Focus: Impact of new US withholding and reporting requirements on Australian funds
2 March 2012
In brief: In an effort to combat tax evasion by United States taxpayers, new provisions have been incorporated into the US Internal Revenue Service Code that will require foreign financial institutions, and some non-financial foreign entities, to report information on their US investors or their substantial US owners to the US Internal Revenue Service, or face 30 per cent withholding tax on most US sourced income. Consultant Derek Heath (view CV) and Senior Associate Amy Hoban report.
- Who will be affected?
- What must an FFI do?
- What must an NFFE do?
- Exceptions from withholding
- Refunds and credits
- Withholdable payments
- Pass-thru payments
- Recalcitrant account holders
- Grandfathered obligations
- Intergovernmental approach
How does it affect you?
- The new US withholding and reporting obligations will affect any fund that has investments in the US, no matter how indirect those investments are.
- Fund managers will have to introduce compliance measures to monitor whether they are caught by the obligations and, if they are, to ensure they are complied with.
- Some affected funds will have to enter into an agreement with the Internal Revenue Service (the IRS). Others will have reporting obligations.
- As well as seeking advice on whether they could be caught by the new withholding and reporting provisions in the United States Internal Revenue Service Code1 (FATCA), fund managers should consider ways to deal with FATCA's impact, through:
- disclosure in offering documents;
- amendments to fund constitutions (eg authorising the fund to become a participating foreign financial institution (FFI) and to comply with the requirements under the agreement with the IRS);
- changes to application forms; and
- structuring new products to take account of FATCA.
- trust companies and custodians; and
- managed funds or investment vehicles (that are engaged primarily in the business of investing, reinvesting or trading in securities3, partnership interests, commodities or interests in these)4.
In summary, Australian entities that are not FFIs will be non-financial foreign entities (NFFEs)5. Therefore, it is important for Australian fund managers to establish whether any of their funds hold US investments or receive payments that attract the FATCA rules.
An FFI will be subject to 30 per cent withholding tax on any withholdable payments (see below) to be made to it6, unless it becomes a participating FFI7 by entering into an agreement with the IRS to, among other things:
- undertake specified due diligence and verification procedures regarding its investors;
- provide specified information on its US investors to the IRS;
- either to:
- deduct and withhold 30 per cent of any pass-thru payments (see below) to any recalcitrant account holders (see below) or any non-participating FFIs; or
- elect to have payments withheld to the extent that any withholdable payment to the FFI is referable to investors that are recalcitrant account holders or non-participating FFIs8;
- obtain from investors a waiver of any local law (such as privacy laws) that would prohibit the FFI from reporting information on the investors to the IRS and, if it is not able to do so, to end the investment of such investors.
An FFI must become a participating FFI before 1 July 2013. Where an FFI is a member of an 'expanded affiliated group'9, its decision to become a participating FFI will impact on any other FFIs in the group. This is because the Code says that the requirements of the FFI agreement will apply to every other FFI that is a member of the same group10.
An NFFE will be subject to 30 per cent withholding tax on any withholdable payments to be made to it 11, unless the NFFE provides a certificate that it does not have any substantial US owners or, if it does, provides the name, address and Tax Identification Number of each12.
There are some exceptions from the withholding obligation for FFIs and NFFEs, including where the FFI or NFFE is the beneficial owner of the payment, and is a wholly owned agency or instrumentality of a foreign government or political subdivision of a foreign government13. This exception may apply to some sovereign wealth funds.
Withheld amounts can only be credited against US tax liability in limited cases14.
A withholdable payment is generally:
- any payment of 'interest, dividends, rents, salaries or profits and income' from sources within the US received after 31 December 2013;
- other 'fixed or determinable annual or periodic gains, profits and income' if such payment is from sources within the US received after 31 December 2013; and
- any gross proceeds from the sale of property of a type that can produce interest or dividends (eg securities or bonds) from sources within the US after 31 December 201415.
However, any item of income effectively connected with the conduct of a US trade or business is not treated as a withholdable payment16. A US trade or business does not include trading in stocks, securities or commodities either on a person's own account or through a resident broker, agent or custodian17.
Pass-thru payments mean any withholdable payment or other payment received after 1 January 2017 to the extent attributable to a withholdable payment18. For example, a pass-thru payment would be a distribution paid by an Australian Fund (Fund 1) to an investor (Investor A) in the fund where the distribution comprises income that the Australian Fund received from an investment in a US partnership (US LLP). Similarly, if Investor A is a FFI and uses the distribution from Fund 1 to make a distribution to its own investors, this distribution would also constitute a pass-thru payment: see Diagram 1.
This means that even FFIs that do not have a direct investment in the US may be impacted if they benefit from investments that produce payments that are attributable to withholdable payments.
A recalcitrant account holder is any investor (whether in the US or not) who fails to comply with the FFI's requests for information required under the FFI agreement or who does not agree to waive its rights under any foreign law to enable the FFI to report information to the IRS19.
Generally, payments made under agreements entered into before 1 January 2013 will not be subject to withholding20. Any material change to an agreement after this date may result in the payment obligation being treated as a new one and no longer grandfathered.
