The Foreign Fund's FATCA Dilemma

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The Foreign Funds FATCA Dilemma:Meeting Your Responsibility by Coordinating

with Third Party Service Providers

By

Ellen Zimiles

Managing Director and Head of Global Investigations and Compliance

Richard KandoDirector and FATCA Task Force Leader

Jeffrey LockeDirector and FATCA Task Force Leader


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1 | DISPUTES & INVESTIG ATIONS OCTOBER 2011

TABLE OF CONT ENTS

I. Introduction....................................................................................................................................................................2

II. ImpactonForeignFunds.........................................................................................................................................2

III. BriefBackgroundofFATCA..................................................................................................................................3

IV. CoordinatingFATCACompliance....................................................................................................................4

A. ForeignFundsNeedtoPerformTheirImpactAssessment.....................................................4

B. TheFATCAComplianceProgramisOnlyasStrongasitsWeakestLink.......................4

V. CantheForeignFundMeetDeemedCompliantStatus?....................................................................6

VI. Conclusion......................................................................................................................................................................6

Biographies.................................................................................................................................................................................7

The Foreign Funds FATCA Dilemma:

Meeting Your Responsibility by Coordinating with

Third Party Service Providers


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|DISPUTES & INVESTIG ATIONS OCTOBER 2011

I . INTRODUCTION

Since2009andUBSsdeferredprosecutionagreement,theU.S.Governmenthasshown

thatitistakingoffshoretaxevasionveryseriously.Todate,therehavebeenapproximately

150grandjuryinvestigationsofoffshorebankaccountholdersinitiated,30ofwhichresulted

inchargesoftaxfraud,aswellasgrandjuryinvestigationsinitiatedagainsteightotheroff-

shorebanksacrosstheworld.1OneofthemostpowerfultoolstheU.S.Governmentwill

haveinitsarsenalasitcontinuestoghtoffshoretaxevasionistheForeignAccountTax

ComplianceAct(FATCA).Amongotherthings,FATCAgenerallymandatesthatforapar-

ticipatingforeignnancialinstitution(FFI)tocontinuetoremitandreceivethefullvalue

ofallofitstransfersandconductitsworldwideoperationswithlimitedimpactbyFATCA,

itmustidentifytotheIRSitsU.S.accounts.Thepenaltyfornon-complianceissteep:a30%

withholdingtaxoncertainwithholdableandpassthrupayments.2

I I . IMPACTONFOREIGNFUNDS

FATCAwillimpactmostoffshoremutualfunds,hedgefunds,privateequityfundsandother

typesoffunds(collectivelyreferredtoasForeignFunds)astheywillbeclassiedasFFIs.

Accordingly,theywillhavetomeettherequirementsofFATCAtoavoidthe30%withhold-

ing.3ForForeignFundstheimplementationofFATCAwillbeparticularlydifcult,asmost

fundsutilizedifferentpartiestocollectaccountholderdata,makedecisionsoninvestments,

holdassetsandmakepaymentsthatmaybewithheldandonwhichshouldbereported.

Assuch,theimplementationofFATCAmayforceForeignFundstochangetheiroperating

modelssoitisimportantforForeignFundstoconductimpactassessmentsassoonaspos-

sibletodetermineifandhowtheircustodians,fundadministrators,transferagentsanddis-

tributors(collectivelyreferredtoasthirdpartyserviceproviders)areplanningtocomplywithFATCA.

Forexample,assumetheForeignFunddoesbecomeFATCAcompliant,butdoesnotco-

ordinateitscompliancewithitscustodianoroutsourcedtransferagentserviceprovider.

TheimpacttotheForeignFundanditsclientsorsubscribersinthissituationcouldbedi-

sastrous.Therecouldbeawithholdingof30%ofcertainpaymentsmadetothecustodian

CONTACTS

EllenZimiles

Navigant

212.554.2602

[email protected]

RichardKando

Navigant

212.554.2698

[email protected]

JeffreyLocke

Navigant

212.554.2694

[email protected]

www.navigant.com

1 http://www.justice.gov/tax/offshore_compliance_intiative.htm

2 A withholdable payment is any payment of interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments,

and other xed or determinable annual or periodical gains, prots, and income, if such payment is from sources within the U.S. and 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. Internal Rev-

enue Code (IRC) 1473(1)(A). A passthru payment is dened as any withholdable payment or other payment to the extent attributable to a withholdable

payment. IRC 1471(d)(7).

