The financial penalties and the potential business disruptions are significant for private equity firms that are not compliant with the Foreign Account Tax Compliance Act, according to a report by private equity fund administrator Broadscope Fund Administrators.
The 2010 FATCA laws require foreign private equity funds to identify and report foreign capital accounts owned by US citizens and withhold 30 percent of source US income that is fixed, determinable, annual or periodical from interest and dividends.
It also requires firms to enter into a compliance agreement with the Internal Revenue Service.
Domestic private equity funds also face the same regulations; with the exception of the IRS compliance agreement.
“There’s been a lot of energy by financial institutions globally, including private equity firms, to mobilise their efforts and make sure for example, that they have all of their non-US entities registered on the IRS portal in time so they can be ready to comply with the rules,” said Jonathan Spalter, global head of tax at private equity investor Pantheon.
The regulations are designed to increase transparency for the IRS so it can gain information about US taxpayers who are investing and earning income abroad, to ensure US citizens are not engaging in tax evasion.
Private equity funds that do not comply with FATCA subject their entire fund to a 30 percent withholding of US FDAP. Starting in 2017, the withholding will also apply to gross proceeds from the sale of securities.
FATCA non-compliance may lead to significant negative financial impacts on a fund’s performance and may threaten the fund’s operating business model, according to the Broadscope report. General partners investing on the secondaries market have to be extra cautious, according to Broadscope co-founder Frank Palmeri.
“As part of their due diligence, secondaries investors must fully understand the FATCA status of their potential investment in a secondaries fund,” said Broadscope co-founder and managing member Robert Aufenanger.
Given the complex and the time-consuming nature of implementing an in-house FATCA compliance programme, the report recommends that it could be better for some firms to outsource the administration.
“Secondaries firms understand that while they can comply with the law internally, there’s an administrator out there that is actually doing compliance for this tax law for 20 other clients, and so it makes sense to tap into their level of expertise,” Aufenanger explained.
Aufenanger says FATCA is one of a number of new technical tax laws that add to back office responsibilities. The benefits of outsourcing are enhanced when a firm has more of these requirements that need to be met.
Still, private equity firms have to be careful when working with a third party service provider because “FATCA responsibility still remains with the financial institution”, explains Spalter.
He says firms need to make sure they have controls and procedures in place in order to have accurate reporting and ultimately mitigate the risk of withholding.