FATCA: PRIVATE EQUITY FUNDS AND THE UK/US IGA

Transcription

1 7 FATCA: PRIVATE EQUITY FUNDS AND THE UK/US IGA This document is published by Practical Law and can be found at: uk.practicallaw.com/ Request a free trial and demonstration at: uk.practicallaw.com/about/freetrial This note looks at the US Foreign Account Tax Compliance Act (FATCA) compliance position for the entities in a private equity fund managed by a UK-based fund manager. Laura Charkin, Matt Clift, Charlotte Haywood and Simon Prosser, King & Wood Mallesons RESOURCE INFORMATION RESOURCE ID CONTENTS Scope of this note Background: FATCA and tax information exchange globally FATCA OECD common reporting standard Crown Dependencies and Overseas Territories agreements EU Directive on administrative co-operation Why does FATCA affect private equity funds? FATCA obligations for fund managers Typical private equity fund structure Entity identification and classification Application of FATCA to typical private equity fund Fund LP Carried interest vehicle General partner Fund manager Adviser Holding company Deal company Fulfilling FATCA obligations: registration and reporting IRS registration Local reporting registration Reporting obligations Classification of investors What happens if a PE fund does not fulfil those obligations? Demonstrating compliance Investor negotiation Typical categories of investors RESOURCE TYPE Practice note PUBLISHED DATE 23 February 2016 JURISDICTION United Kingdom SCOPE OF THIS NOTE This note looks at the US Foreign Account Tax Compliance Act (FATCA) compliance position for the entities in a private equity (PE) fund structure managed by a UK-based fund manager, as shown below (see Typical private equity fund structure below). For simplicity, it assumes a structure in which each entity is formed in and resident for tax purposes solely in the UK. The note is an overview of how the rules are being applied in practice in the PE industry, rather than a detailed review of each technical provision in the relevant law. It is based on the practical experience of the authors and discussions with those running the FATCA implementation programmes at several PE houses. If points of technical detail are relevant, the note generally cross-refers to other Practical Law resources. Funds that use structures similar to PE funds but that invest in different asset classes (such as real estate) have their own specific considerations. These are beyond the scope of this note so, while we have aimed to flag some key points, they are not covered in any detail. Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited. All Rights Reserved.

2 The note focuses on FATCA as implemented by the Agreement of 12 September 2012 with the USA to Improve International Tax Compliance and to Implement FATCA ( as amended by the Exchange of Notes of 3 and 7 June 2013 ( file/228840/8656.pdf) (UK/US IGA), which is, in turn, implemented in the UK through the International Tax Compliance Regulations 2015 (SI 2015/878) (as to which, see Practice note, CRS, EU administrative co-operation and FATCA: UK implementing regulations: Implementing information exchange in the UK ( (Compliance Regulations). The Compliance Regulations revoked the International Tax Compliance (United States of America) Regulations 2014 (SI 2014/1506) (Old Regulations), which were the original UK regulations dealing with FATCA implementation. Unless otherwise stated, references to a regulation in this practice note are to the Compliance Regulations and references to FATCA guidance are to HMRC s September 2015 FATCA guidance ( uploads/system/uploads/attachment_data/file/461542/guidance_notes_for_the_uk-us_fatca_agreement.pdf) on the Old Regulations (FATCA guidance). In September 2015, HMRC also published for consultation its draft Automatic Exchange of Information Manual ( Automatic_Exchange_of_Financial_Account_Information.pdf) on the Compliance Regulations (AEIM or manual). HMRC states that, once finalised, the manual is intended to incorporate the FATCA guidance and its September 2015 guidance on the UK s FATCA-style agreements with the Crown Dependencies and Overseas Territories (CDOT). The manual includes a table of destinations showing the extent to which the FATCA guidance and the CDOT agreements guidance have been incorporated in the manual. HMRC states that, to the extent that the FATCA guidance and the CDOT agreements guidance have not been incorporated in the manual, that guidance remains valid. For more detail, see Legal update, HMRC consults on automatic exchange of financial account information guidance ( The main focus of this note is on FATCA, however where it is considered helpful references are also made to the OECD s common reporting standard for exchange of information (CRS) and the CDOT agreements, as well as to non-uk implementations of FATCA, for example, as regards some specific residence-related issues, relevant for funds based in more than one jurisdiction. BACKGROUND: FATCA AND TAX INFORMATION EXCHANGE GLOBALLY FATCA For an explanation of FATCA, the UK/US IGA and the implementation in the UK of the UK/US IGA through the Compliance Regulations, see Practice note, CRS, EU administrative co-operation and FATCA: UK implementing regulations ( and specifically box, FATCA ( 3605). For Practical Law s resources on FATCA, see Practice note, A guide to Practical Law s FATCA resources (www. practicallaw.com/ ). In the majority of mainstream jurisdictions, FATCA and its tax information provisions are implemented in practice through a Model I intergovernmental agreement (IGA) (in the UK, the UK/US IGA), which is in turn implemented in the local law of a particular country (in the UK, the Compliance Regulations implement the UK/US IGA). However, some jurisdictions have no IGA or a Model II IGA, in which case FATCA compliance is achieved under US law, by entering into a participating FFI agreement with the US Internal Revenue Service (IRS) to disclose information to the IRS. The details of this process are beyond the scope of this note. For more information, however, see Practice note, FATCA: FFIs and NFFEs: FFI Agreements and Account Due Diligence ( com/ ). For a summary of the jurisdictions that have signed a model IGA with the US, see Practice note, Chart of FATCA Intergovernmental Agreements ( To check the FATCA implementation status of a particular jurisdiction and find further information on the US law position, see IRS: Foreign Account Tax Compliance Act ( 2 Practical Law Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited. All Rights Reserved.

