It’s that time of year again. Private equity firms have kickstarted their year-end tax planning. And while the process of gathering documents, sending withholding estimates to LPs and reviewing the tax status of offshore blocker vehicles (among many other things) is always challenging, this year it may be particularly tough.
The feedback from industry tax advisors and chief financial officers is that the US Foreign Account Tax Compliance Act (FATCA) is proving an additional burden.
FATCA was originally scheduled to go live in January, but US authorities recently extended that deadline to July. Nonetheless, GPs shouldn’t take the additional six month breathing window as a cue to delay their FATCA compliance efforts. Advisors warn that reviewing fund structures and LP intake processes for FATCA purposes can take months. To that end, one best practice emerging is to send LPs a questionnaire that solicits information needed for FATCA compliance sooner rather than later. Many GPs are giving investors a response deadline date to avoid significant delay in receiving the completed questionnaires back.
And the real key FATCA deadline date for GPs to meet may be sooner than expected. In early June, the Internal Revenue Service (IRS) will post the first list of financial institutions that have registered under FATCA, a list that US withholding agents will use to determine which firms will suffer a 30 percent withholding tax under the law for non-compliance. To guarantee a spot on that list, firms should complete the online IRS registration process by April 25 – about 10 weeks sooner than the new July deadline.
In other areas of year-end tax planning, private equity outfits will need to consider a popular tax strategy initiated in 2012. Last year, a relatively high number of firms executed dividend payouts from portfolio companies to take advantage of a 15 percent qualified dividend tax rate that jumped to 20 percent at the start of 2013.
The problem is, if those dividends were received in 2012 but ultimately distributed to LPs in the 2013 calendar year, it could cause a timing issue on tax forms. The dividend income will appear on the fund’s 2012 Schedule K1, but because withholding tax on LPs’ share of the distributions doesn’t happen until 2013, the 1042-2 form (which reports dividend withholding) won’t be received by LPs until a year later.
One industry tax advisor says best practice would be to footnote the Schedule K1 in 2012 stating that the withholding done was in 2013; and footnote the 1042-S form in 2013 stating the dividend is connected to 2012 income.
“Remember to make the withholding deposit with the IRS immediately following the distribution to the LPs,” warns the advisor. “We’ve seen scenarios where GPs (new and old) don’t remember to deposit the withholdings with the IRS immediately and at year-end when the accountants finally find out about the distribution, the GPs can get hit with penalties and interest of almost 50 percent of the withholding liability. If GPs don’t discuss distributions with their accountants, they should make sure that someone internally is monitoring the withholding and deposits of tax with the IRS.”
There's no doubt that year-end tax planning can be challenging. No one knows that better than the people at the firm responsible for tax-related responsibilities. But here’s hoping some of the challenges specific to 2013 are less onerous than they appear to be.