FATCA is having a significant impact on the Luxembourg financial sector. Final regulations were released earlier this year and additional guidelines were  issued by the US Treasury on 12 July. With such significant developments in the final version of the regulations, what steps can fund promoters, managers, distributors and other fund service providers take?

FATCA in a nutshell

The goal of FATCA is to enable US tax authorities to obtain information about the income of US persons even if they are a client of a non-US foreign financial institution (FFI). If an FFI does not cooperate, a 30% withholding tax (WHT) will be imposed upon certain US source income.
To avoid this withholding tax, unless an exception applies, the FFI must enter into an agreement with the IRS where it identifies its US accounts, reports information to the IRS, closes accounts of recalcitrant persons and imposes and pays withholding tax to the US in certain circumstances.FATCA might impact everyone in the chain of payments, regardless whether the entity has US clients or if they generally invest in US assets or not.

Where does Luxembourg currently stand?

Luxembourg has announced the start of discussions for a Model 1A IGA. IGAs are bilateral agreements that ease convergence between the FATCA requirements and local rules. This means that Luxembourg FFIs will not have to withhold on payments made to recalcitrant account holders or to close their accounts.Luxembourg FFI’s will still have to register with the IRS but do not have to enter into an FFI agreement, as Luxembourg will exchange information directly with the IRS. It has been clarified that a withholding tax will not be required as long as the IGA is signed even though a law transposing the IGA has not been fully completed.

Are Luxembourg investment funds within the scope of FATCA?

Investment funds fall within the definition of an FFI whatever their investment strategy as well as some of their service providers such as professional managers, depositaries and other entities involved in holding financial assets. Other providers, while not qualifying as FFIs, might help funds to comply with FATCA.

What can a fund do to mitigate the impact of FATCA?

First of all, an FFI may benefit from a “deemed compliant status” the terms of which will be clarified in the IGA. Actors that could be included within this category are fund investment managers, investment funds whose investors are exclusively compliant or exempt financial institutions and investment funds which prohibit the sale of interest to defined prohibited holders.

Furthermore, income that is derived from some bonds could avoid being subject to withholding tax (grandfathered obligation). Pursuant to an IRS notice of July, grandfathered obligations will now include obligations outstanding on 1 July 2014 rather than by December 2013.

Finally, the text foresees a series of situations where a fund will be able to rely on its group and/or service providers to comply with the regulation. Being part of an expanded affiliated group, for example, will allow the management company - and under certain circumstances the fund - to rely on a lead FATCA sponsor to take on a series of responsibilities on its behalf.

A fund can similarly be relieved of compliance obligations if it appoints a sponsoring entity to take on all duties. By the effect of this appointment an investment fund will become deemed compliant and be able to rely exclusively on the sponsoring entity to take actions imposed on it as an FFI. Management companies in particular should generally be able to act as sponsoring entities on behalf of the funds they manage.

Investment funds should also be authorised to delegate certain material tasks to their usual service providers on a purely contractual basis, without this entailing a transfer of responsibility.

Although the IGA is not yet signed, what should fund managers and their service providers put in place in order to anticipate the operational and commercial impacts of FATCA?

Investment vehicles and other related FFIs might like to consider different strategies to avoid or limit the impact of FATCA on their investors and clients. The registration deadline has been postponed for six months and will not be allowed before January 2014, thus allowing FFIs more time to explore their various possible strategies, for example, being a deemed compliant FFI, becoming a sponsoring or sponsored entity, a lead sponsor or acting as sub-contractor etc. Funds could conduct a due diligence process on their distribution networks and underlying investors, revamp their distribution agreements, review their investment strategies and inquire about the willingness of their clients to comply, whatever their specific status.

Sandrine Leclerq is counsel with Baker & McKenzie Luxembourg.