• Recent Developments Spell Relief From FATCA Reporting Requirements for Managers of Certain Offshore Funds
  • May 2, 2013 | Authors: Michael G. Dana; Peter D. Fetzer; Terry D. Nelson
  • Law Firms: Foley & Lardner LLP - Miami Office ; Foley & Lardner LLP - Milwaukee Office ; Foley & Lardner LLP - Madison Office
  • As the U.S. Treasury prepares to open its portal for registering Foreign Financial Institutions under the Foreign Account Tax Compliance Act of 2010 (FATCA), recent developments in the Cayman Islands and the British Virgin Islands are welcome news for managers of offshore private investment funds. In 2010, Congress enacted FATCA as part of the U.S. government’s initiative to curtail tax evasion by U.S. taxpayers through the use of foreign financial accounts. As part of this effort, FATCA requires withholding on payments to certain foreign financial institutions (FFIs) that do not provide information reporting about their U.S. account holders. The definition of an FFI is rather broad in scope and generally applies to all types of foreign financial groups, including offshore private equity, hedge and other private investment funds. Thus, unless offshore funds provide information about their U.S. account holders, such funds will be subject to a significant withholding tax.

    Under FATCA, FFIs must provide certain identifying information to the U.S. Treasury, including the name, address, and the taxpayer identification number (TIN), as well as account-related information, for any “specified U.S. person” named on the account or any “substantial U.S. owner.” A “specified U.S. person” is defined as any U.S. resident, with a few exceptions, including publicly traded corporations and certain banks, to name a couple. A “substantial U.S. owner” is defined as any person who owns more than a ten-percent interest in any entity or, in cases where the payees are primarily in the business of trading, anyone who owns any interest in the entity (including a profits-only interest).

    Almost as soon as the Treasury began reviewing the FATCA legislation for the purpose of issuing regulations, it saw cooperation with other countries as integral to carrying out the FATCA mandate. Accordingly, the Treasury has issued model intergovernmental agreements. Under a “Model 1” agreement, the FFI is required to report the required information to its home country, which then will report the relevant information to the Treasury. Under a “Model 2” agreement, a procedure similar to the statutory procedure is employed - that is, the FFI reports information directly to the Treasury, but is supplemented by exchange of information requests to the foreign government.

    Recently, the Cayman Islands and BVI have both announced that they intend to enter into a Model 1 agreement with the U.S. Treasury. Thus, under this arrangement, FFIs, including foreign private equity, hedge, and other private investment funds will not have to register with the U.S. Treasury and report information thereto; rather, it will simply report FATCA-related information to its home country, which will then transmit the information to the Treasury. This should come as welcome news for foreign private investment funds incorporated in the Cayman Islands and BVI, who will not have to register as FFIs with the Treasury.

    Fund managers should consult with their legal and tax advisors regarding FATCA and what next steps should be taken to ensure compliance. Without proper counseling, fund managers could risk having the funds they managed subject to significant withholding tax and thus negatively affecting the funds’ IRRs.