A federal tax law aimed at preventing Americans from hiding their assets overseas will soon be a major compliance challenge — some say headache — for private equity and hedge fund managers.
While institutional investors are not directly affected by the new law, they will need to ensure the asset managers with which they do business are fully compliant, so that investment returns aren't diminished by tax penalties.
The Foreign Account Tax Compliance Act, which requires financial institutions to identify Americans who have investments in non-U.S. financial accounts or entities, “is increasing exponentially the level of operational difficulty for asset managers. It is probably the most pressing regulatory challenge facing the U.S. now,” said David Richardson, managing tax director for KPMG Financial Services in New York.
“It's going to be a very heavy lift,” agreed Harris Horowitz, managing director and global head of tax for BlackRock Inc., New York.
The final FATCA regulations, issued Jan. 17 by the Internal Revenue Service, are sweeping and, when fully implemented, the law will apply to any fund trading or investing, directly or indirectly, in U.S. assets, or any entity in an affiliated group with that fund. It also applies to the funds' service providers and counterparties.
Except for a few asset managers with purely U.S. funds and no offshore vehicles, most private equity and hedge funds will have to register with the IRS as a foreign financial institution.
Skipping registration, or not registering correctly, can trigger a 30% withholding tax on any payment or dividend considered a “withholdable payment.”
“FATCA is not just one set of rules,” said Mr. Richardson. “Asset managers could be responsible for hundreds of fund vehicles in multiple jurisdictions. For a lot of funds there is a lot to do, and there is a lot of scrambling.”
Along with the time and money involved in these new demands, private equity and hedge fund managers worry it could have a chilling effect on foreign investment in U.S. funds, relative to comparable foreign funds where foreign investors would not be at risk of having 30% withheld.The uncertainty is also hurting product innovation, said Mr. Horowitz of BlackRock, which has $2.3 trillion in institutional assets under management. “We're designing new products, and we need to know if it should be a U.S.-organized product, or foreign.”
For the 34 member firms of the Private Equity Growth Capital Council in Washington — including Apax Partners, Apollo Global Management LLC, The Blackstone Group, The Carlyle Group, Kohlberg Kravis Roberts & Co., Silver Lake Partners and TPG Capital — one of the most helpful fixes would be to distinguish investment fund ”families” from global banking groups, and offer the option of a centralized compliance process, with one entity authorized to serve what can often be hundreds of other entities within fund families.
PEGCC General Counsel Jason Mulvihill said his group will continue to work with Treasury officials on ways of providing regulators the necessary information “while integrating efficiencies for filers into the process.”
While recognizing that investment funds even under the same manager are legally distinct entities but with common management, “U.S. resident investment advisers ... should be permitted to have responsibility for the compliance function,” said Richard H. Baker, president of the Managed Funds Association, in a letter to the IRS last year.
But that raises another potential concern, said Mr. Richardson of KPMG. “It's a significant business issue for asset managers because they are taking on more exposure” if they seek designation at the sponsoring entity in order to save investors the compliance headache.
FATCA officially kicks in January 2014, when non-compliant firms are subject to the 30% withholding tax. But experts say the real deadline for asset managers is October 2013, when the IRS will start designating financial institutions as FATCA-compliant. For the marketing advantage alone, “you want to be on the good list,” said one hedge fund manager who preferred anonymity.