fatca: its impact on the private equityndustry i seminar...pepperhamilton(j,p atto~neys at law...

Pepper Hamilton (J,PAtto~neys at Law

FATCA: its impact on the private equity industry

Tuesday 6 December 2011

Update on FATCA

Joan C. Arnold and Steven D. Bortnick | December 6, 2011

• Compare FATCA to existing withholding regime

• Application of FATCA to financial institutions

• Extraterritorial application to financial institutions

• Interaction with tax treaties• Effective dates

Agenda:

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Pepper Hamilton LLPAttorneys at Law

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Withholding As We Know it Today –Chapter 3 Withholding

• Interest allocable to Foreign Investors subject to 30% withholding, unless it is portfolio interest or a treaty applies

• Dividend allocable to Foreign Investors subject to a 30% withholding unless a treaty applies• No tax to foreign Investors on Capital Gain realized on exit• Exemption from tax/treaty use is done through taxpayer self certification

USPortfolioCompany

EnglishPship

Capital gain on sale of stock

Interestdividends

U.S.Taxables

Foreign Investors

U.S. Tax Exempts

Role of FATCA

• Intended to preclude U.S. tax payers from hiding behind non-U.S. (“foreign”) entities to avoid U.S. tax

• The impact is much more broad reaching• Requires 30% withholding on “withholdable payments”

made to foreign entities unless certain IRS reporting requirements are met

• Does not replace existing U.S. withholding tax rules; it’s an add on

• Very “bank centric,” but applicable to non-banks

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Basics of FATCA - Financial Institutions

• “Withholdable payments” made to foreign financial institution (“FFI”) subject to 30% withholding unless FFI• has agreement with IRS to disclose “U.S. account holders”

and• agrees to impose the 30% tax on passthru payments made to “recalcitrant account holders” and FFIs that themselves do not have an IRS agreement

What is an FFI?

• Accepts deposits in the ordinary course of a banking or similar business such as retail banks;

• Is engaged in the business of holding financial assets for the account of others such as investment banks; or

• Is engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or derivatives. Includes mutual funds, hedge funds, private equity funds, and securitization vehicles.

A non-U.S. entity that:

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What is a Withholdable Payment?

• A withholdable payment is any payment of a type ordinarily subject to withholding tax, including interest, dividends, and royalties from sources within the United States

• Also includes any gross proceeds from the sale of any property that could produce interest or dividends from sources within the United States• Normally such gains are not subject to U.S. income or

withholding tax in the case of a foreign seller not engaged in a U.S. business

FATCA and Funds

• English LP is an “FFI”• 100% of payments of interest and dividends are subject to 30% FATCA withholding unless

English LP becomes a participating FFI – a “PFFI”• Agreement with IRS to disclose U.S. account holders and • Withhold on passthru payments made to recalcitrant owners

and owners that are FFIs, but not PFFIs• Gross proceeds (not gain) subject to 30% withholding unless English LP is PFFI

USPortfolioCompany

Capital gain on sale

Interest dividend

? USTP FCF

Pshp FPIndividual

EnglishLP

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FATCA and Funds

• Assume English LP wants to be PFFI• Turns over U.S. owner information to IRS• Income allocable to and will need to be evaluated

• Is or an FFI? Most likely will be• Is either a PFFI? If not, English LP has to withhold 30% FATCA tax

on income allocable to it• If or are PFFIs, they will have U.S. reporting and

withholding obligations.

• Income allocable to , a recalcitrant owner, is subject to 30% FATCA withholding

• Note: long term acceptance of recalcitrant owners may cause revocation of PFFI agreement.

FC FPshp

FC FPshp

FC

?

FPshp

Passthru Payments

• No FATCA on interest to English LP because it is PFFI• No FATCA on payment to FC1 because it is PFFI• Payment from FC1 to FC2 subject to FATCA withholding because F2 is NPFFI• Payment from English LP to F pshp subject to FATCA withholding as F pshp is NPFFI

U.S.Portfolio

EnglishLP

(“PFFI”)

FC1PFFI

FC2NPFFI

FPshp

NPFFI

Partners

paymentpayment

payment

payment

interest

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FATCA and Funds

• Lends $ to USP in exchange for a note and warrants• If note is legal obligation with a fixed term, and is not equity, and it is

entered into before March 18, 2012, it is “grandfathered,” and the interest is not subject to FATCA

• Warrants – when warrants are redeemed are they gross proceeds of an instrument that can produce U.S. source dividends and thus subject to FATCA? Can they be grandfathered?