3 OECD common reporting standard In the years since FATCA was introduced, further and more ambitious tax information exchange laws have been developed, covering a broader range of jurisdictions, which are equally relevant to PE funds. These use FATCA as their starting point and are based on FATCA in terms of their information exchange obligations, but differ from it in that they do not impose any withholding taxes. The most significant of these is the CRS published by the OECD for automatic and multilateral exchange of financial information between tax authorities, which has a global remit. Unlike FATCA and the CDOT rules (see Crown Dependencies and Overseas Territories agreements below), the CRS is not yet in force but it is due to be implemented by a large group of early adopters in 2016 and by all of the 90-plus jurisdictions that have signed up to it by The CRS will also be implemented in the UK through the Compliance Regulations (guidance on which is contained in the AEIM). For more detail, see Practice note, CRS, EU administrative co-operation and FATCA: UK implementing regulations: box, OECD common reporting standard ( Crown Dependencies and Overseas Territories agreements In addition, the UK government has introduced its own package of tax measures, similar to FATCA, with each of the Isle of Man, Guernsey and Jersey (Crown Dependencies) and Anguilla, Bermuda, the British Virgin Islands, the Cayman Islands, Gibraltar, Montserrat and the Turks and Caicos Islands (Overseas Territories). Regulations implementing the agreements between the UK and the Crown Dependencies and Gibraltar were made on 6 March 2014 and came into force on 31 March 2014 (CDOT Regulations). In March 2015, those regulations were amended with effect from 15 April It is anticipated that these regulations will be repealed once the UK and its Crown Dependencies and Overseas Territories start to exchange information under the CRS (AEIM100120). (See, also, Scope of this note above for details of the September 2015 CDOT agreements guidance and how it interacts with the manual.) For more detail, see Practice note, CRS, EU administrative co-operation and FATCA: UK implementing regulations: Crown Dependencies and Overseas Territories agreements ( EU Directive on administrative co-operation Council Directive 2014/107/EU (DAC) assists EU member states in fighting tax evasion and fraud by extending the scope for the automatic exchange of information. In effect, the DAC implements the CRS (see OECD common reporting standard) within the EU. For more detail, see Practice note, CRS, EU administrative co-operation and FATCA: UK implementing regulations: EU Directive on administrative co-operation ( 3605). WHY DOES FATCA AFFECT PRIVATE EQUITY FUNDS? FATCA and its tax information exchange provisions, as implemented in UK law, impose legal obligations on financial institutions (FIs) to identify and report on account holders. Many of the entities commonly used in fund structures are FIs for these purposes, as they are investment entities (see Entity identification and classification below). It is worth noting that, even prior to the introduction of the CRS, a UK- or CDOT-based fund, with no US investments and no US account holders, will still have to take steps to verify the position and identify its account holders, in order to comply with both FATCA and the CDOT Regulations. The Compliance Regulations and the UK/US IGA (Article 2.2a, UK/US IGA and Regulation 6, Compliance Regulations) require UK reporting FIs (see Entity identification and classification below) to report on any financial accounts held by a Specified US person (Article 1.1.gg, UK/US IGA) or by a Non-US Entity (Article 1.1.ii, UK/ US IGA) with one or more Controlling Persons (Article 1.1.mm, UK/US IGA) that are Specified US Persons. In addition, where a UK reporting FI makes certain payments to a Non-participating Financial Institution, it must Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited.. All Rights Reserved. Practical Law 3

4 report to HMRC the name of the recipient and the aggregate value of such payments made in 2015 and 2016 (Article 4.1(b), UK/US IGA and Regulation 9, Compliance Regulations). This may not be a long term requirement (FATCA guidance ( Guidance_Notes_for_the_UK-US_FATCA_Agreement.pdf): section 9.4). In practice, FIs need to register with the IRS to obtain a Global Intermediary Identification Number or GIIN, which they can then use to demonstrate their FATCA status to third parties and as part of the reporting process, as further explained below (see IRS registration below). Funds that do not take such steps may find that, aside from any withholding tax risk, they have difficulty in practice in dealings with other FIs and third parties who require certifications of their FATCA status. In a funds context, this might include negotiations with investors and dealings with depositories, custodians, administrators and banks, such as when opening accounts and in the context of other financing arrangements. The UK/US IGA applies to UK FIs (Article 1.1.l, UK/US IGA), being any FI resident in the UK, as well as any branch of a non-resident FI located in the UK, including a UK branch of a US FI. As long as UK FIs comply with the Compliance Regulations, they should not normally be subject to US withholding tax under FATCA (Article 4.1, UK/US IGA and FATCA guidance ( file/461542/guidance_notes_for_the_uk-us_fatca_agreement.pdf): section 2.1). If, for example, a UK FI makes repeated late filings or intentionally provides substantially incorrect information or commits other non-minor failures or errors they may become significantly non-compliant. If this non-compliance is not rectified within 18 months then the UK FI will lose its deemed compliant status and become subject to potential US withholding tax under FATCA (Article 5.2, UK/US IGA and FATCA guidance ( uploads/attachment_data/file/461542/guidance_notes_for_the_uk-us_fatca_agreement.pdf): section 10.2). FATCA OBLIGATIONS FOR FUND MANAGERS This section looks at what obligations apply to a typical UK fund manager and the entities it manages, and looks at how to go about putting in place a FATCA compliance program, using the example of a typical PE fund structure (see box Typical private equity fund structure ). Entity identification and classification The first step for a fund manager looking to comply with FATCA is to take stock of all of the entities that it owns or controls and to determine: What type of entity they are for FATCA purposes. Where they are resident for FATCA purposes. The aim here is to identify which of these entities are FIs, which will have reporting obligations under FATCA or other tax information exchange provisions, and to which local law implementation of FATCA they are subject. An example of the type of information that may be useful to note for each entity as part of this process is set out below. Entity name Function FATCA status Rationale Residency FATCA GIIN Reporting under PE Fund II LP Fund vehicle FFI Investment entity UK based on control and management/ tax filings FATCA/CDOT/CRS 4 Practical Law Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited. All Rights Reserved.

