1 FATCA and trustees: part I

Maples and Calder

Michael Gagie, Richard Grasby, Tim Clipstone, Christopher Capewell, Jon Fowler and Tim Frawley

Do trustees need to register with the US Internal Revenue Service (the “IRS”) before 1 January 2015?  Does registration need to be made in respect of a trust?

These questions need to be given due consideration by Cayman Islands and British Virgin Islands (“BVI”) trustees and the trusts in respect of which they act.

Firstly, it is important to note that both the Cayman Islands and the BVI have legislation which mirrors many of the due diligence and reporting requirements of the US Foreign Account Tax Compliance Act (“US FATCA”) and that such legislation applies to all Cayman Islands and BVI Financial Institutions (as defined below) regardless of whether such entities have connections to the US or receive US sourced income.

Second, it is important to note that trusts are treated as entities for the purposes of US FATCA.  Trusts may therefore be Financial Institutions for the purposes of US FATCA and need to be considered separately from the relevant trustee(s).

Third, it is important to note that a trust with a trustee which is incorporated, resident or licensed in the Cayman Islands is regarded as a Cayman Islands trust – with a corresponding definition for the BVI.  Conversely, a trust governed by the laws of the Cayman Islands or BVI with a trustee incorporated elsewhere will be regarded as a non-Cayman/BVI trust.

Registration with the IRS

Pursuant to Cayman Islands domestic law1 (the “Cayman Regulations”), and similar laws dealing with the implementation of US FATCA2 in the BVI, all Cayman Islands and BVI Reporting Financial Institutions (each an “RFI”) must make an application for registration with the IRS by 22 December 2014 in order to appear on the IRS list by 1 January 2015.

Following the 1 January 2015 deadline, an entity that is an RFI (whether in the Cayman Islands or in the BVI) that has failed to register with the IRS is likely to have any future receipt of US sourced income subject to a 30% withholding by the payer under US law.  Failure to comply with the legislation (of which failure to register will be one factor) can lead to financial penalties and a possible custodial sentence being imposed against the entity, its directors and/or other officers under Cayman Islands or BVI law (as the case may be).

With the above in mind, careful consideration needs to be made as to whether any Cayman Islands or BVI trustee or trust is an RFI for the purposes of US FATCA.

The Cayman Regulations define an RFI as a “Financial Institution which is not a Non-Reporting Financial Institution”3. The intergovernmental agreement entered into between the US and the BVI (“US-BVI IGA”) contains an identical definition.

If an entity is not a Financial Institution, it is regarded as a non-financial foreign entity (“NFFE”).  While NFFEs do not need to register with the IRS, FATCA specific advice should still be obtained as an NFFE is required to determine its FATCA status and where necessary self-certify to other RFIs (for example with banks where they hold accounts) and to US withholding agents.  Failure to provide the appropriate self-certification to US withholding agents can result in the imposition of withholding tax.  Certain NFFEs may also need to obtain self-certification from their “Controlling Persons”.

What is a “Financial Institution” for the purposes of US FATCA?

The Cayman Regulations import many of the definitions and concepts from the framework intergovernmental agreement entered into between the US and the Cayman Islands (the “US-Cayman IGA”).  The term “Financial Institution” is defined in the US-Cayman IGA very broadly to mean “…a Custodial Institution, a Depository Institution, an Investment Entity, or a Specified Insurance Company4.”

Each of the subcategories of the Financial Institution definition are then separately defined within the US-Cayman IGA with further clarification on the meaning of such definitions being provided in the recently published Guidance Notes on the International Tax Compliance Requirements of the Intergovernmental Agreements between the Cayman Islands and the United States of America and the United Kingdom (the “Cayman Guidance Notes”)5.

The US-BVI IGA uses a similar definition and it is anticipated that the Guidance Notes on the International Tax Compliance Requirements of the Legislation Implementing the Intergovernmental Agreements between the British Virgin Islands and the United States of America and the United Kingdom (the “BVI Guidance Notes”), once finalised, will provide further assistance in relation to the types of entities falling within the scope of this definition.

The finalisation of the BVI Guidance Notes is expected imminently although it is not anticipated that there will be any substantial changes to the draft BVI Guidance Notes that are already available on the BVI Ministry of Finance’s website.

Custodial Institution

This is any entity that earns a substantial portion (at least 20%) of its gross income from the holding of financial assets for the accounts of others and from related financial services.

Trustees may fall into this category (but see the section below on Private Trust Companies (“PTCs”)).

