Asian institutions can breathe easier after the US agreed to delay penalties for non-compliance with its extraterritorial tax law Fatca, although still some uncertainty remains.

The Internal Revenue Service (IRS) in the US has given foreign financial institutions a transitional period running until 2016 to comply, and relaxed the withholding penalty it would have levied for non-compliance.

Under the Foreign Account Tax Compliance Act previously, non-US financial institutions would have been subject to a 30% withholding tax on US-sourced income had they not started collating account details of US persons on their books by July 1.

However, these latest relaxations only apply to financial institutions that have shown “good faith” in complying with the tax law in the first place.

Karl Egbert, Hong Kong-based partner at law firm Dechert, notes the IRS has not clearly defined what good faith means.

“What I am telling my clients about ‘good faith’ is that they should continue their Fatca compliance efforts, but have some peace of mind that if something goes wrong — and something will go wrong — they are less likely to be withheld against because of it,” he says.

“The message should be to continue as usual; use this delay as a time for a test run in order to make sure everything works.”

The IRS says it will take into account whether a withholding agent, such as a fund custodian, has made “reasonable efforts” during the transition period to modify its account opening practices.

While global financial institutions including fund houses and banks were generally ready to meet the July 1 deadline, regional players were still asking questions about how Fatca works as recently as a couple of months ago, Egbert notes.

One general counsel at a Hong Kong-based hedge fund welcomed news of the transitional period, saying it would give the industry extra time to solve issues, such as whether there is a need to register every entity in a fund structure, as opposed to nominating just one lead financial institution, to the IRS.

But he warns against complacency over the delay. While the deadline for registering Cayman-domiciled funds is December, the counsel says fund managers should consider registering for a global intermediary identification number (GIIN) from the IRS sooner rather than later. This is used as an identifier to show that a financial institution is Fatca compliant.

“If a fund house has not applied for a GIIN, your counterparties might want to pause [the relationship] and not want to trade with you,” he says. “In order to minimise any disruption to trading, I think most people will register way before the deadline.”

The counsel says many fund managers may be in talks with fund administrators, which would be able to review their existing client files to determine who is a US person.

The US has suffered a series of setbacks in implementing its Fatca tax rules. It had already pushed back the compliance deadline by a year to July 2014.

In late 2012, the US said it was speaking to more than 50 countries about signing IGA agreements. However, by May 1 the US Treasury had only signed up 30.

Australia and Japan are the only jurisdictions in Asia Pacific to have signed an intergovernmental agreement (IGA) with the US on Fatca. These accords ease Fatca compliance for domestic institutions as they allow them to report to their local tax authority instead of directly to the IRS.

Since Hong Kong has not yet signed an IGA on Fatca, the city’s Mandatory Provident Fund scheme could have been subject to a penalty.

Egbert, who expects Hong Kong to ink an IGA eventually, notes: “It’s kind of a doomsday scenario that you have working-class people putting their hard-earned money into a fund and having 30% withholding [penalty] on all their US sourced income.”