Investment advisers beware - recent American legislation has potential global reach and could seriously damage your clients' wealth

As a practitioner in Scots law, you might think that legislation passed by the US Senate would not impact on your everyday work. Think again. If you provide investment services to your clients, then from 1 January 2013 things may well change.

The US Inland Revenue Service (IRS) has come up with an evil but ingenious way of raising taxes from that date and getting every financial services provider around the world to do some of the work for them, at no cost to the IRS. The rules from the IRS have not yet been finalised, but it is important that you are aware of their existence and what the implications could be if no concessions are made.

Who will it impact on?

On 18 March 2010, President Barack Obama signed into US law the Hiring of Incentives to Restore Employment Act. When legislation like this is proposed in an effort to boost employment in the economy, a means has to be provided to fund it. And so, that gave birth to the creation of the Foreign Account Tax Compliance Act (FATCA) within that legislation. Its purpose is to raise tax revenue from those who are avoiding payment of US taxes by not declaring their investments and income outwith the US.

FATCA will have an impact on all asset managers, independent financial advisers, distributors of funds and others. They will all be deemed to be foreign financial institutions (FFIs), as a consequence of the very wide definition of s 1471(d)(5) of the FATCA legislation, if they hold financial assets for the account of others as a substantial portion of their business. Nominees are likely to fall within this definition, but if you only give investment advice without holding any client assets then you should not be regarded as a FFI.

Why could it affect me?

What has that got to do with you if all your clients are local residents, and why should you comply with FATCA anyway?

The problem is that the IRS does not know who should be paying taxes to it for offshore investments. The only way it can find that information is to get you to do the work and report it to the IRS. FATCA will require FFIs to review the identity of every client, particularly those with assets under management of over US$50,000, to ascertain whether they are (or should be) a US taxpayer. This is not restricted to US residents and will include Green Card holders and others.

If you are not able to get that confirmation from your client, you must treat that person as a “recalcitrant account holder” and will be required to withhold and pay to the IRS 30% of the capital and income payable to that person for all US-sourced investments. Guidance on how to identify US accounts and the due diligence procedure that the IRS proposes can be found in section I of IRS Notice 2011-34.

To ensure compliance with FATCA, the IRS is going to impose a 30% withholding tax on all capital and income generated from US investments unless you become a participating FFI (PFFI). This is done by signing an agreement with the IRS confirming that you are, and will remain at all times, FATCA compliant by either having no US taxpayer clients or by making an annual declaration of those who are.

Can I avoid it?

Can you avoid FATCA by not holding any US investments directly?

It would seem not, through another piece of evil genius called “pass-through payments”, as defined in section II of Notice 2011-34. For example, if you buy shares in an investment company that is a PFFI and it holds US assets, then part of its profits will be generated in the US and so it will have to calculate and publish on a quarterly basis the ratio of US assets that it owns compared to its total assets to produce its pass-through payment percentage (PPP). If you are deemed to be a non-participating FFI (e.g. because you decide not to enter into an agreement with the IRS), or a recalcitrant account holder (e.g. because you refuse to declare whether you are liable to pay US taxes), then the investment company will be required to withhold and pay to the IRS 30% of the PPP that will form part of any distribution or capital payment due to you. If a PFFI does not regularly calculate and publish its PPP, the IRS has said it will have a deemed PPP of 100% even if it has no US-based assets. This means that the whole amount of dividend or capital payable to a non-PFFI or recalcitrant account holder would be subject to the 30% withholding tax.

How will it affect investment?

How will this affect investing for your clients through platforms and UK funds?

If you make investments in a nominee name for your clients, it will most likely become compulsory for you to confirm to the platform or fund that you are a PFFI. If you cannot do that (or choose not to become a PFFI), then the platform or fund may either close your account before this legislation takes effect, or they will have to declare you as a recalcitrant account holder and withhold 30% tax from all monies due to you that are generated from US assets (regardless of whether you have many or no US taxpaying clients) and pay that to the IRS.

What should I do?

Look at the legislation and guidance published to date, and bear in mind this is due to take effect for all payments made from 1 January 2013. The IRS and the US Treasury Department have published preliminary guidance on FATCA through Notices 2010-60 and 2011-34. Final rules have yet to be issued, and what I have written in this article may change.

Further guidance from the IRS or US Treasury should be published later this year. Consider how it might affect your business if you invest on behalf of your clients.

You might also want to rethink holiday plans in the US if you choose not to comply!


The Author
Carolina Viola is Head of Legal & Compliance at SVM Asset Management Ltd, and a committee member of the In-house Lawyers Group
Share this article
Add To Favorites