It would be a bit much to expect the private funds industry to have achieved full compliance with the Foreign Account Tax Compliance Act (FATCA) by Tuesday, the date the law takes effect – given that the US government has missed its own deadlines to provide the guidance and new forms needed to fulfill the complex new tax law.
One private equity CFO puts it like this: “For the past two years, I’ve had service providers try to create this sense of urgency about FATCA compliance, only to spend money and then see new rules or guidance come out a few weeks later. Now I’m just going to sit and wait until the real deadline approaches – and I know the rules aren’t changing anymore.”
This is one reason why GPs tell pfm that they’ve been able to sleep soundly at night, despite not having fulfilled all their FATCA compliance obligations before the bill’s July go-live date.
Another contributed factor was IRS guidance released in May, which suggested the US tax authority would provide firms that have not yet achieved full FATCA compliance with some leniency, if they are acting in “good faith”. Sources say 2014 and 2015 will be more of a transition period, to allow covered firms to understand and comply with FATCA.
Nonetheless, advisers say acting in good faith probably means writing down some FATCA compliance policies and procedures – “something that shows a timeline of your efforts,” as one US-based accountant puts it.
The compliance work ahead
Indeed for some time now, private fund managers have been hearing that July 1, 2014 is the big date to worry about when it comes to FATCA – which President Obama signed four years ago now to catch US tax cheats hiding money in overseas accounts.
As FATCA’s go-live date, it’s clearly an important milestone. But most GPs see it more as a staging post in what will end up being a four-step compliance project.
The first step, which advisers say should be completed by now, is figuring out which entities under control need to register as their own ‘foreign financial institution’ (or FFI) – each of which will be responsible for gathering and reporting information on any US account holders to the Internal Revenue Service (IRS).
In the run up to the July deadline, GPs have been working with their lawyers, accountants and other service providers to see if things like feeder funds, co-investment vehicles, offshore holding companies and all the other many types of entities that sit in their various fund structures need to be registered as their own FFI – a laborious process that has resulted in compliance officers sometimes having to make a few judgment calls. For instance, legal advisors have been debating whether or not acquisition vehicles are FFIs (the latest thinking is that they may very well be, at least according to UK regulations put out late last year).
With this first step, one saving grace is that it’s possible to designate one entity in the chain of control of a ‘sponsoring entity’ that can take on the reporting and compliance duties for all the entities below it. So for example, a GP can be the sponsoring entity for the three funds under its stewardship. This can save everyone time and money, says one US tax expert.
The logical outcome would seem to be that fund advisors group as many funds (and their sub-entities) as possible under one convenient FATCA reporting parent. But some GPs discovered a big drawback in doing so when trying to work out which entities should be designated as a FFI.
April Evans, chief financial officer of Monitor Clipper Partners, says her team found that each entity in her firm’s fund family tree would ultimately need to be registered on its own anyway. “So we just decided to do everything.”
Each FFI is assigned an identification number (or 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. But a sponsoring entity’s GIIN can only be used by entities under its umbrella for two years; so some GPs are finding it prudent to work ahead of schedule and receive GIINs for all their entities before then.
Nonetheless, there are still some major benefits of assigning a sponsoring entity, says Joan Arnold, a tax-focused partner with law firm Pepper Hamilton.
“For some private fund shops with a large numbers of entities – one client I work with would have more than 50 – registering one sponsoring entity now as opposed to 50 is fine, because they can defer the issue for two years. Plus some of the entities will cease to exist before they would have to be registered, so it would be a wasted effort.”
Each FFI must also appoint a ‘responsible officer’ who takes on some legal duties to see that FATCA rules are being met. But if you follow the sponsoring entity route, you only need one responsible officer for the whole group, points out Arnold. “That can be a very big deal in some fund complexes. They want to use one person now, and they’ll wait to see what happens to the responsible officer before they put forward more people.”
The second step, which only a slight majority of private fund advisors have completed now, according to market sources and informal surveys, is to actually register the FFIs with the IRS via an online portal set up by the tax authority last August. Here, too, some GPs have run into some issues when designating a sponsored entity: the IRS hasn’t exactly provided much guidance on how a sponsored entity completes the registration process. And some question what happens if a responsible officer isn’t actually the officer of a fund or holding company that is part of a larger sponsored group.
