What You Need to Know About FATCA

Editor: Please tell us about your background as it pertains to FATCA and its implementation.

Laveman: FATCA has been something that my firm and I have been focusing on since the law was passed in March of 2010. There have been a lot of starts and stops along the way.

I’m a partner in our firm’s financial service practice, which provides audit, tax and advisory services to a large range of hedge funds and private equity funds. All of my personal clients are either hedge funds or private equity funds. I am co-head of the firm’s FATCA initiative, and in this role I analyze developments and help clients adopt “FATCA action plans.” I have also been doing many road shows, speaking at conferences and meeting with our clients. Education has been a very big part of my activities these last couple of years. We have been and expect to continue to be very active with all our fund clients in terms of helping them register, putting together a plan for them to document the investors in their funds, dealing with any potential withholding taxes that may occur, and all the compliance details along the way. That’s been my role personally, bringing some structure to something very complicated, sitting down with our clients and sort of educating them on FATCA because of its importance.

Editor: Please give us a general description of FATCA and its purpose.

Laveman: FATCA is designed to combat tax evasion by preventing U.S. persons and entities from using foreign entities to hide assets and income from the IRS. That’s really the crux of FATCA. It’s a transparency regime through which the IRS is trying to understand where U.S. persons and entities have or had foreign accounts. This all started because there were a lot of U.S. citizens who had Swiss bank accounts years ago and didn’t report the accounts or the income. FATCA was a reaction to that, and the IRS cast a pretty wide net.

Editor: When do the provisions of FATCA become fully effective?

Laveman: July 1, 2014 is when the full effect of FATCA may be felt because that’s the date when withholding potentially could start. Right now, the IRS has developed its online registration portal where people will go to register starting January 1, 2014. The key date for that is actually April 25, 2014 because if you register by that date, you’re going to be published on a list on June 2, 2014 on what the IRS is calling a “compliant list,” which I refer to as the “good list.”

Editor: Describe the evidences of FATCA status.

Laveman: What the IRS is doing is forcing foreign entities to disclose information that relates to U.S. persons or entities. If you do everything pursuant to the regulations or under an intergovernmental agreement (IGA), if you do everything you’re supposed to do from a registration standpoint, from a due diligence standpoint, and from a reporting standpoint, you’re going to end up being okay. You get into trouble when a foreign financial institution (FFI) does not register to be compliant, or a registered FFI does not provide transparency. You could then find yourself in a very onerous withholding tax situation.

Right now there is a withholding tax regime that the U.S. has had in place for many years on certain types of income that’s paid to a foreign person or a foreign entity, primarily a dividend withholding at a 30 percent rate. FATCA imposes a whole new regime on dividend and interest income, with the big whammy being on the gross proceeds from sales of U.S. securities.

The crux of FATCA, the really difficult part of it, is the burdensome due diligence work you need to do. If I’m legal counsel to a private equity fund-held company, I have to make sure that the private equity fund is fully FATCA compliant, which means I’ve confirmed that they’ve registered with the IRS. I must also review other documentation, primarily a W-8 form that has to be validated (which means I have to make sure that not only did someone give me the form, but they filled it in correctly). It requires quite a bit of scrutiny and time.

Let’s say you have a situation where someone puts down a New York address, a care-of address. The fund may have a sales office in the United States, but the investor is domiciled in Ireland. In this example, there is the existence of “U.S. indicia” based on the care-of address in the U.S. This scenario requires procedures to ensure the fund is not domiciled in the U.S.

Editor: Discuss the types of payments subject to FATCA withholding and the penalties for noncompliance.

Laveman: Under FATCA, up until 2017, the withholding will be 30 percent on dividend and interest income from U.S. sources without the ability for reduced income tax treaty rates. Starting in 2017, if you’re subject to FATCA regulations (rather than an IGA), there is 30 percent withholding on the gross proceeds on the sales of U.S. securities sold at a gain or a loss.

Editor: What types of foreign entities need to be FATCA compliant, and what issues does this present for them?

Laveman: Anyone who meets the definition of a foreign financial institution. That would include (but is not limited to) banks, foreign private equity funds, foreign hedge funds, foreign general partner entities, anything that by definition is an investment vehicle or an entity that holds deposits on accounts for others (and is domiciled in a foreign country).

When the FATCA rules came out, many foreign governments and trade organizations were obviously pretty upset about the fact they were going to have to act as the United States’ police force. So, they developed this concept of an IGA. Twelve jurisdictions today, including the Cayman Islands, have signed IGAs with the United States. To the extent you’re domiciled in one of those IGA countries, you actually fall under the IGA rules and not the FATCA regulations.

The biggest impetus for many countries to participate in IGAs was they didn’t want, for privacy reasons, to have an institution in their jurisdiction hand over information directly to the IRS. Over the next year or two, we’re going to see IGAs developed by many more jurisdictions. Because of their growing popularity, the Treasury Department has developed standardized agreements – a Model 1 and Model 2 IGA; Model 1 is the most common.

Under a Model 1 IGA, information will go from the local entity to the local government; the government will then communicate that to the IRS. It ends up in the same place; it just doesn’t go directly from the foreign financial institution to the IRS.

If you’re domiciled in the Cayman Islands, you are governed by the Cayman Island IGA. The rules for registration and due diligence are the same. However, you have the added problem of making sure you understand local law. This really becomes difficult if you have a multinational bank that has branches in 80 countries. Now you’re dealing with 80 different rules in 80 different countries – that makes it very complex. But the IGAs are really what are going to drive compliance regimes.

Editor: Tell us about the IRS registration process.

Laveman: The IRS created a website called irs.gov/fatca. It offers an online process where a foreign financial institution registers by answering 15 questions. The questions you have to answer and how much information you’ll have to provide will be dependent on the type of entity you are.

The IRS creates an online account and a password for you. You provide basic information about your entity: name, address, where you’re domiciled. At the end of the process, you have to have what’s called a “responsible officer.” That person is the one who submits the filing by hitting “finish.” That responsible officer is the one who has responsibility to make sure the entity is FATCA compliant going forward. Typically, the responsible officer is the CFO, the CCO or the COO. The registration process itself is relatively straightforward. Once you register, the IRS gives you a Global Intermediary Identification Number (GIIN). That will be the tax ID number that an entity uses for all types of FATCA reporting going forward. Once you hit “finish,” the IRS will review your application, then issue that GIIN.

Editor: Please discuss the implications of the IGA with the Cayman Islands. 

Laveman: The Cayman agreement was not a reciprocal one, unlike the UK IGA. Most of the IGAs are based on a model the Treasury Department has on its website, and the Cayman IGA generally follows that model. Its significance is that in the fund world, many hedge funds and private equity funds are domiciled in the Cayman Islands. Without this IGA, it was very unclear how a Cayman-based fund would register.