Finance brief - April 2013
- New regime for registering charges at Companies House
- FATCA: better news for Lenders
- Is your default interest clause enforceable?
- Appropriation of shares and relief from forfeiture
- Security over Art: an introduction
- Margin lending: a brief introduction
This note outlines some of the issues lenders in the UK primary market need to consider in relation to FATCA.
FATCA was introduced by the US legislators to counter tax evasion by US tax payers holding assets outside the US.
So far as the UK loan market is concerned, FATCA potentially applies in the following circumstances:
- A non-US bank or other financial institution ("FFI")
- Fails to disclose details of accounts of a US account holder
- Potential 30% withholding tax is payable on all interest and fees (and from January 2017 on principal) paid by US borrower and paid from US source to FFI
- Only applies to loans advanced or committed from 1 January 2014 (unless there is a material modification to existing loans after that date).
Doesn't apply if:
- US bank or other financial institution
- No US borrower or guarantor or agent and no US source of payment under the facility.
If it applies it raises the following potential issues for lenders:
- If they don't sign up to FATCA and are not deemed FATCA compliant, they may face a punitive withholding tax
- Disclosing information to the IRS would potentially put lenders in breach of data protection and confidentiality obligations to their customers
- But a US/UK agreement makes UK lenders who meet the requirements of that agreement "deemed FATCA compliant", eliminating FATCA withholding risk on payments to those lenders - lenders may seek increasingly to lend from jurisdictions which have an appropriate IGA in place such as the UK and to consider carefully assignability issues in FATCA context
- Subject to that, question is who should bear the burden of any FATCA withholding tax risk, the lender of the borrower?
What is FATCA?
The term refers to the Foreign Accounts Tax Compliance Act ("FATCA") provisions of the US HIRE Act 2010, which are intended to counter tax evasion by US taxpayers holding assets outside the US. Final regulations under FATCA were issued on 17 January 2013.
How does it operate?
FATCA invites foreign (i.e. non-US) financial institutions ("FFIs") to sign agreements with the Internal Revenue Service ("IRS") to disclose details of their US account holders. If they fail to do so they face a punitive 30% withholding tax on, in the case of lenders, all "withholdable payments" made to them from a US borrower or from a US source, being interest and fees (from 1 January 2014) and principal (from 1 January 2017). This would affect payments by such a borrower to a non-participating FFI lender or agent, and by a participating agent to a non-participating FFI lender. Payments to "non-financial foreign entities" may also be affected, but this is of limited relevance for present purposes. But where there is no US obligor, or no FFI borrower, and no US source of payment (or prospect of any) under a facility, FATCA should generally be irrelevant.
If a borrower is itself a participating FFI, then there is potentially also "passthru withholding" (from 2017 at the earliest) on payments to a non-participating agent, and on payments by a participating agent to a non-participating lender, at 30% times the borrower's "passthru percentage", being broadly its percentage of US to total assets. This might apply even in deals with no US nexus. These parts of FATCA are yet to be finalised.
Why did this cause FFIs a dilemma?
The intention was that FFIs would feel compelled to sign up to FATCA. But the exact scope of FATCA was unclear. Agreeing to disclose information to the IRS would potentially put FFIs in breach of their data protection and confidentiality obligations to their customers. Quite apart from that, FATCA would – and still does – impose a considerable compliance burden.
What is the UK-US Agreement?
The UK, France, Germany, Italy and Spain approached the US authorities and two forms of model intergovernmental agreement ("IGA") were agreed to address some of these issues. Such an agreement was signed between the UK and the US on 12 September 2012, and the UK government has been consulting on the detail of how it will operate. Agreements have also been signed or initialled between the US and Denmark, Ireland, Italy, Germany, Mexico, Norway, Spain and Switzerland, and others are likely to follow.
Under the UK/US agreement UK financial institutions may, rather than themselves signing up to FATCA, become deemed FATCA compliant by registering with the IRS and agreeing to provide information on accounts held by US persons (i.e. US citizens or corporations and entities they control) and non-participating financial institutions to HM Revenue & Customs. In turn HMRC will pass this information on to the IRS either through existing arrangements, or as permitted by new regulation. A compliant or deemed compliant UK FFI will not have to operate FATCA withholding or be subject to it, but will have to provide relevant information to a US borrower itself obliged to withhold.
It seems likely that FFIs in countries that sign IGAs similar to the UK/US agreement (including of course the UK) will not be required to apply passthru withholding on payments they make to other FFIs, whether FATCA compliant or not, and indeed that FATCA withholding risk may be of limited concern to such an FFI lender in the absence of significant and sustained failure to meet its reporting obligations (and provided that there are no other lenders or possible future lenders not able to rely on an IGA).
