Any financial institution, regardless of its global location, that does not voluntarily comply with FATCA will find that 30% of any US-sourced payments (e.g. a corporate dividend or a maturing principal payment from a US corporate or government bond) will be withheld. Because U.S. stocks and bonds are so widely owned across the globe, virtually all financial institutions receive substantial U.S.-sourced payments, mostly on behalf of clients who have no connection to the U.S. Allowing 30% of these payments to be withheld is clearly not an acceptable option.
Moreover, adequate grounds to establish a U.S. connection can be deceptively simple, since the U.S. government claims that simply using the U.S. dollar — which nearly every bank in the world does — gives it jurisdiction, even if there are no other connections to the U.S.
It is clear that institutions must either comply with the provisions of FATCA or seek exemption. It is possible for a firm to be awarded ‘limited conditional’ FATCA status, which means that the institution is exempt from reporting because it is deemed to be compliant and information secrecy laws come into force.
When analyzing an investment account, the provisions of FATCA require the account to be classified into one of the following three categories:
- ‘Approved’ as of 1 July 2014
- ‘Limited conditional’ until the end of 2015. These administrators are deemed to be FATCA compliant and may register first and verify their status later.
- The enormous quantity of FFIs that fall into neither category. The IRS calls them ‘rejects’
The first step in seeking ‘limited conditional’ status is to establish whether or not a U.S. individual or entity is part of a foreign financial institution (FFI) and then whether the FFI concerned is in a jurisdiction that restricts the provision of information. If this is indeed the case, then ’limited conditional’ registration is awarded and the FFI is declared compliant with FATCA. This means that the FFI can sign the new W8 BEN-E declaration. If not, then the FFI must first register for a Global Intermediary Identification Number (GIIN) before it can sign the W8 BEN-E. It is possible for an FFI to be dealing with restricted and unrestricted information. An example would be an FFI having both a Foreign Retirement Plan and a Mutual Fund would mean this FFI would have ”limited conditional” covering the retirement plan and a GIIN covering the mutual fund.
The W8 BEN – E Declaration
The rule is simple: no W8 BEN-E, no transactions in U.S. dollars, but what exactly is a W8 BEN-E Declaration? A W8 has been in existence for a long time. It is a declaration by a non-U.S. individual concerning their tax status for U.S. tax purposes. The W8 BEN declaration used to be very simple: a foreign company would declare that it was not a U.S. company, not U.S. controlled and that it didn’t have U.S. income. This was all that was necessary to allow any foreign company’s U.S. counterparty to remit gross income rather than deducting the required amount.
This has all changed since the introduction of FATCA, which has resulted in the introduction of the new W8 BEN-E declaration. Unless the investment platform is able to sign a W8 BEN-E on behalf of the individual, they cannot be party to any U.S.-dollar investment without having some level of FATCA registration.
The FATCA status ‘limited conditional’ means that the institution is exempt from reporting because it is deemed to be compliant and restricted information secrecy laws override FATCA.. This is explicitly for foreign retirement plans as exempt beneficial owners and also for administrators of FATCA identification number pension funds.
The Privacy of Pensions
Many countries have laws imposing secrecy on information about retirement plans and this is in essence why FATCA allows for the ‘limited conditional’ category.
By their very nature, retirement plans are viewed and governed differently. There are sanctions on dealing with retirement plan information which only a Regulator can decide on. There are so many organizations with powers of search and seizure these days that might otherwise demand access to sensitive information. Preventing this is important because retirement plans are proprietary. Moreover, the US Treasury has formally determined that pensions carry a low risk of tax evasion and they are therefore exempt from FATCA reporting.
The Alternative Investment Fund Managers Directive (AIFMD)
Similarly, regulations have changed in Europe. As of July 2014, it is illegal for fund managers to market in Europe unless they are compliant with the AIFMD. What makes this regulation so weighty is that 25% of U.S. capital originates in Europe and most U.S. managers are unaware that their prospective investors may be illegal.
This EU directive is far reaching and effectively states that unless a fund or collective investment scheme is registered somewhere in the EU, it is not compliant. Being non- compliant can have severe consequences. The Managing Director of a major hedge fund administrator recently outlined an example: ‘Let’s say that you are marketing to a German hedge fund. The German fund puts $100 million into your fund. The performance of your fund goes down 25%. That investor’s holding is now worth $75 million. They can go to a German regulation court and claim that you illegally marketed your services to them and guess how much they are entitled to? They are entitled to $100 million because this is the amount that they shouldn’t have been allowed to invest.’ Furthermore, common logic suggests that when you are non-compliant in the EU, it is highly likely that you are not compliant at home either.
There was a time 40 years ago when there was exchange control throughout Europe. The U.S. didn’t have exchange control, but when a U.S.-based investor wanted to invest in Europe he would have to navigate myriad rules and regulations. We have now gone full circle, with the exception that this is no longer termed exchange control – it is now called securities regulation!
Fortress EU and Fortress USA
So it would appear that the Western world comprises two capital blocs with virtual locks. The entity that holds the key to both locks is a tax recognized retirement plan for EU and US purposes.
In both the EU and the US retirement plans are generally exempted from securities laws on offer of securities. The broad rule is that all retirement plans are collective investment schemes. Securities regulators recognize all retirement plans as collective investment schemes.
In summary, individuals wishing to invest internationally (for example in the U.S.) or wishing to have U.S. dollar exposure must take heed of both FATCA and the AIFMD.
For example, if a U.S. fund manager is approached by a potential investor, the question which must be asked is whether or not the fund will be in breach of EU law by accepting the investment. An individual is viewed differently to a foreign retirement plan doing the same thing. Where an individual EU investor wishes to invest, he or she is better placed to invest from outside the EU and through a foreign retirement plan that takes him/her outside the scope of the EU directive. A U.S. fund, hedge fund or private equity fund without registration in the EU runs the risk of exposing itself to claims and therefore being non-compliant even if it is marketing to professional investors.
Has information gathering gone too far? There are now far more restrictions on investment in the EU than ever before and this has effectively shut the U.S. market out of the EU because private equity managers or hedge funds in the U.S. can now face stiff regulatory penalties. Many investors now invest indirectly via their pension funds.
There have been concerns raised about the volume of additional paperwork for the IRS to handle and further, that U.S. business will be negatively affected, but the fact remains: if you want to invest in U.S. dollar-denominated investments you must be FATCA compliant, whether or not you are American. Likewise, if you want to invest inside the EU, you must do so via an EU compliant entity.
The last 5 years have seen an enormous increase in the volume of regulations with which firms must comply. Many of these regulations effectively amount to capital control, including FATCA, with its far-reaching powers of enforcement. Despite freedom of movement of capital in the EU, the same applies in practice as a result of the AIFMD.
Justification for these new regulations, including those governing the exchange of financial information, ranges from a need to uncover and reduce tax fraud, to narrowing the gap between expected and actual tax revenues. On the other side of the coin, there is an argument that both the EU through its directive of 2003 and its subsequent upgrade in 2014 and the U.S. through its formal legal determination on foreign retirement plans are being overly prescriptive.
The question that remains is whether or not these regulations have gone further than absolutely necessary.
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