On 2 December 2014, the US and Cyprus governments signed an intergovernmental agreement (IGA) to implement the Foreign Account Tax Compliance Act (FATCA). There are two types of IGAs known as "Model 1" and "Model 2". The difference in general terms between the two types of IGA is that a Model 1 IGA requires foreign financial institutions (FFIs, referred to simply as foreign institutions or FIs in the IGA itself) to report the required FATCA-related information to their own local competent authority which will report onwards to the US IRS whereas a Model 2 IGA requires the FFIs to report such information directly to the IRS.
Cyprus has signed the Model 1 IGA containing a most favoured nation provision which provides that any more favourable terms negotiated under another country's IGA will automatically be applicable to Cyprus. In addition, the IGA is reciprocal and provides for the IRS to provide Cyprus with information on the US accounts of Cyprus residents (further negotiations are contemplated between the parties with a view to enhancing reciprocity).
What is FATCA?
FATCA is a reporting and withholding regime enacted by the US government with an aim to combat tax evasion by US taxpayers who rely on the use of FFIs to hold their assets. In accordance with the provisions of FATCA, non-compliant FFIs could suffer a 30 per cent withholding tax on certain US source payments (including dividends and interest) made to or paid by the FFI unless certain account verification, due diligence, registration, control burdens and reporting requirements are complied with.
In summary, the IGA provides that Cyprus will require IGA-qualifying FFIs to collect certain information relating to depository and custodial accounts held by US persons, certain interests in investment entities held by US persons and certain insurance policies or annuities that have "cash value" and which are held by US persons and to report such information to the Cyprus Ministry of Finance (the Competent Authority). The Competent Authority will then onward share such information with the IRS on an annual automatic basis. In exchange, the US will permit payments to and from Cyprus FIs without the imposition of withholding tax.
What are the implications of FATCA for a Cyprus entity?
The impact of FATCA on a Cyprus entity will depend on whether such entity qualifies as a FI under the IGA. If it does, eg if the entity in question is a bank, credit institution, fund, custodian or trustee, (or other entity caught in the definition of a FI), FATCA will impose significant information collecting and reporting obligations. If it does not, eg if it is a straightforward holding company, it will broadly not be classified as a FI and will not be materially affected by FATCA (although it will still be treated as a NFFE, see definition and implications below) and will need to disclose certain ownership and other information to FIs when undertaking business with them.
Entity classification is very important to determine the FATCA-related obligations, if any, of the entity in question. There are four categories of FIs under the Cyprus IGA:
- Investment Entities: generally speaking, an entity that conducts (or is managed by an entity that conducts) trading or portfolio and investment management activities as a business on behalf of a customer or otherwise invests, administers or manages funds or money on behalf of other persons.
- Custodial Institutions: An entity that holds, as a substantial portion (generally, more than 20 per cent of gross income) of its business, financial assets for the account of others.
- Depository Institutions: An entity that accepts deposits in the ordinary course of a banking or similar business and regularly engages in one or more of the following activities (a) provision of credit; (b) trading in receivables, notes or similar instruments; (c) issues letters of credit; (d) provides trust or fiduciary services; (e) finances foreign exchange transactions; or (f) deals in finance leases or leased assets.
- Specified Insurance Companies: An insurance company (or its holding company) that issues, or is liable under, certain cash value or annuity contracts.
Reporting and Non Reporting FIs
These four category entities can either be Reporting FIs or Non Reporting FIs. By default, all FIs are Reporting FIs, unless they qualify as Non-Reporting FIs by means of inclusion in Annex II or by qualifying as Deemed Compliant or Exempt under US Treasury definitions. Annex II of the Cyprus IGA provides that various entities may be classified as Non Reporting FIs and key categories are highlighted below.
Exempt beneficial owners other than funds
- The government of Cyprus, any political subdivision of Cyprus or any wholly owned agency or instrumentality of Cyprus;
- International Organisation;
- Central Bank; and
- Funds that qualify as Exempt Beneficial Owners such as participation retirement and pensions funds (ie a fund established in Cyprus to provide retirement, disability or death benefits to beneficiaries who are current or former employees of one or more employers) subject to certain conditions.
- Certain licensed Cyprus FIs with a
local client base which:
- do not solicit account holders outside Cyprus;
- are required by law to perform tax withholding or information reporting with respect to accounts held by Cyprus residents for local AML due diligence requirements;
- have only account holders that are resident in the Cyprus or another member state of the European Union to an amount of 98 per cent of the entity's aggregate outstanding account value; and
- require their affiliates to be subject to the same restrictions.
- A FI with only low-value accounts (no financial accounts with a balance in excess of US$50,000 and no more than US$50m in assets);
- A qualified credit card issuer, subject to certain conditions;
- A trustee-documented trust established under the laws of Cyprus provided the trustee is a Reporting FI and reports all information required to be reported;
- A sponsored investment entity, where a sponsor of the investment entity is registered with the IRS on the IRS FATCA registration website and the sponsor performs all due diligence and reporting obligations of the sponsored entity;
- A sponsored, closely held investment vehicle satisfying specified requirements;
- Investment advisors and investment managers established in Cyprus which are Investment Entities solely because they render investment advice to, and act on behalf of, or manage portfolios for, and act on behalf of, a customer for the purposes of investing, managing or administering funds deposited in the name of the customer with a FI; and
- A collective investment vehicle, provided all of the interests therein are held by or through one or more exempt beneficial owners, Active NFFEs, Persons that are not Specified U.S. Persons, or FIs that are Non-participating FIs.
