FATCA: UK trusts under the UK/US IGA
George Hodgson explains why all UK trusts and trustees urgently need to consider the position of the trusts they administer, reflecting work by STEP, The Law Society of England & Wales and ICAEW examining how UK trusts will be affected by the UK/US Intergovernmental Agreement (IGA)
This guidance is relevant for all UK trusts and trustees, whether or not they have any known US connections.
This guidance has been prepared with the information to hand as of late December 2013. We anticipate that early 2014 may see both revised US FATCA Regulations and revised HMRC Guidance on the UK/US IGA. Given the urgency of trustees considering the position of the trusts they administer, however, we have published this note on a provisional basis and will aim to update it as soon as any such revised HMRC Guidance is available. This guidance only covers issues related to registration. We hope to publish further guidance later covering reporting requirements.
All UK trusts and trustees, whether or not they have any known US connections, need to consider their status under the UK/US IGA. If they are required to register with the Internal Revenue Service (IRS) under the agreement, they must do so by 25 October 2014.
This note is intended to help trustees and their advisors and is based on our current understanding of Guidance published by HMRC in 2013. This Guidance is subject to change. Specialist advice should be sought in cases of doubt.
The UK has also recently signed IGAs with the Crown Dependencies. These IGAs will use similar, but not identical, processes to determine the status of trusts.
The UK/US IGA puts trusts into two broad categories:
- Financial Institutions (FIs)
- Non-Financial Foreign Entities (NFFEs)
The category a trust falls into depends on both the nature of the trust’s assets and the nature of the trust’s trustees (and fund managers, if applicable). Taken together, these will determine who reports on the trust and whether or not the trust needs to register with the IRS under FATCA. If you act as a trustee, there may well therefore be implications for what you should be doing as a trustee. Moreover in some circumstances the trustee (rather than the trust) is required to register with the IRS.
Generally, a trust will be an FI where:
- the trustee is an FI;
- the trustee (on behalf of the trust) engages an FI to manage the trust; or
- the trustee (on behalf of the trust) engages an FI to manage the financial assets for the trust.
In order to determine what category a trust falls into, there are a number of questions trustees need to address. These are illustrated in the below flowchart (click on the picture to enlarge). The following gives further guidance on those questions.
Section A: Is the trust a Financial Institution or an NFFE?
Question 1: Is the trust UK tax resident?
If ‘yes’, go to Question 2.
‘If all the trustees are resident in the UK for tax purposes then the trust is UK resident. Where some of the trustees, but not all are UK tax resident then the trust is to be treated as UK resident if the settlor is both resident and domiciled in the UK for tax purposes.’ (UK Guidance, page 11)
If ‘no’, the trust is not subject to UK IGA reporting but may be subject to reporting either under US FATCA regulations or under an another IGA. Only UK tax resident trusts fall under the UK/US IGA.
Question 2: Is the trust a charitable trust?
If the answer is ‘no’, go to Question 3.
If ‘yes’, the trust is a Deemed Compliant Financial Institution. The trust is categorised as a Non-Reporting United Kingdom Financial Institution and does not need to register or report under FATCA.
This applies to:
‘a. Any entity registered as a charity with the Charity Commission of England and Wales
b. Any entity registered with HMRC for charitable tax purposes
c. Any entity registered as a charity with the Office of the Scottish Charity Regulator.’ (UK Regulations Annex II.II.A)
The UK Regulations are silent on the issue of charities regulated by the Charity Commission for Northern Ireland.
Question 3: Does the trust act for customers and is 50 per cent or more of the trust’s gross income attributable to trading in money market instruments, etc, portfolio management or the investment and administration of funds?
If the answer is ‘no’, go to Question 4. Family trusts will generally not be undertaking activities on behalf of a customer, so most will pass on to Question 4.
If the answer is ‘yes’ the trust is an Investment Entity and therefore a Financial Institution. The trust may need to register with the IRS as a Foreign Financial Institution and report (see Section B).
‘The term “Investment Entity” means any entity that conducts as a business (or is managed by an entity that conducts as a business) one or more of the following activities or operations for or on behalf of a customer:
- trading in money market instruments (cheques, bills, certificates of deposit, derivatives, etc.); foreign exchange; exchange, interest rate and index instruments; transferable securities; or commodity futures trading;
- individual and collective portfolio management; or
- otherwise investing, administering, or managing funds or money on behalf of other persons.’ (UK/US Agreement (‘The Treaty’), Article 1.1.j)
An Investment Entity ‘conducts as a business’ in this context ‘if the entity’s gross income attributable to such activities is equal to or exceeds 50 per cent of the entity’s gross income during the shorter of:
- The three-year period ending on 31 December of the year preceding the year in which the determination is made; or
- The period during which the entity has been in existence.’ (UK Guidance, Section 2.28)
Family trusts will generally not be undertaking activities on behalf of a customer, however, so most will pass on to Question 4.
