FATCA compliance: A ticking clock

Of the nearly 88,000 entities in the US Internal Revenue Service's (IRS) list of foreign financial institutions that have registered for tax disclosures, more than 17,000 hail from the Cayman Islands, jurisdiction of choice for many in the private equity industry. Search any of the leading names in Asia - from The Carlyle Group to Affinity Equity Partners to Hony Capital - and you find entries for one or more of their vehicles.

These firms that have taken the first step towards complying with the US Foreign Account Tax Compliance Act (FATCA), a piece of legislation designed to help America root out taxpayers with assets secreted offshore. Compliance came into force on July 1 but the transition to full reporting will not happen until 2015. It is hoped the next 12 months will see various regulatory wrinkles ironed out and then a frenzy of activity as PE firms rush to meet the looming deadline.

"Some clients are proactive but most are not," says Alexander Traub, head of Asia at fund administrator Augentius. "We will see over the coming year how seriously they take it and there will probably be a mad scramble at the end to put something in place."

The penalty for failing to declare US investors to the IRS is well known: private equity firms and other foreign financial institutions (FFIs) will be subject to a 30% withholding tax on any US source payments. Less clear are the guidelines for individual jurisdictions and the additional costs in terms of due diligence and reporting that will be incurred by PE firms in the name of compliance.

The unknown burden

China-focused Lunar Capital Partners is among those on the IRS' initial FFI list, published on June 2. The firm had to complete some one-off preparation work to meet the deadline - establishing which investors fall under FATCA's jurisdiction and filing documents with the IRS - but this is merely a taste of what is to come.

Stephen Tang, Lunar's CFO, simply echoes what he said to AVCJ in February: "The full compliance burden hasn't hit us yet - no one knows how much extra work will be required."

FATCA compliance should be easier for PE managers than those in other asset classes. GPs have comparatively small investor bases and they usually know each LP. The IRS said that onboarding documentation for new investors should be finalized by May 5 for registration and inclusion on the June 2 list. While many PE firms didn't start asking for assistance on the process until around April, some funds with retail investors have been preparing for two years.

Those with neither US operations nor US investors might be under the impression that they don't have to comply at all, but in the vast majority of cases they are mistaken. First, it is difficult to transact business in Asia without coming into contact with a financial institution that is compliant and won't work with a counterparty that is not. Second, many jurisdictions have signed intergovernmental agreements (IGAs) with the US, making FATCA compliance a local issue.

"A lot of Asian PE funds say, ‘I don't target the US as an investment jurisdiction and I don't look for US investors so therefore the impact on me is non-existent.' But under the Model 1 IGA framework there will be a local legal requirement to comply," says Charles Kinsley, tax principal at KPMG China. "They will also find that more of the banks and custodians they use in the region start asking more questions about FATCA status. Some won't do business with you if you're not compliant."

IGAs are the more complex factor and their impact could be wide-ranging. As of mid-June, the US had signed 24 intergovernmental agreements (IGAs) and reached "an agreement in substance" with another 51 jurisdictions. The majority are Model 1 agreements, which means compliance with FATCA is a local tax requirement, with local authorities collecting the relevant information and passing it on to the IRS.

Cayman signed a Model 1 IGA last November while Singapore and China are among those to have reached agreements in substance. Hong Kong follows Model 2 so there is no automatic disclosure.

Regional variations

Each Model 1 jurisdiction will have its own guidelines that to a certain extent dictate how FATCA will be interpreted, with various local carve-outs and nuances intended to accommodate existing local disclosure requirements.

Areas of uncertainty have already emerged. Augentius' Traub notes that lawyers in Singapore are advising managers to do nothing until the IGA with the US is actually signed. However, if a Singapore fund sits underneath a Cayman master structure, the fund must be FATCA compliant under Cayman law.

Jurisdictional variations also come into play when establishing the FATCA status of special purpose vehicles (SPVs) used by a fund for investment purposes. A private equity firm that invests throughout the Asia Pacific region may use SPVs based in a range jurisdictions to take advantage of tax breaks offered under different double tax treaties. For example, Hong Kong might be used as a conduit for China and Mauritius for India. More SPVs might exist for particular deals if LP co-investors require it.

"All the way down the chain, entities that hold bank accounts will generally be requested to confirm their FATCA status. Moreover, for non-financial foreign entities that derive mainly passive income, they will also have to disclose if they have a greater than 10% US ownership, directly or indirectly, and then provide the details of such persons," says KPMG's Kinsley.

It leaves managers with plenty of food for thought as they either play catch up on registration or press ahead with the next stage, putting in place the infrastructure that will facilitate recurring monitoring and reporting.

The IRS has said many requirements won't be rigorously enforced in the first couple of years provided firms make good-faith efforts to comply - shorthand for having the correct policies and procedures in place and updating onboarding documentation. But appearing on the FFI list is a reputational issue as much as anything else.

"It is in your best interests to register because if you have US investors or counterparties they will look on the IRS website to see if you are registered," says Augentius' Traub.

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• Topics
• North America
• Fundraising
• Regulation
• USA
• tax
• Fundraising
• regulation
• KPMG
• Lunar Capital Management
• Augentius
• Asia