5 The UK/US IGA system of FATCA implementation broadly works to relieve compliant UK FIs from requirements under the US law provisions. An FI which is a reporting FI under UK law (Article 1.1.o, UK/US IGA and Regulation 24, Compliance Regulations) can then qualify as a registered deemed compliant FI under the US law definitions (section (f)(1), US Internal Revenue Code). This means that it is deemed to comply with US reporting obligations and escapes the withholding tax rules that would otherwise apply to it. To be in this category FIs still need to obtain a GIIN from the IRS and, where applicable, will need to submit annual returns to HMRC (FATCA guidance ( Notes_for_the_UK-US_FATCA_Agreement.pdf): section 2.1). The other category into which a UK FI can fall is that of a non-reporting FI (Article 1.1.q, UK/US IGA). These do not have to obtain a GIIN or report under the Compliance Regulations or FATCA (FATCA guidance ( uk/government/uploads/system/uploads/attachment_data/file/461542/guidance_notes_for_the_uk-us_fatca_ Agreement.pdf): section 2.1). This concept mainly covers FATCA-exempt entities such as international organisations and registered pension funds, but there is some overlap here as a non-reporting FI includes an FFI that qualifies as a deemed compliant FFI under the US law definitions, which in turn covers registered deemed compliant FIs such as a Model I IGA resident FI (FATCA guidance ( attachment_data/file/461542/guidance_notes_for_the_uk-us_fatca_agreement.pdf): sections 2.1, and 2.12). There is an unhelpful circularity to the definitions here, but overall the FATCA guidance makes it reasonably clear, however, that if an entity is a registered deemed compliant FI for US purposes and has obtained a GIIN then the intention is that it can still qualify as a reporting FI under the UK law, so that those entities can benefit from the protection of the UK/US IGA (FATCA guidance ( file/461542/guidance_notes_for_the_uk-us_fatca_agreement.pdf): section 2.1). Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited.. All Rights Reserved. Practical Law 5

6 Under UK law, an entity is an FI, with the potential to benefit from the UK/US IGA, if it falls within any one (or more) of the following categories (Articles 1.1.g and 1.1.l, UK/US IGA): Custodial Institution (Article 1.1.h, UK/US IGA). Depositary Institution (Article 1.1.i, UK/US IGA). Investment Entity (Article 1.1.j, UK/US IGA). Specified Insurance Company (Article 1.1.k, UK/US IGA). As a general rule, any entity that is not an FI is instead regarded as an NFFE (paragraph VI.B(2), Annex I, UK/US IGA and FATCA guidance ( Guidance_Notes_for_the_UK-US_FATCA_Agreement.pdf): sections 2.1 and 2.6). Of the categories above, the one of most relevance in a PE fund context is that of a UK investment entity. Under the UK/US IGA, this is broadly any entity which conducts as a business (or is managed by an entity that conducts as a business) in the UK one or more of the following for or on behalf of another person: Trading in securities/instruments of various kinds. Individual or collective portfolio management. Otherwise investing administering or managing funds or money on behalf of other persons. However, owing to an amendment to the UK implementing law, the Compliance Regulations, on 29 October 2015 by the International Tax Compliance (Amendment) Regulations 2015 (SI 2015/1839) (see Legal Update: International Tax Compliance Regulations: definitions and non-reportable accounts ( 8997)), the terms financial institution and investment entity in the Compliance Regulations now have the same meaning as they do in the US FATCA law (Regulation 1(5A) Compliance Regulations and sections (e) (1) and (e)(4)(i) US Internal Revenue Code). The intention behind this reintroduction of the US FATCA law definition (as opposed to the UK/US IGA definition) is not completely clear and no substantive guidance or revised guidance was issued at the time. There are several differences between the different definitions (importantly, as regards the treatment of holding companies, for which see further below). Another key difference is that the US FATCA law definition of investment entity, as it applies to managed entities, incorporates additional requirements such that, when applying the definition to PE funds, it looks to gross income derived from such activities relating to financial assets. Under the original draft of the Compliance Regulations, the definition of investment entity did not incorporate a financial assets concept. This has some interesting knock on effects; this note focuses on PE as an asset class, where the position is reasonably clear cut as regards the status of fund entities as FIs that are investment entities which invest in financial assets. However, in the context of real estate funds, the position is less clear, in that any non-debt interest in real property is not a financial asset (section (e)(4)(ii), US Internal Revenue Code). Whether this can be used in practice, such that an entity is not regarded as an FI, will depend on the local law implementation of FATCA in the jurisdiction in which an entity is resident and the view taken in any guidance issued by the local authorities as to their interpretation of this concept. For example, FATCA guidance confirms that an Investment Entity whose assets consist of non-debt direct interests in real property or land, even if managed by another Investment Entity would not be an Investment Entity (FATCA guidance ( system/uploads/attachment_data/file/461542/guidance_notes_for_the_uk-us_fatca_agreement.pdf): section 2.28(ii)) but offers no further view as to what is meant by direct and how this would apply to a debt-financed real estate holding structure. Under the CRS, non-debt, direct interests in real property are also expressly excluded from the definition of financial assets (paragraph A.7, Section VIII, Annex, CRS), meaning that the CRS reflects the US law position on this point. The manual adds that a real estate investment trust falls within this exception and that the exception 6 Practical Law Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited. All Rights Reserved.

