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It is hard to imagine a recent regulation as far-reaching in its effect as The U.S. Foreign Account Tax Compliance Act (FATCA). Although originally envisioned as a means to detect U.S. taxpayers using offshore holdings to evade taxation, FATCA has mushroomed into a global phenomenon with implications for nearly every participant in the financial services and alternative investment industries.
FATCA was enacted by the U.S. government in March of 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act and went into effect this past January. It requires foreign financial institutions (FFIs) to identify and report to the Internal Revenue Service (IRS) on U.S. persons using non-U.S. financial accounts or non-U.S. entities for the purpose of evading U.S. taxes. Failure to disclose information on their affected U.S. account-holders or those accounts will subject FFIs to a 30% withholding penalty on their U.S.-sourced income. In practice, most private equity funds and hedge funds can be defined as FFIs. Consequently, FATCA will affect most alternative investment fund managers, regardless of whether they have U.S. investors, foreign investors, U.S. funds or foreign funds.
Like many other regulations born out of the global financial crisis of 2008, including Dodd-Frank and the AIFMD, FATCA is now part of the industry-wide drive towards global transparency and the automated exchange of information. Its expansion is now accelerating, in no small part due to the looming June 30, 2014 deadline, after which withholding becomes mandatory and a likely deterrent to potential investors. FATCA implementation is being effectuated through Inter-Governmental Agreements (IGAs) between the U.S. and foreign governments. Since IGAs tend to be reciprocal, many foreign governments are embracing FATCA as an opportunity to gain more information from the United States on their citizens’ offshore holdings. IGA signatories are required to enact provisions for the implementation of FATCA into their domestic legislation and adopt implementing regulations.
According to the latest updates from the Treasury Department, IGAs have been signed with thirty foreign governments, twenty-one of which are in Europe (including 15 E.U. members). All the others, save one, are in North and South America. Currently, the sole Asian government that has signed an IGA is Japan. Thirty-two other governments have either reached agreements in substance or are engaged in discussions pursuant to an agreement. These include a number of significant Asian economies: China, Singapore, Taiwan, Malaysia, Korea, Hong Kong SAR and India.
Interestingly, China has repeatedly refused to discuss the FATCA directly, and will likely continue to do so for some time. Most countries will not put their ability to invest in the U.S. in jeopardy by refusing to sign a FATCA IGA. But, with the U.S. actively soliciting more Chinese investment, the Beijing government has significant leverage in any negotiation of an IGA, and is likely to seek generous exemptions from FATCA rules, especially for its smaller banks.
The goal under FATCA is to have all FFIs deliver data regarding their U.S. accounts to the IRS. So, regardless of location, one might expect to find similar reporting standards. However, this is not the case. FATCA specifies two basic types, or models, of IGAs that define how the required information is gathered and how it is transferred to the U.S. In a Model 1 IGA, the partner jurisdiction agrees to act as an intermediary and report data to the IRS about U.S. accounts maintained by all relevant FFIs in their jurisdiction. In a Model 2 IGA, the partner jurisdiction enacts laws compelling relevant FFIs in their jurisdiction to report U.S account data directly to the IRS without an intermediary. To date, all but five signed IGAs are Model 1.
So, with so many countries acting as intermediaries in the transfer of FFI information to the IRS, every reporting standard will be different. Without universal reporting standards and methodologies, the operational burden on GPs and LPs for compliance is enormous. Consequently, dedicated personnel and financial resources are an absolute requirement. Not surprisingly, compliance professionals are now a very hot commodity in the alternative investment industry.
With the June 30th deadline fast approaching, everyone in a scramble to comply with FATCA and other new regulations. The hard truth of the matter is that collecting, storing and processing all the requisite data for FATCA compliance is simply not possible without a robust and highly adaptable technology solution.
Fortunately, eFront solutions streamline and automate FATCA compliance. In fact, eFront has developed a specific methodology for GPs and depositaries so they can adapt quickly to an evolving regulatory environment. Our FrontInvest and FrontGP compliance solutions enable managers to quickly identify and easily manage the critical data that will keep them in compliance, even in multiple jurisdictions. For example, our Sample Investor Legal screen shows all the information relative to tax identification from the legal domicile of the FATCA-compliant investor to its bank account information. The Document Management Module stores all tax and legal documents required for streamlined communication with the IRS and enables easy editing. Also, eFront solutions standardize the due diligence process across the entire investment team with account opening processes and document management, while tax withholding and reporting are addressed through our existing fund management and accounting features
FATCA is a global reality that can neither be ignored nor avoided. The only hope for meeting the compliance challenge without undue burden is by implementing a comprehensive and flexible technological solution.