Financial Services Quarterly Report - First Quarter 2013: FATCA: Next Steps for Asset Managers

by Dechert LLP

The U.S. Department of the Treasury (“Treasury”) and the U.S. Internal Revenue Service (“IRS”) released final regulations (“Regulations”) on January 17, 2013 implementing the Foreign Account Tax Compliance Act (“FATCA”).1 Although some guidance is still forthcoming, the Regulations at last give asset managers a clearer picture of the steps they will need to take over the next twenty-four months to become FATCA compliant.

FATCA, In A Nutshell

At its core, FATCA is designed to stop U.S. taxpayers from using non-U.S. financial accounts or entities to avoid U.S. taxes. Under FATCA, foreign financial institutions (“FFIs”) must comply with reporting, due diligence and withholding requirements with respect to their U.S. accounts — or face a 30% withholding tax on “withholdable payments”.2 The definition of FFI is broad and expressly encompasses, among others, mutual funds, UCITS, exchange-traded funds, hedge funds, private equity funds, and other investment vehicles.3 So the effect of FATCA will be to require nearly all asset managers (directly or through third-party service providers) to perform due diligence on many of their investors and clients.

First Steps

Asset managers will need to identify all FFIs under their umbrella and then consider whether any FFIs qualify as “deemed compliant” with FATCA, which can reduce an FFI’s compliance burdens considerably. However, the available categories of deemed compliance will depend on (a) where an FFI is domiciled (or possibly offered) and (b) whether that jurisdiction has entered into a special intergovernmental agreement (“IGA”) with Treasury to implement FATCA. For example, certain retirement funds and tax-favored vehicles are exempted from many FATCA requirements under the UK’s IGA.4

If no IGA is available, the Regulations set forth the available deemed-compliance rules. The Regulations relaxed the requirements for two fund-related deemed-compliance categories: “qualified collective investment vehicles” (“QCIVs”) and “Restricted Funds”. To qualify as a QCIV, a fund must be regulated as an investment fund and held only by certain categories of investors (generally, FATCA-compliant or exempt institutions and non-reportable U.S. interests).5 Under the Regulations as proposed, a QCIV would have been required to be regulated as an investment fund by its country of incorporation or organization. Under the Regulations, an FFI may be eligible for QCIV status if either its fund manager is regulated with respect to the fund or the fund is regulated in all of the countries in which it is registered and operates.

Among other requirements, a fund may qualify as a Restricted Fund only if all of its distribution arrangements prohibit sales to certain reportable U.S. persons, non-participating FFIs, and certain nonfinancial entities that have direct or indirect U.S. owners. The Regulations changed and clarified a number of provisions applicable to Restricted Funds. A Restricted Fund now has until the later of June 30, 2014 or six months after the date the fund registers as a deemed-compliant FFI to renegotiate its distribution agreements to include the prohibitions described above. A Restricted Fund is also permitted under the Regulations to sell to U.S. persons other than “specified U.S. persons.”6 The Regulations clarify that interests in a Restricted Fund may be issued by the fund directly if the investor can only dispose of those interests by having them redeemed or transferred by the fund, and not by selling them on a secondary market.

Not all of FATCA’s carve-outs are equally helpful — deemed-compliance categories differ in the extent to which they reduce FATCA’s burdens. For example, a Restricted Fund could, despite being deemed compliant, be required to perform FATCA due diligence on its existing shareholders (a QCIV would not be). Furthermore, the exemptions for retirement funds are generally broader than the deemed-compliant categories. As a result, asset managers will need to evaluate not just whether a fund could be deemed compliant, but what category is most helpful.

Becoming a Participating FFI

If no exemption applies, then each FFI will need to take steps to become a Participating FFI (i.e., an FFI that will not be subject to FATCA withholding). In certain IGA jurisdictions, such as the UK, local rules will specify what FFIs need to do. In other jurisdictions, the Regulations outline the necessary procedure. The IRS will publish a list of all Participating FFIs (and certain “registered” deemed-compliant FFIs, including QCIVs and Restricted Funds) on or before December 2, 2013, which may then be used by withholding agents to determine whether to withhold against FFIs. To ensure that funds and other FFIs are included on this list, an asset manager will need to take certain steps by October 25, 2013.

If the procedure in the Regulations applies, a Participating FFI will be required to enter into an agreement with the IRS to comply with FATCA. This agreement (which has not yet been released) will be a standard form that cannot be modified. FFIs will be able to register with the IRS through a secure online web portal (“Portal”). The Portal will permit an FFI to complete an entirely paperless registration process with the IRS from anywhere in the world. FFIs will be issued a Global Intermediary Identification Number (or GIIN) through the Portal, which will be used by an FFI to establish its FATCA status for withholding purposes and to facilitate compliance. The Portal will also be the primary means for financial institutions to communicate with the IRS regarding their FATCA requirements. It will be accessible beginning no later than July 15, 2013, and FFIs will be required to register by October 25, 2013 to be included on an initial list of compliant FFIs.