Question 4: Is the trust ‘managed’ by an entity that acts for customers and where more than 50 per cent of gross income is attributable to a business trading in money market instruments, etc, portfolio management or the investment and administration of funds.
If the answer is ‘no’, go to Question 5.
If the answer is ‘yes’, the trust is an Investment Entity and therefore a Financial Institution and may need to register with the IRS. See Section B.
‘Managed’ is undefined in the UK regulations, but the US Regulations (§1.1471-5(e)(4)(v) Example 5) indicate that any financial institution undertaking the activities of an investment entity on behalf of the trust, typically either as a trustee or as discretionary fund manager, will be deemed to be a manager of the trust in this context. UK Guidance suggests that with regard to trusts, ‘professionally managed’ ‘would typically be where the trustees have appointed a discretionary fund manager to manage the trust’s assets’. UK Guidance also confirms that a trust will not become an investment entity if ‘it simply holds a Depository Account with a Financial Institution where that Financial Institution does not manage the account.’ (UK Guidance, Section 2.36)
Question 5: Is more than 50 per cent of the trust’s income attributable to investing, reinvesting or trading in financial assets?
If the answer is ‘no’, the trust is a Non-Financial Foreign Entity (NFFE). See Section C.
If the answer is ‘yes’, the trust may be an Investment Entity subject to the answer to Question 6.
It should be noted that this question covers income from a slightly different range of activities than those covered in Question 3. The so called ‘financial assets test’ examines if the gross amount of the income of its business as carried on in the United Kingdom for the applicable period wholly or mainly derives from investing or dealing in –
‘(a) assets capable of being the subject-matter of a transaction that is an “investment
transaction” within the meaning of regulation 14F of Part 2B of the Authorised
Investment Funds (Tax) Regulations 2006(d),
(b) insurance or annuity contracts,
(c) commodities, or
(d) derivative contracts within the meaning of Part 7 of CTA 2009(a).’ (UK Regulations, 3(5))
UK Guidance therefore highlights a trust ‘whose assets consist of non-debt direct interests in real property or land, even if managed by another Investment Entity, would not be an Investment Entity’. (UK Guidance, Section 2.28, page 40)
Question 6: Is the trust managed by a Financial Institution?
If the answer is ‘yes’ the trust is an Investment Entity and therefore a Financial Institution. See Section B. Note our comments on the term ‘managed’ under Question3.
If the answer is ‘no’ the trust is an NFFE. See Section C.
Section B: Trusts that are Financial Institutions
Dependent on the nature of the trustee, trusts that are Financial Institutions may have to register and report directly under the IGA or have the option to appoint a third party to fulfil their requirements under the IGA. In some circumstances, however, the trustee is required to register and report on the trust.
Question 7: Does the trust have a ‘Reporting Financial Institution’ as trustee?
If ‘yes’ the trust is a ‘Deemed Compliant Financial Institution’ and is regarded as a ‘Trustee Documented Trust’. This is defined as:
‘A trust established in the United Kingdom to the extent that the trustee of the trust is a Reporting US Financial Institution, Reporting Model 1 FFI, or Participating FFI and reports all information required to be reported pursuant to the Agreement with respect to all US Reportable Accounts of the trust.’ (UK Regulations Annex II, II.D)
Any corporate entity acting as a trustee may be an FI under the IGA. In these circumstances, the trustee will need to register and report on the trust. The trust itself, however, is a Non-Reporting UK Financial Institution and does not need to register or report.
If the answer to Question 7 is ‘no’, the trust will need to either register with the IRS as a Foreign Financial Institution and report directly or if preferred it can appoint a third party to fulfil its reporting obligations; or the trust can opt to become a Sponsored Investment Entity, a Sponsored Closely Held Investment Entity or an Owner Documented Financial Institution.
The IRS registration portal gives instructions, a user guide and other materials to assist with FATCA registration.
On or after 1 January 2014, each FI will be expected to finalise its registration information by logging-in to its online account on the FATCA registration website, making any necessary additional changes, and submitting the information as final. Once registration is finalised and approved, registering FIs will receive a notice of registration acceptance and will be issued a Global Intermediary Identification Number (GIIN). The GIIN will enable the trust to interact with other Financial Institutions.
The IRS will electronically post the first IRS Foreign Financial Institution (FFI) List by 2 June 2014. To ensure inclusion in the June 2014 IRS FFI List, an FI will need to finalise its registration by 25 April 2014. The list will be updated monthly, but to ensure a smooth transition it may be prudent to ensure that relevant trusts are registered in time to appear on the first list. To meet the regulations, however, FIs do not need to be on the list until 1 January 2015 (prior to which date they can self-certify as an FI). To ensure inclusion on the January 2015 IRS FFI List, however, an FI must finalise its registration by 25 October 2014.
