Foreign Account Tax Compliance Act (FATCA) for Private Funds: Key Considerations
Although the Foreign Account Tax Compliance Act (FATCA) went “live” July 1, 2014, guidance continues to fall into place. On July 16, the IRS issued instructions for the requester of various Forms W-8 and continues to update its FAQ website. The Cayman Islands Tax Information Authorityissued regulations effective July 4, 2014 addressing the implementation of the Cayman IGA, and on July 22 issued the first official version of its FATCA Guidance Notes.
Against this backdrop, private equity and hedge funds must keep their foot on the gas towards FATCA implementation. This bulletin discusses high-level FATCA compliance considerations for a “typical” fund structure involving either a U.S. fund as the sole vehicle, or a U.S. fund coupled with one or more master or feeder funds formed in the Cayman Islands. Non-U.S. funds formed in other jurisdictions may have different considerations.
Background
FATCA imposes a 30% withholding tax on U.S. source payments to “foreign financial institutions” (FFIs) that do not comply with requirements to identify their U.S. account holders, as well as to non-financial foreign entities that do not identify their substantial U.S. owners, unless an exception applies. Many countries, including the Cayman Islands, have entered into an intergovernmental agreement (IGA) with the United States, which sets forth the requirements for FATCA compliance for financial institutions located in that country. The Cayman IGA is a “Model 1 IGA,” under which Cayman Islands institutions report information regarding their U.S. account holders directly to the Cayman Islands Tax Information Authority (rather than to the IRS). Other countries have entered into a “Model 2 IGA,” under which resident FFIs report this information directly to the IRS. FFIs not located in either a Model 1 or Model 2 jurisdiction can comply with FATCA by entering into an “FFI agreement” with the IRS.
For U.S. funds, FATCA compliance means complying with due diligence, withholding and reporting requirements. For Cayman funds, FATCA compliance generally means registering with the IRS, performing required due diligence on investors and reporting investor information to the Cayman Islands Tax Information Authority.
Identify and Register Foreign Fund Vehicles
To comply with FATCA, Cayman funds must register with the IRS to be “registered deemed-compliant” (as a reporting Model 1 FFI) unless an exception applies. Thus, fund groups should review their structure charts to identify their non-U.S. vehicles, such as foreign master funds, feeder funds and management companies.
Most Cayman master and feeder funds will be considered “investment entities” under the Cayman IGA and therefore must register with the IRS. Investment management companies formed in the Cayman Islands are exempt from registration, as long as the company is within the scope of FATCA registration solely because it provides investment advice or portfolio management services, and the fund being managed is FATCA-compliant. Other limited categories of Cayman investment vehicles (described in Annex II to the Cayman IGA) are exempt from registration. Thus, funds should review their structure specifics.
Unless exempt, each Cayman investment entity should register on the IRS website to receive a global intermediary identification number (GIIN). A paper registration using Form 8957 is also permissible. The GIIN will be provided to U.S. payors (withholding agents) to establish that the Cayman fund is FATCA-compliant. Existing Cayman funds (and other reporting Model 1 FFIs) must obtain a GIIN by January 1, 2015.
As part of the registration process, a non-U.S. fund must determine whether it is part of an “expanded affiliated group” (EAG), generally meaning a chain of entities connected by more than 50% equity ownership. For example, a Cayman feeder and master fund would be part of the same EAG if the feeder owns more than 50% of the capital or profits interests of the master. Although the EAG concept is not included in the Cayman IGA, the IRS registration process contemplates that one member of the EAG be designated as the “lead financial institution,” and this member will initiate registration for the other EAG members.
