Do Your FATCA & CRS Due Diligence
Private equity and venture capital (PE/VC) firms can save a lot of grief with their international tax requirements by setting up parameters for their investor onboarding and reporting processes.
International firms are often subject to the Foreign Account Tax Compliance Act (FATCA) and the Common Reporting Standard (CRS)—more details are provided here—oftentimes qualifying as Foreign Financial Institutions (FFI). These international provisions come with stringent reporting requirements that if not followed, could stick PE/VC firms and their investors with steep fines.
Invest in Your Investor Onboarding Processes
Due diligence is a FATCA requirement for new investors who invest in funds on or after July 1, 2014, and a CRS requirement for investors on-boarded on or after Jan. 1, 2016. PE/VC firms will need to ensure they have a thorough review process for obtaining onboarding materials, including IRS Forms W-8/9, together with supplemental information (ex. a withholding statement), and CRS Self-Certifications. This enables downstream FATCA and CRS reporting as well as other U.S. tax return compliance areas, such as IRS Forms 1042-S, 8966, 8805 and Schedules K-1.
Due diligence processes should verify that all of the PE/VC firm’s new investors’ tax forms include the investor’s name (reconciled to the account holder name of record) and are validated through proper completion, inclusive of any treaty rate claim. Firms will also want to ensure that submitted forms are the most recent revisions available, which can be verified through the IRS website.
No standard template for CRS self-certification exists. There are some templates to follow, including one from OECD (originator of the CRS). Other templates exist for certain jurisdictions (like this one for the Cayman Islands), or for certain financial institutions (like this one from Citi Bank). Although there is no set template, there are some general rules, including separate versions for entities and individuals.
PE/VC firms should have processes that verify the self-certification forms are complete and that the forms include the investor’s name (reconciled to the account holder name of record). Firms will need this investor information to meet their funds’ CRS filing requirements. Note that even if the investor is marked as U.S. (i.e. the investor does not operate in a CRS-participating jurisdiction), the investor may have CRS-participating jurisdiction controlling persons behind them that are reportable.
As an added measure of FATCA and CRS compliance, the PE/VC firm should exercise reasonableness in validating forms and self-certifications by leveraging other information obtained from the investor in connection with opening the account. This includes documentation collected pursuant to anti-money laundering or know your customer procedures.
The jurisdictions where your investors may have reporting obligations plays a part in the due diligence process as well. In some instances, there are requirements for the length of time permitted for a review of CRS self-certification forms. For example, in the Cayman Islands, Luxembourg and United Kingdom, there is a regulatory requirement to suspend/close accounts when a self-certification is not validated within 90 days of account opening.
Document Your Due Diligence Process
To verify they have checked all the boxes on the intake process, PE/VC firms may want to thoroughly document their due diligence process for onboarding new investors. Documentation can help ensure that due diligence procedures are followed by internal staff and that the proper controls are in place to comply with FATCA and CRS.
Keep Up the Work on Investor Forms
Firms can save themselves a lot of hassle by making sure that processes and protocol address problems on the front end with proper due diligence as part of the onboarding process, but due diligence should continue throughout the life of the fund. Forms require monitoring through changes in circumstances, investor transfers and expiration. If a lapse in validity occurs, the PE/VC firm could be assessed penalties for noncompliance with Chapter 3 FDAP withholding or Chapter 4 FATCA noncompliance. Additionally, the investor may be subjected to unnecessary U.S. withholding tax, straining the future of the relationship.
Due Diligence for FFI Reporting
Another area that firms will want to monitor is their fund/entity level FATCA and CRS filing requirements. Failing to comply with due diligence procedures, and failing to file the proper reports could come with steep penalties, depending on the jurisdiction affected. A designated financial institution operating in Luxembourg, for example, could face a fine up to €250,000, or 0.5% of the amounts that should have been reported.
If a U.S. PE/VC firm had a Form 8938 filing requirement, it could be subject to a $10,000 failure to file penalty, with an additional penalty of up to $50,000 if the filing is not addressed after an IRS notification.
Proper timing and submission of reporting should be incorporated into a firm’s international tax reporting due diligence procedures.
Managing Your Requirements
One of the ways that firms can help with their ongoing compliance monitoring is to identify and use software solutions for investor, and entity/fund, data management. They may also choose to have a tax preparer periodically review and validate the forms and self-certifications, confirming who is reportable from a FATCA and CRS perspective. For more information about FATCA and CRS due diligence, please contact us.