Richard Cassell, (pictured), a partner in the London office of the international law firm Withers, considers the implications of the Common Reporting Standard – sometimes known as the “global FATCA”, or “GATCA” – which will begin to come into force in some countries as early as 2017.
Some time ago, we wrote an article on the Foreign Account Tax Compliance Act, which said that although FATCA’s tentacles are fairly intrusive, at the end of the day, it represents just another form for tax payers to complete.
Rather to my surprise, this article elicited a threat from one exasperated reader, who clearly thought I had grossly understated the threat. It is nice to know that somebody reads these articles.
So, to continue the theme, we are reporting today on further information reporting requirements – this time from the OECD – which has followed up on the US FATCA initiative with an international, automatic, multiparty information exchange network under its so-called Common Reporting Standard (CRS) framework.
The CRS principles are similar to those set forth in the intergovernmental agreements set up to implement FATCA across Europe and in other places. More than 50 countries have signed up as early adopters of CRS, including the UK, and they will start collect information from the first of January this year, for filing in 2017. More than 70 additional countries have pledged to introduce this by 2017.
Truly, then, there will be nowhere in the world to hide, apart from some rather exotic jurisdictions – and, ironically, the United States.
Yes, the US says it sees no need to sign up to CRS, even though just about everyone else is, because it has FATCA. It believes it is effectively participating in the global exchange of information, through its bilateral FATCA inter-government agreements.
The OECD does not agree, though, and so is classifying the US as a non-participating country.
Meanwhile, some commentators have got very excited about this apparent lacuna in the information exchange network, and are pressing those of their clients who wish to avoid information exchange to move their structures to the United States. “Just move your trust and holding company to Delaware, and your home jurisdiction need never know”, they are being told.
Counter-intuitively – because the US is not a participating jurisdiction – this in fact means enhanced information reporting, unless not only the structure is moved to the United States but also all the investments.
Also bear in mind that the FATCA inter-governmental agreements are two-way streets, and the United States has spontaneously exchanged information with the United Kingdom and other countries under these agreements.
Who is affected?
Anybody who maintains any sort of financial account in a country within an OECD jurisdiction other than the United States will now be expected to comply with the new rules.
Most of those in the financial services industry will be familiar with the now increasingly-commonplace requirement to sign FATCA forms pursuant to bank due diligence requirements, even for ordinary bank accounts, which state whether or not an account-holder is a US person.
Under CRS, these forms will be expanded slightly, to certify an individual’s country of residence as well as to ascertain various tax-paying identification numbers.
For example, if you have an investment account in the United Kingdom and you are resident in Italy, then your investment account information will automatically be sent to Italy.
For individual account holders, it will seem as though it is just yet another form to complete. Provided you report your global income in your country of residence, then it should tally with information that is reported through CRS, so participating should be boringly bureaucratic, but ultimately, not too threatening. Behavioural changes, for them, won’t be necessary.
Trusts, company structures
However, for clients with trusts and partnership interests that own financial accounts, it will be necessary to look at the reporting requirements more closely. And here, there is a much greater risk arising from the information exchange process, because the information gathered is more extensive, and thus may potentially lead to home country audit risks.
When FATCA was first introduced, the society of Trust and Estate Practitioners (STEP) got together with a consultative committee from HM Revenue & Customs to produce a “compliance decision tree”, for use by those having to wrestle with the new FATCA reporting requirements. We think a similar chart would be very helpful for those about to have to get to grips with the CRS data demands.
Particularly since many of the concepts and principles are very similar. Under CRS – as under the FATCA IGAs – entities with financial accounts are divided into two categories: financial institutions (FIs) and non-financial entities (NFEs). There are elaborate definitions as to what does and does not constitute an FI and an NFE.
(If an entity is managing funds for other people, such as a trust or a partnership, and if it is professionally managed, then as a rule of thumb it will be an FI; whereas if it is managed by a family to cover personal investments of that family, it may be an NFE. However, note that if the entity is engaged in an active business, then it will be an active NFE, and therefore will not be subject to CRS reporting.)
