By Bernard Attard PwC Malta

IN BRIEF

The impact of the Foreign Account Tax Compliance Act (FATCA) on the asset management industry is profound. Virtually every asset management fund will have to comply with FATCA as each likely will be considered either a US withholding agent (USWA) or a foreign financial institution (FFI). Compliance involves understanding not only what the FATCA regulations issued by the US Department of the Treasury (US Treasury) in January 2013 (the FATCA regulations) require, but, just as importantly, what various intergovernmental agreements (IGAs) and local law require as well.

Since September 2012, the US Treasury has entered into a number of IGAs with various partner countries specifically to address the challenges faced by foreign entities as they attempt to comply with FATCA. The IGAs not only address legal impediments to compliance, such as local data privacy and other types of restrictions in certain jurisdictions, but also modify certain compliance burdens associated with FATCA reporting and withholding.

Of particular significance to the asset management industry is the recent negotiation of the IGA between the United States and the Cayman Islands (Cayman/US IGA). Both governments have initialed the agreement to indicate their intent to sign it. They also have indicated that the official signing will be held as soon as possible, after which the agreement will be made publicly available.

While the general implications of the Cayman/US IGA are known, there are still many questions that will not be answered until the agreement is signed and guidance is provided by the Cayman Islands Government. However, through the presentation of some frequently asked questions (FAQs), this alert describes some of the more relevant implications of the Cayman/US IGA based on the IGAs signed to date.

IN DETAIL

Importance of the Cayman/US IGA

The Cayman Islands has served as an essential financial center for many enterprises, particularly in the asset management industry. The Cayman/US IGA, generally applicable to funds established or located in the Cayman Islands (Cayman FFIs), is expected to simplify an asset manager’s FATCA compliance program. Although IGAs significantly modify the instances in which FATCA withholding otherwise would apply, asset managers still face substantial compliance tasks under FATCA.

Cayman/US IGA based on Model 1

The US Treasury has promulgated various model agreements, including Model 1 and Model 2, upon which negotiations with FATCA partner countries are based. According to Cayman Islands officials, the Cayman/US IGA is based on the so-called Model 1 IGA. The US Treasury continues to update these model agreements (click here to view the most recent versions).

FAQ #1: What are the practical differences between a Model 1 IGA and a Model 2 IGA?

Both Models are intended to serve as a long-term solution for local law restrictions that otherwise would have prevented compliance with an FFI agreement. Model 1 IGAs require FFIs established or located in FATCA partner countries to follow the terms of the Model 1 IGA as implemented through local law and report information regarding US accounts to their local tax authorities, which will then share that information with the Internal Revenue Service (IRS).

Model 2 IGAs, on the other hand, require FATCA partner countries to direct and enable local FFIs to register with the IRS and report specified information about US accounts directly to the IRS, similar to participating FFIs (PFFIs) in non-IGA countries. Another significant difference is that, except as specifically modified by the IGA, an FFI under a Model 2 IGA is generally required to comply with the terms of an FFI Agreement as provided in the FATCA regulations similar to PFFIs in non-IGA countries.

FAQ #2: What is a reporting financial institution (FI)?

Under a Model 1 IGA, a reporting FI is generally defined as any financial institution that is not a non-reporting FI. Under an IGA, certain FIs that are deemed to pose a low risk of tax evasion are considered non-reporting FIs. Certain FIs that are treated as deemed-compliant or as exempt beneficial owners (e.g. certain pension and retirement funds) under the FATCA regulations are considered non-reporting FIs. In addition, each country that enters into an IGA with the US is able to designate certain types of entities in that country that will be non-reporting FIs. Annex II of each IGA includes a list of the types of local entities that will be treated as non-reporting FIs.

FAQ #3: Is the local law classification or the US tax classification of a fund under a Model 1 IGA relevant for FATCA purposes?

Both are relevant as the classification used depends on the FATCA requirement being assessed.

