The challenges of FATCA compliance

for Cayman funds and their administrators

Sidebar:  Key short term considerations for Cayman funds to be FATCA compliant 

With the August 13, 2013 announcement by the Cayman Islands government that a Model I Intergovernmental Agreement (IGA) has been initialed with the United States the Cayman Islands funds industry now has the necessary information to move forward with U.S. FATCA compliance. However, industry still needs to see more information on what U.K. FATCA compliance, which is at the time of writing this article a virtual certainty, will require.  

This article will outline the key U.S. FATCA steps required for Cayman funds to be compliant. Additionally this article will outline the FATCA customer review processes required both for new investors in Cayman funds as of July 1, 2014, and for the preexisting investors in Cayman funds with a particular focus on the interaction between the funds and their administrators assuming the funds have engaged the administrator to assist them with becoming FATCA compliant. 

As noted in the table accompanying this article there are a number of steps funds need to implement between now and December 31, 2014 to be FATCA compliant. There are additional FATCA requirements and deadlines in 2015 and 2016 but these will be addressed in a subsequent article. The first challenge for most funds is to confirm the funds entity classification.

There is an opportunity for a small number of funds to be qualified as collective investment vehicles if the funds only investors are participating foreign financial institutions or other exempt investors. The advantage of this status is that there is no annual reporting to Cayman government for those funds. Instead the fund would just need to certify its status every three years and not accept any capital from any non-exempt investors.

One of the more significant changes required for a fund will be to the subscription documents and potentially to the private placement memorandum. Those documents will need to be updated by July 1, 2014. It is expected that it will be standard practice in the subscription documents to request a W-9/Applicable W-8 form from all investors going forward.

As outlined in more detail below, funds will not be able to delegate all their FATCA responsibilities to their administrator. There is a risk management role required either by the fund’s investment manager or by the directors to ensure all the requirements in the Model I IGA are complied with. Ultimately, in 2015 when the first FATCA information return is filed by the Cayman fund with the Cayman Islands Tax Information Authority a director of the fund is likely the party that will need to sign that form. That end goal should be kept in mind throughout 2014 by both the directors and investment manager for the fund.

Obtaining a GIIN

In order for investment funds that are organized in the Cayman Islands to be compliant with FATCA the funds need to comply with the terms and conditions of the Model 1 IGA. However, they do not need to enter into an FFI agreement with the Internal Revenue Service. Nevertheless, Cayman funds will need to obtain a Global Intermediary Identification Number (GIIN) and complete the required certification via the IRS FATCA online registration portal. 

The Cayman fund can either obtain the GIIN by filing Form 8957 – Foreign Account Tax Compliance Act Registration – in paper form with the IRS or by using the IRS online registration portal. The IRS strongly recommends using the secure online registration portal for the GIIN application since the IRS expects that the paper application processing will take longer when compared to the online application. 

The online registration portal opened on August 19, 2013. However, the IRS has advised the information can currently only be saved in draft form and cannot be officially submitted via the portal until January 1, 2014. The ‘responsible officer’ will have to submit the registration, in paper or electronic form, to the IRS.

The IRS defines a responsible officer as an individual with authority under local law to submit the information provided on behalf of the entity. Therefore, the responsible officer for a Cayman fund will be defined by Cayman law. Our current thoughts are we believe the responsible officer for a Cayman fund will need to be either a fund director or an officer/director of the investment manager. 

The best approach for Cayman Funds is to register and obtain a GIIN before April 25, 2014 in order to be included in the first FFI list published by the IRS in June 2014. While technically Cayman funds have until the end of 2014 to obtain a GIIN we believe standard industry practice will be to apply for the GIIN by April 25, 2014.

Reviewing preexisting investors

One of the biggest concerns for a Cayman fund is to review its preexisting accounts to determine if any of the account holders are ‘specified U.S. persons’. As a reminder a specified U.S. person will generally include U.S. individuals, U.S. corporations, U.S. partnerships, U.S. estates, U.S. trusts and residents of the U.S. A preexisting account is defined as any account already open as of June 30, 2014. The requirements for reviewing a Cayman fund’s existing entity account holders are greatly aided by the signing of the IGA. 

