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The Foreign Account Tax Compliance Act (“US FATCA”) was enacted in the United States in 2010 in order to reduce perceived offshore tax evasion by US persons holding assets through offshore accounts that were not subject to US information reporting to the Internal Revenue Service (the “IRS”). US FATCA requires a foreign entity that is a foreign financial institution (“Financial Institution” or “FI”) either (i) to enter into an agreement with the IRS relating to such reporting or (ii) to comply with local laws that implement an intergovernmental agreement (“IGA”). If a Financial Institution does not comply with US FATCA, a 30% withholding tax is imposed on US source income of that Financial Institution. Financial Institutions are also required to close accounts where their US customers do not provide information to be collected by it.
On 29 November 2013, the Cayman Islands government signed a Model 1B (i.e. non-reciprocal) IGA with the United States (the “US IGA”). As an IGA partner jurisdiction, the Cayman Islands based Financial Institutions will not be subject to a 30% withholding tax on US source income, unless they fail to meet the requirements set out in the US IGA and in the Cayman Islands implementing legislation referred to below.
On 5 November 2013, the Cayman Islands government signed an intergovernmental agreement with the United Kingdom (the “UK IGA”, and together with the US IGA, the “IGAs”) aimed at improving international tax compliance which provides a framework for the implementation in the Cayman Islands of a UK tax residents reporting regime (“UK FATCA”), which is similar in scope to US FATCA.
Unless there is an available exemption, Cayman Islands based Financial Institutions which are subject to the IGAs will be required to identify Financial Accounts1 held by United States or United Kingdom Specified Persons2 (as the case may be) and report specified information about those accounts to the Cayman Islands Tax Information Authority (the “Cayman TIA”). The Cayman TIA would then pass this information on to the IRS (in relation to US accounts) and His Majesty’s Revenue and Customs (“HMRC”) (in relation to UK accounts) on an automatic basis annually.
On 4 July 2014, The Tax Information Authority (Amendment) (No.2) Law, 2014, The Tax Information Authority (International Tax Compliance) (United Kingdom) Regulations, 2014 (the “UK FATCA Regulations”), and The Tax Information Authority (International Tax Compliance) (United States) Regulations, 2014 (the “US Regulations”, and together with the UK Regulations, the “FATCA Regulations”) were gazetted and became effective. The FATCA Regulations provide legal obligations of Cayman Islands Financial Institutions in relation to US and UK FATCA as a matter of Cayman Islands law. The FATCA Regulations also permit the Cayman Islands government to exchange tax information automatically under the IGAs with the UK and the US without violating Cayman law.
On 22 July 2014, the Cayman Islands government released guidance notes concerning the compliance requirements of the IGAs (the “Guidance Notes”). The Guidance Notes are intended to provide practical assistance to businesses, their advisers and the Cayman TIA in interpreting the IGAs, and will be a key component of Cayman’s automatic exchange of information regime for implementing the IGAs. Since the IGAs are based on the same model, many of the provisions are the same and are covered by the Guidance Notes. Where applicable, differences between the IGAs are noted.
The IGAs and the FATCA Regulations apply to all Cayman Islands Financial Institutions (“CFIs”), regardless of whether they hold any Financial Accounts for Specified Persons.
Some action will be required of all CFIs that maintain Financial Accounts. The extent of that action will depend on a number of factors including whether account holders are Specified Persons and the value and nature of the Financial Account.
FATCA can also have an impact on entities which are not Financial Institutions. Any nonUS entity under the US IGA and non-UK entity under the UK IGA that is not a FI will be considered a Non-Financial Foreign Entity (“NFFE”) under US or UK FATCA. There are two categories of NFFE (i) an Active NFFE3 or (ii) a Passive NFFE. A NFFE, whether Passive or Active, has no obligations itself under the IGAs and FATCA Regulations but may have to confirm its status and provide details of Controlling Persons4 to another Financial Institution if requested to do so by the Financial Institution. A CFI may also have reporting obligations in respect of Financial Accounts it maintains for a Passive NFFE with Controlling Persons who are Specified Persons.
The FATCA Regulations and Guidance Notes assist Cayman Islands entities in determining their status as a Financial Institution or NFFE including whether it would be an Active or Passive NFFE.
The first step to be undertaken by a Cayman Islands entity is to establish whether, for the purposes of the IGAs, the entity is a Financial Institution. This, together with establishing the type of Financial Institution it is, will determine the extent of the obligations that need to be undertaken.