Similar to PFFIs in non-IGA countries, the US tax classification of a fund under a Model 1 IGA will determine the type of documentation it may need to furnish to a USWA in order to ensure the correct amount of withholding tax on US source income. For example, if a fund is classified as a corporation for US tax purposes, it would generally furnish a Form W-8BEN-E, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding (Entities), indicating that it is the beneficial owner of the income it is receiving. Whereas, if a fund is classified as a flow-through entity (e.g., a partnership), it would furnish a Form W-8IMY, Certificate of Foreign Intermediary, Foreign Flow-Through entity, or Certain US Branches for United States Tax Withholding, to indicate it was not the beneficial owner of the income that it is receiving. In addition to a Form W-8IMY, the flow-through entity would also generally furnish a withholding statement that contains allocations of income to payees and beneficial owners as required.

The US tax classification of a fund covered under a Model 1 IGA is also relevant for determining whether a fund under a Model 1 IGA is a member of an expanded affiliated group (EAG), and whether a fund could be the common parent of an EAG (see FAQ #13).

Although the US tax classification of a fund is relevant for these purposes, the general FATCA compliance obligations of a reporting Model 1 FFI (e.g., registration with the IRS, tax reporting and withholding, documentation and due diligence on investors, etc.) will be determined by the applicable IGA and relevant local law, rather than the FATCA regulations. Of particular relevance is whether an entity is respected as a separate legal entity or disregarded for US tax purposes. Cayman local law may vary, but as a point of reference, the United Kingdom’s (UK’s) Guidance Notes on this matter specifically state that entities disregarded for US tax purposes will be respected as separate entities under local law. It appears that the Cayman Islands may mirror the UK treatment.

A typical example in the asset management industry is an entity organized in the Cayman Islands that has elected to be disregarded for US tax purposes. Assuming the Cayman/US IGA is similar to the UK/US IGA, that entity should be respected as a separate legal entity covered by the Cayman/US IGA and treated as either a reporting or non-reporting Cayman FI.

Registration with the IRS

FAQ #4: Does a fund under a Model 1 IGA need to register through the IRS online system and obtain a global intermediary identification number (GIIN)?

Yes. Although not required to sign an FFI Agreement, a reporting FI under a Model 1 IGA is required to register with the IRS and obtain a GIIN. In addition, a reporting FI may authorize one or more ‘points of contact’ to receive FATCA information from the IRS on its behalf. However, a non-reporting FI under a Model 1 IGA is not required to register with the IRS.

It should be noted that, according to Annex II of the Model 1 IGA, a sponsored investment entity that is not a withholding foreign partnership (WP) or withholding foreign trust (WT) and which has not identified any US reportable accounts (generally, US taxable investors) will be treated as a non-reporting FI. Non-reporting FIs are treated as certified deemed compliant FFIs under the US Treasury regulations. As a result, a sponsored investment entity under a Model 1 IGA with only foreign and US tax exempt investors may not be required to register with the IRS to obtain a GIIN. According to the Model 1 IGA, if the investment entity ultimately ends up getting US reportable accounts, the sponsoring entity must register the investment entity within 90 days after such account is first identified. However it should also be noted that the IRS has not yet issued guidelines on how sponsoring entities will register their sponsored entities.

FAQ #5: By what date should a fund under a Model 1 IGA register with the IRS?

Generally, an entity needs to register by April 25, 2014 to be included in the first list of registered FFIs to be published by the IRS on June 2, 2014. However, there are a couple of provisions that allow a Model 1 FFI to register at a later date.

First, the FATCA regulations provide that a fund subject to a Model 1 IGA is not required to provide a GIIN to a withholding agent until January 1, 2015 unless:

The fund elects (or needs to renew its election) to be a qualified intermediary (QI), WP, or WT; or

The fund has ‘branches’ in a jurisdiction not covered by a Model 1 IGA.

While most funds subject to a Model 1 IGA would meet the requirements to rely on the extended deadline to register, it may still be practical to be on the first list of registered FFIs. Not registering could create administrative complexity if the fund is not on the published list and does not have a GIIN to provide withholding agents. While the fund is technically not subject to withholding, it runs the risk of inadvertently being subject to withholding and potentially having to claim a refund or request a credit. It seems any marginal benefit associated with waiting the extra few months may be overcome by the administrative hassle.

