FATCA information exchange

Over the last two years, private equity firms have been working to become compliant with the Foreign Account Tax Compliance Act (FATCA), a bill designed to prevent US tax dodging. 

But this year, updates to US FATCA, which asks foreign funds to report information about US investors to the Internal Revenue Service and UK FATCA, an extension of US FATCA that asks funds domiciled in Crown dependencies and overseas territories (CDOT) to report on UK investors, will further affect the reporting requirements of both US and foreign private equity firms.

In addition, the introduction of global tax disclosure regulation the Common Reporting Standard (CRS), which builds on FATCA and requires an automatic exchange of information between governments, is likely to cause further administrative burdens.
Developing best practice

Under FATCA, which went into effect in mid-2014, foreign financial institutions (FFIs) are required to register with the IRS and identify and report information on their US investors by December 2015. This deadline was extended to December 2016 by the IRS in October.

For private equity firms, individual funds, and some related vehicles such as holding companies and feeder funds, that are classed as FFIs, which places significant obligations on firms.

Each FFI is assigned a Global Intermediary Identification Number (GIIN) that will be used by banks, broker-dealers and other types of withholding agents to see which foreign firms have to pay a 30 percent withholding tax on certain US-connected payments for FATCA non-compliance. As a general rule, funds were required to begin applying the tax to any foreign LPs who invest in one of their funds after June 30, 2014 (unless the income is on grandfathered debt) if that LP isn’t FATCA-compliant.

With the December 2016 extension, fund managers have an additional year to register feeder funds, holding companies and other sub-fund type vehicles under an umbrella entity that handles reporting and compliance for the entire group. This will reduce some of the high administrative costs GPs faced when they were required to register each individual entity.

“At this point, many private firms are already in a position to certify compliance, meaning that all FFIs have been identified, obtained GIINs and complied with their reporting (and, if relevant, withholding) obligations for 2014, as required,” says Adrienne Baker, tax partner at Dechert.

But firms complacent about their FATCA program may find themselves in trouble as updates to the bill, related agreements with foreign countries and the Organization for Economic Co-operation and Development (OECD) CRS are changing some requirements.

Global complications

Since introducing FATCA, the IRS and US Department of the Treasury have struck intergovernmental agreements (IGAs) with a number of foreign governments – including the UK, China and India – to implement US FATCA requirements into their own legal systems. That requires FFIs in these countries to report information on US investors to their local tax authorities, who in turn pass the information to the IRS.

However, the lack of uniformity between jurisdictions is an area that is currently creating confusion for firms. Many IGA jurisdictions define the term FFI more restrictively than the US, although some allow the option to apply the broader US definition. In particular, acquisition-focused holding vehicles may be considered FFIs for FATCA purposes by the US, whereas many IGA jurisdictions would not view holding companies as FFIs.

Reporting requirements are also expanding. Formerly, funds domiciled in IGA countries were required to report only US investors who had subscribed to the fund between July 1 and December 31. This allowed funds to focus their due diligence reviews on a section of investors and enabled them to meet the reporting deadline.

Under UK FATCA, the UK has signed agreements with CDOT jurisdictions. Funds domiciled in crown dependencies such as the Isle of Man and Jersey are required to disclose information on UK investors for the calendar year 2015 and UK domiciled funds must also report on investors from the CDOT countries.

The UK has also signed non-reciprocal agreements with its overseas territories, which include the Cayman Islands, Bermuda and Montserrat, asking for funds in these territories to report on their UK investors. UK funds do not have to report on investors from these territories.

Further complexities

Building on FATCA in the global push for information exchange and transparency, there’s also the OECD’s CRS, the first stage of which came into effect in January and required compliant investor onboarding procedures to be in place.

By the end of December, firms in early-adopter countries, such as the UK and its overseas territories, will be required to identify high-value pre-existing individual accounts to local tax authorities for exchange with the partner jurisdiction.
Certain financial institutions that are treated as non-reporting under FATCA will be reporting financial institutions under the CRS, such as local client base financial institutions.

Despite the similarities between the US and UK FATCA, the CRS has fewer classifications and the criteria for each classification is tighter than FATCA, says Tim Andrews, director of development at fund administration provider Ipes.

“US investor-centric funds already had the pain from FATCA – and could have much more with the CRS if they are US funds investing outside the US,” agrees Jeanette Cook, senior tax manager at KPMG.

Funds that are now more likely to report under CRS include many investment advisors and general partners that did not have to report under FATCA because of the way the funds were structured.

The US has not signed up to the CRS initiative because the government prefers GPs and other financial institutions to follow its FATCA regime. However, this will increase reporting complexities and costs as some GPs will have to run two regimes.

“In addition to the added complexity and cost of requiring separate compliance programs, the separate FATCA regime carries the added threat of withholding that is not present in the OECD regime,” says Baker. “Furthermore, the lack of US participation in the OECD’s regime has created some difficulty for US investment entities that contract or invest with financial institutions that are subject to the OECD regime.”

The decision may also cause additional burdens on European funds. “Firstly, no fund wants the hassle of reporting under FATCA,” says Andrews. “Secondly, because the US has not signed up to CRS, European funds for example will have to look through to the beneficial owners of some of their US investors under CRS. This is an extra burden.”
Under the CRS, a US investor will be treated as a passive Non-financial Foreign Entity (NFFE) and will be required to provide details about controlling persons, to OECD compliant financial institutions.

Unlike US FATCA, which specifically requires information only on US investors, the “wider approach” adopted by many EU jurisdictions means that funds are obliged to obtain information on the tax residence of all investors, whether or not they reside in countries which are participating in CRS, says Jennifer Wheater, a private funds-focused partner at Duane Morris.

The exchange of tax information is now a significant addition to annual reporting and 2016 is a pivotal year for managers to get best practice in place.