fatca implementation: what private investment fund ... · fatca overview the purpose of the fatca...

© 2013 Winston & Strawn LLP

FATCA Implementation: What Private Investment Fund Managers Need To Know Now

Brought to you by Winston & Strawn’s Corporate and Tax Practice Groups

© 2013 Winston & Strawn LLP 2

Today’s eLunch Presenters

Mitch Moetell Tax

New York

[email protected]


FATCA Overview

The purpose of the FATCA rules is to combat income tax evasion by U.S. persons

To that end, FATCA requires certain foreign financial institutions and non-financial foreign entities to report information concerning their U.S. owners and accountholders

Noncompliant financial institutions and non-financial entities are subject to a 30% withholding tax on “withholdable payments”


FATCA Overview

Foreign financial institutions ("FFIs"): Must enter into an FFI Agreement with the IRS that imposes

identification, withholding, and reporting obligations on the FFI with respect to its accountholders

"Deemed compliant" FFIs are generally exempt from these obligations

Non-financial foreign entities ("NFFEs"): Must identify their "substantial United States owners" to

persons from whom they receive withholdable payments "Excepted" NFFEs are exempt from this obligation


Relevance for Investment Funds

FATCA definition of financial institution will include: Fund managers Master funds Feeder funds Certain holding companies established or acquired in connection with

portfolio investments

Thus, such entities that are foreign will be FFIs subject to FATCA A fund family will often include multiple FFIs that are subject to FATCA

U.S. and foreign fund entities may have withholding obligations pursuant to FATCA


Typical Fund Structures

One or more "master funds," generally structured to be treated as partnerships for U.S. tax purposes. May be U.S. or foreign entities.

One or more "onshore" feeder funds, generally partnerships for U.S. tax purposes, through which U.S. taxable persons invest

One or more "offshore" feeder funds, generally corporations for U.S. tax purposes, through which foreign and U.S. tax-exempt persons invest

Holding companies may be formed or acquired in connection with particular investments


Multiple FATCA Regimes

Final FATCA regulations, issued January 17, 2013, provide a "default" set of rules for foreign financial institutions

Treasury is negotiating "intergovernmental agreements" (“IGAs”) with governments of foreign countries that will supplant or modify the Regulations with respect to those countries' financial institutions: Model 1 IGAs: FFIs report to home country under procedures set out

in IGA and home country rules (to be adopted or modified in light of IGA) and do not enter into FFI Agreements with the IRS

Model 2 IGAs: FFIs enter into FFI Agreements with the IRS; home country agrees to facilitate compliance; FFI's obligations are modified in some respects


IGAs

Model 1 IGAs have been signed or initialed with: United Kingdom Denmark Italy Ireland Mexico Spain

Model 2 IGA has been signed with Switzerland Discussions are underway with numerous countries, including the

following jurisdictions in which offshore funds are commonly established: Cayman Islands Jersey Guernsey Isle of Man Luxembourg


Timing Issues

Treasury has announced that it hopes to have initialed IGAs with most interested jurisdictions by January 1, 2014

FFIs should be able to enter into FFI Agreements beginning July 15, 2013; an FFI must register by October 25, 2013, to be sure it will be recognized as a participating FFI by January 1, 2014 (the date that the FATCA withholding requirements begin)

Accordingly, FFIs will need to closely monitor the progress of IGA negotiations with their home countries, and in some cases, an FFI may need to enter into an FFI Agreement even if a Model 1 IGA may later be entered into by its home country


FFI Definition

Accepts deposits in the ordinary course of a banking business (depository institution)

As a substantial part of its business, holds financial assets for the benefit of one or more other persons (custodial institution)

Is an investment entity Is an insurance company or holding company of an expanded

affiliated group ("EAG") that includes an insurance company Is a holding company or treasury center if

Its EAG includes any of the above (other than an entity treated as an investment entity solely because it trades or manages investments for customers) or

It is "formed in connection with or availed of by" an investment vehicle


Investment Entities Category (A): An entity that "primarily conducts as a business" on behalf

of customers: Trading in currencies or financial instruments Portfolio management Otherwise investing, administering, or managing funds, money, or financial assets

Category (B): An entity whose gross income is primarily attributable to investing, reinvesting, or trading in financial assets if it is managed by a depositary institution, custodial institution, insurance company or insurance holding company, or investment manager identified above

Category (C): An entity that functions or holds itself out as a collective investment vehicle (including mutual funds, PE funds, hedge funds, etc.) with respect to financial assets

Note: "financial assets" do not include real estate


Examples of Financial Institutions

Entities that are fund managers generally will be financial institutions

Master funds and feeder funds will be financial institutions A "family office," family trust, or other entity that does not

hold itself out as a collective investment vehicle will not be a financial institution as long as it does not have an outside entity manager

A holding company controlled by a fund through which it makes a portfolio investment will be a financial institution

A holding company not controlled by a fund may be a financial institution if it is "formed in connection with or availed of by" the fund