7 will include structures where the interest in the property is held through a chain of entities provided the entity at the head of the chain has absolute control over the entities below, for example a parent company sitting at the head of a chain of wholly owned subsidiaries (AEIM100760, and see also examples in AEIM100780). It is also worth considering whether any of the fund entities identified as FIs fall into one of the categories of non-reporting FI (Article 1.1.q and Annex II, UK/US IGA and sections (f), (b)(42), (b)-(g) and (e)(5), US Internal Revenue Code). These are numerous, but typically with very tightly drawn conditions, which limit their use. More information as to the different categories and their terms can be found at FATCA guidance ( Notes_for_the_UK-US_FATCA_Agreement.pdf): section 2.1. Of the categories applicable to PE funds, many require the fund entity itself to be regulated and so cannot be used in a typical PE fund context. It may be that, on the facts, some wholly-owned entities in the group can benefit from excepted inter-affiliate FFI status (section (e)(5)(iv), US Internal Revenue Code), and therefore fall within the definition of non-reporting UK FIs (Article 1.1.q and Annex II, UK/US IGA). In addition, some carried interest vehicles could, in theory, qualify as sponsored closely held investment vehicles (see Carried interest vehicles below). The most widely used of these categories, though, is that applicable to investment managers, explained further below (see Fund Manager below). This whole process will need to be repeated and the position for each entity checked for CDOT Regulations and CRS purposes as applicable as, although these regimes are based on FATCA, as can be seen above, the entity classification definitions are not identical and there are some important differences. For example, in a funds context, it is important to note that, for CRS purposes, an FI resident in a jurisdiction that has not signed up to the CRS (such as the US currently) and that is treated as non-participating for these purposes will be treated as a passive NFFE rather than an FI (paragraph D.8, Section VIII, Annex, CRS and HMRC: Implementing Agreements under the Global Standard on Automatic Exchange of Information to Improve International Tax Compliance - Summary of Responses ( Implementing_Agreements_under_the_Global_Standard_on_Automatic_Exchange_of_Information_to_Improve_ International_Tax_Compliance_-_summary_of_responses.pdf): paragraph 2.1). This means that information regarding beneficial owners/controlling persons may need to be obtained for CRS purposes, even if it does not need to be obtained for FATCA purposes, in respect of any investors that fall into this category (for example, US fund of fund investors). APPLICATION OF FATCA TO TYPICAL PRIVATE EQUITY FUND This section looks at how FATCA might apply in practice to a typical fund with the structure depicted above (see Typical private equity fund structure above). Fund LP A UK limited partnership fund vehicle in a wholly UK-based fund structure would be an investment entity (and therefore a UK FI) for these purposes (see Entity identification and classification above). An entity will only fall within the scope of the Compliance Regulations (for FATCA purposes) if it is resident for these purposes in the UK (Articles 1.1.l and 1.1.n, UK/US IGA, as incorporated in the Compliance Regulations at Regulation 1(6), Compliance Regulations). Under the UK/US IGA, what is relevant is where the entity is resident for tax purposes. In many cases, the principles involved will be relatively clear (for example, for UK companies). However, partnership entities are transparent for UK tax purposes and, strictly speaking, have no tax residence as such, so some further guidance is needed on this point. The FATCA guidance notes that, for a partnership, if the control and management of the business of the partnership takes place in the UK, or if the partnership registers with and submits partnership tax returns to HMRC, it will fall within the scope of the Compliance Regulations (see AEIM100620). UK partnerships registered at Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited.. All Rights Reserved. Practical Law 7

8 Companies House in the UK would generally be asked to submit such tax returns (see Self Assessment: Partnership Tax Return (SA800) ( and HMRC: Self Assessment Manual: SAM100136). As such, unless they have obtained dispensation from doing so, for example on the basis that they do not have any UK tax resident partners, they would fall within the scope of the Compliance Regulations. However, UK partnerships that file UK partnership tax returns but that are managed or controlled or both from outside the UK (for example, if a limited partnership s general partner or manager is located outside the UK) could be considered to be dual resident for the purposes of FATCA. HMRC makes it clear that, if an entity is resident in the UK and also in another country, it is still subject to the Compliance Regulations for FATCA purposes in relation to Reportable Accounts (Article 1.1(bb), UK/US IGA) maintained in the UK (see AEIM100620). In this case, it may be that the fund has to register as both a UK FI and an FI resident elsewhere, and could have dual reporting requirements. The position under the CRS is similar in that an entity will only fall within the scope of the Compliance Regulations (for CRS purposes) if it is resident for these purposes in the UK (i.e. a Reporting Financial Institution is an FI that is resident in a Participating Jurisdiction ) (section VIII(A)(1), CRS, as incorporated in the Compliance Regulations at Regulation 241(6)). However, the guidance on the CRS contains a residency tie breaker concept, to deal with any dual residency issues in this context (paragraph A.5, Commentary on Section VIII, CRS). It is worth noting that, for the purposes of determining which accounts are reportable under the CRS, the CRS uses the term Reportable Jurisdiction Person, which also refers to residence (section VIII(D)(1), CRS). The commentary on this definition does not include the same tie breaker concept but provides that for these purposes an entity such as a partnership, limited liability partnership or similar legal arrangement that has no residence for tax purposes shall be treated as resident in the jurisdiction in which its place of effective management is situated (paragraph D.106, Commentary on Section VIII, CRS). These slight differences in approach under the CRS do not appear to be covered in the AEIM. Carried interest vehicle A carried interest vehicle in a typical UK PE structure usually takes the form of a Scottish limited partnership. It will be an investment entity and should therefore be registered as an FI in its own right, with the analysis as to its residency following the position set out above (see Fund LP above). It may be possible to treat some carry vehicles as sponsored closely held investment vehicles (a deemed compliant FI under US law (section (f)(2)(iii), US Internal Revenue Code) and so as a non-reporting UK FI under the IGA (Article 1.1.q, UK/US IGA)) in which case it may not need to be separately registered with the IRS, but only if it is managed by a sponsoring FI who is registered and who can then deal with its FATCA obligations (see FATCA guidance ( uk/government/uploads/system/uploads/attachment_data/file/461542/guidance_notes_for_the_uk-us_fatca_ Agreement.pdf): section 2.24). General partner It is generally considered that a general partner would also fall within the broad definition of the term investment entity (as to which, see Entity identification and classification above). There is some debate as to whether a general partner may be properly treated as a certified deemed compliant FI (that is, one that does not have to report on its account holders), as explained further below (see Fund Manager below). However, given that in a typical UK PE fund the general partner receives a profit share from the fund, this position is debatable, and many fund management houses have so far chosen to register their general partner entities as FIs. Many have taken this approach on the basis that registration of the general partner should be a relatively straightforward process, given the wider registration process that needs to be undertaken for all of the other entities in the fund structure. Many may also perceive it to be preferable, in practice, for the general partner to register and therefore obtain a GIIN (as to which, see IRS registration below), which they can provide to third parties, rather than have to explain, in the context of any third party relations, the basis upon which it has been determined that no GIIN is required. 8 Practical Law Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited. All Rights Reserved.

