This article was published in the March 2014 issue of Middle Market Growth, a publication of the Association of Corporate Growth. It is reprinted here with permission.
FATCA is the new form of 30% U.S. withholding tax that is applied to U.S. source income, such as interest and dividends paid by U.S. companies, starting as early as July 1, 2014 for payments made to non-U.S. entities that are not "FATCA compliant." To be FATCA compliant by July 1, 2014, a non-U.S. entity may need to take certain steps by April 25, 2014. The IRS has publicly stated that there will be no delay in the implementation of FATCA, and no grace period for compliance.
The intention of FATCA is to provide transparency in tax reporting, and to ferret out U.S. persons who are investing through non-U.S. entities. The rules, however, are not "intention" based, and are purely mechanical in their application. This article looks at one common fund structure and identifies the FATCA issues and suggests action steps to be considered.
The Foreign Master/Feeder Structure
Assume that on July 15, 2014 Master closes on an investment, which is the debt of a non-publicly traded U.S. portfolio company. (Note: investments that existed prior to July 1, 2014 generally won’t be subject to FATCA withholding until January 1, 2015 at the earliest; debt investments made before July 1, 2014 may not be subject to FATCA withholding at all). The interest is to be paid quarterly, with the first payment to be made at the end of September. Absent FATCA, the company would expect that the interest is not subject to withholding tax, so long as the Foreign Feeder did not own 10% or more of the equity of the Portfolio Company. After July 1, 2014 however, the payment also has to run through the FATCA gauntlet, and it may be subject to the 30% FATCA withholding tax.
The starting point is that the 30% FATCA withholding tax will apply to the interest payments made to the Master, because the Master is a "foreign financial institution," unless the Master becomes FATCA compliant (and assuming that Master has not elected with the IRS to absorb the responsibility to administer the withholding tax). The Master can be FATCA compliant in a number of ways. However, while the FATCA rules allow for reduced FATCA obligations for certain certified deemed compliant funds, these reduced FATCA obligations frequently do not apply to the commonplace investment fund. Therefore, to be FATCA compliant the Master will generally need to do one of the following.
If Master is formed in a jurisdiction that doesn’t have an agreement with the United States on how to implement FATCA (known as an Intergovernmental Agreement, or IGA), such as the British Virgin Islands, the Master will generally need to:
register with the IRS, obtain a Global Intermediary Identification Number (a GIIN), and enter into an agreement with the IRS to undertake to identify any U.S. investors in the Master and report them to the United States. There are also due diligence and other conditions to being FATCA compliant that are found in the agreement with the IRS, or
determine if there is a fiduciary, such as a fund manager or GP, that can act as a "sponsoring entity" and whether it will manage the FATCA requirements as a fiduciary of the Master. The fiduciary then registers as a "sponsoring entity" and will undertake to do all of the reporting on behalf of the Master, and it will get a GIIN.
If the Master is formed in the Cayman Islands, which does have an IGA with the United States, the Master can be compliant by:
registering with the IRS and obtaining a GIIN, but there is no need to enter into the agreement with the IRS. Instead, the Master would comply with such reporting rules as are determined necessary by the Cayman Islands tax authorities. Under the IGA, the Cayman Islands may share all of the information on U.S. persons reported to them with the IRS.
Determine if there is a fiduciary that can act as the "sponsoring entity" and have it get a GIIN upon which the Master fund may rely. The sponsoring entity then takes on all of the responsibility of undertaking the due diligence and reporting to the Cayman Islands.
IN ORDER TO HAVE THE REQUIRED GIIN BY JULY 1, 2014, THE APPLICATION MUST BE MADE TO THE IRS BY APRIL 25, 2014. The application is made via the IRS portal that is set up for this purpose.
Assuming that Master is FATCA compliant, how does it avoid the withholding? It will deliver to the portfolio company (or its paying agent), a form W-8BEN-E evidencing the GIIN. It would also have to provide a statement of the percentage of its investors that are themselves non-compliant foreign financial institutions, and the portfolio company would withhold the 30% FATCA tax on that portion of the payment. For example, if the Foreign Feeder is a 20% owner of the Master, and it is not FATCA compliant, and the portfolio company pays interest on September 30, 2014 of $100, Master would provide a W-8BEN-E, and a statement that $20 of the interest is allocated to a non-FATCA compliant foreign financial institution. The portfolio company will withhold $6 (30% of the $20) for FATCA withholding on the payment to the Master. In short, the Foreign Feeder also has to be FATCA compliant.
There are numerous variations on the facts that drive alternative conclusions as to the applicability of withholding, or the means of becoming FATCA compliant. What is clear is that funds need to be doing this review now, to have the opportunity to meet the April 25, 2014 filing date.