In November 2013, the Cayman Islands Government entered into a Model 1B Intergovernmental Agreement with the United States (the IGA) which provides the framework for the implementation of the US Foreign Account Tax Compliance Act (FATCA) in the Cayman Islands. Cayman entities are not directly subject to FATCA however the IGA requires the Cayman Islands to implement legislation requiring certain Cayman entities to identify and report US accounts as set out in this Guide.

The IGA requires that Cayman Financial Institutions report to the Cayman Islands Tax Information Authority (TIA). The TIA will automatically pass that information on to the United States Internal Revenue Service (IRS). A Cayman Financial Institution that complies with the Cayman Islands laws implementing the IGA will, under US law, be “deemed compliant” with the requirements of FATCA and will not be subject to the 30% withholding tax which may otherwise be applied.

Implementing legislation will shortly be adopted in the Cayman Islands. The Cayman Islands Government has set up a FATCA Working Group with industry representation (on which Harneys is represented). The Working Group is reviewing the measures required to implement automatic exchange of information in relation to the IGA, the IGA between the Cayman Islands and the United Kingdom as well as additional reporting requirements which are likely to be implemented in future by other countries under the Common Reporting Standards (CRS). Draft Guidance Notes were issued on 12 May 2014 with a consultation period ending on 6 June 2014.

This Guide focuses on the impact of FATCA and the IGA on Cayman domiciled funds whether they are exempted limited companies or exempted limited partnerships. References are made in this Guide to the draft Guidance Notes. It should be noted that the final Guidance Notes may be amended following the consultation period. This Guide will be updated to take into account of any such amendments once the Guidance Notes are finalised.

Financial Institutions and Investment Entities

The definition of a “Financial institution” (FI) (equivalent to a Foreign Financial Institution (FFI) in the FATCA Regulations) is key to the application of the IGA.

The IGA defines a FI as a Custodial Institution, a Depository Institution, an Investment Entity or a Specified Insurance Company. In the funds context, Investment Entity is the most relevant. The term is clearly defined in the IGA itself. However, the Guidance Notes provide flexibility for entities to elect to apply the IGA definition of Investment Entity or the definitions used in the FATCA Regulations or the CRS. In other words, an entity may avoid treatment as an Investment Entity unless it falls within all three of the definitions.

The IGA definition of Investment Entity is any entity which conducts as a business (or is managed by an entity that conducts as a business) any of a variety of financial activity for or on behalf of a customer including managing funds or money. The IGA definition also captures managers, advisors and administrators of funds. The CRS and FATCA Regulations definitions are generally narrower and refer to gross income of the entity being primarily attributable (more than 50%) to investing in Financial Assets. In practice, the majority of Cayman investment funds fall within all three definitions and must be treated as FIs under the IGA.

Non-Reporting Financial Institutions

The IGA distinguishes between Reporting FIs and Non-Reporting FIs. A Non-Reporting FI is any FI that falls within the exemptions set out in Annex II to the IGA or the FATCA Regulations or one which otherwise qualifies as a Deemed Compliant FI, an Owner Documented FI or an Exempt Beneficial Owner. A complete analysis of all of the exemptions is outside the scope of this Guide but in an investment funds context the most relevant exemptions are:

Sponsored Investment Entity – a FI that is an Investment Entity1 may agree for another entity to act as its sponsoring entity to fulfil the registration and related requirements. The Sponsoring Entity must register with the IRS. This provision is proving popular for fund groups where the manager or an affiliate can act as the sponsoring entity for the funds which it manages.
Trustee Documented Trusts – a Cayman trust is a Non-Reporting FI if the trustee is a Reporting FI and reports all information required to be reported pursuant to the IGA.
Investment Advisers and Managers – any Investment Entity which is a FI solely because (a) it renders investment advice to, and acts on behalf of or (b) manages portfolios for, and acts on behalf of, a customer for the purposes of investing, managing or administering funds deposited in the name of the customer with an FI (other than a Non-Participating FI). This category may include entities that delegate their investment management and advisory obligations such as a general partner of a limited partnership.
Collective Investment Vehicle – this is a limited exemption only available to collective investment vehicles which are regulated in Cayman and all interests in which are held by or through certain categories of persons such as other FIs. Investment Entities seeking to take advantage of this category need to follow certain other rules set out in Annex II. The majority of Cayman funds are unlikely to fall within this exemption.
Many Non-Reporting FIs will not need to register and obtain a Global Intermediary Identification Number (GIIN) or carry out the due diligence and reporting requirements under the IGA,2 such Non-Reporting FIs will provide certification to a relevant withholding agent as to its status through the modified W8 certification.

Reporting Financial Institutions

Cayman funds which do not fall within any of the exemptions referred to above are classified as Reporting FIs and will be required to comply with the reporting and registration obligations imposed under the IGA and Cayman legislation. The most notable obligations are:

(a) to identify US Reportable Accounts in accordance with the due diligence requirements set out in Annex I of the IGA and the Guidance Notes;

(b) to report annually to the TIA certain specified information with respect to any US Reportable Accounts; And

(c) to register with the IRS to obtain a GIIN (even if the Reporting FI has no US Reportable Accounts).

Registration with IRS

A Cayman fund which is a Reporting FI or a Registered Deemed Compliant FI is required to register online with the IRS by the end of 2014 to obtain a GIIN. In order to be included on the first list of GIINs published by the IRS in June 2014 a FI must have registered by 5 May 2014. However, FIs are not required to provide verification of a GIIN to withholding agents to establish their FATCA status prior to 1 January 2015 (to be on the IRS list by 1 January 2015, a FI must register and obtain a GIIN by 22 December 2014). The obtaining of a GIIN will be independent certification to prime brokers, custodians and other counterparties of FATCA compliance. Between 1 July 2014 and 31 December 2014, FIs should be able to confirm their status through self-certification on Form W8 or informing the withholding agent that they are a Model 1 Financial Institution. However, it is advisable for entities to liaise with their counterparties to establish any new requirements in advance of 1 July 2014.