9 Fund manager The fund manager is likely to be classified as an investment entity as it manages funds or money on behalf of other persons (see Entity identification and classification above). However, it may be possible for the fund manager of a fund to use a non-reporting FI classification for FATCA purposes if it is only classed as an FI because of its role in acting as an investment manager. Specifically, FATCA guidance notes that where the role of an investment manager is solely to render investment advice or manage portfolios for another entity then it may be regarded as a certified deemed compliant FI for US law and UK/US IGA purposes (see FATCA guidance ( uk/government/uploads/system/uploads/attachment_data/file/461542/guidance_notes_for_the_uk-us_fatca_ Agreement.pdf): section 2.28(a), paragraph V.C(3), Annex I, UK/US IGA and section (f)(2)(v), US Internal Revenue Code). This category of FI is not required to register with the IRS for FATCA purposes, nor carry out any due diligence or reporting obligations (see Entity identification and classification above). The AEIM does not expressly incorporate this part of the FATCA guidance; the implication is therefore that this guidance continues to apply for FATCA purposes but that the same position is not being confirmed for CRS purposes. Adviser Similarly, under the Old Regulations, HMRC considered that investment advisers who solely rendered investment advice to customers and did not otherwise undertake investment services or maintain financial accounts, were likely to be NFFEs, as they were service providers and would not meet the financial assets test. HMRC apparently remains of that view under the new definition in the Compliance Regulations (as to which, see Entity identification and classification above) (FATCA guidance ( data/file/461542/guidance_notes_for_the_uk-us_fatca_agreement.pdf): section 2.28(a)). Holding company Under the Old Regulations, holding companies in a PE fund context were likely to be investment entities and therefore FIs, with all the registration and reporting requirements that follow. FATCA guidance initially noted that a holding company that is formed in connection with or used by... a PE fund vehicle or other vehicle established with an investment strategy of investing, reinvesting, or trading in financial assets, would itself be considered to be an FI. The term formed in connection with or used by... was very broad and applied if the fund directed the investment activity of the company, had representatives on its board or if the fund used the company for banking arrangements or any other financial advantage (see FATCA guidance (August 2014): section 2.30). HMRC subsequently announced that holding companies (and treasury companies) that were not otherwise FIs would not need to report under FATCA. This was supported by the Compliance Regulations (before they were subsequently amended) which incorporated the definition of FI from the UK/US IGA, rather than reflecting the US law definition as the Old Regulations did, and as such holding companies and relevant treasury companies were not separately defined categories of FIs (see Legal updates, Fewer nil FATCA returns required ( com/ ) and Automatic exchange of tax information: FATCA guidance about holding companies and treasury companies ( This meant that unless such companies otherwise fell within one of the other categories of FI (for example, if they were, for regulatory reasons, required to be managed by an authorised entity, such that they themselves were otherwise caught by the investment entity category of FI), they would not have had to register or report under FATCA and would have been classified as either active NFFEs (as defined in paragraph VI.B(4), Annex I, UK/US IGA) or passive NFFEs (as defined in paragraph VI.B(3), Annex I, UK/US IGA), dependent on the activities carried out. On 29 October 2015, however, the International Tax Compliance (Amendment) Regulations 2015 (SI 2015/1839) further amended the Compliance Regulations to re-introduce the concept that financial institution (as well as investment entity ) would have the meaning given in the US FATCA laws (see Legal Update: International Tax Compliance Regulations: definitions and non-reportable accounts ( This was the original position under the Old Regulations and means that holding companies in a PE fund context would once again be FIs. Although HMRC s guidance has not been updated since the Compliance Regulations were amended in October, AEIM does discuss the meaning of FI under the US law and confirms that holding companies are FIs under that. Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited.. All Rights Reserved. Practical Law 9

10 HMRC s failure to clarify why the October 2015 amendments were introduced and to update its position as regards holding companies has caused considerable uncertainty and further guidance would be welcomed on this topic. If it is subsequently established that holding companies are not intended to be FIs, then HMRC s May 2015 guidance may yet be relevant for fund managers who have already registered their holding companies as FIs on the basis of the original FATCA guidance and the Old Regulations, which has since been incorporated in the manual. In this guidance, HMRC confirmed that: An entity (such as a holding company) already registered as a lead FI can continue to be treated as a UK FI if it falls within one of the remaining four categories of FI (as set out above at Entity Identification and classification above). Where the above does not apply, such entity can nonetheless maintain its registration by availing itself of the extended definition of FI in FATCA, which includes relevant holding companies and treasury centres of financial groups. (See Legal update, Automatic exchange of tax information: HMRC guidance about holding companies and treasury companies ( If a holding company of a trading group exists in a PE fund structure but does not qualify as an FI, it may be classifiable as an active NFFE for FATCA purposes (paragraph VI.B(4), Annex I, UK/US IGA) although, again, the actual position will depend on the facts. Deal company A trading deal company will typically be an active NFFE, but care should be taken to consider this question carefully in each case. For example, an investment may be in a portfolio company that is itself some form of FI, for example, a custodian or depository business. FULFILLING FATCA OBLIGATIONS: REGISTRATION AND REPORTING Once the FATCA status of each entity in the structure has been ascertained (see Entity identification and classification above), those entities that are identified as reporting UK FIs are required by the Compliance Regulations to establish and maintain arrangements that are designed to identify reportable accounts (regulation 3, Compliance Regulations) and each year must prepare a return to satisfy their reporting obligations (regulation 6, 8 and 9, Compliance Regulations). See Reporting obligations in relation to the due diligence and reporting requirements below. As noted, this article focuses on the position in the UK under FATCA, where reporting is carried out directly to HMRC, which then exchanges the information it receives with the US. In non-iga and Model II IGA jurisdictions, reporting by FIs is direct to the IRS and different procedures therefore apply (see Legal update, Model II Intergovernmental Agreement to Implement FATCA Published ( IRS registration The first step that UK reporting FIs will need to take is to register with the IRS on the IRS registration portal (see IRS: FATCA Foreign Financial Institution Registration ( Financial-Institution-Registration-Tool)). Assuming that a single registration is completed for each entity (see below), this process involves each entity creating a FATCA registration account and then completing the FATCA registration pages with its identifying information details, including legal name, country of residence for tax purposes, FATCA classification, address and points of contact. 10 Practical Law Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited. All Rights Reserved.

