The extension of grandfathering periods under the
US Foreign Account Tax Compliance Act (Fatca),
announced last week, will help overcome a deadlock that
has plagued loan negotiations between foreign financial
But it does little to mitigate the larger risk of lenders
from certain countries effectively being shut out of the US
The most important deadline pushed back relates to so-called
passthru provisions. These oblige FFIs (including those that
are Fatca-compliant) to impose a 30% withholding tax on
transactions with non-compliant FFIs.
The US Internal Revenue Services (IRS) October 24
notice extended the grandfathering of these clauses from
January 2013 to six months after the IRS finalises passthru
Weeks have been spent negotiating over this point in
some deals, with each side trying to avoid taking the
risk, said Clifford Chance partner Dan Neidle. How
can parties reach agreement on allocating a risk which is
technically so uncertain but economically so
To date, two factors have made it difficult to allocate this
risk in relevant transactions. First, the peculiar nature of
passthru withholding (it applies to transactions with no US
nexus) means there is no market precedent to convince a party
that they must assume the risk. Second, the IRS is yet to
release even draft regulations.
Lack of regulatory guidance and the January 2013
implementation date had created fears of a continuing stalemate
when negotiating this risk between non-US parties.
The extended grandfathering does make that easier, as
you can be reasonably comfortable that by signing a loan [which
isnt materially amended later] you are within the
grandfathering period for the passthru withholding, said
By the time the extended grandfathering period comes to an
end the market will have IRS guidance and hopefully a
better established market standard to help allocate this
How politics could divide the loan
The overarching risk, which has captured the markets
attention, is the ramifications for lenders from countries with
governments which do not enter intergovernmental agreements
(IGAs) with the IRS.
An IGA simplifies and in some instances exempts Fatca
compliance for its FFIs. The
UK is the only government to have agreed an IGA with the
IRS, but up to 40 countries have announced their intention to
This is telling, according to Debevoise & Plimpton
partner Matthew Saronson. The fact that all these
countries around the world are looking to agree IGAs evidences
a view that absent these special rules, it seems very difficult
if not impossible for FFIs to comply, he said.
The most basic benefit to come with an IGA is that the FFI
wont have to comply with the 30% withholding tax relating
to payments it receives from the US.
For smaller countries that want their financial services
industries to continue doing business with the US, they
dont really have a choice but to agree an IGA.
But it seems that not all governments will sign IGAs.
From a political standpoint, in much of the world (and
particularly in Asia), Fatca is seen as a fairly outrageous
piece of extraterritorial taxation, so its by no means
clear that China and others will sign intergovernmental
agreements said Neidle.
This is already affecting deal flow. Late last month the
FT reported that $2 billion loan from the China
Development Bank to a San Francisco borrower has been delayed
because it raised the real possibility of the bank paying 30%
tax on interest income.
More deals could be
abandoned for the same reason.
This is particularly true of FFIs from non-IGA countries
where privacy and data protection laws make it illegal to
comply with Fatca (ie providing the IRS with details about US
In practice, it may not be possible for financial
institutions in those countries to lend into the US as we get
closer to the end of this year, said Neidle.
"For countries in that position (ie no IGA and where Fatca
compliance is unlawful) Fatca is in effect creating a barrier
for investment into the US," he added.
IRS did not respond to IFLRs request for comment on
why the deadlines have been delayed.
Are you Fatca ready?
Colombian financial institutions and