South Africa: The Impact Of FATCA On Investment Funds

Last Updated: 6 September 2011
Article by Shayne Krige

The United States Foreign Account Tax Compliance Act (FATCA) is the latest salvo fired by the United States (US) against offshore structures used to avoid US tax.

Foreign financial service providers bear the collateral damage in this latest battle and if, as anticipated, the law is implemented in its current form, it will have important consequences for South African financial service providers, including investment funds.

The aim of FATCA is to clamp down on Americans who use foreign structures to avoid paying US tax. In going after these structures, the US tax authorities face the significant practical issue of how to obtain information about structures set up outside their jurisdiction.

Recent experiences in Abbottabad notwithstanding, the US cannot enforce its laws in foreign countries and so must turn to persuasion. By way of coaxing information about foreign structures out of foreign financial institutions (FFIs), FATCA imposes a withholding tax on all uncooperative FFIs and ultimately excludes them from the US securities market.

Certain provisions of FATCA come into force next year and its impact goes well beyond tax issues extending to compliance, internal controls, IT systems, service provider relations and customer operations.

Who is affected?

The definition of an FFI under the Act is extremely broad and includes banks, trust companies, custodians and any entity involved in investing, reinvesting or trading in securities, partnerships or commodities. Investment funds are therefore impacted.

How FA TCA affects investment funds

Investment funds, as FFIs, are "invited" to enter into an agreement with the IRS in terms of which they undertake to institute procedures to identify US customers and report their investments to the IRS.

Identification of US accounts

The fund must identify all interests in the fund held directly or indirectly by "US Persons".

Most investment fund administrators currently store information about the addresses of investors during the subscription phase, but this information invariably relates to the registered holder of interests in the fund rather than the ultimate beneficial owner.

Some are required to collect information about the ultimate beneficial owner but this is collected in accordance with the administrator's own money laundering obligations which will in most cases not dovetail with the FATCA requirements. It is also generally stored separately and the circumstances in which it can be disclosed will be limited.

As a result, most funds will, as a minimum, have to go back to their investors to find out whether any of them are holding as nominees or intermediaries for US Persons.

Obtaining waivers from investors

FATCA obliges the fund to obtain a waiver from each investor so that it can report the required data to the IRS. This applies not only to investors who are US Persons but each and every investor in the fund. If an investor refuses to allow the fund to report information about it to the IRS, even if the investor is not a US Person, the fund must close the account, i.e. forcibly redeem the investor.

This creates a host of problems for funds such as:

  • Investors may have valid grounds, unrelated to US tax evasion, for not wishing to give personal information to the IRS.
  • The fund itself may be subject to data protection rules that prohibit it from supplying this information even if it does hold a waiver.
  • The contract the fund has with investors may not allow forced redemptions in this context.
  • The South African Consumer Protection Act (CPA) contains a prohibition on unfair and unjust terms. Terms that allow the fund to terminate the investment in these circumstances may well breach the CPA.

Annual reporting

The record-keeping and reporting requirements of FATCA are potentially the most burdensome and costly compliance issues that FATCA raises. Funds are required to supply the IRS with certain information about US investors on an annual basis

Most funds and their administrators will not currently have systems in place capable of collecting and providing all of this information to the IRS in the requisite format. Major changes will need to be made to the IT systems used by funds and their administrators to collect and report this information.

Many South African businesses are still grappling with multiple corporate record keeping systems in the context of the inconsistencies between the Income Tax Act and new Companies Act and the addition of another record keeping layer will exacerbate the problems FFIs currently face.


Any FFI that does not sign an agreement with the IRS will be subjected to a 30% withholding on all payments from US payors. This withholding is not limited only to US revenue. The 30% withholding is payable on any payment routed via a US payor irrespective of the original provenance of the payment.

Unlike the European Union Savings Tax Directive, the withholding under FATCA is not an alternative to compliance. In addition to the imposition of the withholding, the Act requires financial institutions to close the accounts of any FFI that fails to sign an agreement with the IRS. This ultimately means exclusion from the US securities market.

If an FFI does sign an agreement with the IRS but specific investors refuse to provide information, the withholding will only apply to payments on behalf of non-compliant investors. A fund would therefore need systems in place to allocate liabilities from gross receipts to specific investors only. This may in turn impact the reporting of the fund's net asset value and require formal segregation of compliant from non-compliant investors within the fund.

Although the Act does allow the 30% withholding to be made further upstream by an FFI that has an agreement with the IRS, this is not a viable alternative for funds.

The challenges

Certain particular issues relating to the application of FATCA to investment funds have been raised with the US Treasury, but authorities have not provided any significant guidance to date other than to make it clear that they do not accept that there are fundamental issues with the legislation and do not anticipate significant changes.

With FATCA coming into force next year, many funds have already started:

  • restructuring so that they can offer sub-funds reserved exclusively for US investments (or US Persons) and eliminate FATCA issues for funds that do not trade in US investments;
  • amending their fund documentation to address the specific issues raised by FATCA;
  • upgrading their internal systems to meet the new compliance standards;
  • consulting with their administrators with a view to outsourcing FATCA compliance; and
  • consulting with their banks, custodians and prime brokers to assess their readiness to deal with FATCA and the impact on the services they receive.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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