U.S.Public

SHFPshp

PIPE

FATCA – For non-FFI’s

• NFFE = foreign entity that is not an FFI• Withholdable Payments to an NFFE that is the beneficial

owner of the payment is subject to 30% withholding unless• NFFE provides certification that it does not have a more than

10% U.S. owner, or• NFFE provides certain identifying information about U.S.

owners, and• Withholding agent reports the information.

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Holding Company

• U.S. pays dividend to FC• If FC is a holding company of

operating subsidiaries that are primarily engaged in non-Fl business, IRS proposal would be no reporting, no withholding

• Certification by FC?• FC cannot be an investment

vehicle whose purpose is to hold companies for investment purposes for a limited time period

FC

FC1 USC FC2

dividend

Holding Company

• Is FC still exempt holding company?

• Will regs provide that dividend from FC to PE funds is passthru? Not statutorily in definition

• If dividend to FC is deemed made to an FFI, it would have to agree to withhold on passthru payments to the PE funds

FC

FC1 USC FC2

dividend

PE Funds

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Integrating Withholding

• Run the FATCA test. Do not apply the treaty• If FATCA test is passed and no FATCA withholding, apply treaty and

withhold at 5% rate• FC could be PFFI, or holding company exception may apply

• If FATCA is flunked, withhold 30% FATCA tax. Do not impose additional 5% withholding

• FC files refund claim for 25%. Refund is subject to compliance with disclosure of US account holders

U.S.

FC

dividend, under applicable treaty, 5% U.S. withholding

Expected Guidance

• Proposed Regulations are due out before the end of the year

• Final regulations expected summer 2012

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Effective Dates - Agreements

• FFI Agreement applications available no later than 1/1/2013

• Last date to enter into FFI agreement to preclude withholding in 2014 is June 30, 2013

• A QI or WFP or WFT Agreement with original expiration date of December 31, 2012 is automatically extended to December 31, 2013.

Effective Dates - Withholding

• U.S. source interest, dividends, royalties (generally income other than sale of goods) etc.• Payments made on or after January 1, 2014

• Gross proceeds of sale assets (e.g., U.S. stocks and bonds) that produce or could produce U.S. source interest or dividends• Payments made on or after January 1, 2015

• Passthru Payments that are not U.S. source• Payments made on or after January 1, 2015

• Passthru Payments that are U.S. source• Payments made on or after January 1, 2014

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Phasing in FATCA

• Due diligence• For new accounts, begins on or after the effective date of the

FFI Agreement• For pre-existing private banking accounts of $500,000 or

more, begins within one year of the effective date of the FFI Agreement

• For pre-existing accounts of less than $500,000, begins the later of 12/31/2014 or 1 year after the effective date of the FFI Agreement

• For all other pre-existing accounts, two years after the effective date of the FFI Agreement.

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The Impact of FATCA – an in house private equity perspective

Lizzy Conder

Taxation Adviser

3i

Agenda

• Does FATCA apply to you?

• Making FATCA a business wide issue

• Project planning

• Areas of uncertainty for private equity

• Lobbying

Does FATCA apply to you?

• Even if you have no US assets and no US investors then FATCA is still potentially an issue for your business.

• Custodians, registrars, lenders, brokers and other private equity houses will have to become FATCA compliant.

• They will need to know that you are FATCA compliant or have to withhold 30% of US related cash flows.

Moving FATCA out of the Tax Arena

• FATCA is not just a tax issue

• Has the potential to impact all aspects of a private equity organisation and business

• Share the knowledge / impact assessment with:»Managing Partners / the board» Across functions » Advisers» Counter parties

• Need a plan.

Project planning – one perspective

Stage One:• High level impact assessment:

– Where is the resource to analysis the impact of FATCA on the organisation? Internal / External.

– Estimate of the scale of FATCA compliance:• How many entities affected? • What functions need to be involved?

