Enacted in 2010 by Congress as part of the Hiring Incentives to Restore Employment Act, the Foreign Account Tax Compliance Act (FATCA) was intended to prevent tax evasion by US taxpayers holding investments in offshore accounts. However, with foreign investors representing an increasing amount of capital for private equity real estate funds, rules affecting overseas institutions have become a nail-biter for the industry.
Under FATCA, certain US taxpayers with foreign financial assets of more than $50,000 are required to report those assets to the US Internal Revenue Service (IRS) or otherwise face penalties of $10,000 or more. Additionally, foreign financial institutions also must disclose to the IRS information about financial accounts held by US taxpayers or by foreign entities in which US taxpayers hold a large ownership interest.
The regulations have been worrisome for both private equity real estate firms and the foreign institutions that invest with them. Jim Fetgatter, chief executive of the Association of Foreign Investors in Real Estate in Washington DC, notes that FATCA will place an “extreme burden” upon a number of foreign financial institutions. Many of the association’s members, he says, “are very worried about the dampening effect it will have on investments into the US.”
Exacerbating the situation are the delays that have beset the implementation of FATCA. Foreign financial institutions originally were scheduled to begin registering with the IRS on January 1 of this year and enter into agreements with the agency by June 30 to identify US accounts, report certain information regarding those US accounts and withhold a 30 percent tax on certain US-related payments to non-participating foreign financial institutions and account holders unwilling to report the required information.
Those deadlines were pushed back to 2014, however, as the disclosures required under the new regulations conflicted with the privacy laws in many countries. Consequently, US Department of Treasury spent much of 2012 negotiating intergovernmental agreements with more than 50 jurisdictions around the world. In July and November 2012, Treasury published two model intergovernmental agreements that will serve as the basis for bilateral agreements with participating jurisdictions, which to date have included Mexico, Denmark and the UK.
Meanwhile, Treasury and the IRS have yet to issue final regulations that would provide many of the details on FATCA’s new information reporting and withholding tax provisions. Proposed regulations were issued in February 2012, but it remains unclear when the final regulations – originally expected to come out last fall and then by year’s end – will be released.
No time to rest
With deadlines extended and no final regulation in place, “almost everyone has put FATCA on the backburner,” says Harry Shannon, principal of international tax services at Ernst & Young. Firms, however, should begin their compliance efforts sooner rather than later, he advises.
In particular, firms should be collecting information that may be needed for disclosures under FATCA and consolidating that information in one place, since relevant documents currently may reside in different parts of the organization. Firms also should address withholding requirements, which could affect their cash flow, and keep foreign clients updated on how they are responding to the new regulations. Additionally, firms should examine their organizational structure and determine whether entities within the organization should be classified as a foreign financial institution or withholding agent under FATCA.
For real estate investment funds, Shannon believes that many of the worries surrounding FATCA largely are unfounded. While the compliance process may seem daunting, “in most cases, it’s not all that cumbersome for a real estate fund,” which typically has a fairly static array of investors and investments, he explains. “The requirements for real estate funds are much less of a burden than for an insurance company, pension plan or bank. It’s tedious and annoying, but completely manageable.”
Furthermore, FATCA’s impact on foreign investment in US real estate funds likely will not be a cause for major concern. While some foreign institutional investors have claimed they will no longer invest in the US because they do not want to comply with the new regulations, “it stands to reason that whenever you increase the cost and risk of an activity – investing in the US –you will get less of that activity at the margin,” says Shannon. “My feeling is that, at the end of the day, it will not be that substantial.”
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