3 According to FATCA, an FFI is a foreign entity that: (1) accepts deposits in the ordinary course of a banking or similar business, (2) as a substantial

portion of its business, holds nancial assets for the account of others, or (3) is engaged (or holds itself out as being engaged) primarily in the business of

investing, reinvesting, or trading securities, partnership interests, commodities, or any interest in these mentioned items. IRC 1471(d)(5).


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forthebenetoftheForeignFundsimplybecausethecusto-

dianisnotFATCAcompliant.Additionally,clientsorsubscrib-

ersoftheForeignFundmayalsosufferfrom30%withholding

iftheoutsourcedtransferagentdoesnotappropriatelyupdate

on-boardingprocedurestoensureadequatedocumentationand

informationiscollectedontheclientorsubscriber.Usingthese

starkexamples,onecanseewhycoordinationisakeytobuild-

ingastrongFATCAcomplianceprogramforaForeignFund.

Thispaperisdividedintothreesections:(1)abriefbackground

ofFATCA;(2)coordinatingFATCAcompliancewiththeForeign

Fundsthirdpartyserviceprovidersand(3)workingwiththird

partyserviceproviderstodeterminewhetherForeignFundscan

meetthedeemedcompliantstatusrequirements.

III .BRIEFBACKGROUNDOF FATCA

OnMarch18,2010,FATCAwassignedintolawaspartofthe

HiringIncentivestoRestoreEmploymentAct.FATCAgenerally

goesintoeffectonJuly1,2013andprovidestheTreasuryand

theIRSwithoversightresponsibility.Ingeneral,FATCArequires

FFIstoputprocessesinplacetoidentifyandreporttheirU.S.

AccountstotheIRSorsufferawithholdingtax.ParticipatingFFIs

willberequiredtoenterintoanagreementwiththeIRS(theFFI

Agreement)toreportcertaininformationregardingaccount

holdersandwithholdoncertainpayments,ifnecessary.TherststageofwithholdinggoesintoeffectonJanuary1,2014.

4 A recalcitrant account holder is an account holder who does not comply with a request for information or a waiver from the FFI within a set period of time, usually one year. IRC 1471(d)(6).

5 Electronically searchable information refers to information that an FFI maintains in its tax reporting les, or customer master les or similar les that is stored in the form of an electronic database against which standard queries in program-

ming languages, such as Structured Query Language, may be used. Customer master les include an FFIs primary les for maintaining account holder information, such as information used for contacting account holders and for satisfying

AML/KYC requirements. Information, data, or les are not electronically searchable merely because they are stored in an image retrieval system (such as .pdf les or scanned documents). Notice 2011-34, pp. 1415.

6 According to Notice 2011-34, indicia of a U.S. account for individual accounts includes:

(1) U.S. citizenship or lawful permanent resident (green card) status;

(2) U.S. birthplace;

(3) U.S. residence address or a U.S. correspondence address (including a U.S. Post ofce box);

(4) Standing instructions to transfer funds to an account maintained in the U.S., or directions regularly received from a U.S. address (only accounts tting the denition of a private banking account under FATCA need to be searched fordirections regularly received from a U.S. address);

(5) In care of address or hold mail address that is the sole address with respect to the client; or

(6) Power of attorney or signatory authority granted to a person with a U.S. address.

If one or more of the above indicia is identied, the FFI has to request additional documentation and/or information from the account holder.

TohelpputFATCAintoaworkingframework,theGovernment

hasissuedthreeNotices:(1)Notice2010-60onAugust27,2010;

(2)Notice2011-34onApril8,2011and(3)Notice2011-53on

July15,2011.ThersttwoNoticesprovidemuchneededdetail

toallowFFIstostarttocreatetheirFATCAcompliancesystems,

althoughtohaveafullyoperationalsystemmoreguidanceorpro-

posedregulationsareneeded.ThethirdNoticegivesFFIssome

breathingroomonthecompletionofdifferenttasks.TheGovern-

mentisexpectedtoissueproposedregulationsinDecember

2011andnalregulationsinthesummerof2012.

