Foreign Account Tax Compliance Act Overview
Account Tax Compliance Act (“FATCA”) was enacted by Congress as part of the HIRE Act of 2010. FATCA will become effective on January 1, 2013 and some parts of the act will be applicable to investment managers. The primary objective behind FATCA is to combat tax evasion by making it difficult for U.S. persons to hide income and assets overseas. To accomplish this objective, the new regulations will require financial institutions to identify and disclose direct and indirect U.S. investors and withhold U.S. income tax on nonresident aliens and foreign corporations. Foreign financial institutions, and certain onshore entities, will be required to comply with the new disclosure and tax withholding requirements or be subject to a 30% FATCA tax. While proposed regulations and applicable forms have yet to be finalized, investment managers should be prepared for the new FATCA regime and compliance rules.
Application to Investment Funds
Foreign financial institutions (each, an “FFI”), which include hedge funds, funds of funds, commodity pools and other offshore investment vehicles, will be required to enter into an agreement with the IRS (“FFI Agreement”) to avoid being subject to the FATCA tax. Each FFI will be required to:
- obtain, verify and report information on its direct and indirect U.S. investors pursuant to specific due diligence procedures;
- perform annual reporting;
- deduct and withhold 30% from any payment made by the fund to U.S. investors refusing disclosure and non U.S. investors without proper FATCA documentation; and
- comply with requests for additional information.
Domestic funds will need to determine the FATCA status of each of their investors and will be subject to new due diligence and reporting obligations for current and new investors. In addition, U.S. funds will be required to deduct and withhold a 30% FATCA tax from investors who do not provide the required documentation.
The current timeline for FATCA compliance is as follows (however dates may change as regulations are finalized):
- FFI Agreement – FFIs will be able to enter into an FFI Agreement through an IRS online system starting on January 1, 2013 (but no later than June 30, 2013).
- Reporting Obligations – due diligence and reporting requirements under FATCA will be implemented in a staggered manner, based on an investor’s account balance, beginning on January 1, 2013. IRS plans to release new tax forms in the next few months.
- Withholding Obligations – the 30% FATCA tax will be implemented in a staggered manner, beginning on January 1, 2014 and will eventually include interest, dividends and other FDAP (fixed, determinable, annual, periodic) income from U.S. sources, gross proceeds from sale of U.S. securities and foreign pass-through payments.
As we mentioned previously, final regulations have not been promulgated. However, when they are, managers will need to do the following:
- Review and update fund offering documents and other investor agreements to disclose additional reporting obligations imposed by FATCA and risk of withholding for “recalcitrant investors” (those investors who choose not to disclose their name to the IRS).
- Asses fund structure and identify entities that may be affected by new FATCA regime.
- Work with third-party service providers to ensure proper registration and compliance once FATCA rules are finalized, including: (a) investor due diligence and documentation; (b) FFI Agreement; and (c) FATCA withholding.
If you have questions about the new FATCA requirements and how they impact your fund, please contact us directly.
Cole-Frieman Mallon & Hunt LLP, an investment management law firm which provides legal services to the hedge fund industry. Bart Mallon can be reached directly at 415-868-5345.