Untangling the FATCA Web for Hedge Funds (Next Up: GATCA)
After a four-year ramp up, America’s far-reaching tax law, FATCA – the Foreign Account Tax Compliance Act (enacted in 2010) – is now in full effect. With over 60 countries (including, most recently, the Vatican) having signed an agreement with the United States related to the enforcement of FATCA, it appears as if this law is here to stay.
That means that hedge funds will have to continue trying to navigate the complexities of FATCA, all while keeping an eye on the not so distant horizon where GATCA, aka Global FATCA, is poised to complicate compliance even further.
No One-Size-Fits-All Approach
The common structures for hedge funds that allow them to attract U.S.-taxable, U.S.-tax-exempt, and foreign investors (e.g., mini masters, master-feeders, or parallel funds) can create headaches for fund managers trying to understand how FATCA affects each of these vehicles. Unfortunately, there is not a one-size-fits-all approach because each jurisdiction has its own set of agreements, rules, local registration requirements, reporting frameworks and deadlines.
Fortunately for most management companies and investment advisor entities, they will likely fall under the “deemed compliant” definition, which exempts these entities (whether formed in the U.S. or abroad) from registration and certain reporting requirements. However, most fund entities will fall under the “investment entity” definition, which can result in several FATCA obligations, depending on where the entity is domiciled.
Requirements for U.S.-Domiciled Funds
A common misconception for U.S.-domiciled funds is that because there is no IRS registration requirement, there is nothing to be concerned about in regards to FATCA.
However, some general rules do apply, including performing due diligence to verify that all investors have submitted complete un-expired tax withholding certificates, and searching for U.S. indicia (and “curing” it if necessary) when an investor declares it is foreign. In fact, any issues found during this due diligence process can be more onerous on a U.S.-domiciled fund. For example, a U.S. fund is required to withhold 30% on certain U.S.-source payments made to foreign entities, if it is unable to document such entities for purposes of FATCA.
Requirements for Foreign Funds
On the offshore front, the key differences from a U.S.-domiciled fund aside from the required IRS registration include additional registration with the local jurisdiction (for Model 1 jurisdictions such as the British Virgin Islands and the Cayman islands) as well as annual reporting.
Many of these jurisdictions have experienced issues rolling out their reporting regime websites. As a result, some countries have extended filing deadlines and relaxed requirements – at least for 2015.
Additionally, any U.K. Crown Dependency jurisdiction (including Bermuda, BVI and the Caymans) also has the equivalent “U.K. FATCA” to deal with. The deadlines for U.K. FATCA reporting start in 2016, though the due diligence expectations began in 2014.
A further complication has arisen where jurisdictions like Cayman have guided the use of an additional “self-certification” form instead of the traditional W8/W9 forms, which can make the due diligence process more cumbersome and confusing for investors. Thankfully, many jurisdictions have been waiving the requirement for funds to file a “nil report” (when there are no U.S./U.K. investors to report), but again keep in mind that each jurisdiction is different and is subject to change.
Getting Help With Compliance
Non-compliance can result in serious consequences.
For example, a foreign-domiciled fund that hasn’t registered for a Global Intermediary Identification Number (GIIN) with the IRS could have issues with banks and brokers. Those issues could be related to opening an account or being hit with the aforementioned 30% withholding.
Given all of these complex nuances, continual changes in many jurisdictions, and risks related to noncompliance, managers should lean heavily on their service providers for assistance. For example, legal counsel can review the offering documents for relevant disclosures and forms.
In many cases, the fund’s administrator may be the service provider best positioned to assist with FATCA compliance. The due diligence procedures required under FATCA align closely with traditional subscription processing steps that the administrator would perform, such as collecting required documentation and anti-money laundering checks. Similarly, the reporting aspects will be driven by information collected, calculated and stored electronically by the administrator.
Although service providers can assist a fund with FATCA compliance, not everything is outsourceable –
including the ultimate responsibility for FATCA. Additionally, even though the administrator may receive subscription documents directly from investors, any additional communications between the advisor and investor could contain U.S. indicia so it’s important that investment advisor employees be aware of FATCA and the types of indicia to look for.
A manager might be able to handle FATCA compliance without service provider assistance in the early stages of, say, a U.S. fund launch with just U.S. family and friends investing, but the complications and distractions can begin to mount quickly with institutional money and offshore investors.
Finished? Not Quite: GATCA Is on the Way
As if all of this wasn’t complicated enough, it appears as if things will likely become even more complicated with GATCA, or Global FATCA.
Over 65 countries have publicly committed to this proposed global standard. While the goal of GATCA is to provide for common reporting and due diligence standards with deadlines beginning in 2016, it could, in theory, require a fund to report each and every investor to the investors’ local jurisdiction. Ultimately, GATCA could introduce a whole new level of confusion to an already complicated topic.
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Keith Diamond, MBA, CAMS, is a director and AML compliance officer at Kaufman Rossin Fund Services (KRFS).
