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UK trustees cannot afford to ignore US FATCA law

Thursday, 26 September, 2013

Practitioners who thought that UK-based trusts with no American connections were exempt from the US Foreign Accounts Tax Compliance Act may have been too optimistic.

FATCA comes into effect in January 2014, though most of its practical consequences do not start to bite until July. The most important one is that 'foreign (i.e. non-US) financial institutions' or FFIs, such as banks, and certain non-US non-financial entities or NFFEs will have to report their US clients to the US Internal Revenue Service, either directly or through their own national tax authorities, and to cease dealing with those clients if the IRS so requests. Anybody that fails to comply will see a 30 per cent withholding tax being applied to income from its US investments.

Trusts classified as NFFEs will generally need to review their beneficiaries, fiduciaries and office holders to determine if there is any substantial US owner or US controlling person, and be able to make appropriate certifications accordingly, according to law firm Withers. 'Non-US trusts and corporate fiduciaries must be prepared to identify their default or desired status under FATCA and understand what is required to prove and maintain that status', it says.

While the implementation of FATCA rules was being negotiated with the UK authorities, there were hopes that some trusts at least, such as family trusts with lay trustees, would be exempted or 'deemed compliant' so that they would not have to make FATCA reports. However, following recently issued guidance from HM Revenue & Customs, it now appears that UK trusts may have to register for FATCA reporting if they hold any financial investments managed by a third party financial institution, apart from a simple bank account.

Thus if the trustees do not register their trust with the IRS before 31 December 2013, financial institutions holding their investments may be required to apply the 30 per cent FATCA withholding tax of payments due to the trust, says George Hodgson, STEP's Deputy Chief Executive. 'The family trust concept, while floated initially in the US regulations, did not really survive the translation into the US-UK intergovernmental agreement on FATCA', he says.

There are now three main trust categories of concern to practitioners, Hodgson explains:

  • Trusts with a trustee who is a 'reporting financial institution', typically a corporate entity. In these circumstances the trust is a 'trustee documented trust' and does not need to register for FATCA reporting. But the trustee does need to register, and will have to report on the trusts for which it acts as trustee.
  • If the trust is not a trustee documented trust, the next test examines if the trust has an 'investment entity' responsible for managing the trust or its assets – for example because the trust has engaged a fund manager on a discretionary basis. If it does, the trust is also deemed to be an investment entity and does need to register and report. It is possible that trusts in this position can acquire the status of ‘sponsored investment entities’ if they can arrange for another financial institution to report for them.
  • Trusts that do not fall into either of the above groups are generally NFFEs and need not register or make FATCA reports. Instead they will be reported on by the financial institutions they interact with.

HMRC expect the majority of UK trusts to fall into the first and last category above, but clearly significant numbers of UK trusts will fall into the investment entity grouping. STEP's UK Practice Committee is particularly concerned that this category was poorly understood by practitioners.

STEP and other professional bodies are in the process of drafting more detailed guidance to supplement that already issued by HMRC.

Sources