Fatca, for those not familiar, is a new US tax law targeted at preventing tax evasion by US individuals. It requires all non-US financial institutions (foreign financial institutions or FFIs) to sign up to an agreement with the IRS to provide the US tax collection agency with detailed information on their US clients or, where the client does not provide sufficient information to prove they are not a US taxpayer, withhold 30 per cent US tax from certain payments to them.
If FFIs do not sign up to this agreement, the IRS will subject the FFIs themselves to a 30 per cent withholding tax on US source income and disposal proceeds.
The definition of FFI includes much more than collective investment schemes such as UK-authorised investment funds, capturing any entity that holds financial assets on account of others, that is, any entity that provides custody or nominee services.
Consider the common UK distribution chain, starting with the fund providers and their funds. These may be listed on a platform and then an IFA may use such a platform to manage their clients’ assets. Both the platform and the IFA may aggregate all of their clients’ assets and deal on an omnibus basis. The fund provider will only see the platform as an investor and the platform will only see the IFA as a client.
So far, so straightforward, but how does Fatca apply?
The fund is an FFI, but the key point to note is that both the IFA and the platform are also FFIs, because they are acting as nominee for their clients.
The Fatca rules deal with chains of FFIs by providing that payments between FFIs can only be made with no withholding tax if the paying FFI is satisfied that the recipient FFI has also signed up with the IRS. If the recipient FFI has not signed up with the IRS under Fatca then the paying FFI is required to withhold 30 per cent from any payment made to the extent it is attributable to US sources.
It is sensible to assume that the fund has signed up with the IRS, as not to do so would make it incredibly difficult for the fund to operate, even if it does not invest in US assets. We would also assume the majority of platforms will sign up, as otherwise they restrict themselves from working with the funds, so platforms will receive payments from the fund with no withholding.
They then pass that payment on to the IFA’s omnibus account. They will have recognised this account as one held by an FFI and therefore they have to ask the IFA to certify that they have signed up with the IRS.
If the answer is no, then the platform will be required to withhold 30 per cent tax from payments made to the IFA (to the extent that they are attributable to US sources).
Here is the crux of the matter. IFAs who have not signed up with the IRS may find themselves and their clients either suffering a 30 per cent withholding tax or may even be shut out by the fund providers and platforms that do not want to deal with FFIs that are non-compliant.
IFAs face a series of difficult decisions in relation to Fatca. They need to start weighing up the consequences of not signing up with the IRS against the potentially significant costs of compliance.
For the vast majority of IFAs who deal with a localised client base and are unlikely to have US taxpayers as clients, it may seem more sensible to opt out of being an FFI but this will fundamentally challenge the current distribution chain model, potentially limiting the channels of investment they have access to.
Many asset managers and fund providers are concerned at the impact that Fatca will have on their UK distribution model. They are beginning to think about strategic options to address some of the issues but, to date, this has been done largely without talking to their distributors.
The diverse range of business models across the IFA industry means that there will be no one-size-fits-all solution to the challenges posed by Fatca.
The IMA and EFAMA have both been making representation to the IRS that explain some of these issues but it is clear that for any sort of headway to be made here the fund providers and distributors need to get together to agree on potential solutions.
Stuart Chalcraft is associate partner at Ernst & Young