South African private equity funds and FATCA – no room for lingering lethargy
15 April 2015
Posted by: Author: Andrew Knight
article describes the current legislative vacuum in which South African
entities, including private equity funds, find themselves with regard to the US
Foreign Account Taxation Compliance Act (FATCA).
Along with over 100 other countries, South Africa
is a signatory to an intergovernmental agreement (IGA) with the United States
government that provides the basis for making the automatic exchange of
information known as FATCA applicable to South African entities. Although the
South African government has taken the necessary steps to put the IGA into
effect, it would appear that the US has not completed its own ratification
processes. Technically, therefore, there is the small matter of the IGA
currently having no legal force.
However, even if the IGA was fully in place (and
this is certain to happen), it would have no direct binding effect on South
African financial institutions (FIs) as they would only be legally obliged to
carry out the due diligence and reporting requirements set out in the IGA once
the SA government had introduced the necessary domestic regulations. It would
normally be expected that, as in countries like the UK and Canada and to a
lesser extent Australia, there would be a detailed set of regulations that
would largely mirror the IGA. This has so far not been the case and indications
are that South African FIs remain in something of a legal vacuum. However, before
anyone starts to argue (or continues to argue as there were signs of such an
argument in the panicked run-up to the deadline for the registration of
entities with the IRS) that this means that a South African FI need do nothing
until a long set of regulations is in place, the following points need to be
borne in mind:
- Under the IGA, South Africa is under
a duty to make sure that its FIs comply. It cannot do that until formal
regulations are introduced. Thus, until that is the case, South Africa is
technically in breach. If the SA government is in breach, then so are its FIs.
Thus, there is no merit in an FI arguing that it is the government’s problem
and not the FI’s. But clearly government has an important role to play in
ensuring that South African FIs are compliant.
- Breach in this context means
that the IGA would be ignored and the FIs would be subject to the full set of
US Regulations and would be required to report directly to the IRS.
- The US government is displaying
(without saying it) a remarkable degree of tolerance in not making a song and
dance about IGA governments not having passed the necessary laws to make FATCA
binding on their local financial community. This is perhaps because it is
itself behind in its implementation processes but it is also consistent with
the pragmatic line it took on getting IGAs negotiated, signed and ratified where
it was prepared to accept that countries had made sufficient progress to be
treated as having signed an IGA.
- In fact, the SA government,
with very little fanfare, introduced two Notices in June 2014 that purport to
require an SA FI to:
- keep the necessary records to
show that it has complied with the due diligence requirements under the IGA;
- submit to SARS a return
containing the information required by the IGA.
- There may be some legitimate
questions to be raised as to the legal effectiveness of these Notices. Indications
are that a new set of secondary legislation is being prepared. However, the
Notices comprise a clear statement of intent from SARS that they expect the
necessary compliance work to be done and returns submitted, all on pain of
significant criminal sanctions in the event of non-compliance.
- In any event, any new
legislation will be with effect from 1 July 2014 and so there will be a lot of
catching up to do for FIs that have done nothing.
- The financial community, in
particular banks and investment funds, is generally behaving as though FATCA
applies. Therefore, technical arguments, whether or not correct, will fall on
deaf ears of those FIs that are obdurately applying the FATCA regime and that
will not do business, and indeed cease to do business, with another person that
they consider is not to be FATCA compliant.
So the bottom line is that, if any FIs still have
delusions that FATCA may not yet apply or may be a problem for governments
only, these should be very quickly abandoned. FIs should behave as if the IGA
applied directly to them and should take account of the draft Guidance Notes
that SARS published for comment on 17 December 2014.
The future position – multilateral FATCA
And, before we know it, 1 January 2016 will be upon
us and that means that the Common Reporting Standard (CRS), being the OECD
version of FATCA, will be in play for those governments that have committed to
so-called early adoption. There are over fifty early adopters (including South
Africa) and this number is likely to increase. At the moment, South African FIs
only need to worry about reporting to SARS on US taxpayers for whom they hold
accounts either directly or indirectly. As from 1 January 2016, the full range
of CRS due diligence and reporting will apply in relation to accounts
maintained for tax residents in all of the early adopter countries. And, SARS
will need to package all of those reports and exchange the relevant information
on an automatic basis with the relevant countries, hopefully all in a secure
At the risk of re-stating the obvious, a South
African resident entity that has not yet determined its FATCA status should do
so without further delay. Without understanding its status, and in particular
whether it is a so-called Reporting FI, the entity will not be in a position to
understand the extent of its FATCA obligations.
Which takes us on to the next immediate priority,
namely due diligence and reporting. In summary, a Reporting FI now needs to
take care of the following:
- It needs to identify accounts
that it maintains for clients or investors and that existed as at 30 June 2014 or
that it opened between that date and 31 December 2014 – these are referred to
as "pre-existing accounts” and in the context of a private equity fund would be
the debt or equity interests held in the fund.
- The fund then needs to carry
out due diligence on those accounts to determine whether there are US taxpayers
behind them. The nature and level of due diligence depends on the size of the
account and whether it is held by an individual or entity.
- For any accounts opened from 1
January 2015, the due diligence needs to be carried out at the point of the
account being opened and should be completed before the account can be treated
as operational. For example, an investment subscription should not be accepted
and implemented before the due diligence has been completed.
- The deadline for the first
reports, which will cover the period from 1 July 2014 to 28 February 2015, is
30 June 2015. SARS will be required to report any relevant information to the
US Inland Revenue Service by 30 September 2015.
- Reports will need to be made in the format proposed by SARS
and as published on the SARS website accessible through the following path www.sars.gov.za - Business and
Employers - Modernised 3rd party data Platform - Automatic Exchange of
Information, scroll down to ‘Useful Links’ and select ‘SARS External BRS 2014’.
- Even where the due diligence
process reveals that nothing needs to be reported, it would appear to be
necessary that the FI in question file a nil return with SARS.
Not only is FATCA here to stay, its impact will
soon criss-cross the globe. While parts of the South African financial
community have been pro-active in dealing with FATCA, there would appear to be
a number of FIs that are not fully engaged and are therefore at risk of being
non-compliant with the serious consequences that can result. Although SARS has
itself been pro-active, the continued lack of clarity in the legal position,
including in the form of definitive guidance, is making an already difficult
situation more difficult to manage. It may also be the cause of some entities remaining
detached from the reality of the new FATCA environment in which the entire
world is now living.
This article first appeared on the March/April 2015 edition on Tax Talk.