Third party service providers
Trusts that are categorised as Investment Entities may wish to consider using third-party service providers to meet their reporting obligations, although it is clear that all reporting obligations remain ultimately with the trust.
‘Each Party may allow Reporting Financial Institutions to use third-party service providers to fulfil the obligations imposed on them by a Party, as contemplated in this Agreement, but these obligations shall remain the responsibility of the Reporting Financial Institutions.’ (UK Agreement, Article 5.3.)
Sponsored Investment Entity
A Sponsored Investment Entity is a Registered Deemed Compliant Financial institution and will need to obtain, or have its sponsor obtain on its behalf, a GIIN from the IRS and submit annual returns to HMRC. (N.B. Following changes to US Regulations it is anticipated that these provisions may well be changed to require registration only after a US reportable account has been identified).
A Sponsored Investment Entity is an entity that has a contractual arrangement for its due diligence and reporting responsibilities to be carried out by a sponsoring entity. The Sponsoring Entity is an entity that is authorised to manage the sponsored Financial Institution and to enter into contracts on behalf of the sponsored Financial Institution. This option may of interest, for example, to a trust whose investments are managed on a discretionary basis by a fund management group. In these circumstances the trust would be an Investment Entity, but it could delegate its reporting under the IGA to the fund management group if the fund management group was prepared to be its sponsor.
A sponsor must register with the IRS as a sponsoring entity, and must, where a Sponsored Entity has reportable accounts, register each of the funds it manages with the IRS as ‘Sponsored Entities’. A Sponsored Entity will remain liable for any failure of its Sponsoring Entity to comply with IGA reporting obligations on its behalf.
The requirements for both Sponsored Investment Entities and Sponsoring Entities are outlined in US regulations (see 1.1471-5(f)(1)(i)(F)).
An Investment Entity can be a Sponsored Investment Entity provided that it is an Investment Entity that is not a Qualified Intermediary (QI), Withholding Foreign Partnership (WP), or Withholding Foreign Trust (WT) and an entity has agreed to act as a sponsoring entity.
The Sponsoring Entity must:
- Be authorised to act on behalf of the Sponsored Entity to fulfil the requirements of the FFI agreement.
- Be registered with the IRS as a Sponsoring Entity.
- Have registered the Sponsored Investment Entity with the IRS by the later of 1 January 2016, or the date that the Sponsored Entity identifies itself as qualifying.
- Agree to perform, on behalf of the Sponsored Entity, all due diligence, withholding, reporting, and other requirements that the Sponsored Entity would have been required to perform if it were a participating Financial Institution.
- Identify the Sponsored Entity in all reporting completed on the Sponsored Entity’s behalf.
Sponsored Closely Held Investment Vehicles
This category is similar to a Sponsored Investment Entity, which renders the trust a Registered Deemed Compliant Financial institution, but Sponsored Closely Held Investment Vehicles are instead certified Deemed Compliant Financial Institution and as such they do not need to register either directly or via their sponsor.
To qualify, the trust must be an Investment Entity that is not a US Qualified Intermediary, Withholding Foreign Partnership or Withholding Foreign Trust. The trust must also have a contractual arrangement with a Sponsoring Entity that is a Participating Financial Institution, Reporting Model 1 Financial Institution or US Financial Institution that is authorised to manage the Financial Institution and enter into contracts on its behalf under which the Sponsoring Entity agrees to all due diligence, withholding and reporting responsibilities that the Financial Institution would have if it were a Reporting Financial Institution.
Crucially, Sponsored Closely Held Investment Vehicles must not hold themselves out as an investment vehicle for unrelated parties and must have 20 or fewer individuals that own debt and equity interests (disregarding interests owned by Participating Financial Institution, Deemed Compliant Financial Institutions and an equity interest owned by an entity that is 100 per cent owner and itself a Sponsored Closely Held Investment Vehicle).
If these criteria are met, the Sponsoring Entity will have to register with the IRS as a Sponsoring Entity but it does not need to register the sponsored entities. The Sponsoring Entity will, however, be required to report on the Sponsored Entity.
Owner Documented Financial Institution
Owner Documented Financial Institutions are Certified Deemed Compliant Financial Institutions and as such are not required to register with the IRS and obtain a GIIN. UK Guidance states that this classification is ‘intended to apply to closely held Passive Investment Vehicles that are Investment Entities, where meeting the obligations under the Agreement would be onerous given the size of the entity.’