11 Once on the IRS registration portal, various different registration options are available: FIs can be registered individually, as separate entities. Groups of FIs may opt to register as group, with one FI taking on the role of Lead FI. One FI may take on the role of Sponsoring FI with other FIs being Sponsored FIs of this entity (in which case they need not be in the same group). Any of these options could be used in practice, so the fund manager will need to make a decision as to which is the most suitable them in practice. As will be clear from the following discussion, as the IRS portal is US-run, it is based on US law FATCA principles and defined terms, rather than those in the Compliance Regulations. A Lead FI of an expanded affiliated group (as defined in section (e)(2), US Internal Revenue Code and referred to in the UK/US IGA) (see Practice note, FATCA: FFIs and NFFEs: Affiliated Group FFIs ( com/ )) may initiate the FATCA registration process for each Member FI that is within its expanded affiliated group. However, in practice, many PE groups are taking the view that it is preferable not to use this option and for each entity to register separately instead. There are a number of reasons for this: The expanded affiliated group is broadly identified by establishing a chain of common control under US law principles, which may not necessarily correspond with how the PE fund internally views or operates their own group or groups, or indeed how groups are made up for corporation tax purposes, for example. It is not always clear whether entities lower down a PE fund structure would fall within the expanded affiliated group. Privacy concerns relating to the fact that entities that are registered by a Lead FI as being within the same expanded affiliated group will receive a GIIN number that has a common stem. The FATCA FFI List is available online for anyone to search (see IRS: FATCA Foreign Financial Institution (FFI) List Search and Download Tool ( Therefore, in theory, it might be possible for anyone to identify particular entities as belonging to a particular PE fund, which may not necessarily be desirable, particularly after that entity is sold. In relation to the Sponsored FI option, for a long time, in practice, while the Sponsoring FI could be registered and obtain a GIIN the IRS portal did not permit Sponsored FIs to register as such to obtain their own GIIN. While most FATCA on-boarding forms specifically catered for this original problem (for instance, US W8 forms allowed the sponsored entity to use the sponsor s GIIN), this may have required some explanation to counterparties requesting a GIIN, potentially creating an additional administrative burden. The IRS has since developed a streamlined process such that sponsoring entities can now register their sponsored entities, and sponsored entities will now be assigned a GIIN and will appear on the FFI List if the sponsoring entity is also in approved status (see IRS: Frequently Asked Questions (FAQs) FATCA Registration System ( FAQsFATCARegistrationSystem): Sponsoring Entity). Once the entity has submitted its registration, the IRS will review the registration and, once approved, the relevant entity should be assigned a unique GIIN. Local reporting registration Reporting UK FIs must also register with HMRC in order to be able to submit their FATCA returns to HMRC (as to which, see Reporting obligations below). Once an entity has been registered as a UK FI with HMRC, they should be provided with a FATCA identification number and an HMRC Registration Identification Number (see HMRC: FATCA registration guidance ( and FATCA: reporting information to HMRC ( Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited.. All Rights Reserved. Practical Law 11

12 Reporting obligations Reporting UK FIs are required, under the Compliance Regulations, to provide information to HMRC on an annual basis in relation to their reportable accounts (see Practice note, CRS, EU administrative co-operation and FATCA: UK implementing regulations: What are the reporting obligations? ( ). In a PE fund context, each investor in the main fund vehicle will hold a financial account. Therefore, it is necessary for the fund to identify what FATCA category each investor (as an account holder ) falls into and whether any of the accounts are reportable accounts for FATCA purposes; in other words, whether any of the holders is a Specified US Person or a Non-US Entity with one or more Controlling Persons who are Specified US Persons (Regulations 6 and 8, Compliance Regulations and Article 1.1.dd, UK/US IGA). In addition payments to a Non-participating Financial Institution may need to be reported currently for 2015 and 2016 only (Regulation 9 and Article 4.1(b) UK/US IGA). It is worth noting that, for PE funds whose main fund vehicle is an FI subject to the CDOT Regulations, it will also be necessary to ascertain whether any of the investors are specified persons in their local jurisdictions under the CDOT Regulations and, therefore, reportable account holders for CDOT Regulations purposes. For example, a Cayman Islands fund would also be required to identify and report on any UK tax resident investors. Once the CRS comes into force, there will be a requirement to report on account holders from a much wider range of jurisdictions (Practice note, CRS, EU administrative co-operation and FATCA: UK implementing regulations: Implementing information exchange in the UK ( The UK FATCA reporting obligation requires FIs to submit FATCA returns for each year by 31 May (the first were due on 31 May 2015) (see regulation 6(4), Compliance Regulations, AEIM and Practice note, CRS, EU administrative co-operation and FATCA: UK implementing regulations: Reporting obligation ( com/ )). FIs should review the due diligence obligations set out in the Compliance Regulations and will need to establish whether any of their existing and new investors hold reportable accounts (Regulations 3 and 5, Compliance Regulations and Practice note, CRS, EU administrative co-operation and FATCA: UK implementing regulations: Which accounts require reporting? ( For more information on compliance with reporting obligations, see (HMRC: The Foreign Account Tax Compliance Act: registering and reporting information to HM Revenue and Customs ( Classification of investors In the case of new investors, it is not strictly necessary to collect this information prior to the account being opened (in other words, before the investor subscribes to the fund). The manual notes that an FI should request and obtain the information within a reasonable period and a suggestion of 90 days is given (see AEIM103140). In practice, most PE funds would collect this information by requesting the investors to self-certify as part of the wider on-boarding process at each closing in the fund raising process. As such, investors are requested to provide details as to their FATCA status at the same time as they are asked to complete their adherence documentation and provide other anti-money laundering information as part of the subscription package for investing in the fund. On receipt, the fund manager should take reasonable steps to verify this information, checking, for instance, for any obvious errors by the investor. This is because the FI may not rely on self-certification or documentary evidence if it knows, or has reason to know, that the self-certification or documentary evidence is wrong or unreliable (paragraph VI.A, Annex I, UK/US IGA and FATCA guidance ( uploads/system/uploads/attachment_data/file/461542/guidance_notes_for_the_uk-us_fatca_agreement.pdf): section 4.8). There are a number of different certification options available for funds who want to send forms to investors so that investors can use the self-certification route: The IRS W8/W9 series of forms. These have been amended by the IRS and enable investors to tick the category that applies to them for FATCA purposes. These forms may be an attractive option for USfocused funds, due to their familiarity to US investors. However, these forms are originally designed for US 12 Practical Law Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited. All Rights Reserved.

