Fatca delay to break loan negotiation deadlock

Author: Danielle Myles | Published: 30 Oct 2012
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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 institutions (FFI).

But it does little to mitigate the larger risk of lenders from certain countries effectively being shut out of the US market.

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 Service’s (IRS) October 24 notice extended the grandfathering of these clauses from January 2013 to six months after the IRS finalises passthru regulations.

“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 significant?”

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 isn’t materially amended later] you are within the grandfathering period for the passthru withholding,” said Neidle.

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 risk.

How politics could divide the loan market

The overarching risk, which has captured the market’s 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 do so.

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 won’t 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 don’t 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 it’s 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 accountholders).

“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 IFLR’s request for comment on why the deadlines have been delayed.

See also:

‘Are you Fatca ready?’ http://www.iflr.com/Web-seminars.html

‘Colombian financial institutions and Fatca’ http://www.iflr.com/Article/3062083/Search/Results/Colombian-financial-institutions-and-Fatca.html