The banking market’s approach to FATCA has settled down to the point that FATCA is now “just another point to be covered by the drafting”. It has become market standard that lenders carry the risk of a FATCA withholding apply to them if they are not FATCA-compliant, and what was originally known as “LMA FATCA rider 3” has now become an standard part of LMA loan facilities. In most transactions, FATCA is not a substantive issue in practice. Nonetheless it is still necessary to be mindful of situations where it may be more of an issue – for example if a syndicate of lenders to a US borrower includes lenders in non-IGA jurisdictions.
Borrowers in model 1 IGA jurisdictions
On many transactions (including most investment grade lending), the borrower is in a jurisdiction that has or will have a model 1 intergovernmental agreement (IGA) with the US. Most major European jurisdictions have or are treated as having a model 1 IGA with the US. For example the UK, France, Germany, Spain, Italy, Netherlands, Ireland and all four Nordic countries have a model 1 IGA in place. In cases where the borrower is in a model 1 IGA jurisdiction, FATCA should not be a material issue, as the borrower will simply have information exchange obligations rather than being required to apply FATCA withholding.
Nonetheless, loan documentation normally passes residual risk of FATCA withholding onto lenders by incorporating standard FATCA provisions into facility agreements – ie by excluding FATCA from the tax gross-up and tax indemnity provisions, accompanied by FATCA information sharing requirements. The lending market has typically accepted this, and what was originally LMA “FATCA rider 3” has become a standard part of LMA loan documentation. Most lenders recognise that in practice they need to be FATCA compliant to participate in the lending market.
Borrowers in non-IGA (or model 2 IGA) jurisdictions
If the borrower is in a jurisdiction that does not have an IGA with the US, or has a model 2 IGA (see IGA status table), then the borrower applying FATCA withholding might be a more realistic possibility, for example if the borrower is or becomes a (non-IGA) FATCA compliant financial institution, it could be required to apply “pass thru withholding” from 01 January 2017. This may be particularly relevant in relation to emerging markets lending transactions, and similarly on trade financing. Moreover, in cases where lenders provide finance via back to back loans through a local bank, then the borrower facing the lender will usually be a financial institution.
In such situations, the now-standard FATCA provisions which allocate FATCA withholding risk to the lenders are likely to be viewed as particularly important by the borrower. Market practice is that it is the lenders’ responsibility to ensure they are FATCA compliant (rather than attributing the risk to the borrower’s location in a jurisdiction which might conceivably have to apply a FATCA withholding). Again, lenders can tolerate this, as FATCA compliance is seen as a requirement for participating in the lending market.
For a US borrower, FATCA is a particularly live issue – they are much more likely to have a real obligation to apply FATCA withholding if paying a non-FATCA compliant lender. US borrowers are almost certain to insist on the now-standard FATCA provisions allocating FATCA risk to the lenders.
Can silence still be golden?
Some loan facilities may still be silent altogether on FATCA, though this is increasingly rare where sophisticated parties are involved. This is typically to the lender’s advantage, as FATCA will normally be covered by the tax gross-up and tax indemnity provisions even without express reference, so in the absence of the normal FATCA provisions, residual FATCA risk would be generally be allocated to the borrower by default.
In the absence of express FATCA provisions, provision of FATCA information would not be covered, though practically speaking FATCA information may still be obtained through other means, such as the agent’s and/or lenders’ procedures for taking on clients/loans/syndicate members.
Some lenders actively prefer FATCA provisions to be included even though these allocate residual FATCA risk to them. In some cases this may be driven by a preference to have enforceable FATCA information provisions, or simply by an internal procedural or approval requirement to “tick the FATCA box”. In the case of syndicated facilities, some lenders feel confident that they will be FATCA compliant, and their prime concern is to ensure that other lenders in the syndicate bear their own FATCA compliance risk – and hence actively prefer FATCA risk to be allocated to lenders ie in the event that another lender in the syndicate were to be FATCA non-compliant and this triggered FATCA withholding on payments to that lender, the FATCA compliant lenders in the syndicate may prefer that the non-compliant lender bears that cost, rather than a gross-up causing it to be borne by the borrower (on whose credit the syndicate is depending).
How are branches and subsidiaries treated?
FATCA status and IGAs are based on the location of the branch or subsidiary which is party to the loan and receives/makes the payments, rather than the location of the headquarters or ultimate parent. For example, if a German bank lends through its UK branch, or a Russian bank lends from its UK subsidiary, then both would be viewed as located in the UK for FATCA purposes and hence look to the UK’s IGA with the US rather than the position relating to Germany or Russia.
Syndicated facilities and the agent
Most facility agents tend to be located in model 1 IGA jurisdictions, in which case the interposition of the agent between borrower and lenders generally has little impact on the FATCA position, save that the model 1 IGA agent may have information reporting obligations to notify its tax authority or the borrower of the payments to or FATCA status of the lenders in the syndicate. (Facility agents should ensure that they have the practical ability to comply with this, either through FATCA information sharing provisions in the facility agreement or as part of their wider processes for admitting lenders into a syndicate.) If the borrower is a US Tax Obligor, and there are non-FATCA compliant (non-IGA) lenders in the syndicate, then the borrower would withhold FATCA from payments made to the model 1 IGA agent on behalf of the non-compliant lenders, in the same way that the borrower would have withheld FATCA if it had made the payments directly to the non-compliant lenders.
A facility agent that is located in a model 2 IGA jurisdiction (eg Switzerland or Japan), or is FATCA compliant but not in an IGA jurisdiction, may have to apply FATCA withholding tax from payments it passes on to non-FATCA compliant (non-IGA) lenders.
A facility agent that is neither located in an IGA jurisdiction nor FATCA compliant could cause FATCA issues (or at least increased FATCA risks) for the whole syndicate. If the borrower is or becomes required to apply FATCA, then FATCA withholding would apply to payments made to the non-compliant agent on behalf of the entire syndicate, even in respect of syndicate members which are in IGA jurisdictions or otherwise FATCA compliant, so would not suffer FATCA withholding on payments made directly. Accordingly, it is becoming a commercial requirement that facility agents are in IGA jurisdictions or otherwise FATCA compliant, and the LMA riders contain standard language requiring a facility agent to resign if is not or ceases to be entitled to receive payments free from FATCA withholding. Lenders participating in syndicated transactions that do not already include this LMA language may wish to consider requesting its inclusion.
This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.