Second, sponsored entities may use their sponsoring entity’s GIIN until 2016, allowing them additional time to register and obtain their own GIIN. As of now, guidance is still pending on how sponsoring entities will obtain the GIINs on behalf of their sponsored entities. Also, as stated in FAQ #4, sponsored investment entities under Model 1 IGAs may not be required to register at all unless and until they have US reportable accounts.

Identifying a responsible officer

FAQ #6: Does a fund under a Model 1 IGA need to have a responsible officer (RO)?

Yes. Although the IGAs make no reference to an RO, the role of an RO for a reporting Model 1 FFI is different than that of an RO for a PFFI under the FATCA regulations. The RO of a reporting Model 1 FFI only needs to be authorized under local law to establish the status of the FI for registration purposes whereas the RO of a PFFI has responsibility over a PFFI’s FATCA compliance program and is required to make various compliance certifications to the IRS. It is not anticipated that the Cayman Islands will require an internal controls certification, but more information should be available once the Cayman/US IGA is signed.

While there is no requirement for reporting Model 1 FFIs to regularly certify to the IRS regarding internal controls, it is still recommended that funds design a governance model to support FATCA compliance, including a framework of internal controls to mitigate risk to their entities and related business functions and/or third party service providers.

Due diligence procedures

FAQ #7: Will a fund under a Model 1 IGA be subject to the same due diligence procedures as PFFIs under the FATCA regulations?

Not exactly. While significant overlap between the due diligence procedures of the FATCA regulations and the IGAs exists, substantial differences remain. These include:

In documenting new individual investors, reporting Model 1 FFIs may generally rely on a self-certification from an individual and information otherwise collected for anti-money laundering (AML)/know your customer (KYC) purposes to determine the status of an individual investor. However, the FATCA regulations generally require a PFFI to obtain tax withholding certificates (e.g., Form W-8BEN) and/or documentary evidence to establish the status of an individual investor. Although the IGAs do not require an actual Form W-8, the self-certification process can clearly be satisfied by completing the appropriate Form W-8.

For pre-existing individual investors, a search for US indicia and the relationship manager inquiry are still required when appropriate. If no indicia are found, no further action is necessary unless there is a change in circumstance. If indicia are found, the fund would have to get documentary evidence similar to that required of new investors.

For pre-existing entity accounts, PFFIs generally have to comply with the same requirements as USWAs, in that the focus is around whether the investors are specified US persons or FIs. However, reporting Model 1 FFIs have a streamlined process under which they determine the status of entity investors based on a combination of self-certification, AML/KYC processes, and publicly available information. Similar rules apply for new entity investors.

In addition, funds are allowed to rely more heavily on the fact that an entity investor is located in any IGA jurisdiction, based on publically available information, so long as they are not on notice that the investor is a nonparticipating FFI (NPFFI).

As the standards differ between IGAs and the FATCA regulations, funds should confirm with their administrator that they are applying the appropriate set of rules for each entity.

FATCA withholding on income

FAQ #8: Will a reporting Model 1 FFI be subject to FATCA withholding on income it receives?

At the fund level, FATCA withholding should apply only if the fund has not resolved any identified instances of significant non-compliance within 18 months of first receiving notification from the US and the US treats the fund as a NPFFI.

FAQ #9: What are the implications of FATCA withholding to investors in a fund that is covered under a Model 1 IGA?

An investor in a fund covered under a Model 1 IGA could experience FATCA withholding to the extent the investor is not FATCA compliant or does not furnish adequate documentation with respect to its investment. Although reporting Model 1 FFIs are generally not responsible for withholding 30% FATCA tax, they will need to furnish documentation to USWAs when they receive US source income. Based upon the documentation received from a reporting Model 1 FFI, a USWA will withhold 30% FATCA tax on withholdable payments paid to the fund that are allocable to investors who are not FATCA complaint or who have not furnished adequate documentation.

Reporting obligations generally

FAQ #10: Will a fund under a Model 1 IGA have any reporting obligations?