Exceptions to Financial Institution Status A holding company, treasury center, or captive finance

company that is a member of a nonfinancial group and meets certain requirements

Certain start-up companies or companies entering a new line of business

Certain nonfinancial entities in liquidation or bankruptcy "Excepted inter-affiliate FFIs" Section 501(c) entities Foreign non-profit entities


Retirement Funds

Under the foregoing definition, a foreign retirement fund is treated as an FFI. However, certain retirement funds are treated as "exempt beneficial owners," payments to which are not subject to FATCA withholding. Accordingly, such retirement funds will not be required to comply with the FATCA regime. Exempt retirement funds include: Treaty-qualified retirement funds (a fund established in a country with which the U.S.

has a tax treaty and which qualifies for benefits under that treaty) Broad participation retirement funds (among other requirements, must be government

regulated and have no beneficiary with a right to more than 5% of the fund's assets) Narrow participation retirement funds (among other requirements, must have fewer

than 50 participants and sponsoring employer cannot be an investment entity or passive NFFE)

Fund that would qualify under section 401(a) if it were formed in the U.S.


“Deemed-Compliant” FFIs

The Regulations provide three categories of “deemed-compliant” FFIs: Registered deemed-compliant FFIs Certified deemed-compliant FFIs Owner-documented FFIs

Such FFIs will not be required to enter into FFI Agreements, but may have certain due diligence and reporting requirements


Registered Deemed-Compliant FFIs

Local FFIs Nonreporting members of FFI groups “Qualified collective investment vehicles”

A regulated investment fund whose owners are generally limited to participating FFIs, registered deemed-compliant FFIs, retirement plans, nonprofits, U.S. persons other than “specified U.S. persons,” nonreporting IGA FFIs, or exempt beneficial owners.

Restricted funds A regulated investment fund that takes steps to ensure it is not held by

specified U.S. persons, nonparticipating FFIs, or passive NFFEs with substantial U.S. owners

Qualified credit card issuers Sponsored investment entities and CFCs


Certified Deemed-Compliant FFIs

Nonregistering local banks FFIs with only low-value accounts Sponsored, closely held investment vehicles Limited life debt investment entities (transitional).


Sponsored Investment Entities

While most of the deemed compliant categories will not be useful to fund managers and investment funds, the provisions for "sponsored investment entities" will reduce the registration requirements and streamline reporting for a fund family Registered sponsored entities

Cannot be a QI, withholding foreign partnership, or withholding foreign trust Must register with the IRS Sponsor must be authorized to manage the sponsored entity and enter into

contracts on its behalf Sponsor must register with the IRS and perform all FATCA requirements that would

have applied to the sponsored entity if it were a participating FFI Sponsor's status may be revoked for material failure to comply with its obligations Sponsored entity remains liable for its FATCA obligations if sponsor fails to perform


Sponsored Investment Entities

Certified sponsored investment entities Not required to register with the IRS Rules are the same as for registered sponsored entities

except: Sponsor must be a participating FFI, reporting Model 1 FFI, or U.S.

financial institution Sponsored entity does not hold itself out as an investment vehicle

for unrelated parties Twenty or fewer individuals own all debt and equity interests in

sponsored entity (other than debt owned by participating FFIs, registered and certified deemed compliant FFIs, and equity owned by a 100% owner that is itself a sponsored entity)


Definition of Financial Accounts

Participating FFIs have identification, withholding and reporting obligations with respect to "financial accounts." This term includes the following: Depository accounts Custodial accounts Nontraded equity or debt interest in a category (B) or (C) investment entity Nontraded equity or debt interest in certain holding companies and treasury

centers Nontraded equity or debt interest in a depository institution, custodial

institution, category (A) investment entity, or insurance company if: Value of interest determined primarily by reference to assets that could give rise to

withholdable payments (consider application to interest in a fund manager that owns carried interests)

Interest issued with a principal purpose of avoiding the FATCA reporting or withholding requirements

Cash value insurance and annuity contracts.


Accountholder Classifications

In order to carry out its obligations under an FFI Agreement, a participating FFI must classify each accountholder according to its “chapter 4 status.” The relevant categories are: U.S. person Specified U.S. person Foreign individual Participating FFI Deemed-compliant FFI Restricted distributor Exempt beneficial owner Nonparticipating FFI Territory financial institution Excepted NFFE Passive NFFE


Specified U.S. Person

A specified U.S. person is any U.S. person other than A publicly traded corporation or a member of its EAG; An exempt organization under section 501(a) or an IRA; The U.S. or any wholly owned agency or instrumentality thereof; Any U.S. state, the District of Columbia, any U.S. territory, or any

political subdivision, agency or instrumentality of any of them; A bank, REIT, RIC ,or common trust fund; Certain charitable remainder trusts; A broker or registered dealer in securities, commodities, or

derivatives; Trusts relating to certain employee plans.


