Originally published on April 19, 2011
Introduction
On April 8, 2011, the Internal Revenue Service issued Notice
2011-34 (the "Notice"), which provides additional
guidance regarding Sections 1471 through 1474 of the Internal
Revenue Code (commonly referred to as the "Foreign Account Tax
Compliance Act" or "FATCA"). Under FATCA, a private
investment fund formed under the laws of a non-U.S. jurisdiction
generally will be treated as a "foreign financial
institution" (an "FFI") and will be required to
enter into an agreement with the IRS (an "FFI Agreement")
to comply with certain diligence, reporting and withholding
obligations with respect to its account holders (i.e., the
investors in the fund). An FFI that does not comply with FATCA will
suffer a 30% withholding tax on any "withholdable
payments" (as described below) that it receives. FATCA
is generally not effective until January 1, 2013.
The Notice, which can be found here, is the second piece of guidance
issued by the IRS with respect to FATCA. A link to our prior Email
Alert discussing the initial guidance issued last August, Notice
2010-60, is provided
here.
Guidance in Notice Relevant to Private Investment Funds
Notice Creates Concept of "Passthru Payment
Percentage"
FATCA requires an FFI to withhold a 30% tax from any "passthru
payment" that the FFI makes to an account holder that is a
"non-participating FFI" or a "recalcitrant account
holder." A "passthru payment" is defined under FATCA
as a "withholdable payment or other payment to the extent
attributable to a withholdable payment." A "withholdable
payment" includes any payment of interest or dividends from
sources within the United States, any gross proceeds from the sale
or other disposition of any property of a type which can produce
interest or dividends from sources within the United States
(e.g., the gross proceeds from the sale of stock of a U.S.
portfolio company), and certain other types of U.S. source
income.
The Notice provides the method by which an FFI, which may hold both
U.S. and non-U.S. assets, determines the extent to which a payment
the FFI makes to its account holders is a "passthru
payment." Under the Notice, a payment made by an FFI will be a
passthru payment to the extent of: (i) the amount of the payment
that is a withholdable payment, plus (ii) the amount of the payment
that is not a withholdable payment multiplied by the FFI's
"passthru payment percentage."
An FFI's "passthru payment percentage" is a
percentage that the Notice requires an FFI to calculate each fiscal
quarter that is determined by dividing: (i) the sum of the gross
asset values of the FFI's "U.S. assets" on the
determination date by (ii) the sum of the gross asset values of the
FFI's total assets on that date. The Notice requires an FFI to
"publish" its passthru payment percentage by, for
example, making the percentage available on the FFI's website
(private funds and their investment managers should consider any
possible securities law implications of providing information in
this manner). A "participating FFI" that does not
calculate and publish its passthru payment percentage will be
deemed to have a passthru payment percentage of 100%.
The IRS intends to issue regulations defining a "U.S.
asset" to include any asset to the extent that it is of a type
that could give rise to a passthru payment. The Notice requests
comments on various issues related to the passthru payment
percentage concept, including the definition of "U.S.
asset" and the manner in which an FFI publishes its passthru
payment percentage.
IRS Considers Centralized Compliance Option for Funds
Associated with Common Asset Manager
The Notice indicates that the IRS is considering a centralized
compliance option for FFIs that are funds associated with a common
asset manager. Under this option, an asset manager would execute a
single FFI agreement on behalf of the funds that contract with the
asset manager. The asset manager would be required to act as a
point of contact for the IRS with respect to all issues concerning
the FFIs in its group (or to designate an agent to assume this
responsibility) and comply with certain other requirements.
Category of "Deemed-Compliant FFIs" Remains
Limited
The IRS continues to consider whether certain funds will be deemed
to have complied with their obligations under FATCA (i.e.,
will be treated as "deemed-compliant FFIs"). Under the
Notice, only funds which satisfy the following three requirements
will be deemed-compliant: (i) all holders of record of direct
interests in the fund are participating FFIs or deemed-compliant
FFIs holding on behalf of other investors, or entities described in
Section 1471(f) (e.g., foreign governments, international
organizations, and foreign central banks); (ii) the fund prohibits
the subscription for or acquisition of any interests in the fund by
any person that is not a participating FFI, a deemed-compliant FFI,
or an entity described in Section 1471(f); and (iii) the fund
certifies that any passthru payment percentages that it calculates
and publishes will be done in accordance with the Notice. Obviously
this provision will apply only to a very narrow category of funds.
The Notice indicates that the IRS may designate additional
categories of funds as deemed-compliant in future guidance.
Additional Guidance
The U.S. Treasury and the IRS are still considering many issues relating to the implementation of the FATCA provisions, and additional guidance, including proposed Treasury Regulations and a form of FFI Agreement, is expected before the FATCA provisions become effective on January 1, 2013.
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.