– Where do your operations interact with US and/or other FFIs?– Time needed to become FATCA compliant by 1 January 2014 (and impact if not)

• Share the impact assessment with the Partners / Board and the relevant function heads.

Functional impact on private equity managers

• Fund Investor Relations• Valuations

• Regulatory / Compliance• Legal• Shareholder communications (especially for listed foreign financial institutions)• Treasury• Accounting• Internal Audit

• HR• I.T. Systems• Investment executives• Portfolio companies• External service providers - custodians, registrars

Do

Scope

Dec'11 Jan'12 Feb'12 M:ar'12 AprTask Name

EI Project Governance07 14 21 28 05 12 19 26 02 09 16 23 30 06 13 20 27 05 12 19 26 02

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Plan

Review

Project Planning

Stage Two: Detailed review of organisation• Form a small cross functional project team for the initial planning and lobbying. • Level of input/support required from external advisers• Determine a strategy for dealing with the FATCA compliance.• Entity classification and affiliate group identification• Counterparty identification• Identification of internal processes that need to be FATCA compliant• Gap analysis of investor information held• Internal communication strategy – ensure any external queries on FATCA are

passed to the project team. • Assessment of Budget and Resource implications• Identify key areas of difficulty for your organisation and make a decision whether

need to lobby through trade bodies (BVCA / EVCA)

Project timeline for stage two – an example

High Level Project Plan

Project Design and Implementation

Step Three: Design and Implementation• A broad cross functional working group• Determine level of internal and external resource required to implement the upgrade to

processes and procedures– what changes are needed to the financial and treasury systems to deal with FATCA withholding,

quarterly valuations, annual reporting to the IRS.– how best to approach investors for additional information to verify their FATCA status? – what changes are needed to KYC / investor data systems to ensure have sufficient data points to

make FATCA classification for existing and new investors?– what changes to banking documents are required?– revisions needed to standard fund and investment documents. – how to verify that custodians, registrars and other counterparties will be participating FFIs?– Who will be the Chief Compliance Officer?– Entering into FFI contracts for all applicable entities– Roll out to portfolio companies if required

• Get buy-in from across the whole organisation to the changes required. • Implement changes to processes and procedures. • Test the new processes and procedures

FFI contract, monitoring and reporting

End Result - Being FATCA compliant

• Regular reporting to the IRS

• Pass thru percentage quarterly calculations from Jan 2015

• Tri-annual external audits of FATCA compliance processes

Areas of uncertainty in guidance to date

• Holdcos – are Holdcos set up by private equity funds to make acquisitions caught as FFIs or not? Definition not clear in the notices.

• Private banking – does the GP have to treat carry partners as “private banking”clients so more disclosure

• No grandfathering of existing fund agreements. • Will funds be required to kick out recalcitrant investors to comply with rules?• Are GPcos characterised as FFIs?• Can the same or sister GPs make funds become affiliated? • Custodians and nominees• Characterisation of cash deposits• How will buyers react? • How will lenders react? • Impact on listed foreign financial institutions

Impact on portfolio companies if newco set up by private equity funds are FFIs

PFFI NPFFI

New UKHoldco

New UKBidco

New US Holdco

Bank debt

UK group of Target

TexasCo of Target

50% 50%

EV = £50m EV = £45m EV = £5m

2015 Buyout. One of the PE owners will become a participating FFI, the other is non participating FFI

The two UK Holdcos set up for the acquisition may be viewed as FFIs

Rest of US group of Target

loan loan


PFFI NPFFI

New UKHoldco

New UKBidco

New US Holdco

Bank debt

UK group of Target

TexasCo of Target


50% 50%

EV = £50m EV = £45m EV = £5m

The group decides to sell the TexasCo in 2016 for £5m. If UK Bidco is not a PFFI itself then buyer needs to withhold £1.5m of proceeds under FATCA

So both new UKcos will need to enter into an agreement with the IRS to become participating FFIs and publish passthru payments to get proceeds gross


PFFI NPFFI

New UKHoldco

New UKBidco

New US Holdco

Bank debt

UK group of Target


50% 50%

EV = £50m EV = £45m

(a) UK Bidco uses cash to repay bank debt. Needs to know FATCA status of banks to determine whether any withholding

(b) UK Bidco uses cash to repay £2m of shareholder loans but has to withhold on payments to NPFFI

£1,000,000 * 30% x (55/100) = £165,000)

£5m of cash is US source


• Will portfolio companies become part of the same affiliate group as the funds?