Exempt Beneficial Owner

Exempt beneficial owners include: Foreign governments, including political subdivisions or

wholly owned instrumentalities or agencies thereof; Certain international organizations or wholly owned

agencies or instrumentalities thereof; A foreign central bank of issue; A government of a U.S. territory; Certain foreign retirement funds; Certain entities wholly owned by one or more of the

foregoing.


NFFEs

Non-financial foreign entities ("NFFEs") are foreign entities that are not FFIs. They are divided into several categories: Excepted NFFEs. Excepted NFFEs are exempt from FATCA withholding. An

NFFE is an excepted NFFE if it is: A publicly traded corporation; A member of a publicly traded corporation's EAG; An entity organized in a U.S. territory and wholly owned by one or more bona fide

residents of that territory; An "active NFFE," meaning an entity if less than 50% of its gross income for the

preceding calendar year is passive income and less than 50% of the weighted average percentage of assets (tested quarterly) are assets that produce or are held for the production of passive income.

Passive NFFEs. A passive NFFE is any NFFE that is not an excepted NFFE. Passive NFFEs are exempt from FATCA withholding if they provide information

regarding their "substantial U.S. owners" (generally, 10% U.S. owners) to the withholding agent and the agent reports that information to the IRS.


Participating FFI Obligations

The core obligations of a participating FFI under an FFI Agreement are: Withholding. The FFI must deduct and withhold tax from

withholdable payments made to recalcitrant account holders and nonparticipating FFIs. A recalcitrant account holder is an account holder that is not an FFI, if the account

does not qualify for certain exceptions (including exceptions for low-value accounts) and the account holder:

Does not comply with requests to determine whether account is a U.S. account; Does not provide a valid W-9 on request; Does not waive a foreign law that would prevent reporting; or Is a passive NFFE (other than a WP or WT) that does not provide the required

information regarding its owners.

Withholding begins 1/1/2014 for US-source FDAP; 1/1/2017 for gross proceeds of assets that could produce U.S.-source interest or dividends; not earlier than 1/1/2017 for foreign passthru payments (as to which additional regulations are needed).


Identification and Documentation of Account Holders and Payees The FFI is required to identify and document the chapter 4 status of each holder of an

account, as well as whether the account is: A U.S. account A non-U.S. account An account held by a recalcitrant account holder An account held by a nonparticipating FFI.

A U.S. account is an account held by: A specified U.S. person; or A U.S.-owned foreign entity.

A U.S.-owned foreign entity is any entity that has one or more "substantial U.S. owners;" a substantial U.S. owner is a specified U.S. person that owns 10% of the entity; there is a 10% threshold for substantial ownership that is reduced to 0% in the case of foreign entities that are investment entities or specified insurance companies. Because reporting is only required for the substantial U.S. owners of NFFEs, the significance of the

0% threshold is unclear.

Detailed due diligence rules and transiation rules apply to the identification and documentation requirements.


Reporting requirements

Participating FFIs generally must report account information with respect to: Accounts held by specified U.S. persons; Accounts held by passive NFFEs with substantial U.S. owners; Accounts held by owner-documented FFIs; Accounts held by recalcitrant accountholders.

The FFI may report under procedures set out in the Regulations and FFI Agreement or by applying the rules applicable to Form 1099 reporting (with certain additional requirements.

Participating FFIs and registered deemed-compliant FFIs must also report "foreign reportable amounts" paid to nonparticipating FFIs. These are FDAP payments that would be withholdable payments "if paid by a U.S.

person." Dividends and interest paid by foreign fund Redemption payments treated as dividends for U.S. tax purposes?


IGAs

Financial institutions that will be governed by an IGA, rather than the regulations, will need to register as such Not currently clear how registration will be implemented (with U.S. or

with home country)

The rules that will apply to financial institutions in an IGA partner country will depend on the terms of: The relevant IGA The implementing legislation in the partner country

However, the IGAs released to date give an indication of the pattern that future IGAs can be expected to follow

Impact of “most favored nation” clauses

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IGAs

Each IGA will have an Annex identifying the local financial institutions that will be excluded from the FATCA/IGA reporting requirements

Each IGA will have an Annex specifying the due diligence requirements applicable to resident financial institutions Generally, a two-year documentation period for accounts in existence on

12/31/2013 Accounts created on or after 1/1/2014 generally must be documented upon

opening

Financial institutions generally will not be required to withhold on payments to nonparticipating FFIs, but instead will be required to report such payments made during 2015 and 2016 Withholding required by QIs, WLPs, and WFTs

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IGAs

Financial institutions that fail to comply with the terms of the IGA will become subject to FATCA withholding only upon a determination by the IRS Each jurisdiction agrees to notify the other of instances of significant

non-compliance The FFI's jurisdiction of residence has 18 months to bring the FFI into

compliance through internal enforcement procedures If the FFI is not in compliance at the end of that period, it will be

designated a nonparticipating FFI and become subject to withholding

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