Substantial regulatory changes to the Foreign Account Tax Compliance Act (FATCA), which were announced on February 20th, 2014 and are set to come into force in July, are set to have a massive impact on the alternative investment industry.
The FATCA regulations are aimed at cracking down on the practice of wealthy individuals evading millions of dollars in taxes by using offshore and international financial accounts that are not reported to the Internal Revenue Service (IRS) or other tax authorities. FATCA was enacted by Congress in 2010 with bipartisan support to target these activities, which are considered by the US Government to be illegal and create inequity in the tax system, as well as contributing significantly to the Federal debt.
Offshore tax evasion undermines confidence in our tax system and deprives the United States of revenues necessary to protect and provide for its citizens, said Secretary Jacob J. Lew in an official US Treasury statement.
There is significant momentum to implement FATCA across the globe, and we will continue to work closely with our international partners to combat these illicit activities and raise global tax standards.
The final pieces of the FATCA jigsaw?
The latest amendments to the act are considered by the US Department of the Treasury and the IRS to have completed the changes to the regulations. The new regulations come in two parts, with the first set making changes to the provisions of Chapter 4 of the Internal Revenue Code, which are often referred to as the FATCA Regulations, and the second set of regulations pertain to the documentation standards, reporting and withholding rules relating to payments made to non-US and US persons.
The FATCA regulations now run to over 550 pages, including preambles that explain the rationale and the process behind the regulations and the amendments. The latest changes number over 50 discrete clarifications and amendments to the final regulations, which were issued in January 2013. These have been influenced by suggestions from stakeholders with regards to reducing the compliance workload associated with the Act, and harmonize FATCA with the approach taken in the intergovernmental agreements (IGAs).
The changes, which will have a greater or lesser effect depending on whether your investments are onshore or offshore, cover four key areas. These are:
- Rules for the identification of payees
- Withholding requirements
- Information reporting with respect to US persons
- Conforming changes to the regulations.
As a whole, the FATCA regulation is designed to stop US taxpayers from avoiding US tax on their income by investing in offshore funds and via overseas financial institutions. Funds of all types will be impacted by the rules, including mutual funds, hedge funds, venture capital and private equity funds, and funds of funds will be affected, including those that are managed in the US and those that are based abroad.
Under the regulations, funds based in the US will be treated as US financial institutions (USFIs), and will therefore be obliged to withhold payments to investors who do not provide the requisite documentation and/or information.
Also, foreign financial institutions (FFIs) such as offshore investment funds will be obliged to disclose information on specified US persons to the Internal Revenue Service (IRS), while Non-financial foreign entities (NFFEs) will be required to do likewise. Any refusal to cooperate will result in a 30% tax on “withholdable” payments such as on interest or dividends. The new rules will apply to certain payments made on or after 1st January 2013, meaning that investors and fund managers will have to act quickly to make sure that they meet the regulations before the July 2014 deadline.
Other key takeaways from the latest regulatory changes include:
- Funds that are withholding foreign partnerships will be obliged to enter into FFI Agreements, unless they are deemed compliant..
- Fully intermediated funds and certain local institutions will be deemed compliant, and will therefore not have to enter into FFI Agreements.
- The chief compliance officer (or the equivalent) of the FFI is obliged to guarantee that the required review processes for pre-existing individual accounts will be completed in a timely fashion.
- A centralized application procedure for investment funders under common management is being considered by government.
- The rules over passthru payments, which apply to all payments, have been clarified, with participating FFIs being required to determine and publish passthru payment percentages that correspond with the US assets they own, calculated as a quarterly average.
The new regulations are a significant challenge to the fund industry, and with the deadline for assessment looming, fund managers will have to undergo a significant planning process. which will need to be carried out in a timely fashion.
Next steps for fund managers
The first step that fund managers will have to take is to assess the classification and legal entity structure of the funds under their management, whether they be FFIs, NFFEs or USFIs.
Then, there will need to be a substantial review of investor data in order to classify investors into the categories set out in the FATCA guidelines. This will also entail a thorough examination of the investment firm’s existing on-boarding processes to find out whether the current know-your-customer procedures are adequate, and if not, they should be amended accordingly.
Finally, fund managers, aided by compliance officers and administrators, will have to take a thorough look into the payment systems that will be affected by the incoming FATCA guidelines with regard to reporting and withholding. The sheer scale and scope of the regulatory changes means that concerted efforts will have to be made within all financial organizations to raise employee, partner, and investor awareness of the regulatory changes. Also, given the huge amount of data involved, many firms may also wish to consider an investment in technology-based solutions in order to streamline the process of complying with the new regulations.
For a full text of the FATCA regulations, as well as the associated joint statements between the US and participating countries, visit the FATCA page on the US Treasury website.
I am a writer based in London, specialising in finance, trading, investment, and forex. Aside from the articles and content I write for IntelligentHQ, I also write for euroinvestor.com, and I have also written educational trading and investment guides for various websites including tradingquarter.com. Before specialising in finance, I worked as a writer for various digital marketing firms, specialising in online SEO-friendly content. I grew up in Aberdeen, Scotland, and I have an MA in English Literature from the University of Glasgow and I am a lead musician in a band. You can find me on twitter @pmilne100.