TheidenticationofU.S.accountsisdividedintodifferentpro-

cessesforindividualandentityaccountholders.Inattemptingto

identifyU.S.accountsamongtheFFIsindividualaccountpopula-

tion,therearethreeclassicationsforindividualaccountsthatwill

triggerdifferentactionsbytheFFI.Theaccountcanbeclassiedas:

(1)aU.S.account,whichtriggersareportingrequirement;(2)a

non-U.S.account,whichdoesnottriggeranyfurtherreportingor

withholdingobligationor(3)arecalcitrantaccountholder,4which

triggersawithholdingandreportingrequirement.Forpre-existing

privatebankingaccounts,asdenedbyFATCA,andforaccounts

withbalancesorvaluesof$500,000ormore,anFFImustconduct

adiligentreviewofallelectronicandpaperlesofanaccount

holder.Forallremainingpre-existingindividualaccountswitha

balanceorvalueof$50,000orgreater,aFFIonlyhastoconductareviewofelectronicallysearchableinformation5forindiciaofaU.S.

account.6Theanalysisofentityaccountsismorecumbersome,but


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andreportinginformation.ParticipatingForeignFundswillbe

awithholdingagentforFATCApurposes,9sostrictcoordina-

tionwithitsthirdpartyserviceprovidersisnecessarytoen-

surethecorrectpartiesarebeingwithheldupon,ifrequired.

Becauseofalloftheseuncertainties,eachForeignFund

shouldstarttheirimpactassessmentnow.TheForeignFunds

impactassessmentshouldcover,amongotherthings,coor-

dinationwiththirdpartyserviceproviderstodiscovertheir

plansforFATCAcompliance.

B. The FATCA Compliance Program is Only as

Strong as its Weakest Link

AForeignFundthatoutsourcessomeorallofitsassetcus-tody,complianceandregulatoryfunctions,transferagency

servicesanddistributionwillbedependentonitsthirdparty

serviceproviderstomeetitsFATCAcompliancegoals.

Becauseofthisrelianceonthirdparties,theresultsofthe

impactassessmentcouldleadtoanaugmentationoftheFor-

eignFundsbusinessmodelanditsoperations.

AForeignFundthatwantstobeaparticipatingFFIwillneed

toworkwiththirdpartyserviceprovidersthatalsobecome

FATCAcompliant,orarewillingtoassistparticipatingFFIs

inbecomingcompliant.Forexample,iftheForeignFunds

custodianisnotplanningonbecomingFATCAcompliant(notalikelyoptionformostcustodians),theForeignFund

maywanttochangecustodianssothereisnowithholding

ontransferstothecustodian(anon-participatingFFI)forthe

benetoftheForeignFund.Moreoverotherthirdpartyser-

viceproviders,suchastransferagents,willmostlikelyneed

toupdateprocedurestoensuretheyarerequestingand

hassimilargoals:identifyingU.S.accountsanddeterminingifthere

shouldbereportingand/orwithholdingfortheirentityaccount

holders.7

Afteranalyzingtheiraccounts,FFIswillhavetoreportU.S.Ac-

countstotheIRSandwithholdonnon-participatingFFIsandre-

calcitrantaccountholders.

UnderFATCA,ForeignFundsareresponsibleforcompliance,as

Notice2011-34explicitlystatesthataparticipatingFFIisliable

fortheperformanceofitsobligationsunderitsFFIAgreement,but

mayuseanagenttoperformthoseobligationsonitsbehalf.8

IV.COORDINATINGFATCA COMPLIANCE

A. Foreign Funds Need to Perform Their

Impact Assessment

FATCAwillbeparticularlycomplexaseachForeignFund

thatdesirestobecomeaparticipatingFFIwillneedtocoor-

dinatewithitsthirdpartyserviceproviderstofulllitsobli-

gations.ForeignFundshavetodeterminewhichoftheirthird

partyserviceproviderswillcomplywithFATCAandwhat

stepsthethirdpartyserviceprovidersaretakingtocomply

withFATCA.Workingwithanon-compliantthirdpartyser-

viceprovider,whichmaybeanFFI,maynotbearealisticop-tionforForeignFundsasthepotentialpenaltyof30%with-

holdingistoogreatariskandcouldhaveanegativeimpact

onthecashowofthefund.Moreover,eveniftheForeign

FundsthirdpartyserviceproviderswillbeFATCAcompli-

ant,aForeignFundmayhavetoreorganizeitsdistribution

systemandcreatenewworkowsofcollecting,distributing

7 Under FATCA, an entity account holder can be classied as one of the following:

(1) Participating FFI;

