Jurisdiction - Australia
Reports and Analysis
Australia – Impact of New US Withholding and Reporting Requirements on Australian Funds.

30 March, 2012

 

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. 
 
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.
 
Who will be affected?
 
FFIs include2:
 
  • 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.
 
What must an FFI do?
 
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.
 
What must an NFFE do?
 
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.
 
Exceptions from withholding
 
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.
 
Refunds and credits
 
Withheld amounts can only be credited against US tax liability in limited cases14.
 
Withholdable payments
 
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
 
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.
 
Recalcitrant account holders
 
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.
 
Grandfathered obligations
 
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.
 
Intergovernmental approach
 
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.
 
Conclusion
 
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.
 
 
For further information, please contact:
 
Susan Burns, Partner, Allens Arthur Robinson
susan.burns@aar.com.au
 
Penny Nikoloudis, Partner, Allens Arthur Robinson
penny.nikoloudis@aar.com.au
 
Mark Cerché, Partner, Allens Arthur Robinson
mark.cerche@aar.com.au
 
John Beckinsale, Partner, Allens Arthur Robinson
john.beckinsale@aar.com.au
 

 

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