13 withholding tax purposes and are, naturally, very US law-focused (for example, incorporating concepts such as disregarded entity which are not necessarily relevant or helpful in the context of FATCA). Where funds choose this option, for FATCA compliance purposes only (and not for other US withholding tax purposes) they may currently choose to permit investors to ignore the specific Chapter 3 questions on the form (see IRS: Updated Information For Users Of the Instructions for Form W-8BEN-E ( Updated-Information-For-Users-Of-The-Instructions-for-Form-W-8BEN-E)). However, these forms are not designed to enable funds to collect information relevant for the CDOT Regulations or CRS. Funds choosing to use the W8/W9 series for FATCA purposes may, therefore, need to supplement that information in any case to satisfy their current and future obligations under other tax information provisions. Bespoke self-certification type forms. A number of these forms have been produced by different industry bodies, including the British Private Equity and Venture Capital Association ( library/documents/model%20documents/fatca%20self-certification%20for%20entities%20pe.pdf). Many of these forms have been designed for use by funds and have a broader range of tax information provisions in mind. As time moves on and the practice of collecting and reporting tax information develops, it is likely that these forms will themselves be developed and adapted (for instance, to capture new definitions under the Compliance Regulations and ensure CRS compliance in addition to FATCA and CDOT Regulations compliance). Many fund administrators have also developed their own forms for these purposes. As yet, few of these forms have been updated to gather CRS compliant data and, if the fund requires US withholding tax forms in any case, these bespoke forms would then have to be used in addition to the W8/W9 US forms. The forms themselves are not particularly user friendly, as FATCA itself imposes many different categorisations of FATCA status for the investor to choose from in order to certify their status accurately. Many investors will ask the fund manager for guidance in completing these forms. Of course, it is not only the main fund vehicle that may have an obligation to report under FATCA. As noted above (see Application of FATCA to typical private equity fund above), various other entities in the fund structure may be classified as FIs, including, for example, the carried interest vehicle. Each carried interest holder in that vehicle is likely to be an account holder for FATCA purposes and the carried interest vehicle would have to perform the obligatory due diligence on these executives. It is possible for an FI to elect to apply a de minimis threshold exemption, in respect of certain pre-existing account holders (in other words, any account opened on or before 30 June 2014), such that for example where the value of the account does not exceed US$50,000 (for certain individual accounts), it does not need to be reviewed, identified or reported (see FATCA guidance ( attachment_data/file/461542/guidance_notes_for_the_uk-us_fatca_agreement.pdf): sections 4.14 (example 1), 5.1, 6.1 and 7.1 and Regulation 2.2(c), Compliance Regulations and paragraphs II.A, III.A and IV.A, Annex I, UK/US IGA). While it is unlikely that the relatively low de minimis thresholds would apply to investors in a main fund vehicle, it may be relevant for individual carried interest holders in relation to the financial accounts in a carried interest vehicle if they are pre-existing accounts. However, there is no applicable de minimis exemption for new account holders in this particular context and it is not completely clear how such accounts would be valued. In practice, PE funds may find that it is more straightforward to simply operate the due diligence procedures and report where applicable, rather than using this exemption. Note also that, when the CRS comes into force, it will contain no such de minimis threshold. HMRC announced in April 2015 that UK FIs are no longer required to file nil returns under FATCA (see Legal update, Fewer nil FATCA returns required ( However, HMRC s more recent published guidance (AEIM and FATCA Guidance: section 3.1) suggests that nil returns are required. As such the position is slightly unclear; if nil returns are not required for FATCA then, where a PE fund has established that it has investors that are neither Specified US Persons nor that have one or more controlling persons that are Specified US Persons, it may not be necessary for the fund to actually file an annual return. Obviously, this position would need to be kept under review. However, if a UK FI is in a nil return position through applying a de minimis threshold on pre-existing accounts, it may still be necessary to submit a return in order to make the election (see FATCA guidance ( file/461542/guidance_notes_for_the_uk-us_fatca_agreement.pdf): section 10). Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited.. All Rights Reserved. Practical Law 13