The US Treasury Department and the IRS are also currently in discussion with a number of other governments21 to determine whether the principles of FATCA can be implemented through existing bilateral treaties.
Although the proposed regulations required to implement Chapter 4 are still subject to public consultation, fund managers should start to assess the likely impact of FATCA on their business, so they have time to implement the changes and procedures necessary to comply with FATCA, and to adopt measures to minimise its impact.
Note: This publication summarises FATCA only and does not involve interpretation of the provisions themselves. Allens is not qualified to advise on US law. Allens can advise on Australian legal issues that might arise for Australian fund managers in relation to FATCA, for example, disclosure issues and possible changes to fund constitutions.
- Chapter 4 of subtitle A of the Internal Revenue Code of 1986, introduced as part of the Foreign Account Tax Compliance Act of 2009 (commonly known as FATCA).
- They also include Australian banks and ADIs and some insurers. See sections 1471(d)(4), 1473(5), 7701(a)(30) and 1471(d)(5) of the Code.
- Section 475(c)(2) of the Code defines a 'security' to mean any: '(A) share of stock in a corporation; (B) partnership or beneficial ownership interest in a widely held or publicly traded partnership or trust; (C) note, bond, debenture or other evidence of indebtedness; (D) interest rate, currency, or equity notional principal contract; (E) evidence of an interest in, or a derivative financial instrument in any security described in subparagraph (A), (B), (C) or (D) or any currency, including any option, forward contract, short position, and any similar financial instrument in such a security or currency; and (F) position which – (i) is not a security described in subparagraph (A), (B), (C), (D), or (E), (ii) is a hedge with respect to such a security, and (iii) is clearly identified in the dealer's records as being described in this subparagraph before the close of the day on which it was acquired or entered into (or such other time as the Secretary may by regulations prescribe).'
- Proposed regulations issued by the IRS clarify that an entity is engaged primarily in the business of investing, reinvesting or trading if the entity's gross income attributable to such activities equals or exceeds 50 per cent of the entity's gross income during the last three-year period ending on 31 December or, if shorter, since its establishment. See s1.1471-5(e)(4) of the Proposed Regulations.
- Section 1472(d) of the Code, which defines a NFFE to be 'any foreign entity which is not a financial institution'.
- Section 1471(a) of the Code.
- Section 1471(b)(1). Under s1471(b)(2) of the Code, the IRS can treat certain FFIs as though they are participating FFIs ('Deemed-compliant FFIs'). The proposed regulations set out a number of categories of deemed-compliant FFIs, including retirement funds, non-profit organisations and 'qualified collective investment vehicles' that are FFIs that are regulated in their country of incorporation as an investment fund, only have investors with interests in excess of $50,000 that are participating FFIs, registered deemed-compliant FFIs, or certain US persons or exempt beneficial owners, and if the FFI is a member of an expanded affiliated group, all other FFIs in the group are either participating or registered deemed-compliant FFIs.
- Section 1471(b)(3) of the Code.
- See s1471(e)(2) of the Code. Generally, one or more chains of corporations connected through stock ownership with a common parent holding at least 50 per cent of stock by vote/value and partnership or other entities controlled (directly or indirectly) by other members of the group.
- However, under proposed regulations, a two-year transitional period (until 1 January 2016) will apply under which an FFI affiliate in a jurisdiction that prohibits reporting or withholding required by Chapter 4 of the Code will not prevent other FFIs in the same group from entering into an FFI agreement subject to certain conditions. See s 1471(e) of the Code and also s1.1471-4 of the Proposed Regulations.
- Section 1472(a) of the Code.
- Section 1472(b) of the Code. Generally, a 'Substantial United States owner' is a corporation, partnership or trust where specified US persons (being any US person other than certain excepted entities, such as listed companies, REITs, banks and regulated investment companies) own (directly or indirectly) more than 10 per cent of the stock (by vote or value)/profits or capital interests/beneficial interests. However, where an investor is a financial institution by virtue of being engaged primarily in the business of investing or trading in securities etc, then any ownership by a specified US person will make that investor a 'Substantial United States owner'.
- Sections 1471(f)(1) and 1472(c)(1)(D) of the Code.
- Section 1474(b) of the Code.
- See s1473(1)(A) of the Code, and also ss 1.1471-2(a) and 1.1473-1 of the Proposed Regulations.
- Section 1473(1)(B) of the Code.
- Section 864(b)(2) of the Code.
- Section 1471(d)(7) of the Code and the Proposed Regulations.
- Section 1471(d)(6) of the Code.
- See s1.1471-2(b) of the Proposed Regulations.
- Including the United Kingdom, France, Germany, Italy and Spain. Although Australia is not yet a party to these discussions, it is possible that it will enter into similar discussions with the US Treasury and IRS at some stage, since it is a party to a double-tax treaty with the U.S.
- Derek HeathConsultant,
Ph: +61 2 9230 4233
- Penny NikoloudisPartner,
Ph: +61 2 9230 4805
- Mark CerchéPartner,
Ph: +61 3 9613 8872
- John BeckinsalePartner,
Ph: +61 7 3334 3520