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7/31/2019 Hedge Fund Operational Due Diligence Corgentum Insights FATCA

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The Importance of Understanding FATCA

The Foreign Accounting Tax Compliance Act ("FATCA") is a 2010 US tax law which has implications forboth hedge fund managers and investors. Tax is an area that unfortunately causes many investors eyes

to glaze over during the operational due diligence process. The goal of analyzing tax structures during

due diligence is not to necessarily develop a formal tax opinion as would be received from an investors

tax advisers (i.e. - tax counsel or accountant) but rather to gain a better understanding of whether a

hedge fund's trading activities could potentially generate negative tax consequences for its investors.

Examples of common tax hedge fund and private equity tax issues which can fall into this classification

include an analysis of whether or not a fund may have generated or anticipates generating unrelated

business taxable income or effectively connected income, more commonly referred to as UBTI and ECI.

Furthermore, as with most things related to operational due diligence, the way in which a hedge fund

manager approaches detailed issues such as tax structuring can provide valuable operational insights

into the ways in which it approaches its larger business infrastructure.

What is FATCA?

FATCA, was formally enacted in March 18, 2010 with the

goal of preventing US citizens from tax evasion through

hiding income or assets abroad in foreign businesses. FATCA

applies to many different types of firms including hedge

funds and private equity funds both within the US and

international. FATCA technically classifies these non-US fund

managers, sometimes referred to as passive foreign

investment companies or PFIC in IRS jargon, as so-calledForeign Financial Institutions or FFIs.

The US is seeking to work in cooperation with international

governments to enforce FATCA. In 2012, the US Treasury and the IRS released a statement alongside

France, Italy, Germany, Spain and the US stating as much. The IRS' master plan is to allow non-US fund

managers to deal more directly with international tax authorities and then the IRS would step in to

collaborate.

Although FATCA was signed into law in 2010, it does not technically take effect until January 1, 2013.

Withholding for FATCA, what in IRS speak is known as so-called fixed or determinable annual or

periodical payments or FDAP, will not begin until January 1, 2014.

How do hedge funds and private equity funds comply with FATCA?

In order to comply with FATCA, fund managers must provide US Internal Revenue Service ("IRS") with

documentation on its investors. Specifically, those investors that have more than $50,000 invested

outside of the US. Similar to anti-money laundering documentation, these documents include certain

client

balances, receipts, withdrawals and account identification numbers.
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Why do investors need to understand FATCA?

Although FATCA will not take effect until 2014, there are a number of reasons why investors need to

inquire now about their fund managers plan to comply with FATCA. The penalties for non-compliance

are steep. If a fund manager violates FATCA, they will be penalized by a 30% withholding tax being

placed upon the foreign financial institutions US assets or sourced income. This is a materially negative

consequence and could have large negative implications for both investors and the fund.

Additionally, because FATCA is effectively a US tax regulation which has international implications, there

are privacy concerns raised. For instance a hedge fund may be required under FATCA to make FATCA

related disclosures to the Canadian regulators. Under Canadian privacy it is unclear whether such

disclosures may be mandated or voluntary in nature. Furthermore, a hedge fund manager which makes

such disclosures may be subjected to potential liability for violating privacy concerns.

Investors can often obtain some guidance in regards to how their hedge funds and private equity funds

approach FATCA by asking their fund managers how they plan to develop a plan to comply with FATCA.Typically, most fund managers seeking to develop a plan to comply with FATCA will work with external

accountants and legal counsel to address this issue. Some key questions investors can ask to gauge if a

fund manager has thought about FATCA and has developed a plan for compliance include:

Does the fund manager, or operations personnel, understand what FATCA is?

Do they understand the timeline by which they need to comply?

Has the fund spoken to their accountants and lawyers about FATCA?

What advice did they give the fund?

Has the fund begun to think of the specific details of FATCA compliance including:

(i) Identifying so-called "Responsible Officers" who must certify FATCA compliance

(ii) Developing a plan for fund offering

memorandum and subscription documents with FATCA disclaimers

(iii) Analyze internal AML/KYC procedures as well as the work with the fund's administrator

to ensure AML/KYC procedures will be appropriately in compliance with FATCA

(iv) Classify investors into FATCA groups and ensure FATCA compliant documentation on each

investor is maintained

During the operational due diligence process investors should take measures to effectively vet the

approach their fund managers take to FATCA before the IRS shows up at their door.
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Originally posted in the August 2012 edition of Corgentum Consulting's Operational Due Diligence

Insights.

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About Corgentum Consulting:

Corgentum Consulting is a specialist consulting firm which performs operational due diligence

reviews of fund managers.

The firm works with investors including fund of funds, pensions, endowments, banks ultra-high net-

worth individuals, and family offices to conduct the industry's most comprehensive operational due

diligence reviews. Corgentum's work covers all fund strategies globally including hedge funds, private

equity, real estate funds, and traditional funds. The firm's sole focus on operational due diligence,

veteran experience, innovative original research and fundamental bottom up approach to due

diligence allows Corgentum to ensure that the firm's clients avoid unnecessary operational risks.

2012 Corgentum Consulting, LLC
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