INSIDE VIEW: The big Fatca challenge

US authorities have pushed back the date for compliance with its Fatca rule in recognition of the burden it will cause. Nick Matthews and Matt Haddow, of Kinetic Partners, explain the challenges for fund businesses.

The bid to establish transparency across the global financial services industry, as increasingly demanded by regulators, politicians and investors, continues. 

In an effort to prevent tax evasion, the Foreign Account Tax Compliance Act (Fatca) was enacted in the US on 18 March 2010.  

Fatca will affect all “foreign financial institutions”, including banks, custodians and investment vehicles that invest in or hold US assets and receive US-sourced income on behalf of account holders or investors. It will also establish significant new reporting requirements to the IRS, the US tax authorities. 

Although the final guidelines from the US Treasury and the IRS have yet to be published, it is already clear from IRS notices that foreign financial institutions with US income or US “passthru” income will be confronted with a major task in order to meet the new requirements. In recognition of the burden on foreign financial institutions, the IRS pushed back the deadline for Fatca compliance from 1 January 2013 to a staged implementation starting from 30 June 2013. 

This delay is welcome; nonetheless, firms still have a lot of work to do to ensure timely compliance and to avoid tax penalties on US-sourced income, and should use their time wisely to complete their impact assessments as soon as possible.

The breadth of foreign financial institutions affected should not be underestimated. While much of the spotlight to date has been on banks, Fatca will have a significant impact on the investment management industry, especially fund managers, and their administrators, and similar service providers including prime brokers and custodians. Like all other foreign financial institutions, investment funds have until 30 June 2013 (previously 31 December 2012) to enter into an FFI (Foreign Financial Institutions) Agreement with the IRS, committing to provide certain information and fulfill certain functions. 

Although the form and content of the FFI Agreement is yet to be determined, funds in receipt of US-sourced income, whether directly or indirectly, will essentially have to sign an agreement which will commit them to provide detailed information to the IRS on US investors and payments made to them.  

Penalties for non-compliance
A fund which fails to provide such information will, initially, suffer 30% withholding tax on US-sourced income and, in the case of continued recalcitrance, will have its investment or account terminated. In instances where investors themselves decline to provide the information or permit it to be disclosed to the IRS, the fund will be required to withhold 30% on US-sourced payments to those investors before, ultimately, terminating the relationship. 

Before funds undertake a purge of US investors, they should note that simply removing US persons from investor lists is unlikely to be the solution if US-sourced income remains; even funds with no US investors are encouraged to enter into FFI agreements and to certify that they have no such investors, in order not to suffer withholding, or, possibly, termination.

This new legislation and the reporting obligations it imposes will be onerous. Funds are waking up to the fact that despite the title of the act, Fatca is not just a tax issue, but poses a substantial compliance project likely to require significant upgrades to systems and procedures. Not only will investor take-on and compliance monitoring processes require attention, but the annual requirement to report to the IRS on all US accounts and investors, including name, address, taxpayer identification number, account number and account balance, gross receipts and gross withdrawals will be a further systems challenge. In addition, FFIs will be required to identify US-sourced income, highlight any necessary withholdings when making payments to investors, and pay over the proceeds to the IRS.

Indeed, Fatca has become a far-reaching and onerous compliance project, little anticipated at its political inception. Implementation guidelines have yet to be finalised; however, despite continued industry lobbying, it seems unlikely that a meaningful carve-out for funds on the basis that they set up ‘restricted’ funds that do not, and cannot, accept US investors, will be incorporated in the forthcoming, final, guidelines. 

With all this in mind, practical implementation considerations require thought and action now to meet the 30 June 2013 deadline for signing the FFI Agreement and 1 January 2014 deadline of Fatca compliance. It is essential that senior management understand the scale of Fatca and the steps that are necessary to comply with the requirements. CCOs, tax reporting heads and other key players within firms will need to evaluate the potential impact of these regulations and develop a plan for managing and remediating any potential risk associated with non-compliance. This risk identification process may be onerous in itself. Understanding and quantifying the impact of Fatca will further require technology to create new account identifying techniques in order to stratify the individual and institutional accounts into US and non-US accounts, and identify the accounts that fall within the prescribed thresholds.

Understandably, many fund managers are likely to look to their administrators to fulfill their Fatca obligations, as the administrators already perform investor take-on processes. Administrators will need to be ready to service these enhanced requirements. This additional delegation to administrators is likely to necessitate amendments to service agreements and, in all likelihood, fee arrangements. By extension, investment management agreements may also need attention if the burden of monitoring compliance with Fatca, particularly if on behalf of a group of funds, falls to them.

Fund managers should not delay informing clients about how Fatca will impact them, and the type of information that may be sought from them in the run-up to 30 June 2013 and beyond. Doing so benefits both the investor and the fund manager; investors’ delays in communicating compliance or failure to comply completely will pose further problems for fund managers and administrators, such as how to segregate those investors that comply and those that do not. 

Things to consider
If funds are considering their approach to Fatca, they should note that the requirement for the automatic exchange of information is being discussed in other national and international contexts. Furthermore non-participants may be withheld against by participating foreign financial institutions (it is widely anticipated that most firms will sign FFI agreements) before, ultimately, having their account closed. While yet to be published, the mechanics of recovering such withholding is unlikely to be a straightforward or efficient process.

Another consideration for fund managers is that they will need to set up oversight of the activities of the administrators to ensure they are content that Fatca is being complied with in order to sign off on the annual reporting. Furthermore, while it is not yet clear how or who will audit Fatca compliance, funds should anticipate that foreign financial institutions may be subjected to additional audit and oversight requirements. 

It is evident that implementing Fatca requirements will be no easy task, and the reporting obligations are, in places, quite intrusive. The legislation is expected to significantly impact the systems and operations of non-US hedge fund managers and their administrators, and any delay in addressing the necessary changes is not advised. As with any significant challenge, robust programme management, including identification of workstreams, adequate resourcing, quality assurance and governance will ensure that the transition to Fatca compliance in all its guises will be successful.

• Nick Matthews is a member and Matt Haddow a consultant at Kinetic Partners

©2011 funds europe



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