Finding the way to implement FATCA…

The implementation of FATCA, the U.S. Foreign Account Tax Compliance Act, adopted in March 2010, gained momentum with the publication of proposed regulations in February 2012, following three Notices providing preliminary guidance for the stakeholders concerned. Final regulations are expected for summer 2012, and they are needed for a timely implementation. &hellip;in terms of a suitable legal framework However, apart from the debate on technical details, which will be further elaborated in this article, most of the European member states that have not been involved in discussions with the U.S. tax authorities were surprised by the joint statement of the governments of the U.S. and five European countries, confirming their efforts to conclude bilateral agreements. Such agreements would be designed to solve local-law, privacy restrictions on providing information directly to the U.S. tax authorities. A multilateral agreement, negotiated under the chairmanship of the European Commission, was being considered as a preferable solution, but not as a realistic option in the short-term. Many other jurisdictions are currently evaluating the advantages and disadvantages of having an intergovernmental solution, which would still have to be implemented by a national law. Clearly, the rules would be similar to the final regulations, and therefore not offer foreign financial institutions (FFIs) a way to escape from the burden of mandatory identification or from reporting requirements. Moreover, country-specific issues could be addressed, and stakeholders concerned could liaise directly with their national tax authorities: a process with which they are familiar. Given that international funds are characterised by a multi-layer distribution chain, these funds might have to comply with different national laws. The same applies to other financial institutions operating internationally. To avoid any legal uncertainty, or even a higher burden of complexity, these FFIs should still have the option of concluding a direct FFI agreement with the U.S., and possible bilateral agreements should provide for such a solution. &hellip;in terms of suitable rules adapted to existing business models The fund industry is of the view that the proposed regulations do take into consideration many of the extensive comments submitted by stakeholders over the past months. This being said, the European Fund and Asset Management Association, EFAMA, underlined in its comment letter [1] that there is still an important need for critical refinements to the proposed rules, and a need to provide greater clarity in areas not addressed in the proposed regulations. A large number of EFAMA&rsquo;s comments focused on deemed-compliant foreign financial institutions (FFIs) and fund distributors. Many European investment funds should be eligible to benefit from a deemed-compliant status, meaning that they would not be subject to FATCA withholding on U.S. sourced payments and would have no obligation to withhold tax on so called &ldquo;foreign passthru payments [2] &rdquo; made to investors until 1 st January 2017. Reporting before that date would be limited to annual reporting of specific amounts paid to each FFI which had not concluded an FFI agreement. The proposed regulations distinguish between two categories of deemed-compliant FFIs (DCFFIs): registered and certified DCFFIs. Whilst the first category will be registered with the IRS, following a certification from the responsible officer that the FFI meets the requirements for deemed-compliant status, the second category implies only a certification to the withholding agent. The latter and less restrictive status is available for retirement funds, non-profit organisations and FFIs with low value accounts, amongst others. The majority of European funds will probably elect to be classified under the &ldquo;restricted funds&rdquo; regime or the so called Qualified Collective Investment Vehicles (QCIVs), falling both in the registered DCFFIs category [3] . QCIVs may have as record holders of their interests only participating FFIs, i.e. financial institutions whose identification and reporting obligations are governed by an FFI agreement concluded with the U.S. Internal Revenue Service (IRS). This sub-category is applicable to fund units that are issued as dematerialised shares, held by a central securities depositary in a collective safe custody account. The dematerialised shares are then held in safe custody with custodian banks, which will normally be FFIs. The funds industry thinks that this category will also prove useful where funds are sold exclusively to, and held directly by, large institutional investors or where funds qualify as so called publicly traded funds, such as ETFs. Remaining issues, in particular in respect of funds employing a hybrid fund registry system, or in the event that a fund ceases to meet the requirements of being a QCIV, have been addressed by EFAMA. International fund units or shares are often distributed via transfer agents, who are not necessarily considered as FFIs. However, they may qualify as restricted funds, i.e. funds presenting a low risk of being used for US tax evasion because they do not accept US investors. Therefore, each distribution agreement must prohibit sales to U.S. persons, non-participating FFIs and passive non-financial foreign entities with one or more substantial U.S. owners (unless they are distributed or held through participating FFIs). Moreover, each distributor of the fund&rsquo;s interests must be a participating FFI, registered DCFFI, a nonregistering local bank, or a so called restricted distributor. In this context, it is important to note that the proposed regulations do not appear to make restricted distributors a deemed-compliant category in their own right. EFAMA underlined that this presents difficulties in the application of the restricted funds category. In particular, distributors which are in the chain of ownership (i.e. by holding the fund interests in a nominee capacity) are likely FFIs, whereas those acting in an advice only capacity (such as an introducing broker) may not be. The former should be treated similarly to a nonregistering local bank. If it was still considered as non-participating FFI, the distributor potentially could not distribute restricted fund interests through a participating FFI (i.e. in a multi-tiered distribution chain). Therefore, the