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Background
The tax authorities in many jurisdictions have long lamented the potential for tax evasion created by foreign accounts and offshore structuring. It can be difficult for tax authorities to detect non-compliant individuals who fail to accurately report their offshore income and gains.
There have been international attempts to achieve disclosure of offshore accounts. The EU Savings Directive was an early version of a multilateral attempt to force greater compliance amongst EU residents. The US Foreign Account Tax Compliance Act (FATCA) has forced the world’s financial institutions to agree to provide information on US taxpayers to the IRS or to face a withholding cost. A number of jurisdictions have developed their own versions of FATCA: the UK has a regime applying to its Crown dependences and overseas territories.
CRS seeks to go further than these existing regimes. CRS is a model standard for global automatic information exchange developed by the OECD.
Drawing heavily upon concepts that have been refined and developed with the implementation of FATCA, CRS has come a long way in a short period of time. While CRS is yet to be fully considered and enacted into local law by participating countries, there is no doubt that it will become relevant shortly.
What is the CRS?
Under the CRS, financial institutions operating in a participating country will be required to apply enhanced due diligence procedures to existing and new financial accounts. The measures are designed to reveal the country of residency, for tax purposes, of the holder of financial accounts. This includes those individuals who ultimately control financial accounts through interposed investment entities.
Information about these financial accounts is then automatically exchanged on an annual basis with the identified country of residency as a check and balance against the records of that country. The idea is to highlight any differences to a tax authority which may give rise to a suspicion of under reporting, or the basis for further investigation.
The concept of a ‘financial account’ under the CRS is broader than simply depositary accounts, and includes custodial accounts and certain types of insurance policies. It also covers debt and equity interests held in investment vehicles such as managed funds and trusts. The idea of a financial institution has been broadened in a corresponding fashion. It can include investment managers and trustees as well as more traditional depositary and custodial institutions.
The due diligence and client on boarding provisions to be applied by a financial institution under CRS vary depending upon the size of the financial account. In all cases an account holder may provide a self-certification as to their country of tax residency. A financial institution is entitled to accept this self-certification unless they know, or have reasons to believe, that it is incorrect.
Scope of the information exchange
A key element of the CRS is that it will result in information exchange between countries on an unsolicited basis. This is a significant departure from the current process of formal requests having to be made on a case by case basis. Over 90 countries have now indicated that they will implement the CRS. This includes virtually all major onshore financial centres and offshore jurisdictions. It is expected that the first flow of information will take place under the CRS in 2017 amongst the so-called early adopters group. In addition to this group, there are over 30 countries which have committed to CRS and are targeting the first exchanges of information in 2018.
The information exchanged under CRS is both detailed and specific. It includes identifying information of the holder of an account, or the individual controller(s) of the account holder if it is a passive entity. An individual’s name, address, and date and place of birth is disclosed, together with the closing balance of the account as at the end of the reporting period, and details of certain types of passive income which have been received during the reporting period.
Under the CRS, information will be initially provided to the government of the country in which the financial accounts are kept. This information will then be formally exchanged with the relevant country of residency under an intergovernmental agreement in a prescribed electronic format.
Application of CRS to investment structures
The application of the CRS reporting to an investment structure will depend upon a variety of factors. CRS works by requiring a financial institution to report information in relation to the financial accounts which a Reportable Person holds, and the interests of Controlling Persons who may hold a financial account through an interposed investment entity. A distinction is drawn between entities which may be carrying on active business operations and those which are mere holding vehicles. The reporting in relation to the indirect interests of Controlling Persons only applies where the actual account holder is a Passive non-financial entity or ‘Passive NFE’.
In relation to a trust structure, reporting under CRS potentially applies at two levels.
First, where a professional trustee has been appointed, there is the reporting to be made in relation to the interests held by settlors and beneficiaries of the trust. The interest in the trust is treated for these purposes as being a financial account. Discretionary beneficiaries are taken to hold a financial account in the year in which a distribution is made.
Second, reporting is also to be made to the country of residency of the Controlling Persons of any Passive NFEs which may be held through the trust. The overall result is that the use of a trust does not prevent the exchange of information under CRS. In fact, the reporting outcome is likely more complicated.
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While many jurisdictions are yet to adopt CRS legislation into local law, the core concepts of this reporting regime are virtually settled. Now is an opportune time for intermediaries, wealth planners and individuals with existing structures to examine the impact of CRS. If the potential for the exchange of information under this new regime is considered to be problematic for account holders and Controlling Persons, then consideration should be given as to how to address this going forward. This may include engaging with domestic tax authorities on unresolved tax compliance matters or seeking professional advice about questions of tax residency and the attribution of foreign sourced income.