The rules determining whether an entity would qualify for one of the above exceptions for the status of Non-Reporting FI are complex and require close analysis. The Guidance Notes are expected to provide further detail on how to make this determination. The distinction is important as only Reporting FIs are required to register and submit reports, even if nil. A Non Reporting FIs on the other hand will generally not need to obtain a global intermediary identification number (GIIN), nor will it need to register, or carry out the due diligence and reporting requirements under the IGA unless it identifies US Reportable Accounts (but it must still self-certify its status to the FIs with which it maintains financial accounts to avoid FATCA withholding).
As stated above, if an entity does not fall within the four categories of FFIs, it will be a non-financial foreign entity (NFFE) with fewer obligations under the IGA. There are two categories of NFFE, Passive or Active and it is important each Cyprus NFFE establishes which category it belongs to so that it can provide the necessary self-certification to the FIs with which it maintains accounts. Broadly speaking, if the NFFE is Passive, the FI with which it maintains an account should request information in respect of Controlling Persons of such NFFE and report to the local tax authorities in respect of those Controlling Persons (broadly, a US person with a ten per cent or more interest). To the extent it has substantial US owners, the name, address and US taxpayer identification number of each substantial US owner must be provided.
If on the other hand, a NFFE is Active, meaning that it meets certain specified criteria including for example that less than 50 per cent of its gross income for the preceding calendar year is passive income (such as dividends, interest, royalties, annuities and rent) and less than 50 per cent of the assets held during the preceding calendar year or other appropriate reporting period are assets that produce or are held for the production of passive income, there is no need to identify any US owners.
The entity classification and reporting status of a Cyprus registered trust will largely depend on the nature of the activities and the type of assets held by the trust. If professional advisors are appointed to manage a portfolio of financial assets such as stocks, bonds and shares, the trust will likely qualify as a FI with equivalent registration and reporting requirements. Charitable trusts will generally be exempted from registration and reporting. Broadly a trust must register if:
- 50 per cent or more of its gross income is attributable to trading in money market instruments, portfolio management or the investment and administration of funds on behalf of others (as it will then itself qualify as a FI);
- the trust or its assets are managed by an entity that acts for clients and 50 per cent or more of its gross income is attributable to trading in money market or stock exchange investments; or
- it is a Custodial Institution, such as an employee benefit trust continuing to hold shares for an employee after he/she has become entitled to them.
What are the key dates for FATCA compliance?
For a Cyprus FI for which an exemption is not available, ie a Reporting Cyprus FI, the following steps must be contemplated:
- Obtain a GIIN by 31 December 2014: Cyprus FIs that are not exempt must register on the IRS FATCA registration portal for the purpose of obtaining a GIIN by 31 December 2014.
- Identify Reportable
Accounts: Cyprus Reporting FFIs must identify and report
details of Reportable Accounts to the Competent Authority.
Reportable Accounts are financial accounts where the account holder
is either a Specified US Person.
Financial accounts include any depositary or custodial accounts and also, in the case of certain Investment Entities, any debt or equity holdings in the FFI.
There are two separate processes for identifying Reportable Accounts, one for pre-existing accounts and one for new accounts:
Existing accounts: Financial accounts existing as at 30 June 2014 (subject to certain de minimis thresholds) are required to be reviewed for prescribed US indicia, including US place of birth and US address. If the account holder is a Specified US Person, details of their account must be reported. If the account holder is not a Specified US Person but US indicia are present on its account, a Cyprus FFI must take certain steps such as request self-certification by the account holder and further documentation to prove that the person is not a Specified US Person. If the account holder is not responsive to such request, the account should be treated as a Reportable Account. High Value accounts are subject to enhanced review procedures. The deadline for review depends on a number of factors including value thresholds. A search for US indicia must be completed on all accounts over US$1 million by 30 June 2015.
New account procedures: For accounts set up with a Cyprus FFI after 1 July 2014, it is necessary to carry out due diligence and obtain self-certification whether the account holder is a Specified US Person or not. If US indicia are discovered indicating that the person may be a US taxpayer, prescribed steps will need to be taken to confirm this. Cyprus is committed to establishing rules, by 1 January 2017, with respect to 2017 and subsequent years, requiring Reporting FIs to obtain the tax identification number of each Specified US Person.
- Reporting: On or before 31 May 2015, Cyprus FFIs must make their first report to the Competent Authority in relation to accounts held by Specified US Persons or a non-US entity with one or more Controlling Persons that are Specified US Persons. Enhanced information is required for the subsequent reporting period ending 31 May 2016.
The Competent Authority is expected to publish further guidance on the application of the US-Cyprus IGA to offer practical assistance to Cyprus businesses which will need to determine how they are classified for FATCA purposes in order to determine whether registration and reporting is required. Harneys is participating in a government-led Working Group to draft the Guidance Notes. Cyprus FIs which are subject to FATCA must ensure that they have policies and procedures in place to address the registration, due diligence, account opening and reporting requirements which will be imposed by the implementing legislation.
The provisions described above represent certain key features of the US-Cyprus IGA but do not represent a comprehensive analysis of the agreement. FATCA rules are very complex and extensive, and persons who consider they may be affected should seek appropriate professional advice.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.