Everybody’s talking about FATCA, you have seen FATCA amendments in your loan documentation; and you know it’s a hot topic in the regulatory market but have you got to grips with the basic principles of this new legislation and how it could affect you? If not, then read on…
What is FATCA?
The Foreign Account Tax Compliance Act (FATCA) is a US law, which was introduced in 2010. The overriding intention of it is to counter tax evasion by US taxpayers by making it difficult for them to hold unreported “hidden” assets outside the US. It requires foreign financial institutions (FFIs), which includes non-US banks, to provide certain information to the US Internal Revenue Service (the IRS) or, unless one of the exceptions below applies, from 1 July 2014, face a 30% withholding tax penalty.
The withholding tax will be deducted in the US on “US source income” paid to FFIs. This includes payments made by US borrowers and other borrowers whose payments are deemed to be from a US source.
Are there exceptions?
There are exceptions to the requirement to pay withholding tax:
- Grandfathering: loan agreements entered into before 1 July 2014 will automatically be ‘grandfathered’ meaning that no FATCA withholding will apply (including for payments made after 1 July 2014). However, if the agreement is ‘materially modified’ after that date payments may be caught by FATCA;
- Intergovernmental Agreements: where the lender (or FFI) is in a country which has entered into an InterGovernmental Agreement (IGA) with the US, the lender will automatically be deemed to be a “participating” FFI (PFFI) and payments it receives should not be subject to the withholding tax;
- FFI Agreements: if an FFI is not located in an IGA jurisdiction it can avoid the 30% withholding tax if it enters into an FFI agreement with the IRS and becomes a PFFI. Under an FFI agreement, the PFFI must comply with specified verification and due diligence requirements to identify US accounts and report to the IRS on information gathered.
What’s the UK position?
Concerns were raised with the IRS that providing the required information would put FFIs in breach of data protection and confidentiality laws in their own country. In response to this the IRS agreed two forms of IGA to overcome this issue.
The UK has entered into what is called a “Model I” agreement which means that UK FFIs are deemed to be “participating” (i.e. PFFIs) and so can pass the relevant information to HMRC instead of the IRS. Legislation is being introduced in the UK to address this. By way of an example, this means, in relation to bilateral facilities made in the UK, payments made by a US borrower to a UK bank should not be subject to the withholding tax.
Ok, so what about syndicated facilities?
The application of FATCA will depend on whether any of the finance parties are non-PFFIs. In circumstances where a syndicated loan is made to a US borrower (or a borrower whose payments are deemed to be US sourced) and the agent is a PFFI (e.g. a UK bank) but one of the syndicate lenders is a non-PFFI, a withholding tax would apply to the non-PFFI lender.
What does it mean for UK lenders?
- Withholding – the LMA provides different options which parties can select to deal with the risk of withholding. US market practice appears to have settled on lenders taking the FATCA withholding risk on syndicated loans. The European approach is much less settled with many lenders still looking at FATCA requirements on a case by case basis;
- Reporting requirements – UK banks (as PFFIs) need to ensure that facility agreements contain sufficient information disclosure requirements to ensure that they can comply with their reporting requirements;
- Transferability – lenders who accept the FATCA withholding risk on loans may have difficulty transferring loans to non-PFFIs; and
- Amendments – significant amendments to the terms of a loan agreement originally entered into prior to 1 July 2014 could be deemed a material modification and result in the loss of the grandfathering status.
Word of warning
This blog post aims to simplify what is complex legislation, some of which still requires further clarity and guidance from the IRS, and summarises the key issues for UK banks.
Here is a link to the US Department of the Treasury website setting out jurisdictions which have agreed IGAs: http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA-Archive.aspx