Hedge funds warned on FATCA complacency amid US-EU negotiations

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01 Feb, 2012

Hedge funds and investment banks should not view proposed changes by the US Treasury towards FATCA (Foreign Account Tax Compliance Act) reporting requirements as a concession, the head of the fund management business at Ernst & Young (E&Y) has warned.

It was revealed that US officials were exploring the possibility of allowing European Union financial institutions to transfer data on US citizens to national governments, who would then pass this information onto the US Internal Revenue Service (IRS). It had been feared that FATCA’s reporting requirements were in breach of European privacy laws.

“Hedge fund administrators and custodians in Europe, who are assisting their hedge fund clients in ensuring they are compliant with FATCA, are still going to have to do a lot of work. The only difference is that they will be making submissions to national governments rather than the US directly. Like many things, the devil remains in the detail and, as things stand, these proposals will not lessen, indeed they might, increase the administrative burden,” said Ratan Engineer of E&Y.

Engineer suggested that the proposals, if agreed to, are a pragmatic solution to the data protection concerns but only for financial institutions based in the EU. “The IRS has recognised data protection laws as one of the key areas for them to address in the detailed rules for FATCA. The potential agreement with the EU would be a step forward but still leaves open the issue in other countries” he said.

The fund itself is classified as an FFI (Foreign Financial Institution) and subject to FATCA, and not the manager. As most funds are based either in Cayman or other offshore jurisdictions, they will probably not come under the auspices of any EU negotiated agreement. “The proposals are no more than discussions between the EU and US at the moment and there is no agreement that this is how they will proceed. It is not clear to me how the proposals would actually impact hedge funds,” said Stuart Chalcraft, associate partner for Europe, Middle East, India and Africa for financial services tax at E&Y.

Under FATCA FFIs (which will include hedge funds and investment banks) must conduct extensive due diligence on their underlying investors to help the IRS identify and clamp down on wealthy US citizens who are not paying their taxes. Failure to comply with the rules can lead to punishing withholding taxes of up to 30%. The IRS and various Congressional leaders believe FATCA, which becomes effective on January 1, 2013, could generate $100 billion in taxes although industry experts have disputed this figure. Financial institutions appear to be lagging in their preparations for FATCA. An RBC Investor Services survey in September 2011 revealed 26% of respondents worldwide had little or no awareness about FATCA.

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