Depository Institution

This is any entity that accepts deposits in the ordinary course of a banking or similar business.  Both the Cayman and BVI Guidance Notes further specify that such entity must also regularly engage in one or more other activities, one of which is providing trust or fiduciary services.  Certain trustees that are also banks may fall into this category.

Investment Entity

The definition of Investment Entity for US FATCA purposes has received widespread publication.  This is the category of Financial Institution which is most likely to catch trustees and relevant trusts.

Cayman entities have a choice whether to apply the definition in the US-Cayman IGA, the US Treasury Regulations or under the OECD Common Reporting Standard (“CRS”).  Once the final BVI Guidance Notes have been published, they will provide clarity as to whether BVI entities will have a similar choice.

For current purposes, it is sufficient to note that the US-Cayman IGA definition includes: “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 (cheques, bills, certificates of deposit, derivatives, etc.); 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.”

In practice this means that:

A professional trust company will generally be either a Custodial Institution or an Investment Entity;

An entity which is professionally managed will generally be an Investment Entity, by virtue of the managing entity being an Investment Entity.  This would include a trust where a professional (corporate) investment manager is responsible for investment management or a trust where a professional trust company is the trustee and remains responsible for investment management.

The CRS definitions have an alternative test where the gross income of the entity needs to be primarily attributable to investing, reinvesting or trading in Financial Assets (as defined below) (provided that the entity is managed by an RFI).  This may result in certain trusts not being an RFI.  “Financial Assets” do not include cash, non-debt interest in real estate and companies holding such real estate.

Based on the above, many Cayman Islands or BVI trustees will be Investment Entities as will the trusts in respect of which they serve (but see the section below on PTCs).

A trustee which is an RFI can take responsibility for the trusts to which it acts as trustee and remove the need for a separate registration to be made in respect of each trust (such trust is  known as a “Trustee-Documented Trust”).  In this respect the trust itself is regarded as a “Non-Reporting FI”.

The consequences of a trustee (or a trust) being an RFI mean that it will need to register with the IRS by 1 January 2015.

Registration is made directly with the IRS.  Once registered, the RFI will receive a Global Intermediary Identification Number (“GIIN”).  MaplesFS can assist with the registration procedures.

In addition, where trusts wish to take advantage of the Trustee-Documented Trust exemption, the relevant trustee must take out a separate GIIN registration as if it were a “sponsoring entity”.  Trustees may therefore have two different GIINs for use in different circumstances.

Private Trust Companies

Certain trustees may not be Financial Institutions as they may fall outside of the definitions.

The main examples of this would be PTCs.  A PTC is unlikely to be a Custodial Institution if it is not paid.  A PTC is unlikely to be a Depository Institution as it is not engaged in banking or similar business.

In addition, if it can be shown that the PTC is neither (a) itself in business nor (b) managed by a Financial Institution, then the PTC may not itself be an Investment Entity.

Although not specified under the Cayman Regulations or Guidance Notes (but in the draft BVI Guidance Notes), indicia of being in business could include whether or not the PTC was remunerated or otherwise benefitted for acting as trustee.  It should also be noted that many licensed trust companies assist with the management of PTCs which, depending on the nature of that management, may make the PTC an Investment Entity.  However, the provision by a licensed trust company of inter alia registered agent services to a PTC should not constitute the PTC being “managed”.

A PTC which is not an RFI does not need to register with the IRS.  A trust which has a non-RFI PTC as trustee will most likely not be an RFI unless another RFI was responsible for management of the trust assets.

UK FATCA

In addition to the above, it is also important that consideration be given to the potential application of the United Kingdom’s own version of US FATCA (“UK FATCA”).  Whilst UK FATCA does not impose a requirement to register with Her Majesty’s Revenue & Customs there is, pursuant to both Cayman Islands and BVI law, the potential for penalties and a custodial sentence to be imposed for non-compliance.

UK FATCA has a similar scope and adopts similar definitions to US FATCA (with some subtle differences).  We would therefore encourage Cayman Islands and BVI trustees to have regard to both UK and US FATCA.

Further Advice

If clients require legal advice or have any concerns about FATCA, Maples and Calder has leading expertise on the relevant provisions having established a FATCA team that has worked closely with the Cayman Islands and BVI governments over the past three years.  MaplesFS also provides client focused solutions to FATCA.

To the extent that any Cayman Islands or BVI trustees are regarded as resident in another jurisdiction, specific advice should be obtained.

Further updates on trusts will follow as will any updates relating to the BVI Guidance Notes.