(2) Deemed compliant FFI, as described in section V;

(3) Non-participating FFI;

(4) Non-Financial Foreign Entity (NFFE);

(5) Excepted NFFE (i.e. an NFFE that operates an active trade or business);

(6) Excepted entity under FACTA 1471(f) (an excepted entity according to the statute);

(7) Recalcitrant accountholder; or

(8) U.S. account.

A U.S. Account is dened, generally, as a nancial account held by a specied U.S person or by an entity that, directly or indirectly, had one or more substantial U.S. owners. FATCA denes a substantial U.S. owner as a direct or indirect

owner of: (1) more than 10% of the stock of a corporation; (2) more than 10% of the prot or capital interest in a partnership; or (3) more than 10% of the benecial interest of a trust. Investment vehicles owned by a U.S. person must also

be reported to the IRS. IRC 1473(2) and 1473(3).

8 Notice 2011-34, p.33.

9 A withholding agent pursuant to FATCA includes a participating FFI. Notice 2011-53, p. 8.


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obtainingadditionalinformationanddocumentationabout

newsubscriberstotheForeignFundaswellasconducting

therequiredanalysisonpre-existingaccountsinclosecoor-

dinationwiththeForeignFund.AForeignFundworkingto-

wardsbecomingaparticipatingFFIneedstoalignitselfwith

thirdpartyserviceprovidersthatarealsoworkingtowards

FATCAcompliance.

1. WillYourThirdPartyServiceProvidersPlanToBe

FATCACompliant?

ForeignFundsnotwantingtoriskthe30%withhold-

ingneedtoensuretheirthirdpartyserviceproviders

areplanningoncomplyingwithFATCAaspartoftheir

impactassessment.10TheForeignFundshouldasktheir

thirdpartyserviceprovidersquestionsconcerningtheir

plansforcomplianceincluding:

a. Doesthethirdpartyserviceproviderplanonbe-

comingFATCAcompliant?

b. Howwillthethirdpartyserviceproviderandthe

ForeignFunddividethenewFATCA-related

responsibilities?

c. Atwhatstageisthethirdpartyserviceproviderin

theprocessofbuildingaFATCAcompliance

program?

d. Howisthethirdpartyserviceprovidergoingto

workwithitsclientstoensureasmoothtransition

foranynewFATCA-relatedservicesbeingoffered?

e. Doesthethirdpartyserviceproviderhavesugges-

tionsforimprovingthebusinessoperatingmodel?

f. Howmuchwillthethirdpartyserviceprovider

chargeforanyadditionalFATCA-related

complianceservices?

10 Although not a focus of this whitepaper, the impact assessment should cover other topics such as:

(1) A legal entity analysis to determine whether each afliated legal entity falls within the denition of a nancial institution;

(2) An inventory of affected business lines, products and services;

(3) The identication of the types of accounts maintained, including an estimate of the number of private banking accounts (as dened by FATCA) and the type of data maintained on account holders; and

(4) The identication of affected information technology systems.

11 Additionally, the Foreign Fund should request a clause for a righ t to an annual audit or review of FATCA-related procedures when negotiating a new o r updated contract with its third party service prov iders.

g. Howcanthethirdpartyserviceprovider

guaranteeitwillmaintainitscompliancewith

FATCAorparticipatingFFIstatus?11

Continuedcompliancebythethirdpartyservicepro-

vidersisamustforForeignFunds;non-compliance

couldforcetheForeignFundtomissitswithholding

obligationsandcouldalsoputtheForeignFundsFFI

Agreementatrisk.Anywithholdingonpaymentsforthe

benetoftheForeignFundcouldultimatelyaffectthe

ForeignFundsperformance,whichcoulddamagethe

fundsreputationanditsrelationshipwithclients.