The Cayman Islands Government has issued guidance in relation to the requirement for a FI to have a FATCA Responsible Officer. When registering for a GIIN, the IRS portal requires the name of a natural person to be listed as the FI’s Responsible Officer despite the fact that under the IGA there is no specific role. The Cayman guidance states that the Responsible Officer of a Cayman FI will be required to deal with the IRS online registration, certify that certain information (entered as part of the online registration) is accurate, and certify that the Cayman fund will comply with its FATCA obligations. It does not invoke the US Treasury concept of a Responsible Officer and those obligations are not imported into the Cayman legal framework.

Identifying US Reportable Accounts

A US Reportable Account is any Financial Account maintained by the FI and held by one or more Specified US Persons or by a non-US entity with one or more controlling persons that is a Specified US Person.

In the funds context, a Financial Account is any equity or debt interest in the Investment Entity other than interests which are regularly traded on established securities markets. A Specified US Person is generally defined as a US Person that is not otherwise:

a corporation listed on an established stock exchange;
a member of an expanded affiliated group (of the FI);
a US federal or state agency;
any tax exempt organisation under the IRS Code; or
an entity registered with the SEC.
A US Person includes any US resident or citizen, any US partnership or corporation and any trust over which a US court has jurisdiction over the administration of the trust or one or more US Persons have the authority to control all substantial decisions of the trust.

The IGA provides that the term “controlling person” is to be interpreted in a manner consistent with the FATF Recommendations. The Guidance Notes provide that it includes the natural person on whose behalf a transaction is being conducted and those persons who exercise effective control whether directly or indirectly.

Annex I and the Guidance Notes set out detailed steps which a FI must take to identify US Reportable Accounts and distinguishes between Pre-existing Accounts (those in existence as at 30 June 2014) and New Accounts (those opened after on or after 1 July 2014).

Reporting to the Tax Information Authority

The IGA requires the TIA to provide information to the IRS by the end of nine months from the end of each calendar year. The first information will need to be supplied to the IRS by 30 September 2015. The Guidance Notes provide that Reporting FIs must report to the TIA no later than 31 May in each year. The information which must be provided about each US Reportable Account increases through 2014 to 2016. For 2014, the information on each Specified US Person holding a US Reportable Account or as a controlling person of an entity holding an account comprises name, address, US Taxpayer Identification Number (TIN) (where applicable or date of birth for pre-existing accounts), account number and account balance or value as at the period end.

Non-Participating FIs

Reporting FIs are not subject to withholding tax unless they are designated as Non-Participating FIs. The IRS may classify a Cayman Reporting FI as a Non-Participating FI following the conclusion of the procedures set out in the IGA. The IRS may determine that a Reporting FI is in “significant non-compliance” with the FATCA obligations. It may then notify the TIA and require it to compel the Reporting FI to obtain and report the required information. Failure to do so within 18 months of first notification permits the IRS to deem the Reporting FI to be a Non-Participating FI and the Cayman entity will be subject to withholding tax.

Review of fund documentation

To address the issues arising under FATCA, fund managers are well advised to review their documentation. Provisions which may be considered include the following:

a power for the fund to compulsorily redeem the interests of any investor which does not provide the required due diligence to determine whether or not it is a Specified US Person (a Recalcitrant Investor).
specific authority to withhold from redemptions, dividends and other distributions due to a Recalcitrant Investor.
ability to allocate amounts withheld from the fund to a Recalcitrant Investor – without such a provision, other investors potentially suffer losses due to one Recalcitrant Investor.
ability to move Recalcitrant Investors to separate share classes in which the withholding can be applied – i.e. the ability to convert shares/partnership interests from one class to another without the consent of the investor affected.
exculpation of directors/general partner and the fund from liability arising from FATCA compliance.
specific disclosures describing the effect and risks of FATCA compliance.
Subscription documents require special attention to include:

an obligation on the investor to provide FATCA information and comply with due diligence requests which may require the provision of nationality, permanent residency information and tax residency representations.
an acknowledgement that the fund will disclose FATCA information to the IRS, UK, third parties etc.
a general waiver of any legal restrictions which might otherwise prevent disclosure of information by the fund.
an acknowledgment of the effect of non-compliance and lack of disclosure by an investor and an acknowledgement that the fund may take any of the actions outlined above.
an agreement that the investor shall not have any claim against the fund for any damages or liability arising as a result of actions taken by the fund or remedies pursued by the fund in order to comply with any existing IGAs or any future obligations imposed either under future IGAs or any enabling legislation enacted in the Cayman Islands.
Summary of actions for Cayman investment funds

1. Entity Classification – it is necessary to determine the status of each entity within the fund structure. Is it an FI? If so, is it a Reporting FI or Non-Reporting FI?

2. IRS Registration – all Reporting FIs and Registered Deemed Compliant FIs must register and obtain a GIIN in advance of 1 January 2015.3

3. Implement a comprehensive FATCA compliance program and carry out due diligence on investors – Reporting FIs should put in place a due diligence program to meet the requirements of Annex I of the IGA. The new program must apply to all new accounts opened after 1 July 2014. The FI should note the deadlines for obtaining due diligence on pre-existing accounts.

4. Review of Fund Documents – see section above with respect to specific changes that may be contemplated.

5. Report relevant FATCA information to the TIA – Investment Entities will have to be ready to report information with respect to 2014 by no later than 31 May 2015