14 What happens if a PE fund does not fulfil those obligations? There are a range of penalties for failing to comply with the Compliance Regulations and the UK/US IGA: For failing to comply with any obligation under the Compliance Regulations, a person is liable to a basic penalty of 300 and a further daily default penalty not exceeding 60 per day for each subsequent day on which the failure continues, which may be increased by HMRC for more serious breaches to a maximum of 1,000 per day (regulations 14 and 21, Compliance Regulations). For failing to report (or accurately report) payments made by a UK/US IGA reporting FI to a non-participating FI, a person is liable to a penalty of 300, subject to a limit of 3,000 per calendar year (regulation 16, Compliance Regulations). For failing to provide accurate information, a person is liable to a penalty not exceeding 3,000 (regulation 15, Compliance Regulations). See Practice note, CRS, EU administrative co-operation and FATCA: UK implementing regulations: What are the penalties for not complying? ( for a more detailed discussion of the penalties for non-compliance. In addition to the above penalties, continued/repeated failure to meet the reporting requirements of FATCA may result in the entity becoming significantly non-compliant with the UK/US IGA and suffering 30% US withholding tax under US FATCA laws. DEMONSTRATING COMPLIANCE It will be important for FIs to have an audit trail that demonstrates that they have the appropriate procedures and systems in place to be able to correctly identify their account holders and meet their reporting obligations, and that they are used in practice. FATCA guidance notes that, if FIs have an HMRC customer relationship manager (CRM), the CRM should seek to understand how the business intends to meet its obligations under the legislation and the systems and process that it has put in place as part of the normal relationship management activity (see FATCA guidance ( Guidance_Notes_for_the_UK-US_FATCA_Agreement.pdf): section 10.3). Although the tax teams at PE fund houses are increasingly well-briefed about FATCA and its consequences for the house in terms of fund entity classification and reporting requirements, other areas of the business tend to be less familiar with the implications of FATCA, perhaps viewing it as a purely tax exercise. However, as outlined in this note, the tax consequences of FATCA for a UK fund should be limited and are non-existent as regards the other tax information legislation. PE houses need to have a business-wide grasp of FATCA, as it will often be other departments that have the power and information to enable the group to ensure proper compliance. For example, the information that needs to be analysed to determine the classification of entities within a PE structure (see Reporting Obligations above) may variously be held by the fund-raising teams, HR, the deal teams or any combination of them, so they will need to be able to access and disseminate that information. For instance: An investor relations team may be in charge of collecting the subscription packs from investors and so be running the FATCA collation method that has been chosen by the fund. They will need to be familiar with the classifications that investors may fall within. The HR team may hold information (which may be sensitive) about the carried interest holders, whose accounts may also need to be reported (see Reporting Obligations above). Gathering all of this widely disseminated information and keeping it updated may be a logistical challenge. 14 Practical Law Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited. All Rights Reserved.

15 TYPICAL CATEGORIES OF INVESTORS Many investors will be up to date with FATCA and the self-certification procedures required to be completed by them. Others may struggle with the completion of such forms and need additional guidance. Some investors, because of their particular status, may object to providing a full set of information, or to agreeing to provisions in the fund documents requiring certain information from investors for the purposes of tax information provisions. It is, therefore, useful for the fund manager to have a good understanding of the categories that certain types of investor may fall into, and what implications that has. Several of the more commonly seen types of investor are set out below. Registered pension funds These often take the form of trusts and the trustees may be unwilling to agree to any term that could, in theory, oblige them to provide beneficial ownership information which relates to the pensioners. Sovereign wealth funds These may or may not be classified as exempt beneficial owners and they will often request limits on obligations placed on them on this basis; the fund manager would typically require them to certify and represent that they have this status (see FATCA guidance ( system/uploads/attachment_data/file/461542/guidance_notes_for_the_uk-us_fatca_agreement.pdf): section 2.7, paragraphs IV.D(3)(C)(1) and V.C(3), Annex I, UK/US IGA and sections (b)(42) and (b)-(g), US Internal Revenue Code). Fund of funds These should themselves be FIs but, if US fund of funds are involved, care will need to be taken to ensure that any specific requests still enable CRS compliance to be attainable for the fund manager (see Entity identification and classification in the main text). Asset manager clients Asset managers, who manage long-term investments for a range underlying private clients, will often be protective of their client details, and request specific terms for this reason. Development finance institutions Development finance institutions, which are normally financial institutions established by a single government or sometimes multiple parties to provide alternative sources of capital in developing countries (often via PE funds), may or may not be classified as exempt beneficial owners and will often request limits on obligations placed on them on this basis. Executives/high-net-worth individuals These are the least likely to be familiar with completing FATCA on-boarding forms, so may require assistance and an explanation of the process. Knowledge and understanding of FATCA will be equally useful for other people in the business, for example, those who deal with establishing new entities (which may need to be registered for FATCA) and those who deal with bank account opening (who may need to provide evidence of an entity s FATCA status). Some funds are dealing with this by, for example, organising business-wide training sessions or coordinating cross-functional FATCA project teams (this may be more appropriate for bigger PE houses) and others are outsourcing the whole process, as far as possible. Note that even if FATCA compliance is outsourced to an external adviser, the responsibility for complying with FATCA remains with the individual FIs themselves (as is also the case if FIs delegate their compliance obligations to their sponsoring entities (see FATCA guidance ( gov.uk/government/uploads/system/uploads/attachment_data/file/461542/guidance_notes_for_the_uk-us_ FATCA_Agreement.pdf): section 2.20)) and the appropriate people within the business will need to have sufficient knowledge to be able to oversee the process to ensure FATCA compliance. Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited.. All Rights Reserved. Practical Law 15

16 In non-iga jurisdictions, FATCA requires an FFI to appoint an individual to act as a responsible officer, who is personally responsible for carrying out or certifying certain of the compliance obligations of the FFI. The concept of a responsible officer in these terms has not been incorporated into the Compliance Regulations. However, a UK FFI will still be required to provide the name of such responsible officer as part of the IRS registration process (see IRS: Foreign Account Tax Compliance Act (FATCA) User Guide ( section 2.3). It may be commercially practical to choose someone who is already a director of the FFI and has a grasp of the firm s FATCA strategy. INVESTOR NEGOTIATION FATCA is increasingly becoming a key feature of investor negotiations. The focus of the negotiations may alter depending on the type of investor: Some investors may require express reassurance in the side letter that the fund will comply with FATCA. The side letter supplements or, in some cases, modifies the terms of the governing partnership agreement and is typically executed by a fund manager and acknowledged by a negotiating investor. Some may (simultaneously) ask for limits on their FATCA obligations under the fund documents; for example, limiting the situations in which they could have to provide information about their beneficial owners, or specifying that they will only complete a W8/W9 form. Other investors may seek confirmation as to how any withholding tax would be allocated to investors, often requesting express confirmation that it will not be suffered by them unless they cause it. The extent to which a fund needs to accede to these requests will obviously depend on a number of factors, not least the relative size and importance of the investor to the fund. Great care needs to be taken to ensure that whatever is agreed is, in fact, deliverable (and implemented), and thought needs to be given to the prospect of other investors being able to demand the same terms under a most favoured nation process. 16 Practical Law Reproduced from Practical Law Tax with the permission of the publishers. For further information visit practicallaw.com or call Copyright 2016 Thomson Reuters (Professional) UK Limited. All Rights Reserved.