In light of the fact that hedge funds and other investment funds are different in significant ways from banks and other types of financial institutions covered by the Foreign Account Tax Compliance Act, the hedge fund industry asked Treasury and the IRS to provide additional guidance regarding the application of FATCA to investment funds. In a letter to Treasury and the IRS, the Managed Funds Association responded to IRS Notice 2011-34, which provides guidance for public comment on priority issues arising in connection with the implementation of information reporting, withholding and documentation requirements of sections 1471-1474 of the Internal Revenue Code enacted under FATCA, which will take effect with respect to payments made after December 31, 2012
FATCA is US legislation intended to ensure that US tax authorities obtain information on investments by US residents in foreign financial institutions. FATCA casts a wide net in search of undisclosed accounts and hidden income. It adds a new Chapter 4 to the Internal Revenue Code, essentially requiring foreign financial institutions to identify their customers who are U.S. persons or U.S.-owned foreign entities and then report to the IRS on all payments to, or activity in the accounts of, those persons. The Act broadly defines foreign financial institution to comprise not only foreign banks but also any foreign entity engaged primarily in the business of investing or trading in securities, partnership interests, commodities or any derivative interests therein
While the MFA supports the broad anti-tax evasion objectives underlying FATCA, the association urged Treasury and the IRS to establish an appropriate regime under which the information needed for U.S. tax enforcement purposes is obtained in a manner that does not impose unnecessary administrative burdens, particularly on those foreign financial institutions presenting little or no opportunity for U.S. taxpayers to evade their obligations.
Although the Notice provides guidance regarding how investment funds can become deemed compliant foreign financial institutions for purposes of FATCA, the MFA is concerned that the conditions set out in the Notice are overly restrictive. Specifically, the first two conditions with respect to the types of investors that are permitted in a deemed compliant investment fund are too restrictive in the absence of further guidance.
Many investors in offshore funds, including U.S. tax exempt entities and accounts and pension plans and non-U.S. natural persons, are not entities specifically identified in section 1471(f) and have not yet been identified by the Treasury as persons that pose a low risk of tax evasion. The MFA believes that these investors meet the statutory standard of persons that present a low risk of tax evasion. Without including such persons as eligible investors in deemed compliant investment funds, many investment funds would not be able to be deemed compliant foreign financial institutions.
Because offshore hedge funds do not typically have employees, noted the MFA, guidance is needed as to which entities and persons acting on behalf of a fund have responsibilities for carrying out the compliance duties of a fund that is a foreign financial institution under FATCA. Given differences in structure and delegation of responsibilities in the investment fund industry, the MFA believes that foreign financial institution funds should be able to designate which entity or person has responsibility for specific aspects of the fund’s FATCA compliance. Even with such delegation, assured the MFA, the foreign financial fund will continue to have ultimate responsibility for its FATCA compliance.
The MFA also urged Treasury and the Service to provide guidance allowing investment fund foreign financial institutions with a common asset manager or agent to centralize their FATCA compliance obligations under a single agreement with the asset manager or agent. It is important to recognize that investment funds, even when managed by the same adviser, are legally distinct entities which often have different investors and can engage in entirely distinct trading activities in different assets and markets.
Any losses at one fund are borne exclusively by the investors in and counterparties to that fund, said the association, and do not subject other funds managed by the same adviser directly to losses. It would be efficient for both market participants and regulators to allow for this centralized option. The MFA also noted that the entity responsible for the compliance function should not be required to be a foreign financial institution individually. Many funds are commonly managed by U.S. resident entities, said the MFA, which should be permitted to have responsibility for the compliance function.
The Notice expressed concern that a narrow definition of pass thru payments could result in structures being unfairly used by foreign investors to avoid withholding or having to enter into a foreign financial institution agreements. While cognizant of this concern, the MFA believes that the manner in which the Notice would deem payments attributable to withholdable payments is overly broad and could have the unintended consequence of discouraging investment in the US by foreign investors with limited US exposure.
The MFA is also concerned that the asset-based methodology to calculate the pass thru payment percentage proposed in the Notice could lead to over-withholding or double counting by investment funds. Also, because investment funds invest in a wide variety of assets and in a number of jurisdictions, said the MFA, the asset test will be difficult to implement for investment funds, especially for funds-of-funds. The MFA urged that the proposed guidance be amended to permit investment fund foreign financial institutions to use any reasonable method of attributing a payment to a withholdable payment as long as the fund can document its method and that method is used consist