A CFI is any Financial Institution organised under the laws of or resident in the Cayman Islands. For these purposes, organised under the laws of the Cayman Islands means the following:
Having established that an entity is a Cayman Islands entity (for FATCA purposes), it should be determined whether it is a Financial Institution. Under the US IGA, the term Financial Institution applies to non-US entities which fall within any, or more than one, of the below categories. Under the UK IGA, the term applies to non-UK entities in the same categories. These are:
In practice, when applying this definition, an entity that is professionally managed will generally be an Investment Entity, by virtue of the managing entity being an Investment Entity.
The definitions of the entities above are as provided by the IGAs, however, the FATCA Regulations and Guidance Notes provide that it is open for a CFI to choose to use a definition of Financial Institution set out in the US FATCA Treasury Regulations relating to US FATCA (the “US Treasury Regulations”). Whether that would be beneficial to a particular entity will need to be assessed on a case by case basis.
A subsidiary or branch of a non-Cayman Islands entity (including a US entity) carrying on a business, as a Custodial Institution, a Depository Institution, an Investment Entity, or a Specified Insurance Company in the Cayman Islands, will also be a Reporting Cayman Islands Financial Institution.
The FATCA Regulations and Guidance Notes assist Cayman Islands entities in determining whether it falls within one of the above categories and therefore whether it is a Financial Institution. In practice, most investment funds in the Cayman Islands (including hedge and private equity funds) will be considered an ‘Investment Entity’ and therefore a Financial Institution.
The next step to be undertaken is to establish whether the CFI is a “Reporting FI” or “NonReporting FI”. By default, all Financial Institutions are Reporting FIs, unless they qualify as Non-Reporting FIs.
In the US IGA, Non-Reporting FI means any CFI, or other entity organized under the laws of the Cayman Islands, that is described in Annex II of the US IGA as a Non-Reporting FI or that otherwise qualifies as a deemed-compliant FFI or an exempt beneficial owner under the US Treasury Regulations. Annex II of the US IGA provides that the following entities are each Non-Reporting FIs:
The rules which may determine whether an entity would fall within one of the above exceptions and therefore qualify as a Non-Reporting FI are complex and will require careful analysis on a case by case basis. The Guidance Notes particularly focus on the classification of, and distinction between Reporting FIs and Non-Reporting FIs, as well as Registered Deemed Compliant and Certified Deemed Compliant entities under the US Treasure Regulations.
In the UK IGA, Non-Reporting FI means any CFI, or other entity resident in the Cayman Islands, that is described in Annex II of the UK IGA as a Non-Reporting FI other than a Sponsored Investment Entity or a Sponsored Closely Held Investment Vehicle where the sponsoring entity has failed to comply with its obligations set out in that Annex II. Annex II of the UK IGA is similar to that of the US IGA except exceptions (iii), (v) and (vi) above do not apply. Again, the Guidance Notes assist a CFI in determining whether it might fall within one of the exemptions in Annex II of the UK IGA.
A Reporting FI will (for the purposes of the US IGA and US FATCA Regulations) need to register with the IRS and obtain a Global Intermediary Identification Number (“GIIN”). An application for registration should be made as soon as possible but prior to 22 December, 2014 or, if the FFI has not commenced to carry on business on that date, not later than 30 days following the date of commencement of that business. Registration can be completed through the IRS FATCA registration online portal and the IRS has issued guidance to assist with this process. Withholding agents that verify the GIIN for Cayman Islands Reporting FIs are not required to withhold tax on payments to those Cayman FIs.
Where the Financial Institution is a member of an expanded affiliated group, current IRS procedures require that the lead of this group registers and has obtained their GIIN so that when other group members/ Related Entities5 are registering they are also able to use this information.
In relation to all Financial Accounts maintained by a Reporting FI, that Reporting FI will need to establish and maintain:
A Reporting FI will be taken to have complied with such obligations only if:
For the purposes of US FATCA only, a Reporting FI will also be required to establish and maintain arrangements that are designed to identify payments made by that FI to a Non-Participating FI7 in the calendar years 2015 or 2016. Annex 1 of the US IGA sets out steps which can be taken by a Reporting FI to identify whether an account holder is a Non-Participating FI.
A Reporting FI must also implement arrangements to obtain the United States federal taxpayer identifying number (“TIN”) or United Kingdom national insurance number (“NI number”) and date of birth (as applicable) of every Specified Person who is an account holder of a Reportable Account. This obligations takes effect from 1 July 2014 in the case of new accounts opened on or after that date and from 1 January 2017 in the case or pre-existing accounts as at 30 June 2014.