fund industry argues that restricted distributors acting in a nominee capacity should be certified DCFFIs in their own right. In addition, EFAMA stated that the current account identification and documentation requirements for restricted funds would imply significant changes to existing anti-money laundering regimes. Furthermore, the proposed regulations did not sufficiently take account of the fact that funds will have to amend their prospectuses and renegotiate distribution agreements in order to become FATCA compliant. As it will take some time for them to complete these tasks, the final regulations should provide a transition rule until a future date, such as two years after registration as a deemed-compliant restricted fund. Furthermore, among the issues that have not been addressed or clarified in the proposed regulations are the treatment of umbrella structures with multiple sub-funds and of contractual funds [4] . Ambiguity namely exists on whether FATCA must be applied at the umbrella level or at sub-fund level. Considering that funds are predominantly marketed, distributed and sold at sub-fund level, even though they may not have separate legal personalities, EFAMA recommends that each sub-fund that is part of an umbrella structure should be treated as a separate FFI. This will also avoid the situation in which investors in one sub-fund are impacted by the FATCA provisions resulting from the characteristics of another sub-fund. For funds that are contractual vehicles but that have no legal personality in their countries of organisation, the funds industry noted that there was a lack of reliable guidance for foreign contractual funds. These funds should be considered as separate FFI for FATCA purposes. Many other topics regarding the proposed regulations were raised or picked up again. They included issues such as seed capital contributed from the fund manager to a new fund; the standard of knowledge that will be imposed on the chief compliance officer or other person providing certification to the IRS; a centralised compliance option for funds; and considerations on expanded affiliated groups. &hellip;in terms of timing Due to concerns raised by different stakeholders, the timeline for a phased implementation of FATCA was again slightly modified by the proposed regulations. As mentioned previously, the adoption of final rules in summer 2012, and the provision of final FFI agreements in autumn 2012, is crucial for a timely implementation, e.g. in view of the necessary adaptation of existing IT systems. No later than 1 st January 2013, the IRS will make an online process available for FFI applications. The deadline to enter into FFI agreements with the IRS (with respect to the 2014 calendar year) is 30 June 2013, and FFIs will be accountable for identifying any new U.S. accounts as from 1 st July 2013. While the identification procedures for high-value accounts (meaning more than 1 Mio US Dollars) and all presumed FFIs must be completed by 30 June 2014, identification procedures for all other pre-existing accounts can be delayed one year until 30 June 2015. A first reporting of U.S. accounts and recalcitrant account holders (due for calendar year 2013) is required for 30 September 2014, but it will be limited to the name, address, TIN, account number and account balance with respect to U.S. accounts. As from 1 st January 2016, reporting on income associated with U.S. accounts (with respect to the 2015 calendar year) will be phased in, whereas the full reporting, including on gross proceeds phased in during this year (with respect to the 2016 calendar year), will only start in January 2017. The proposed regulations also foresee a transition period for the given withholding obligations. Withholding on U.S. source FDAP payments (FDAP stands for fixed or determinable, annual or periodic) will begin on 1 st January 2014, on gross proceeds on 1 st January 2015, and on foreign passthru payments (i.e. passthru payments that are not withholdable payments) on 1 st January 2017. It remains to be seen whether the proposed timeline could be negotiated in the context of a bilateral agreement, and in this way be further adapted to the needs of the funds industry. 1 ALFI&rsquo;s FATCA sub-committee contributed to the response of EFAMA, which is available by clicking on the following link: http://www.alfi.lu/sites/alfi.lu/files/files/news-flash/2012-05/12-1046-EFAMA FATCA Comment Letter.pdf 2 A Passthru Payment Percentage is required to determine the withholding to be operated on the passthru payments made by a PFFI. The percentage is determined based on the proportion of U.S. assets on total assets (including off-balance positions). Funds and other PFFI will need to publish such a PPP. This percentage will be used as taxable basis to withhold the 30% tax to recalcitrant account holders irrespective of whether the payment is derived from U.S. assets or not. In case of the non-publication of this PPP, the withholding would be operated on the basis of a deemed prorata of 100% PPP. 3 &amp;quot;The restricted funds category reflects an understanding that certain funds present a low risk of being used for U.S. tax evasion because they do not accept U.S. investors. The category can be useful because many funds already prohibit U.S. investors for other reasons. The value of the restricted funds category is that it builds on existing procedures and adapts those procedures to FATCA. However, the requirements for restricted funds with respect to the identification and documentation of new accounts are the same as those placed on participating FFIs and will require significant changes to current anti-money laundering (&ldquo;AML&rdquo;) regimes. These requirements impose a disproportionate burden on a category of funds that presents a low risk because it does not have U.S. investors.&amp;quot; EFAMA, Comments of the European Fund and Asset Management Association in Response to Proposed Regulations under Internal Revenue Code Sections 1471-1474 4 An umbrella fund is an investment term used to describe a collective investment scheme which is a single legal entity but has several distinct sub-funds which in effect are traded as individual investment funds. This type of arrangement originated in the European investment management industry, most notably with the SICAV. The SICAV model was copied for the UK OEIC and offshore fund models.

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