• How to roll out a program of FATCA compliance across a private equity portfolio?

• Level of resource required in portfolio company to deal with FATCA issues

• Quarterly valuations

• Will this make strategic investors more attractive than private equity?

Impact on listed foreign financial institutions

• Section 1471(d)(2)(C) of the primary legislation states that FFIs that issue only debt or equity interests that are regularly traded on an established securities market do not maintain “financial accounts”

• Some concern over what the definition of “regularly traded” and “established securities market” would be, but initially the rules looked like listed foreign financial institutions should be treated as “deemed compliant”due to not maintaining “financial accounts”.

• A deemed compliant FFI would be able to receive payments gross without having to enter into a contract with the IRS nor have the reporting burden that other FFIs would suffer.

• But then Notice 11-34 was published in April 2011.

Impact of Notice 11-34 on listed financial institutions

Private Equity Fund

Financial Institution listed on London Stock Exchange (FFI)

Notice 11-34 introduced the idea that although FFIs just issuing listed securities maintain no U.S. accounts, they would be subject to certain obligations under FATCA to the extent they receive passthru payments.

Listed FFI is a partner and receives a distribution from a Private Equity Fund with US assets.

This distribution is a passthru payment

In order to receive the payment without FATCA withholding, then the Notice 11-34 appears to indicate that Listed FFI will have to actively comply with the FATCA rules.

This seems to impact many financial and related organisations

distribution

Being compliant with FATCA for listed FFIs

• Need to determine cash flows out of listed FFIs - dividends, interest payments on debt, debt repayments.

• Who is the payment actually too? For example, dividend payments made to a Registrar who makes the payments to individual shareholders.

• Registrar will be a financial institution – must be participating so listed FFI can be a participating FFI and pay dividend cash gross into registrar’s account.

• How will registrars identify the non participating FFIs upon which IRS will require withholding penalty to be imposed? (Use of nominees, ISA wrappers etc)

• At what point is the registrar required to identify the non participating FFI?

• Attractiveness of shares if 30% penalty is imposed on some shareholders?

• Can any fund or corporate FFI owned by the listed FFI become a participating FFI if the listed FFI can not?

• Will those FFIs require or be required to ensure that the non participating listed FFI exits the fund?

Lobbying

• BVCA is working with national private equity bodies across Europe to lobby the US Treasury and IRS on current areas of concern to private equity:– Grandfathering

– Treatment of recalcitrant investors (especially in existing funds)

– Holding companies

– Pass thru payments

Summary

• Don’t assume that your organisation can avoid FATCA.

• Assess the impact and start planning

• Raise areas of concern with your trade body / your external advisers so that these can be included in their lobbying.

FATCA: changes needed to fund documentation

Laura Charkin, SJ Berwin LLP

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Fund Documentation

• Overview of Issues:• Disclosure to IRS of investor details• Investor consent to disclose and to provide information• Interaction with data protection laws (EU Data

Protection laws and the Tournier principle)• How to deal with non-compliant investors• Relevance for new and existing fund structures

Waiver of confidentiality

• EU Data Protection Laws • Written consent• Data Protection Act 1998 • New and old customers’ consent

• Tournier Principle• Duty of confidentiality • Exceptions

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Key Documents

• Documents affected:• Limited Partnership Agreement (“LPA”) • Deed of Adherence• Information Memorandum

• LPA Key provisions: • Provision of information• Agreement to disclosure• Non-compliance - removal/transfer/costs targeting• Restrictions on transfers

Key Documents

• Deed of Adherence key provisions: • Provision of information – what is it reasonable to

request of investors?• Agreement to disclosure

• Information Memorandum key provisions: • Clear, fair and not misleading• Coverage in US tax section• Risk warnings

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• Investor requests:• Warranties• Parallel fund vehicles• Fund of funds investor requirements

Q & A