United States: Drinking GIIN And The IRS' Juice

Last Updated: February 11 2014
Article by Peter Stafford

"Rollin down the street, smokin indo, sippin on gin and juice/ Laid back (with my mind on my money and my money on my mind)." — Snoop Doggy Dogg. Nov. 23, 1993.

Like Snoop Dogg, the vast majority of investment managers, directors of hedge funds and private equity funds, plus their service providers and counterparties, including administrators, banks, custodians, prime brokers and other financial institutions, whether foreign (i.e., non-U.S.) or U.S., must soon start sipping on gin and juice before they can be laid back when thinking about their money.

This potent cocktail is the perfect metaphor for the powerful combination of the Global Intermediary Identification Number mixed with the tremendous power or "juice" of the Internal Revenue Service, spawned by the Foreign Account Tax Compliance Act. Like the cocktail, it will deliver more than a few headaches, but this time the hangover will not go away.

The IRS will issue a GIIN on June 2, 2014, to each foreign financial institution (FFI) that registers on the IRS FFI registration portal by April 25, 2014. The GIIN is foolproof commercial assurance against disruption in the FFI's counterparty relationships.

Withholding agents will require the GIIN to ensure the FFI is not subject to Foreign Account Tax Compliance Act withholding. It is prudent to obtain the GIIN before FATCA "goes live," since the actions of withholding agents are beyond the FFI's control.

We understand that withholding agents, such as prime brokers and other fund counterparties, may insist on FFIs producing their GIIN on July 1, 2014, to avoid any possibility of them being held liable to the IRS for FATCA withholding tax on U.S. source payments to nonparticipating financial institutions (NPFIs). Unlike Snoop Dogg, withholding agents are notorious for being conservative in protecting their interests.

Generally, the only person who can register an FFI with the IRS is its FATCA-responsible officer (FRO). It is not practical for a U.S. investment manager to act as "sponsoring entity" of its Cayman Islands or British Virgin Islands funds. One reason is that, although the U.S.-Cayman/BVI intergovernmental agreements permit that sponsorship, the U.K.-Cayman/BVI IGAs do not. The most practical solution is for Cayman and BVI funds (and other investment entities) to appoint their own FRO.

The FRO must be a natural person appointed as a duly authorized corporate officer (or director) by the FFI's board of directors (or equivalent). That is because the FRO must be legally authorized to register the FFI. Furthermore, the FFI's directors have fiduciary duties to understand the scope of the FRO's responsibilities and that the FRO has the capacity and ability to perform his/her obligations.

The FRO is mandatory for any FFI required to register with the IRS and obtain its own GIIN. The IRS must know the FRO's identity. The IRS will not process the FFI's registration for the GIIN unless it is signed by the FRO who, in doing so, must certify the accuracy and completeness of information and agrees that the FFI will comply with all its FATCA obligations.

The FRO must also agree that the FFI will comply with all relevant FATCA obligations. Consequently, the FRO has a dual responsibility to the IRS and the partner jurisdiction's competent authority; i.e., the FRO is personally liable to the IRS1 in addition to any liabilities imposed under the laws of any partner jurisdiction under an IGA.

The FRO's initial responsibilities include registering the FFI with the IRS to obtain the GIIN, overseeing the FFI's compliance program, answering the regulators' questions and remediating any instances of noncompliance. The FRO's formal reporting responsibilities commence in 2015.

The IRS relies on the FRO to approve and oversee the FFI's FATCA compliance program, being the due diligence, withholding and reporting policies and procedures established in accordance with the relevant intergovernmental agreement between the U.S. Treasury and partner jurisdictions, and/or FFI agreement between the IRS and the FFI itself. Other additional FRO responsibilities may arise under local IGA legislation once implemented.

FROs and FFIs should be aware that the Internal Revenue Manual states that the IRS will instigate covert (secret) investigations long before it makes them overt so the FRO would also be the target when and if the IRS believes that administrative or other errors may have led to incorrect or incomplete information reporting or resulted in other infringements of the IGA.

We recommend that investment managers and their FFIs' board of directors give serious consideration to appointing a specialist independent FRO. First, we are not aware of any fund administrators willing to act as FRO. Second, there are a number of reasons why an investment manager may find it unappealing for its employee to be the FRO of the FFIs it manages, as explained below.

The FRO has personal strict liability for the accuracy and completeness of the FFI's FATCA reports and also for any failure to report on reportable accounts. The FRO would also have fiduciary duties in the performance of his/her duties, which could make the FRO personally liable in the event of breach of those duties, particularly if it amounts to willful default or fraud.

These legal risks expose the investment manager, through vicarious liability and/or indemnification, to liability for any losses caused to an FFI by an employee of the investment manager serving as FRO. Investors and regulators alike may perceive that an employee of the investment manager, who is also FRO of its funds, has an inherent conflict of interest and could lack objectivity where personal or employer interests conflict with those of the FFI/regulators.

If the investment manager's employee acts as the FFI's FRO, the investment manager would bear that expense (or at least the opportunity cost), whereas the FFI itself would bear the cost of any independent specialist FRO. Any FRO, who is a U.S. person, may have additional personal tax reporting requirements to the IRS on Form 5471 regarding his/her position as an officer or director of a corporate FFI.

FATCA is the responsibility of the FFI and is not a core compliance function of the investment manager. The network of IGAs that impact each FFI are local and will become increasingly complex; the U.K's IGAs with Cayman, the BVI and all other overseas territories and crown dependencies "go live" on July 1, 2014.

FATCA will grow in scope, particularly as all G20 countries, representing 90 percent of global output and two-thirds of the world's population, are now party to the Organisation for Economic Co-operation and Development Multilateral Convention on Mutual Administrative Assistance in Tax Matters.

Fund managers and their tax advisers are already recognizing the value of offshore funds appointing a specialist independent FRO to drink the new "GIIN and juice." Like Snoop Dogg, managers want the freedom to be "rollin' down the street ... laid back (with my mind on my money and my money on my mind)."

Footnotes

1 26 U.S. Code - Internal Revenue Code — Fraud and False Statements, §7206(2); 18 U.S. Code — Crimes — Ch. 19 — Conspiracy, §371

Published in Law360, New York (January 28, 2014, 1:54 PM ET)

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