is reached, what then?
At that point the GP should examine what they are allowed to do under the fund documentation. Can you target the FATCA tax costs to the LP who is unwilling or unable to release the necessary disclosures? Under FATCA rules there is this concept that you would have to eject this type of LP, who is known as a “recalcitrant account holder”. So perhaps the GP might need to transfer the problematic investor to a separate fund vehicle if the fund documents allow this.
US Treasury has signalled it is open to the idea of implementing FATCA under an “intergovernmental approach” whereby foreign governments relay account disclosures on local firms’ behalf. Does this solve the local data privacy protection challenge?
It seems clear that the intention of the intergovernmental approach is to solve that data privacy challenge, but we’re still waiting to see how such an arrangement would work in practice. And as of now, the data privacy law is still a big question – simply because there are a number of jurisdictions with strong data protection laws that have not yet signed up as FATCA partners.
US Treasury seems to acknowledge this problem in the FATCA regulations released this February. The revised proposals provide a temporary fix in the form of a transitional period available up to the start of 2016. So it means that if you have a group of financial institutions, and one of them is in a jurisdiction where they’re unable to comply with the rules, the other institutions are not automatically shut out from the favourable status available to groups that comply.
Could the intergovernmental approach eventually evolve into a global information exchange network?
It’s clear from the statement issued on the intergovernmental approach that the ultimate goal is to encourage other jurisdictions to adopt similar FATCA style rules, and thus improve international tax compliance. But whether that’s attainable remains to be seen. The countries signed on as the first group of FATCA partners are all jurisdictions with a sophisticated level of tax transparency already in place: France, Germany, Italy, Spain and the United Kingdom.
But the multilateral approach does reflect the wider trend toward greater tax transparency worldwide. Jurisdictions which traditionally had strong confidentiality around this area are already finding it hard to maintain former levels of secrecy.
Can you speculate what actions need to be taken by popular fund domiciles like Cayman or the Channel Islands should they elect to become “FATCA partners”?
Jersey and Guernsey have already entered into information exchange agreements with the US, which form a good basic starting point when it comes to agreeing to the automatic exchange of information that the intergovernmental approach requires. But as with the other FATCA partners, any jurisdiction will need to resolve any local data protection law issues before agreeing to anything.
It also seems that the US is likely to encourage jurisdictions to enact their own FATCA equivalent legislation, as they are encouraging other FATCA partners to do.
The question of whether holding companies used in private equity deal structures could fall within the scope of FATCA is still unresolved; if they do fall within the FATCA rules, will fund managers need to help them with the compliance burden?
That’s a hot topic at the moment. While it’s not yet clear, it looks as though some holding companies used in target company acquisition structures might well themselves need to be FATCA compliant. If so, what should fund managers do? On a practical level obviously the investing fund will not want to suffer withholding tax, so the GP may well have to help in dealing with the costs and technical requirements of FATCA compliance at the holding company level.
The IRS appears to be open to dialogue on this and other problem points, and is trying to find sensible solutions, where possible. So now is the time to make your voice heard if you have come across particular problems.
What should private equity firms be doing about FATCA compliance right now?
The implementation timetable was pushed back, meaning firms now have until 2017 to reach full compliance with the bill. However, some of the key early dates in the timetable have been preserved. So for instance, funds need to begin entering into agreements with the IRS by June 2013 to avoid the 30 percent withholding tax at the start of 2014. As such, even though the FATCA regulations are still in draft form, many firms are implementing processes and conducting impact assessments ahead of those deadlines. For example, firms should review how they take on new clients, and what information is sought. And for existing funds, fund documents should be reviewed to see if they need amendment in order to enable FATCA compliance and to check what level of investor consent would be needed to do this.
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