2. WhatAreThePotentialChangestothe BusinessModel?

AtougherquestionforForeignFundswillbeifand

howtochangetheirbusinessmodeltoassistinensur-

ingFATCAcompliance.Twoareastoconsiderinclude:

a. Flowofinformation

ForeignFundsmayhavetoreworktheirinternal

owofinformationandinformationfromthird

partyserviceproviderstocomplywithFATCAs

duediligence,reportingandwithholdingrequire-

ments.Inaddition,ForeignFundswillhavetoup-

dateserviceprovidercontractsandcorrespond-ingservicelevelagreementstoincorporatenewly

delegatedactivitiesandescalationprotocolswhich

clearlyassigntoeachpartytheirresponsibilityfor

implementingFATCApolicies.

BecauseofFATCA,differentthirdpartyservice

providerswillhavetoshareinformationwithone

another.Forexample,atransferagentorother

collectorofclienton-boardingandsubscriberin-

formationwillneedtoinformthepayoroffunds

towithholdifanaccountholderisclassiedasa

non-participatingFFIorrecalcitrantaccountholder.


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12 Treasury and the IRS continue to consider comments received regard ing whether there may be a category of funds that may be treate d as deemed-compliant because: (i) all direct interest holders in the fund are participating FFIs, USFIs,

deemed-compliant FFIs, entities described in section 1471(f), or non-participating FFIs acting as distributors; (ii) distribution or similar agreements prohibit the sale of interests to specied U.S. persons, NFFEs other than excepted NFFEs,

and non-participating FFIs holding for their own account; (iii) each distributor agrees to enforce the sales prohibitions described in (ii) above, and (iv) the fund satises other requirements and meets other criteria relevant to the purposes of

chapter 4. Notice 2011-34, pp. 3233.

13 Id., pp.3132. Section 1471(f) is an excep tion to FATCA for foreign governments, international organizations, central banks of issue and any other class of persons identied by the Secretary for purpose s of this subsection as posing a low

risk of tax evasion. Also, for a discussion of the passthru payment percentage see Navigants previous white paper entitled, FATCA: Take 2, Are You Ready to Certify Compliance? (May 2011).

14 Id., pp 3233.

Thisismademoredifcultbecausethestatusof

anaccountholdermaychangefromonedayto

thenext.Forinstance,theaccountholdercould

supplytherequisiteinformationtoprovenon-U.S.

taxpayerstatusafteralreadybeingclassiedasa

recalcitrantaccountholder,soaone-timedatacol-

lectionandexchangeisnotsufcient.

b. Distributors

Fundsmaywanttoevaluatetheirdistribution

partners.Forexample,itisunclearwhethersmall

distributorsofaForeignFundwillbecomeFATCA

compliantbecauseofthepotentialcostsofcom-pliance.12ItmayalsobedifcultforForeignFunds

toensuresmalldistributorsareFATCAcompliant.

ForeignFundsshouldhaveaplanwithregardto

smalldistributorspriortowithholdingbeingman-

dated.Potentialsolutionsinclude:(1)limitingthe

numberofdistributorsutilized;(2)bringingdistri-

butionin-house;(3)continuingwithalldistributors,

butmakingitveryclearwhatwillhappen(i.e.30%

withholding)ifaFFIdistributorisnotFATCAcom-

pliantor(4)combiningtheabovesolutions.

V. CANTHE FORE IGNFUNDMEET DEEMEDCOMPLIANTSTATUS?

Selectfundsmaybeabletobecomedeemed-compliantFFIs,

whichwillalleviatesomeoftheFATCArequirements.TheGov-

ernmentintendstoissueguidanceconcerningForeignFundsthat

willbetreatedasdeemed-compliant,asNotice2011-34states:

afundwillbedeemed-compliantifitmeetsthe

followingthreerequirements:(1)allholdersofre-

cordofdirectinterestsinthefund(e.g.theholders

ofitsunitsorglobalcerticates)areparticipating

FFIsordeemed-compliantFFIsholdingonbehalf

ofotherinvestors,orentitiesdescribedinsection

1471(f)(2)thefundprohibitsthesubscriptionfor

oracquisitionofanyinterestsinthefundbyany

personthatisnotaparticipatingFFI,adeemed-

compliantFFI,oranyentitydescribedin1471(f);