A Financial Institution which has reporting obligations summarised below, should notify the Cayman TIA of that fact (in the form that the Cayman TIA) may require no later than 31 March in the first calendar year in which it is required to comply with reporting obligations. Such notification should include:
In respect of 2014 and every following calendar year, a Reporting FI will then be required to prepare a return setting out:
Such return should be sent to the Cayman TIA on or before 31 May of the year following the calendar year to which the return relates (in the form required by the Cayman TIA), whether electronically or otherwise.
For the purposes of US FATCA only, in respect of each of the 2015 and 2016 calendar years, a Reporting FI must also prepare a return setting out the names of the nonparticipating FIs to whom payments have been made and the total amount of those payments made to each of the non-participating FIs in question. If no payments were made, the return should state that fact. As with the other return mentioned above, this return should be sent to the Cayman TIA on or before 31 May of the year following the calendar year to which the return relates (in the form required by the Cayman TIA), whether electronically or otherwise.
In respect of the US IGA only, the concept of Related Entity is relevant in the context of the reporting obligations of the CFIs in respect of any Related Entities that are Non-Participating Financial Institutions. When a CFI has any Related Entity that, as a result of the jurisdiction in which they operate, is unable to comply with US FATCA, then in order to maintain compliance the CFI must fulfil the obligations set out in the US IGA.
In certain circumstances the due diligence, reporting obligations and registration with the IRS can be undertaken by a third party service provider although the responsibility for compliance with the IGAs and FATCA Regulations (and any liability for failure to comply) remains with the Reporting FI.
Financial Institutions referred to as ‘Registered Deemed Compliant’ (under the US Treasury Regulations8) will be obliged to register with the IRS and obtain a GIIN. Financial Institutions referred to as ‘Certified Deemed Compliant’ (under Annex II of the US IGA) will not need to register with the IRS (save for certain limited exceptions). Rather than register with the IRS, Certified Deemed Compliant Financial Institutions should self-certify with withholding agents to evidence their status and avoid the imposition of 30% withholding on US source payments.
Exempt Beneficial Owners and Deemed Compliant Financial Institutions have no reporting obligations in respect of Financial Accounts that they maintain under the US IGA.
Financial Institutions which are Non-Reporting FIs under the UK IGA have no reporting obligations in respect of Financial Accounts that they maintain under the UK IGA.
A Financial Institution will need to follow one or more of the following processes for identification of account holders depending on whether the account holder is an individual or entity:
It should be noted that a self-certification cannot be relied upon if a Financial Institution has reason to know that it is incorrect, unreliable or there is a change in circumstance which changes the account holder’s status.
We set out below a summary of the relevant procedures that a Cayman Islands Reporting FI will need to follow to perform its due diligence obligations which are dependent upon whether the financial account is pre-existing (i.e. held on or before 30 June 2014) or new and whether it is held by an individual or entity. There are also exemptions for accounts with a balance below certain threshold amounts. Some of these procedures may allow a Financial Institution to not have to seek self-certification from an account holder but in practice, given the complexity of the various rules and regulations, we expect that many Financial Institution will adopt a general approach to obtain, as a matter of course, self-certification from both its existing and new account holders, although that remains to be seen.
A new Individual Account is a Financial Account opened on or after 1 July 2014. When opening a new Individual Account, the Financial Institution must obtain the TIN for US Persons or the date of birth and NI Number for UK Persons.
The threshold exemption for new Individual Accounts is a balance or value which does not exceed US$50,000 for Depository Accounts and Cash Value Insurance Contracts only. These do not need to be reviewed, identified or reported to the Cayman TIA unless the Financial Institution has elected to disregard such threshold exemption.
There the threshold exemption does not apply, the Financial Institution must obtain self-certification to determine where the account holder is tax resident and confirm the reasonableness of this based on the information the FI obtains in connection with the opening of the account.
A Pre-existing Entity Account is a Financial Account maintained by a Financial Institution as of 30 June 2014. An account holder must be classified as either:
A Pre-existing Entity Account is only reportable where the account is held by one of more entities that are Specified Persons or by Passive NFFEs with one or more Controlling Persons who are Specified Persons. If the account holder is a Non-Participating Financial Institution, only payments made to it are reportable.
The threshold exemption for Pre-existing Entity Accounts applies to a balance or value which does not exceed US$250,000 for any financial account. These do not need to be reviewed, identified or reported to the Cayman TIA until the account balance exceeds US$1,000,000 at 31 December of a calendar year, unless the Financial Institution has elected to disregard such threshold exemption.