Yes, it is anticipated that the information reported to the local tax authority will be substantially similar to that required under the FATCA regulations. The local tax authority will exchange such information with the IRS, but it remains unclear how that reporting will be submitted (i.e., electronic media, a local tax form, or a US information return such as Form 8966 and Form 1042-S). To the extent a reporting obligation exists under any other US information reporting regime, those requirements would presumably still apply.

Use of sponsored groups

FAQ #11: If a fund under Model 1 IGA is part of a sponsored group which includes FFIs that are not Model 1 IGA funds, does the sponsoring entity follow the rules under the Model 1 IGA or the FATCA regulations?

The sponsoring entity should follow the rules of the particular Model 1 IGA as implemented by local law for those funds it is sponsoring that are resident or located in a country governed by the Model 1 IGA; it should not follow the FATCA regulations in that instance. A sponsored group, however, can include funds subject to a Model 1 IGA, Model 2 IGA, or the FATCA regulations. As such, the sponsoring entity should follow guidance that is appropriate to where the fund is located or resident rather than the guidance appropriate to the sponsor.

FAQ #12: Can a fund under a Model 1 IGA be a sponsoring entity?

Yes, to the extent an FI in a Model 1 IGA country meets the requirements under the FATCA regulations and is able to fulfill the requirements on behalf of the FFIs in the sponsored group, it can act as a sponsoring entity.

Expanded affiliated groups

FAQ #13: In determining whether a reporting Model 1 FFI is a member of an EAG, should the local laws of the relevant IGA country or the FATCA regulations be followed?

Unlike other compliance requirements under an IGA, the US tax classification, the FATCA regulations, and other US tax concepts should be followed for purposes of this determination. An EAG is a group of entities connected through more than 50% ownership with a common corporate parent. To determine whether a corporate entity is a member of an EAG, the 50% test is determined relative to vote and value. For non-corporate entities, voting power is not taken into account.

In a typical master/feeder structure in the asset management industry, the offshore feeder is generally treated as a corporation for US tax purposes and owns an offshore master fund that is generally treated as a partnership for US tax purposes. In such example, the offshore feeder and master fund would be part of an EAG to the extent the offshore feeder owns more than 50% of the master fund. The fact that the Cayman feeder is sometimes a partnership under local law does not change this assessment as the US tax classification of an entity is followed for EAG determinations.

FAQ #14: What are the implications to a reporting Model 1 FFI of being in an EAG?

In general, all PFFIs and registered deemed-compliant FFIs that share common ownership sufficient to be part of the same EAG must be registered and identified as members of the same EAG. As part of an EAG, a lead FI must be selected to register the entities pursuant to each FI’s applicable status (e.g., PFFI, reporting Model 1 FFI, etc.) Each member of an EAG has the ability to taint the FATCA compliance of the other members to the extent it does not comply with the registration requirements under either the applicable IGA or the FATCA regulations, depending on which rules are applicable to each entity in the group.

FAQ #15: Can a fund under a Model 1 IGA be a lead FI of an EAG

Yes. A lead FI initiates and is authorized to carry out most aspects of each of its member FI’s FATCA registrations. Thus, its registration schedule will be impacted by the registration needs of its member FIs. To the extent it intends to be a lead FI for one or more member FIs that are not established and operating exclusively in other Model 1 IGA jurisdictions, it may not be able to avail itself of the extended January 1, 2015 date to avoid being subject to FATCA withholding.

THE TAKEAWAY

While many countries are contemplating or have signed IGAs with the US Treasury, the initialing of the Cayman/US IGA is one of the more significant developments for the asset management industry. Asset management professionals should be prepared to analyze the impact of the IGA and other guidance once it is made public. Issues to consider include:

Annex II of the Cayman/US IGA which will specify the entities treated as exempt beneficial owners or deemed-compliant FFIs and the types of accounts that are excluded from the definition of ‘financial accounts’

Legal entity management issues such as the identification of EAGs and sponsoring relationships prior to entering any information into the IRS on-line registration system at the beginning of 2014

Gauging the efficiency of internal controls

Enhancing existing policies and procedures

Evaluating the use of automation and technology

Training relevant stakeholders within the organization

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.