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Foreign Account Tax Compliance Act Provisions (FATCA): Investment management

How the U.S. FATCA rules may impact investment management


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The Foreign Account Tax Compliance Act (FATCA) withholding provisions in the U.S. Hiring Incentives to Restore Employment Act (the HIRE Act, P.L. 111-147) seek to compel the disclosure of direct and indirect U.S. investors in certain Foreign Financial Institutions (FFIs) and non-Financial Foreign Entities (NFFEs). Unless investment managers and their investment vehicles enter into an agreement with the Internal Revenue Service (IRS) to find, document and disclose certain U.S. direct and indirect interest holders, any U.S. source payment, including portfolio interest and the gross proceeds of sale or other disposition of securities that could generate U.S. source income, will be subject to 30% withholding. Income tax treaties will not affect this rate. All members of an expanded affiliated group, even those without U.S. owners or interest holders, will be covered under the same agreement. Isolating U.S. investments within an affiliate that has no U.S. direct or indirect interest holders will therefore not avoid the negative impact to investment returns if an agreement is not signed, or if there is a failure by any affiliate to document and report. In addition, there may not be limited liability for the withholding tax due (the liability pierces the corporate veil). These provisions generally become effective after December 31, 2012.

For the new additional U.S. withholding requirements, investment entities will need to determine whether they or any of their affiliates are FFIs or NFFEs subject to the FATCA withholding rules, and review the impact to their future financial statements, investment returns and current client facing and offering materials.

Other FATCA provisions extend to bearer bonds, synthetic payments under securities lending, and periodic payments on derivative contracts. For obligations issued after March 18, 2012, the portfolio interest exemption as to interest paid on foreign targeted bearer bonds will no longer be available.

Substitute dividend payments
Substitute dividend payments on securities lending and repo transactions will be considered U.S. source if the referenced asset is a U.S. security. Withholding on U.S. source substitute dividend payments will apply to the gross amount of the substitute payment. The substitute dividend provisions within the HIRE Act generally apply to payments made on or after September 14, 2010. However, effective since May 20, 2010, withholding tax applies to such payments where either the withholding agent or the foreign lender knows that the principal purpose of the transaction is reducing or eliminating U.S. tax.

Submission of comments
Some FFIs may want to outsource their withholding and/or reporting function, or in an extreme case, divest from U.S. securities. Since the IRS has some discretion as to how the new rules will be implemented, financial institutions and their industry associations are currently making submissions to the IRS to request exemptions and provide comments.

Deloitte recently assisted the Investment Funds Institution of Canada (IFIC) in the submission of comments to the IRS with regard to FATCA’s implementation.

Learn how the new FATCA provisions can impact your company