A Financial Institution must use information previously recorded on its files, standardised industry codes, electronic searches (provided all AML information is stored electronically) and paper review to determine an entity’s status. If there are US or UK indicia indicating the account holder is a US or UK Specified Person, the account will generally be reportable. A Financial Institution can also obtain self-certifications if it is believed an entity is a Specified Person for example and it does not want to unnecessarily report on that account. The FI should also determine whether the account is held by another FI – and if it is a Cayman FI or another IGA partner jurisdiction and the GIIN has been verified, no further action will be required. To establish whether an entity is a Passive NFFE, the FI must obtain selfcertification from the account holder unless the FI can reasonably determine it is an Active NFFE. For accounts of Passive NFFEs, if an account has a balance that exceeds US$1,000,000, the FI will need to obtain self-certification as to the Passive NFFE’s Controlling Persons’ status as Specified Persons
A New Entity Account is a Financial Account opened on or after 1 July 2014. An account holder of a new Entity Account must be classified as one of the categories of persons as set out above for Pre-existing Entity Accounts. The same rules apply in relation to which categories of persons are reportable as with Pre-existing Entity Accounts except that there are no threshold exemptions for new Entity Accounts. A Financial Institution will generally be required to obtain self-certification if account holders are identified as being a Specified Person, Passive NFFE with Controlling Persons who are Specified Persons, a Financial Institution (unless a GIIN has been obtained) or NPFIs.
For purposes of determining the aggregate balance or value of Financial Accounts, all accounts belonging to an individual or entity will need to be aggregated unless the Financial Institution has elected under the FATCA Regulations to not apply the thresholds. In this regard, a Financial Institution is required to aggregate all Financial Accounts, belonging to an individual or entity, maintained by it or by a Related Entity, but only to the extent that the Financial Institution’s current computerised systems link the Financial Accounts by reference to a data element, for example a customer or taxpayer identification number, and allow account balances or values to be aggregated. Each holder of a jointly held Financial Account shall be attributed the entire balance or value for the purposes of applying the aggregation requirements.
It should also be noted that for the purposes of determining if there is a High Value Account, account balances need to be aggregated where there is a relationship manager who knows or has reason to know that accounts are directly or indirectly owned, controlled or established by the same person.
| Type | US IGA | UK IGA |
|---|---|---|
| Pre-existing individual - Low Value Account | 30 June 2016 | 30 June 2016 |
| Pre-existing individual – High Value Account on 30 June 2014 | 30 June 2015 | 30 June 2015 |
| Pre-existing individual – not a High Value Account on 30 June 2014 but became one by 31 December 2015 | Within six months of the relevant year end | Within six months of the relevant year end |
| New individual | On account opening | Procedures need to be in place from 1 July 2014 |
| Pre-existing entity with balance below US$250,000 at 30 June 2014 | Not until balance exceeds US$1,000,000 | Not until balance exceeds US$1,000,000 |
| Pre-existing entity with balance below US$250,000 on 30 June 2014 but exceeding US$1,000,000 by 31 December 2015 | Within six months of the relevant year end | Within six months of the relevant year end |
| Pre-existing entity with balance exceeding US$250,000 on 30 June 2014 | 30 June 2016 | 30 June 2016 |
| New entity account | On account opening | Procedures need to be in place from 1 July 2014 |
As mentioned above, in respect of the US IGA and US FATCA, a the Cayman Islands based Financial Institutions that is significantly non-compliant with the US IGA and in the US Regulations, will be subject to a 30% withholding tax on US source income.
As the UK IGA is not part of a withholding tax regime, there is no withholding tax that will arise as a result of being regarded as significantly non-compliant.
If corrupted or incomplete information is reported, the Cayman TIA will give the Reporting FI an opportunity to resolve the problem, which could lead to information having to be resubmitted. Compliance measures may be exercised by the Cayman TIA if the error is considered to contravene the FATCA Regulations. Continual or repeated administrative or minor errors could be considered as significant non-compliance where they disrupt and prevent transfer of the information.
Significant non-compliance (e.g. repeated failure to file a return or repeated later filing, ongoing or repeated failure to establish appropriate due diligence processes, deliberate or negligent omission of required information) may be determined by the IRS (in relation to the US IGA) or HMRC (in relation to the UK IGA) or in either case the Cayman TIA. Upon notification of significant non-compliance, there will be an 18-month period for the Financial Institution to resolve the non-compliance and if it does not so resolve the issue, under the US IGA only, the FI will be considered a Non-participating Financial Institution.
The Cayman TIA may also exercise its compliance measures under the FATCA Regulations.
For the purposes of determining whether information provided by a FI was correct and complete, the Cayman TIA may request that the FI to provide or make available information including copies of relevant books and records (“Disclosure Regulation”).
