Thursday, September 06, 2012

Global Hedge Fund Group Scores Treatment of Investment Entity in FATCA Model Intergovernmental Agreement

The treatment of an investment entity in the model intergovernmental agreement the US Treasury has developed to implement the information reporting and withholding tax provisions of the Foreign Account Tax Compliance Act  (FATCA) is not helpful to hedge fund managers, in the view of the global hedge fund industry. In a letter to Treasury and the IRS, the Alternative Investment Management Association noted that the agreement provides that an investment entity is treated as a financial institution and must report to its own jurisdiction information about all US holders of its equity, debt and other financial accounts if the investment entity conducts specified investment management operations as a business for or on behalf of a customer or is managed by an entity that conducts such operations for or on behalf of a customer. According to AIMA, this definition broadens a financial institution beyond the provisions of FATCA itself, and also beyond the draft FATCA regulations, to expressly include the investment manager or investment adviser.
AIMA does not believe that it was the intent of Treasury to implement an agreement that expands the definition of financial institution to bring hedge fund managers within its scope. Indeed, if that was the intent, it would be inappropriate, said AIMA, given that the objective of the statute itself does not have such a broad scope. AIMA urged Treasury and the IRS to revise the IGA to provide that the term “Investment Entity” means any entity that conducts as a business trading in money market instruments (bills, certificates of deposit, derivatives, etc.); foreign exchange; exchange, interest rate and index instruments; transferable securities; or commodity futures trading.

If the broad definition of investment entity currently in the agreement is not clarified, cautioned AIMA, a non-US based hedge fund manager of offshore funds is likely to have to implement two FATCA projects: one for itself and another on behalf of its funds, under two different regimes, albeit, with some synergies. This could give rise to some anomalous situations, warned AIMA, under which a fund manager would need to apply the intergovernmental agreement on its share capital in the place where the manager operates, but the fund, assuming it is in another jurisdiction, would have to report under another agreement under the full FATCA. 

On a separate and broader note, AIMA found it problematic that the general definitions and categories differ within the model IGA and the draft FATCA regulations.  Some standardization of categories, with only a few exceptions, would clearly be preferable, said the hedge fund group. More generally, it is unclear to what extent the IGA represents a significant change from the draft regulations or whether the IGA represents some movement in the light of industry comments submitted: for example, the  focus on information on file is useful but is this something only offered under the auspices of an IGA.

Finally, AIMA opined that for large, global financial institutions the approach in the model IGA is likely to complicate matters, not least because it introduces new terminology, which is not aligned with that in the draft FATCA regulations nor in the legislation itself.

The  U.S. Treasury developed  the model intergovernmental agreement first with EU partners  to implement the information reporting and withholding tax provisions of FATCA. The model agreement marks an important step in establishing a common approach to combating tax evasion based on the automatic exchange of information.  The United States will, in close cooperation with other partner countries, the OECD, and, when appropriate, the European Commission, work towards common reporting and due diligence standards in support of a more global approach to comply with FATCA.
There are two versions of the model agreement, a reciprocal version and a nonreciprocal version, which both establish a framework for reporting by financial institutions of certain financial account information to their respective tax authorities, followed by automatic exchange of such information under existing bilateral tax treaties or tax information exchange agreements.  Both versions of the model agreement also address the legal issues that had been raised in connection with FATCA, and simplify its implementation for financial institutions.