FATCA

EVERYTHING YOU NEED TO KNOW ABOUT FATCA AND IMPLICATIONS FOR CAYMAN ISLANDS HEDGE FUNDS IN FIVE MINUTES (FAQ FORMAT)
By Victor Murray, May 2012

FATCA FAQ’s

Q. What is FATCA?
A. It is the Foreign Account Tax Compliance Act (FATCA) was drafted to fund tax reliefs available under the Hiring Incentives to Restore Employment (HIRE) Act. In essence FATCA requires reporting from US taxpayers on their foreign assets or apply a withholding payable to the IRS.

Q. Is FATCA in force yet?
A. Yes but only partially and the following are now in force:

Form 8938 – annual reporting assets US$50,000

The requirement for a US Taxpayer to file a Form 8938 is now in force and mandates the US taxpayers to file where they have foreign financial assets exceeding US$50,000 in aggregate including hedge fund investments.

Form 8621 – PFIC – now filed annually

FATCA amended the existing requirement for a US Taxpayer to file Form 8621 which reports on their holding in a passive foreign investment company (PFIC) (most hedge funds) as previously the US Taxpayer would only file when they received a redemption or disposed of their investment but it is now required annually regardless of any transactions.

SWAP embedded dividend now subject to a withholding

Hedge funds typically use a total return swap on US dividend paying securities and therefore they would not be subject to a withholding on the dividend that is usually applicable to foreign investors. Such swaps will now be subject to a withholding tax on the embedded dividend.

Q. What will be the future requirements for FATCA and the potential impact.
A. In general FATCA requires reporting to the IRS by hedge funds on their US Taxpayer investors or in the absence of such reporting the application of a 30% withholding.

Q. When will the reporting or withholding be implemented.
A. The implementation of the reporting or withholding of FATCA has been delayed from January 1, 2013 to at least 2014.

Q. Why would foreign funds such as a Cayman Islands hedge fund be caught by FATCA?
A. Almost all foreign hedge funds will be deemed to be ‘Foreign Financial Institutions’ (FFI) under FATCA and as such they will have the reporting and or the withholding obligation with respect to an US Taxpayer investor.  Of course most hedge funds do not have employees and the reporting obligations will in most cases be requested by the fund’s  administrator.

Q. What can be done to ensure a Cayman Islands fund does not apply the withholding?
A. The fund will have to enter into an FFI Agreement with the IRS (through an online system) which requires the following:

  1. The fund will implement an enhanced due diligence on their investors to ensure that they can identify US persons and US owned foreign entities (10% US owned or more) for reporting purposes.
  2. Actually report the details of the US investors holdings directly to the IRS.
  3. Agree to apply a withholding on payments to investors that do not provide the due diligence information which would include Foreign Financial Institutions (in practice other funds) that have not entered into the FFI Agreement with the IRS.

Q. When can the fund enter into the agreement with the IRS and is there a deadline?
A. The fund will be able to enter into the agreement with the IRS from January 2013 and it must have done so by June 30, 2013 as the FFI Agreement will take effect from July 1, 2013.

Q. What information should our administrator start gathering now to make the process easier?
A. The FFI will have to report the following information to the IRS on an annual basis:

-        Name and address of the US investor.
-        TIN of each US investor.
-        Shareholder number (usually the administrator holder number they have allocated).
-        The number and value of shares held.
-        Any redemptions paid during the year.
-        Similar information on corporate entities with 10% or more of US investors.

Therefore subscription documents should be updated now and a FATCA questionnaire should be drafted to be issued to current investors before the end of 2012.

Q. What other steps should the Cayman Islands fund take to allow the release of the information?
A.The FFI Agreement is likely to state that where the foreign law does not allow disclosure of the information but such law allows a waiver then it should be obtained or the US shareholder should be redeemed from the fund. In the Cayman Islands we have the Confidential Relationships

(Preservation) Law (2009 Revision) which allows the release of confidential investor information where the owner of such information does so by “consent, express or implied” (Section 3 (2) (b) (i) and therefore Subscription Documents should be amended to provide for the consent and existing investors should be circularized for their consent to release information under the FATCA reporting.

Q. Are there any other obligations for a Cayman fund? 
A. Yes, the fund will have to periodically review their due diligence process to gather the information for FATCA and under the FFI Agreement they will have to appoint a ‘Responsible Officer’ who will certify the fund’s compliance directly to the IRS.

Q. What are the obligations of Responsible Officer for FATCA?
A. The obligations of the Responsible Officer (RO) are set out below:

-        Within a year of the FFI Agreement: The RO must certify that they have reviewed all accounts of more than $1 million that existed at the time of signing the FFI Agreement  and that the fund did not have any formal or information agreements to assist US taxpayers to avoid the FATCA withholding or reporting.

-        Within two years of the FFI Agreement: The RO must certify that they have reviewed all their investors and that they have obtained the required due diligence and where they have not obtained the required information they are treating the shareholder in accordance with the FFI Agreement.

Q. What is likely to be the next development under FATCA that I need to worry about?
A. The draft FFI Agreement is likely to become available in June 2012.

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