The U.S. Foreign Account Tax Compliance Act (“FATCA”) is becoming a reality. Fund managers around the world over are facing requests from U.S. withholding agents for FATCA documentation from funds and inquiries from potential investors regarding the status of FATCA compliance. Tasked with assessing the FATCA status and compliance of numerous funds, the Fund Manager must review the U.S. FATCA regulations with the application of a Model 1 intergovernmental agreement (“IGA”) if funds are resident in India. We briefly highlight below the key factors fund managers must analyse when determining the FATCA status and compliance obligations of funds resident in a Model 1 IGA country.
As a means of combating U.S. tax evasion, FATCA generally imposes registration, due diligence, withholding, and reporting obligations on foreign financial institutions (“FFIs” or “FIs”), including banks and all types of funds that are organised outside the United States. Failure by an FFI to comply with FATCA can result in a new 30 per cent penalty tax being withheld from certain U.S. source income.
Under FATCA, FFIs generally are required to register their FATCA status on an online portal administered by the U.S. Internal Revenue Service (“IRS”) and enter into an agreement (an “FFI Agreement”) with the IRS to undertake U.S. tax compliance obligations, including reporting certain information to the IRS.
However, in a bid to collaborate with other governments to simplify the burden imposed by FATCA and avoid conflicts with local laws, the United States has entered into “Model 1” IGAs regarding FATCA with over 35 countries, including the U.K., France, Germany, Spain, Sweden, Mauritius and Italy. In addition, the United States has reached agreement in substance, on a Model 1 IGA with more than 50 other countries, including India and Singapore, which now is treated as having a Model 1 IGA “in effect” for all FATCA purposes.
An FI, resident in India or Mauritius or Singapore, a Model 1 jurisdiction, must register with the IRS on the online portal (unless exempted), but it need not enter into an FFI agreement. Model 1 FIs are treated as “deemed compliant” under FATCA and generally are not subject to the FATCA penalty tax.
FATCA status under Model 1 IGA
A fund manager must determine whether the fund in question is an FI under the relevant Model 1 IGA. Generally, the fund will be an FI if it falls within the scope of the “Investment Entity” prong of the FI definition, set out in the Model 1 IGA as:
- Any entity that conducts as a business (or is managed by an entity that conducts as a business) one or more of the following activities or operations for or on behalf of a customer:
- trading in money market instruments; foreign exchange; exchange, interest rate and index instruments; transferable securities; or commodity futures trading;
- individual and collective portfolio management; or
- otherwise investing, administering, or managing funds or money on behalf of other persons.
Most domestic and offshore funds will more likely than not fall within this designation. Foreign collective investment entities, private equity and hedge funds, mutual funds, venture capital and other similar investment vehicles generally should expect to be an FI within the Investment Entity category under a Model 1 IGA.
Once FI status for a fund is established, the second undertaking for the fund manager is to analyse whether the fund is a “Reporting FI” or a “Non-Reporting FI” pursuant to the relevant IGA. Fund managers generally should engage an adviser to assist in ascertaining the application of such categories to a fund. In particular, fund managers will want to assess the suitability of potentially acting as a sponsor for a fund whereby the fund manager can render the fund a Non-Reporting FI by agreeing to take on the fund’s FATCA obligations directly.
Upon registration an FFI is assigned a “Global Intermediary Identification Number” or “GIIN” which will be used by other FFIs and U.S. withholding agents to quickly identify the FATCA compliance of counterparties, investors, and account holders. Reporting FIs in Model 1 IGA countries must register by December 31, 2014 to be compliant with their IGA. It is generally advised that Reporting FIs in Model 1 IGA countries register no later than December 22, 2014 in order to ensure processing before year end and inclusion on the first list published in January 2015.
While registration of a fund may not be a terribly difficult undertaking once the fund’s FATCA status has been determined, it should be understood that the act of registering certifies a Reporting FI’s commitment to comply with its obligations under the local IGA. This commitment in turn requires that such Reporting FI has the knowledge and systems in place to carry out these obligations, such as due diligence reviews of accounts and, if relevant, collection and reporting of certain information.
Fund managers dealing with funds in Model 1 IGA countries must start focusing now on the application of FATCA to these funds. These entities have until the end of 2014 to determine their FATCA status and the obligations that follow. Any Reporting FI should ensure that it registers before year-end in order to comply with its Model 1 IGA.
(Pranay Bhatia is a Partner and Kriyang Karia is Senior Manager with BDO India LLP; views are theirs.)
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