Life after registration
The third step in GPs’ FATCA compliance planning, which most firms have only just begun, is arguably where the July deadline really starts to matter. Fund advisors must update their onboarding procedures for new LP accounts, and analyze their existing LP accounts to see that all the right information for FATCA reporting purposes is there. If not, July marks the date when certain types of LPs could start incurring that 30 percent withholding tax on future realizations.
As a general rule, funds will 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, explains Arnold.
To avoid this fate, fund managers are in the process of updating their onboarding procedures to require investors to document their FATCAclassification to enable proper withholding and reporting on an annual basis. Similarly, existing investor documentation will need to be updated forFATCA; in this regard, IRS Forms W-9 or W-8, as applicable, need to be supplemented or newly solicited from every LP, stress advisors.
Unfortunately that’s something easier said than done, says EisnerAmper tax partner Jay Bakst. “Some of the instructions to the new forms designed for FATCA documentation and reporting are not even out yet and managers receiving these new forms from their LPs may be reluctant to accept them as valid pending the release of detailed guidance regarding how to complete them.”
Over the coming months and years GPs may have to go back to investors to correct the forms as new guidance comes out, says Bakst. Worse still there’s a risk that LPs will be slow to move in sending or correcting their forms in a manner that properly documents them as FATCA compliant, which can delay the firm’s own FATCA compliance planning.
Some GPs are hopeful that LPs are familiar enough with FATCA that the process won’t prove too burdensome.
“Our industry is dealing with very sophisticated investors who are already well aware of FATCA,” says Corsair Capital director of accounting Kristy Rocca Trieste. “And like all GPs we continuously update our LP tax files and obtain updated documentation from our LPs no less frequently than every five years.”
Nonetheless GPs should assume that not every form sent by their LPs is coming in perfect, says Bakst. “The form must be reviewed and validated as the LP may have left a certain mandatory line blank or answered in a manner that the GP knows, or has reason to know, is incorrect.”
In fact this third step around LP due diligence may be the most difficult one of all, advisors predict. For starters GPs must make the decision to either supplement their pre-FATCA LP documentation (assuming they are valid) with information needed for FATCA classification or solicit the new version of the forms released earlier this year which contain all of the lines for proper FATCA documentation from their LPs.
Evans says her firm decided to update its existing LP files and records late last year because “anyone who did not reach out to LPs in 2013 to refresh LP W8s using the old forms is now in the position of going out to LPs to complete the new W8s – which no one seems to understand how to complete.”
Others however are deciding to wait for the IRS to release some more detailed instructions to the new W-8 and W9 forms designed with FATCA in mind and solicit these new forms rather than “patching together different pieces of information or documentation depending on the type of investor and risk getting it wrong,” says Bakst.
(EDITOR’S NOTE: In late June the IRS released long-awaited instructions for its Form W-8BEN-E, which foreign LPs must complete to certify their tax status for FATCA purposes, see related coverage or privatefundsmanagement.net for further details)
After all the forms are collected and LPs’ tax files are updated, advisers must then cross-reference the files with their existing LP records. What can’t happen, advisors warn, is an LP submits a FATCA form that contradicts information in a subscription agreement, anti-money laundering form or other fund documents. “GPs can’t just rely on investors’ forms as completed without applying the relevant due diligence procedures,” warns Bakst.
Approaching the finish line
The final and fourth step is one many GPs appear to have put on the backburner for the moment. Once LPs have been certified FATCA-complaint (or if not, properly isolated from other investors to ensure that only withholding tax applies to them – something legal experts say should be spelled out clearly in the LPA), the adviser must implement procedures for FATCA reporting and withholding.
With respect to reporting, the IRS will refrain from enforcing many of its requirements until March 31, 2015 for GPs based in countries that have signed a ‘Model 2’ intergovernmental agreement (or IGA) – or if they have no IGA in place, meaning they will be reporting directly to the IRS. For firms reporting via their local regulators under a ‘Model 1’ bilateral FATCA pact, which most jurisdictions have opted for, the relevant reporting date is September 30, 2015. Since the IRS has so far failed to provide all the necessary guidance and final forms, those dates seem somewhat optimistic.
Clearly, the sheer complexity of FATCA has caused a lot of unexpected stress and compliance planning. But while large swathes of the industry still have a way to go before they’re fully compliant, it does appear that private fund advisers are getting a grip on this new reporting reality.