Responsible Parties

Because many different service providers and parties act for funds, many asset managers are unsure of which party is responsible for FATCA compliance. Under FATCA, the FFIs (i.e., the fund itself and also its manager, if a non-U.S. entity) have primary responsibility. But depending on the fund’s organizational structure and domicile, a fund manager, trustee (if any), custodian and administrator may need to act on the fund’s behalf. Service providers and managers will need to agree among themselves how FATCA compliance will be carried out, but the FFIs (that is, a fund and potentially its non-U.S. managers) will bear ultimate responsibility for the fund’s compliance.

The Regulations provide a mechanism to reflect these arrangements: the “sponsored FFI” deemed-compliance category. Under this category, a “sponsoring entity” will agree to register with the IRS and undertake the diligence, withholding and reporting obligations of a participating FFI on behalf of one or more sponsored FFIs. The provisions enable trustees and fund managers to ensure FATCA compliance of family trusts, investment subsidiaries and other passive investment vehicles where compliance by each vehicle itself would be impracticable (for example, due to lack of any employees) or overly burdensome.

Similarly, an FFI that is a member of an “expanded affiliated group” that includes one or more FFIs may elect to be part of a consolidated compliance program where a “Compliance FI” reports and ensures FATCA compliance on a consolidated basis.

Going Forward

By January 1, 2014, funds will need to conform their account opening procedures to FATCA’s requirements. Among other requirements, funds will need to collect FATCA-mandated information on all new investors, either by amending their investor intake documents or by collecting U.S. tax forms (W-9 for U.S. taxpayers and, typically, W-8BEN for non-U.S. taxpayers). Because funds will eventually need to collect similar information from existing investors, there may be some benefit to beginning collection of U.S. tax forms as soon as possible. While W-8BEN is currently being revised to reflect FATCA’s requirements, the Regulations allow FFIs to rely on pre-FATCA forms in certain circumstances. Finally, funds will need to report certain information gleaned from this due diligence process to the IRS, beginning March 15, 2015 (with respect to calendar years 2013 and 2014).

In many respects, the final Regulations are only a first step — the IRS still has work to do. The Preamble to the Regulations states that the IRS will publish a revenue procedure containing all the terms and conditions applicable to FFIs for FATCA purposes before July 15, 2013 (when the Portal is expected to become accessible). It is also expected that Treasury will conclude a substantial number of IGAs with partner jurisdictions before the October 25, 2013 deadline, which may ease the burdens of FATCA compliance substantially for FFIs resident in those jurisdictions. But, for the first time, asset managers have a good picture of what FATCA will require.


1 FATCA encompasses the foreign account reporting provisions of the U.S. Hiring Incentives to Restore Employment Act enacted in March 2010.

2 A "withholdable payment" generally includes (i) passive U.S. source income such as U.S. source interest, dividends, and other fixed or determinable annual or periodical gains, profits, and income, and (ii) any gross proceeds from the sale or other disposition of any property of a type which can produce U.S. source interest or dividends. Because the rules relating to the U.S. source income are technical, it can be hard to predict whether a particular asset will generate U.S. source income in a given year.

3 The Regulations also make clear that asset managers are themselves likely to be FFIs, subjecting them to the same requirements as the funds they advise. However, many asset managers should be able to take advantage of a carve-out from the bulk of FATCA’s requirements as they pertain to the manager’s own interest holders.

4 Agreement Between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland to Improve International Tax Compliance and to Implement FATCA, Annex II, available at

5 Per § 1.1471-5(f)(1)(i)(C)(2): “Each holder of record of direct debt interests in the [QCIV FFI] in excess of $50,000, direct equity interests in the FFI (for example the holders of its units or global certificates), and any other account holder of the FFI is a participating FFI, registered deemed-compliant FFI, retirement plan described in § 1.1471-6(f), non-profit organization described in paragraph (e)(5)(vi) of this section, U.S. person that is not a specified U.S. person, nonreporting IGA FFI, or exempt beneficial owner.”

6 Under the Regulations as proposed, no sales to U.S. persons would have been permitted. A “specified U.S. person” includes a U.S. person other than a regularly-traded corporation, U.S. tax-exempt investor, bank, REIT, RIC, registered dealer, broker, or certain individual retirement plans. Non-U.S. persons other than noncompliant FFIs are generally permitted to invest in a Restricted Fund.


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