A trust may only be treated as an Owner Documented Financial Institution for payments received from and accounts held with a ‘Designated Withholding Agent’. A Designated Withholding Agent is a reporting Financial Institution that has agreed to undertake relevant due diligence and reporting. To qualify as an Owner Documented Financial Institution, the entity must:
- Be a Financial Institution solely because it is an Investment Entity.
- Not be owned by or in an expanded affiliated group with any Financial Institution that is a depository institution, custodial institution, or specified insurance company.
- Not maintain a financial account for any non-participating Financial Institution.
- Provide the Designated Withholding Agent with the necessary documentation and agree to notify the withholding agent if there is a change in circumstances.
- Secure the agreement of the Designated Withholding Agent to report the relevant information with respect to any specified persons.
The Designated Withholding Agent will need the following information (US Regulations 1.1471-3(d)(6)(iv)):
- The name, address, TIN (if any), and ‘Chapter 4 status’ (i.e. position under FATCA) of ‘every individual and specified US person’ that owns a direct or indirect equity interest in the owner documented FI (looking through all entities other than specified US persons).
- The name, address, TIN (if any), and chapter 4 status of every ‘individual and specified US person’ that owns a debt interest in the owner documented FI (including any indirect debt interest) in excess of USD50,000 (disregarding all such debt interests owned by ‘participating FFIs, registered deemed-compliant FFIs, certified deemed-compliant FFIs, excepted NFFEs, exempt beneficial owners, or US persons other than specified US persons’).
- Any other information the withholding agent reasonably requests in order to fulfil its obligations under FATCA.
As an alternative to the process outlined above, the Owner Documented Financial Institution can opt to provide an ‘auditor’s letter substitute’ (US Regulations, 1.1471-3(d)(6)(ii)).This requires the Owner Documented Financial Institution to provide a letter from an auditor or an attorney that is licensed in the US or whose firm has a location in the US, signed no more than four years prior to the date of the payment, that certifies that the firm or representative has reviewed the Owner Documented Financial Institution’s documentation with respect to all of its owners and debt holders described in that the Owner Documented Financial Institution meets the necessary requirements. The Owner Documented Financial Institution must also provide an owner reporting statement and a Form W-9, with any applicable waiver, for each specified US person that owns a direct or indirect interest in the Owner Documented Financial Institution or that holds debt interests. A withholding agent may rely upon the auditor’s letter substitute if it does not know or have reason to know that any of the information contained in the letter is unreliable or incorrect.
Section C: Trusts that are NFFEs
Trusts that are NFFEs must determine if they are ‘Active’ or ‘Passive’ NFFEs. The definition of a ‘Passive NFFE’ is simply any NFFE that is not an ‘Active NFFE’ (UK Regulations, Annex I.IV. B.3).
To be an active NFFE, a trust must meet one of a variety of criteria. The two most relevant for trusts are likely to be:
‘Less than 50 percent of the NFFE’s gross income for the preceding calendar year or other appropriate reporting period is passive income and less than 50 percent of the assets held by the NFFE during the preceding calendar year or other appropriate reporting period are assets that produce or are held for the production of passive income’ (UK Regulations, Annex I. IV.B.4.a);
or ‘Substantially all of the activities of the NFFE consist of holding (in whole or in part) the outstanding stock of, and providing financing and services to, one or more subsidiaries that engage in trades or businesses other than the business of a Financial Institution, except that an NFFE shall not qualify for this status if the NFFE functions (or holds itself out) as an investment fund, such as a private equity fund, venture capital fund, leveraged buyout fund or any investment vehicle whose purpose is to acquire or fund companies and then hold interests in those companies as capital assets for investment purposes’ (UK Regulations, Annex I. IV.B.4.e).
‘Passive income’ is not defined within the IGA agreement, but under the terms of the IGA can be assumed to have the same meaning as under UK law. This would suggest that it includes dividends, interest and royalties. While a UK trust can hold parent company and subsidiary shares among its assets, it cannot itself have a subsidiary.
It is worth noting, however, that the US FATCA regulations give a rather wider definition of ‘Active NFFE’, focusing on ‘related persons’ rather than ‘subsidiaries’. In particular, it defines as active income:
‘Any income from interest, dividends, rents, or royalties that is received or accrued from a related person to the extent such amount is properly allocable to income of such related person that is not passive income. For purposes of this paragraph (c)(1)(iv)(B)(1), the term “related person” has the meaning given such term by section 954(d)(3) determined by substituting “foreign entity” for “controlled foreign corporation” each place it appears in section 954(d)(3)’ (1.1472-1(c)(1)(iv)(B)(1))
UK Guidance (Page 8) indicates that ‘where a Financial Institution identifies an alternative element of the US Regulations or alternative element of a different Intergovernmental Agreement that it feels it would like to apply then it should contact HMRC to discuss the issue’.