Five years out now from the signing of the US Foreign Account Tax Compliance Act (FATCA), many firms “FATCA-readiness” is still less than perfect. Should the firm’s CFO or CCO be worried?
Jay Bakst’s answer:
That’s tough to answer without knowing the firm’s individual circumstances, because FATCA will impact private fund managers in very different ways depending on the structure of their funds, the nature and source of their income and the profile of its investor base.
But let’s imagine an ideal world for a moment in which every firm treats FATCA the same and follows best practices.
By mid-2015, a few essential steps should have been completed. Of course, registering each non-US fund or investment entity with the Internal Revenue Service (IRS) to obtain a Global Intermediary Identification Number (GIIN) is a first step. With those GIINs, new self-certification forms (like Forms W-8) evidencing FATCA status should then have been provided for each of the funds to US withholding agents. Funds should also have collected new FATCA self-certification forms from their investors, new and old; performed due diligence to determine if the forms are valid; determine which accounts are “reportable,” and which accounts are subject to the dreaded 30 percent FATCA withholding. Funds domiciled in countries that have executed Model 1 IGAs (most countries in which funds are organized) should have registered with, and be ready to report their “reportable accounts” to, their local country’s tax authority.
Now let’s come back to the real world where obtaining valid FATCA documentation from all investors and various other parts of a firm’s FATCA compliance program are easier said than done.
The key objective should be to look at your FATCA compliance program and identify areas of weakness. To that end, let’s consider three types of funds: (1) a Cayman partnership, (2) a Cayman Limited, and (3) a US partnership. As a threshold matter, the most significant potential exposure is the 30 percent withholding tax, and accordingly the first question in assessing risk is to what extent is the fund expected in 2015 to receive US source interest, dividends, and other types of investment income (but not capital gains) that are not grandfathered payments exempt from withholding?
A Cayman partnership fund that expects to receive US source income that is subject to FATCA withholding must, in addition to providing its own Form W-8IMY with its GIIN, provide its US withholding agents with its investors’ W-8 and W-9 forms. A quick warning: US withholding agents will likely have little appetite for risk and will be more inclined to simply withhold without communicating deficiencies in documentation (legitimate or otherwise), meaning it will be tough to resolve. Still, Cayman partnership investors that joined the fund before 2015 (so they’re “preexisting accounts”) are not subject to FATCA withholding prior to 2016; that is unless they meet the strict definition of being a “prima facie FFI,” which many investment vehicles do not.
Neither are individuals (foreign or US) subject to FATCA withholding. Ever. So, if the fund has on file valid pre-FATCA versions of the form that were executed last year, the failure of such investors to furnish the new forms should not be a major concern for now. The key is to proactively reach out to each US withholding agent – well in advance of receiving income subject to FATCA withholding – and discuss the documentation you provided and ensure that you are on the same page as them with respect to whom they withhold upon.
At any rate, every Cayman partnership should have by April 30 notified the Cayman Tax Information Authority via its online portal that it is a “Reporting Cayman Island Financial Institution.” Then, by the end of May, it will be required to report limited information about its 2014 US “reportable accounts,” which most commonly will be investors who are US individuals and US entities that are not expressly exempt from FATCA (so most tax exempt entities). A side word of relief: while there are many rules associated with this process, the consequences of having less than perfect FATCA documentation for an investor appear to be less than dire. That is, the fund will treat an investor’s account as being reportable or not based on the available information it has in its records in accordance with the Cayman Guidance Notes, but there is no need to “worry” if a GIIN is missing from an investor’s Form W-8BEN-E or even if an investor did not furnish a form at all inasmuch as the required Cayman reporting is concerned. It is also worthwhile to note that there is no requirement per se for funds to repeatedly chase investors for documentation.
Now let’s consider a fund that is organized as a Cayman Limited. Life is so much simpler here – and hence less of a need to worry if investor documentation is not ideal – since its interaction with its US withholding agent (assuming it is expected to even receive US source income that could be subject to FATCA withholding) is limited to providing its own Form W-8BEN-E with its GIIN. Since it is not a flow through entity for US tax purposes, it does not have to furnish any of its investors’ FATCA documentation to the US withholding agent. In other words, it will not be withheld upon, nor will it have to withhold under FATCA on any of its investors during 2015. It will though have to document its investors strictly for the purpose of reporting to the Cayman TIA (as described above) and for these purposes it need not even use IRS Forms W-8/W-9 at all, but it may rely on another much simpler self-certification form which it can modify to suit its investor base. Furthermore, it is not likely to have many US reportable accounts, if any, since 1) US taxable investors will generally prefer to invest in flow through entities to achieve certain tax advantages, and 2) tax exempt US investors that don’t have the aforementioned preference would typically be exempt from FATCA reporting.
Finally, let’s consider a fund that is organized as a US partnership, which does not need to register with the IRS (assuming it is not a so-called Sponsoring Entity) or report to another tax jurisdiction at all. And now I’ll let you in on a little secret: it’s reporting to the IRS (Form 8966 for 2014, due 6/30/15) will generally be required only in very limited circumstances, if at all, because unlike Cayman funds it does not have to report on the accounts of most direct US investors. Its requirement to document investors altogether arises only if and when it pays or allocates US source income that is subject to FATCA withholding to its investors. Even if the US fund is expected to receive a significant amount of US source income subject to FATCA withholding – and let’s assume it doesn’t have “complete and proper” documentation from one or more investors – like the Cayman partnership it should consider if the investor is an individual or an entity that is not a prima facie FFI that was admitted to the fund prior to 2015. If so, there should be no FATCA withholding in 2015. And unlike the Cayman partnership that has to effectively subject itself to the documentation standards of the US withholding agent, the US fund itself is the withholding agent and accordingly is in the driver’s seat in setting standards of acceptance for its investors with whom it is in direct contact. A nice sigh of relief there.
In conclusion, CFOs and CCOs of firms whose FATCA state of readiness is less than perfect should assess and focus on the areas that are of the greatest risk to their investors and spend less time worrying about shortcomings that are not likely to make a whole lot of difference to their particular funds.