United States: FATCA: Implications For Non-US Funds

A general guide in determining the application of FATCA to non-US funds.1

I. What Is FATCA?

FATCA refers to the US Foreign Account Tax Compliance Act (contained in Sections 1471 through 1474 of the US Internal Revenue Code). FATCA was enacted in 2010 in order to reduce perceived offshore tax evasion by US persons holding assets through offshore accounts that were not subject to US information reporting to the Internal Revenue Service ("IRS") under the existing reporting system. As discussed below, FATCA generally requires certain foreign (i.e., non-US) entities that are not exempt from or deemed to be compliant with FATCA to either register with the IRS and conduct certain diligence and reporting regarding their investors and account holders or be subject to 30% US withholding tax on certain US source income paid to the entity. Many countries, including Japan, have entered into intergovernmental agreements ("IGAs") with the United States that modify the basic FATCA rules set forth in the US Treasury regulations promulgated under FATCA.

II. Does FATCA Apply to Me?

FATCA will apply to foreign entities that are foreign financial institutions ("FFIs"). FFIs are foreign entities that:2

  • Accept deposits in the ordinary course of a banking or similar business;
  • Hold financial assets for the account of others as a substantial portion of their business;
  • Are foreign investment entities, including entities that conduct certain investment and asset management activities for customers, entities that are managed by other FFIs and the gross income of which is primarily attributable to investing, reinvesting, or trading in financial assets, and certain collective investment vehicles with investment strategies of investing, reinvesting, or trading in financial assets3;
  • Are insurance companies that issue investment-like contracts or annuity contracts; or
  • Are certain holding companies or treasury centres that are members of corporate groups that include FFIs or that are formed by certain investment vehicles.

This definition is very broad and encompasses entities that would not typically be considered to be financial institutions, such as private equity funds, hedge funds, venture capital funds, certain family investment vehicles, and other similar investment funds (other than investment funds wholly owned and controlled by foreign sovereigns). FATCA will also apply to foreign feeder funds, alternative investment vehicles, parallel funds, and foreign blocker entities organized in connection with such foreign investment funds or US funds.

If a foreign entity is not an FFI, it will be a "non-financial foreign entity" (an "NFFE"). An NFFE generally will not be required to comply with the diligence and reporting requirements applicable to FFIs and described in this memorandum. However, in certain circumstances, an NFFE may be required to identify and make a certification to a withholding agent regarding US persons that own accounts or substantial interests in the NFFE.

III. When Will FATCA Apply?

FATCA will apply when an FFI receives "withholdable payments", which include:

  • payments of US-source interest and dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other "fixed or determinable annual or periodic" gains, profits, and income (so-called "FDAP" income); and
  • gross proceeds from the sale or other disposition of any property of a type which can produce US-source interest or dividends, regardless of whether the recipient realized a gain (or loss) with respect to such property.4

In general, an FFI that does not derive, and is not treated as the payee of, any withholdable payments should not be subject to withholding under FATCA even if it does not become a Participating FFI or a deemed-compliant FFI (as explained below).

Payments of FDAP income will be subject to FATCA withholding from July 1, 2014. Gross proceeds from the disposition of property that can produce US-source interest and dividends will only be subject to FATCA withholding for dispositions occurring after December 31, 2016. FATCA will not apply, however, with respect to FDAP income derived from, and gross proceeds from a disposition of, any "grandfathered obligations"5. In addition, prior to January 1, 2017, a payment made with respect to collateral under a collateral agreement securing certain transactions, including debt instruments and derivative financial instruments, will not be subject to FATCA withholding provided that only a commercially reasonable amount of collateral is held by the secured party as part of the collateral arrangement. This is the case even if the securities posted as collateral would not themselves be considered "grandfathered obligations".

Footnotes

1 This publication is intended as an overview of these issues and does not address all aspect of FATCA. It should not be regarded as legal advice. We would be pleased to provide additional details or advice about specific situations if desired.

2 This definition is drawn from the US Treasury regulations and may be modified to varying degrees by an applicable IGA or country-specific guidance notes, as discussed below.

3 "Financial assets" are securities, partnership interests, commodities, notional principal contracts, insurance or annuity contracts, or any interest (including a futures or forward contract or option) in a security, partnership interest, commodity, notional principal contract, insurance contract, or annuity contract.

4 In addition, beginning no earlier than 2017, withholding may also be required with respect to "foreign passthru payments". An initial notice issued by the IRS in 2011 proposed that noncustodial payments by an FFI (such as interest payments on savings accounts at the FFI) would be subject to FATCA withholding in proportion to the percentage of US assets owned by the paying FFI, referred to as its "passthru payment percentage". However, the current US Treasury regulations under FATCA reserve on the definition of a foreign passthru payment, and it is unclear whether, or to what extent, withholding on foreign passthru payments will be required.

5 The most important category of grandfathered obligations comprises obligations, such as debt obligations, outstanding on July 1, 2014 and not materially modified thereafter. Equity interests will not qualify as grandfathered obligations regardless of when they are issued.

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