Where other lenders or future lenders are not protected by an IGA, there could be a credit risk issue for other lenders that are protected, because any FATCA witholding and gross-up could impact on the credit rating of the borrower.
What about grandfathering?
Loans advanced or committed prior to 1 January 2014 – a period recently extended from 1 January 2013 – are "grandfathered" and fall outside the scope of FATCA, but care will be needed if they are materially amended (as a matter of US tax law) after that date, since that might result in the benefit of grandfathering being lost. It is not yet clear when FATCA regulations dealing with passthru withholding will be issued, or even whether they will apply to loans at all, but the IGA approach means that in many cases no such passthru withholding should be required, making grandfathering irrelevant.
Lenders would be well advised to review their loan portfolios, where the loans will subsist beyond 1 January 2014, in order to assess the FATCA impact and to make any changes to the loan agreements as necessary. Such changes should be made before the end of 2013 in order that the changes themselves do not upset grandfathering.
How are loan agreements being amended?
There is no single drafting solution for FATCA. It involves allocating a withholding tax risk that has not historically been dealt with by English law loan documentation. Although English practice is, in broad terms, that withholding tax risk is borne by the borrower, a fair allocation in the case of FACTA is more open to debate, given that a lender can generally control whether it not it is FATCA compliant. The standard US approach is to treat FATCA withholding as a lender risk.
The Loan Market Association ("LMA") has not added FATCA provisions to its model forms of loan agreement as standard. It has, however, published three forms of model clause by which FATCA can be treated as a borrower or a lender risk. The latest versions of these were released on 23 January, and are intended for use in deals entered into in 2013. There is also some debate in the market about the LMA's interpretation of FATCA.
A borrower risk approach is likely to comprise a representation by the borrower that it is outside the scope of FATCA (e.g. it is not a US person and will not make payments from a US source), and/or a gross-up and indemnity obligation if the borrower or another obligor is obliged to make a FATCA withholding. Lenders may adopt this approach because, for example, they are not certain that they will be able to satisfy FATCA reporting requirements within applicable time limits and so be FATCA compliant. Commercially, however, this approach may only be acceptable where no FATCA withholding obligation is anticipated, and in particular for facilities entered into in 2013.
In the case of a syndicated facility, the view may be taken that making FATCA a borrower risk is necessary to facilitate syndication or on-sale, or required to give assurance to a non-IGA agent concerned about agent-level withholding. Finance parties may also want a right to withhold themselves if required to do so, and an obligation by the borrower to compensate them for any shortfall if this is done. If this approach is taken, a borrower is likely to require a right to prepay or replace any lender that triggers a FATCA withholding. It may still be acceptable to lenders after 2013 if coupled with a borrower representation that it is not US tax resident or paying with US source income.
The LMA's two lender risk approaches allow the borrower or other obligor to make a withholding if required to do so by FATCA, without being required to gross-up, meaning that there is a FATCA carve out from the gross-up provisions. The first version relies on the FATCA grandfathering provisions and, given the extension of the grandfathering period, may be used for deals closed in 2013 even though there are US or FFI borrowers. It requires all lender consent to an amendment or waiver that might cause the benefit of grandfathering to be lost. If the borrower overrides a lender's veto and FATCA withholding arises, it must repay or replace that lender, with optional wording to restrict the class of lenders protected in this way. The second version simply provides that all parties are entitled to make any withholding required by FATCA without being obliged to gross-up. From a finance party's perspective this is only suitable if it is satisfied that it will be FATCA compliant within applicable time limits and, where applicable, that such a provision will not affect its ability to syndicate or on-sell. A UK lender under a bilateral facility may also accept such a provision if satisfied that it will be FATCA compliant, particularly as it appears that it would only lose the benefit of the UK/US treaty for significant and persistent non-compliance with its reporting requirements.
As the LMA envisages, additional provisions will be appropriate, such as a requirement by each party to provide information about its FATCA status on request, and to extend protection to security trustees.
How do I identify customers subject to FATCA?
Outside the loan markets one result of FATCA, as financial institutions in the UK will be well aware, has been to require them to undertake what has often been a major due diligence exercise to identify which of their customers will be subject to FATCA. As mentioned above, under the UK/US agreement, information on their US accountholders must be supplied to HMRC, subject to the accounts reaching applicable minimum thresholds. The process is intended to be aligned with their customer due diligence obligations under UK anti-money laundering regulations. Mandates will commonly now include a declaration that the customer has no US resident status, where this can be given.
How can we help?
We will be pleased to provide detailed advice on FATCA, and where necessary on how documents should be amended to meet any challenge that it poses. Please speak to your usual contact at Fieldfisher for further information.
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