and(3)thefundcertiesthatanypassthrupay-

mentpercentagesthatitcalculatesandpublishes

willbedoneinaccordancewithSectionIIofthisNotice.13

Moreover,adeemed-compliantFFIwillneedtoobtaincerti-

cationstatusfromtheIRS.TheGovernmentisstillconsidering

whetherothercategoriesoffundsmaybetreatedasdeemed-

compliantandrequestedcommentsonsuchinNotice2011-

34.14ForeignFundsshoulddeterminepreliminarilywhetherone

ormoreForeignFundswithinthefundfamilytstheconditions

aboveandthenplantheirFATCAcomplianceaccordingly.This

couldbeanotherareawhereaForeignFundcouldworkwith

theirdistributorstoonlytakeoncertaintypesofclientsorsub-

scriberssotheForeignFundcouldmeetandmaintainitsdeemedcompliantstatus.

VI .CONCLUSION

OntheroadtoFATCAcomplianceForeignFundshavedifferent

optionstoconsiderincludingtheirrelationshipswiththeircurrent

thirdpartyserviceprovidersandtheirbusinessmodel.Although

theroadforwardmaynotbereadilyclear,ForeignFundsneedto

conductanimpactassessmentsoontodeterminehowtheyand

theirthirdpartyserviceproviderswillworktogethertoallow

eachForeignFundtobecomecompliantwithFATCAandavoid

unnecessarywithholding.


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BIOGRAPHIES

Ellen ZimilesisaManagingDirectorandHeadofGlobalInvestigationsandComplianceinNavigantsDisputes&Investigationspractice.Shehas

morethan25yearsoflitigationandinvestigationexperience,including10yearsasafederalprosecutor.Ms.Zimilesisaleadingauthorityonanti-mon-

eylaunderingprograms,corporategovernance,regulatoryandcorporatecompliance,fraudcontrolandpubliccorruptionmatters.Shehasworked

withamultitudeofnancialinstitutionspreparingforregulatoryexams,developingremediationprogramsandassistingorganizationsasaregulatory

liaison.Ms.ZimilesfoundedandservedasCEOofDaylightForensic&AdvisoryLLC,aninternationalinvestigationsandcomplianceconsultingrm

whichmergedwithNavigantin2010.AsanassistantUnitedStatesattorneyintheSouthernDistrictofNewYorkformorethan10years,Ms.Zimiles

servedinthecivilandcriminaldivisionsandwaschiefoftheforfeitureunitformorethansixyears.Shewasresponsibleformanyhigh-prolemoney

laundering,fraudandforfeiturecases.

Richard KandoisaDirectorinNavigantsDisputes&Investigationspractice,andalongwithJeffreyLocke,aleaderofNavigantsFATCATaskForce.

Mr.Kandoprimarilyassistscounselwithanti-moneylaunderingandotherregulatorycompliancerelatedengagementsandlitigationrelatedmatters.

Priortojoiningtheconsultingindustry,Mr.KandoservedasaspecialagentfortheInternalRevenueServiceCriminalInvestigationDivisioninNew

YorkCitywhereheinvestigatedallegationsoftaxevasionandothertaxrelatedcriminaloffenses,mailandwirefraud,embezzlement,moneylaun-

deringandidentitytheft.Inrecognitionofhisservicesasaspecialagent,hereceivedtheU.S.DepartmentofJusticeTaxDivisionAssistantAttorney

GeneralsSpecialContributionAward.

Jeffrey LockeisaDirectorinNavigantsDisputes&Investigationspractice,andalongwithRichardKando,aleaderofNavigantsFATCATaskForce.

Mr.Lockespecializesinregulatorycompliance,anti-moneylaunderinginvestigationsandnancialinvestigations.PriortojoiningNavigant,hewasa

prosecutorofwhitecollarcrimeforthestateofNewYorkandheworkedfortheUnitedNationsMissioninKosovo,whereheconductedinvestiga-

tionsintowarcrimes,corruptionandorganizedcrime.


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The Foreign Fund's FATCA Dilemma

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