From JDSupra

The UK and the Cayman Islands recently entered into an agreement to improve international tax compliance (ITC). Similar to the US Foreign Account Tax Compliance Act (FATCA), the ITC imposes wide-ranging UK financial reporting obligations on financial institutions in the Cayman Islands, and may subject non-compliant financial institutions to legal sanctions. The UK has entered into similar agreements with Bermuda, Montserrat, Turks and Caicos, the British Virgin Islands, Anguilla, the Isle of Man, Guernsey, Jersey and Gibraltar. This article focuses on the Cayman Islands ITC, but similar treatment will apply under the agreements with the other jurisdictions.

The ITC and FATCA

The ITC closely follows the US and UK’s FATCA Intergovernmental Agreement (IGA). FATCA aims to prevent tax evasion by US taxpayers through the use of offshore accounts, by requiring foreign financial institutions (FFIs) to report to the US Internal Revenue Service (IRS) certain information regarding US account holders. Non-compliance by an FFI can lead to a 30% withholding tax on US source payments distributed to the FFI. Under the IGA, UK financial institutions must report the information due under FATCA to HMRC instead of to the IRS. HMRC must, in turn, provide this information to the IRS.

Unlike FATCA, non-compliance under the ITC will not lead to withholding on UK source payments. However, failure to provide information may subject a financial institution to sanctions under Cayman domestic law.

Scope of the ITC

The ITC applies to Cayman financial institutions (FIs). The definition of “financial institution” is broad and encompasses most Cayman-domiciled investment funds or funds that have a branch in the Cayman Islands. Cayman FIs will be required to report in respect of UK “reportable accounts”, which are financial accounts maintained by an FI for UK resident individuals and entities.1 FIs will need to go through the procedures described below to determine if an account is a UK reportable account. Reportable information includes the name, address, date of birth and UK national insurance number (where relevant) of the UK account holder, along with the name of the FI and account balance or value. For custodial accounts, the gross amount of interest and gross amount of dividends will also be reportable.

Procedures

The necessary due diligence procedures under the ITC depend on: (a) whether the account is maintained for an individual or an entity; (b) the US dollar value of the account; and (c) whether the account has been “pre-existing” as of 30 June 2014.

Pre-Existing Individual Accounts

For individuals, pre-existing accounts fall into three categories: (i) excluded accounts; (ii) lower value accounts; and (iii) higher value accounts.

FIs have no obligation to review, identify or report “excluded accounts”, which are:

pre-existing individual accounts with a balance or value of $50,000 or less as of 30 June 2014;

pre-existing individual accounts that are cash value insurance contracts and annuity contracts with a balance or value of $250,000 or less as of 30 June 2014; and

depositary accounts with a balance or value not exceeding $50,000.

Lower value accounts are those pre-existing accounts with a balance or value of between $50,000 and $1,000,000. FIs must search electronically maintained data for these accounts for key UK indicators such as UK tax residency, UK mailing or residential address, power of attorney or signing authority in the UK (UK Indicia). Any accounts with UK Indicia must be treated as UK reportable accounts. If any accounts subsequently have any of the above UK Indicia, they must be treated as UK reportable accounts at the date of discovery.

Higher value accounts are those accounts above $1,000,000 in value (HVA). In addition to an electronic search (as above), FIs must search paper records if the electronic database does not capture all of the UK Indicia. Further, FIs must ask any relationship manager responsible for a HVA whether such manager has actual knowledge that the account holder is a UK person/entity. If so, the respective account will be treated as a reportable account. Additional procedures apply to accounts not initially high value but which subsequently become high value.

New individual accounts (those opened on or after 1 July 2014) will be subject to different rules, as follows:

There will not be an obligation to review, identify or report depositary accounts and cash value insurance contracts not exceeding $50,000.

For all other new individual accounts, a self-certification must be obtained and the FI will need to determine whether the account is a UK reportable account.

Pre-Existing Entity (Non-Individual) Accounts

If the account or balance for an entity does not exceed $250,000 as of 30 June 2014, it will not be subject to review. However, if it exceeds $1,000,000 as of 31 December 2015, the FI will need to determine whether the entity is a UK specified person, by reviewing information maintained for regulatory or customer relationship purposes.

Aggregation of Accounts

In determining an account value or balance, FIs must aggregate all accounts they hold for that entity/individual.

Practical Consequences for Cayman Funds and Other Offshore Funds

Information relating to calendar year 2014 must be provided to HMRC by the Cayman Islands no later than 30 September 2016. No date has been set for the provision of information by FIs to the Cayman Islands Tax Authority, but a working group has been established to finalise the domestic Cayman rules. Draft legislation and regulations are expected in May 2014.

It remains to be seen how closely the Cayman domestic reporting regulations will mirror the FATCA equivalents. It is not yet clear whether the ITCs will allow for a “sponsoring entity” concept (as exists with FATCA) to enable FIs to delegate responsibility for compliance to the fund manager (which may act as the manager of multiple funds) or another service provider, although it is anticipated that such arrangements will be permissible.

FIs will already have incurred time and expense preparing for FATCA. As a consequence, most are likely to have systems and procedures in place to enable the identification and reporting of UK reportable accounts. However, FIs should take care to update and amend their FATCA systems and fund documentation to comply with the ITC.

FIs that are outsourcing FATCA compliance to an administrator or other service provider should contact such third party to discuss the impact of the ITC. Under FATCA, most foreign financial institutions are looking to their administrators to perform the due diligence, reporting and, where necessary, withholding obligations. We understand that most administrators are separately pricing and documenting FATCA services (often on a per account basis, with the contractual arrangement taking the form of a separate addendum to the administration agreement). These contracts may need to be further amended and revised fees negotiated in light of the ITCs. The addition of a new regime will place an increasing compliance burden on administrators.

FIs may wish to notify UK investors of the forthcoming reporting obligations (whether by including disclosure in fund documentation or otherwise). UK account holders who have not disclosed offshore accounts to HMRC may wish to pre-emptively make an unprompted disclosure to HMRC regarding any accounts, to avoid more stringent penalties.

Developing OECD Proposals

It is also worth noting that the OECD has been developing proposals to implement a common international reporting standard for the automatic exchange of financial account information, to be used by those jurisdictions wishing to automatically exchange financial information. There is significant international support for such standards. Although proposals are in the early stage of development, an OECD standard model will likely be introduced in due course. Any such model is likely to have a direct impact on FATCA and the ITCs, although the precise nature of interaction between any OECD standard and the existing regimes remains to be seen.

Footnotes

1. This marks another distinction between FATCA and the ITC – the ITC focuses only on the residency of entities and individuals, whereas FATCA focuses on US citizens (wherever resident) and US residents.

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