A Reporting FI which:
commits an offence and is liable on summary conviction to a fine of five thousand dollars, or in the case of subparagraphs 1), 3), 4), 5) and 6) to imprisonment for a term of 2 years, or to both. That offence can be considered to be committed by any director, manager, secretary or other similar officer of the body corporate where the offence committed by the relevant body corporate is proved to have been committed with the consent or connivance of, or to be attributable to any neglect on the part of, any such person who was purporting to act in the capacity of director, manager, secretary or other similar officer of the body corporate.
In practice, it is likely that most Funds’ administrators will take on the due diligence requirements as they typically deal with existing onboarding and KYC requirements. It will be extremely important for an entity to show that it has taken the due diligence requirements seriously and that such procedures are auditable so that it can prove what steps it has taken.
Any technology/software solution that a Cayman entity invests in to deal with FATCA should not be limited to a FATCA only solution. Other countries are developing their own FATCA reporting regime (e.g. China) and it is increasingly likely that the regulatory landscape will change and a global FATCA reporting regime could be implemented.
1 The term “Financial Account” means an account maintained by a Financial Institution, and includes: (i) in the case of an Entity that is a Financial Institution solely because it is an Investment Entity, any equity or debt interest (other than interests that are regularly traded on an established securities market) in the Financial Institution; (ii) in the case of a Financial Institution not described in subparagraph (i), any equity or debt interest in the Financial Institution (other than interests that are regularly traded on an established securities market), if [(i) the value of the debt or equity interest is determined, directly or indirectly, primarily by reference to assets that give rise to U.S. Source Withholdable Payments, and (ii)] the class of interests was established with a purpose of avoiding reporting in accordance with the [relevant] IGA; and (iii) any Cash Value Insurance Contract and any Annuity Contract issued or maintained by a Financial Institution, other than a noninvestment-linked, nontransferable immediate life annuity that is issued to an individual and monetizes a pension or disability benefit provided under an account that is excluded from the definition of Financial Account in Annex II. Notwithstanding the foregoing, the term “Financial Account” does not include any account that is excluded from the definition of Financial Account in Annex II of the relevant IGA.
2 The term “Specified Person” means: (i) in respect of the US IGA, a U.S. citizen or resident individual, a partnership or corporation organized in the United States or under the laws of the United States or any State thereof, a trust if (i) a court within the United States would have authority under applicable law to render orders or judgments concerning substantially all issues regarding administration of the trust, and (ii) one or more U.S. persons have the authority to control all substantial decisions of the trust, or an estate of a decedent that is a citizen or resident of the United States, subject to certain exceptions set out in the US IGA; and (ii) in respect of the UK IGA, a person or Entity who is resident in the United Kingdom for tax purposes, and includes a person or Entity who is resident in both the United Kingdom and the Cayman Islands, under the respective domestic law of country, subject to certain exceptions set out in the UK IGA..
3 An “Active NFFE” is essentially an entity that conducts an actual business activity other than holding assets that produce investment income such as interest, dividends etc and less than 50% of that entity’s gross income for the preceding year is passive income (i.e. income other than trading income) and less than 50% of its assets are assets that produce passive income. A Passive NFFE is any NFFE that is not an Active NFFE.
4 “Controlling Person” means a natural person who exercises direct or indirect control over an entity. For this purpose, a 25% ownership threshold applies for companies, partnerships, trusts and foundations.
5 An entity is a “Related Entity” of another entity if either entity controls the other entity, or the two entities are under common control. For this purpose control includes direct or indirect ownership of more than 50 percent of the vote or value in an entity. Notwithstanding the foregoing, the Cayman Islands may treat an entity as not a Related Entity of another entity if the two entities are not members of the same expanded affiliated group as defined in section 1471(e) (2) of the U.S. Internal Revenue Code.
6 “Reportable Account” in relation to a Reporting FI, means:
7 “Nonparticipating Financial Institution” means a Financial Institution that is not compliant with US FATCA by virtue of either (i) the FI is located in a jurisdiction that does not have an IGA and the FI has not entered into an agreement with the IRS or (ii) the FI is classified by the IRS as being a Non-participating Financial Institution.
8 This note does not include consideration of what entities might fall within the Registered Deemed Compliant category pursuant to the US Treasury Regulations. However, this is covered in the Guidance Notes.
This publication is for general guidance and is not intended to be a substitute for specific legal advice. Specialist advice should be sought about specific circumstances.
This publication is for general guidance and is not intended to be a substitute for specific legal advice. Specialist advice should be sought about specific circumstances.
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