In general, as long as the entity investor is a U.K. or other IGA partner jurisdiction financial institution then no review, identification or reporting is required with respect to the account. The definition of a financial institution is very broad and includes an investment entity. In short, as long as the investor in the Cayman fund is a financial institution that financial institution investor will take on the review of their investors so there is minimal review and no reporting required by the Cayman fund.

For most funds the majority of entity investors are expected to be financial institutions from IGA partner jurisdictions so clearly this is a very beneficial rule. The documentation of the review and conclusion by the fund that the investor is a financial institution in a partner jurisdiction should certainly include obtaining self-certification from the investor and verifying that the entity has a valid GIIN by comparing the GIIN provided to the list published by the IRS. 

The deadlines for reviewing existing investor accounts have also thankfully be moved back due to the July 12, 2013 announcement by the IRS. The first notable deadline is December 31, 2014 which is only for completing the review of existing entity account holders which are also financial institutions.
All other pre-existing investor account reviews, whether the investor is an individual or an entity, are due by June 30, 2016. 

The key requirements for a Cayman fund’s existing individual investors will be:

a):  Reviewing all electronically searchable information on record for U.S. indicia. Examples of U.S. indicia include any of:

  1. U.S. mailing address,
  2. identification that they are a U.S.citizen/resident,
  3. U.S. place of birth,
  4. U.S. telephone number,
  5. power of attorney authority has a U.S. address,
  6. standing instructions to transfer funds to an account maintained in the U.S.
  7. account holder has an “on-care-of” or a “hold mail” U.S. address that is the sole address on file.

b):  If the account balance is over US$1 million as of June 30, 2014 then the review of U.S. indicia mandates that the fund must make an enquiry to the relationship manager assigned to that individual account and establish whether the relationship manager has knowledge that would identify the account holder as a specified U.S. person.

As stated above, if the fund has engaged the administrator to assist them with FATCA compliance this will require the fund administrator to contact the investment manager to confirm whether they have actual knowledge that the account holder is a U.S. person. Standard practice will be to obtain and retain documentation that this was confirmed. This will be an additional procedure for the administrator both in terms of the contact required and the retention of the response.

Only when both (a) and (b) above have been completed with no indication of U.S. indicia can the investor be ruled out as being a Specified U.S. person. If however, there is U.S. indicia found, a U.S. mailing address for example, the administrator (acting on behalf of the fund) will need to obtain a self certification by the account holder that they are not a U.S. citizen or resident on an IRS Form W-8BEN (or similar agreed upon form) accompanied by a non-U.S. passport or other government identification that shows their citizenship/nationality in a country other than the U.S.
Interaction between the fund administrator and fund directors 

If a fund engages an administrator to assist them in being FATCA compliant, my personal opinion is that only retail banks have more burden/responsibility under FATCA than administrators do. First there is the commercial issue; fund clients are already sensitive to overall costs including fees such as the Cayman master fund registration fee.

Training staff, delegating key FATCA responsibilities to personnel within the organization, incurring tax/legal advice, and verifying withholding tax forms will be costly for administrators. How much cost will the administrator incur and how much will they pass on to the fund for reviewing at least the preexisting investors which is a significant one time process?

The administrator is certainly a key service provider to the fund and they generally have all of the KYC and other investor documentation. However, they are not part of the fund’s management nor are they the fund’s sponsor − the administrator will not be the party signing the FATCA information return being submitted to the Cayman Government in 2015.

The obligation to comply with the Cayman lslands law that will be enacted with respect to FATCA reporting and compliance is ultimately the fund’s obligation. As the fund will not have any employees that could fill a sponsoring or management role, the investment manager or directors will generally be the responsible persons. Our observation is that there remains the perception by many investment managers and perhaps even some directors that FATCA will be a significant nuisance but “the fund’s administrator will handle the requirements.”

Whether it is the investment manager or the director signing the FATCA information return we expect the standard corporate governance practice will be to discuss at several different times in 2014 the FATCA processes and procedures the administrators are implementing to determine who is a specified U.S. person and to document that the other investors are indeed foreign U.S. persons for FATCA purposes.

Clearly communication between a Cayman fund’s tax advisors, administrators, the investment manager and the directors will be critical to achieve FATCA compliance.