We should point out that these are very broad summaries of quite detailed rules, so specific application of the rules needs to be checked in each case.
That said, though, whether your entity is an FI or an NFE is, in our view, quite critical. The key difference is that FIs report directly to the relevant revenue authority, whereas the account-holding institutions report on NFEs. In the case of trusts and partnerships which are FIs, they report the amount that is distributed to the relevant beneficiaries or partners.
In the case of a NFE, each of the banks and financial institutions with which the trust or partnership has an account will report gross income and account balances attributed to that entity by reference to its beneficial owners and its controlling persons. This may be completely different from the net income or assets attributable to that person.
In the case of a trust, the “controlling person” definition includes its settlor, trustee and protector.
Despite some confusing language in the CRS Handbook, we had hoped that HMRC would clarify that FIs do not need to report financial information for most categories of controlling persons, and need only focus on net income distributed to beneficial owners. Generally the CRS Handbook only applies controlling person reporting to NFEs.
However, the CRS Handbook apparently expands the reporting requirement for controlling persons with regard to an FI by expanding the definition of an equity interest to include an interest held by a controlling person. This is a very different interpretation of the same language found in the FATCA agreements which HMRC had interpreted differently. We wait to see whether HMRC will change course (and so impose a different reporting regime based on similar authority) or affirm its existing interpretation.
If HMRC interprets the same language in the same way, as it has said informally it plans to do, then the information which is reported to a revenue authority by an FI using the UK interpretation as a model is likely to approximate the information that is actually reported on the beneficiary or partner’s tax return.
It will be the net income that is actually distributed rather than gross receipts from different account relationships. Given that many trusts and partnerships have complicated distribution rules, it is very likely that account holding institutions will generate reports for NFEs that will be a somewhat arbitrary collection of financial data relating to a series of accounts in different countries, which will not match up with the net amounts actually reported on the partner or the beneficiary tax return.
Therefore, this is more likely to lead to some kind of enquiry into that person’s tax affairs by the revenue authority.
On the other hand, if the trust or partnership signs up to do its own reporting as an FI, the amounts reported are the amounts actually received by the partner or beneficiary – so that the beneficiary or partner’s accountant should be able to reconcile the information with the partner or beneficiary’s tax return.
This means that it will be less likely for CRS to trigger individual taxpayer enquiries.
Meantime, if your trust happens to be in the United States, there will be no trust level CRS reporting, because, as mentioned, the US is not participating in the CRS.
A US domestic trust will be subject to US domestic information reporting, however. And there also may be exchange of information pursuant to inter-governmental agreements, although the categories of information that are subject to exchange is somewhat limited.
However, if the US trust has an account relationship – for example, with a German or UK investment adviser – then the trust will automatically be treated as a passive NFE, because the US is not a member of CRS. Therefore it cannot be a reporting FI.
This means that the German or UK financial institution will report directly on gross income attributed to that account. The trust will also be required to identify controlling persons, as well as beneficial owners with respect to that account, and they will be reported.
If the trust is administered by a US trustee but it is classified as a foreign trust under US tax rules – perhaps because it has a foreign protector, or because a non-US beneficiary has the power to change trustees – then it will be subject to FATCA reporting under certain US Treasury regulations rather than under the FATCA inter-governmental agreement network.
It will still not be subject to CRS reporting, though. Therefore, the same result will apply if it has a securities account outside of the United States, and there will be reporting on the trust as a NFE by the account holding institution.
While it would be easy to say that a solution to concerns about CRS can be resolved by moving all of an individual’s entities to the United States, this will in fact result in enhanced reporting, unless all of the investments are also moved into the United States.
Perhaps the most pressing source of concern about CRS reporting, ultimately, relates to complex structures that are beneficially owned by residents of countries with tax administrations which do not measure up to US or western European standards, possibly because tax information is known to potentially leak outside the tax authority, and can therefore be used by others for political or other purposes. And this is a very real concern to a number of clients.
For such people, one solution may well be to move the entire structure, including the investments, into the United States.
It will be important, however, to check whether the relevant country has a reciprocal inter-governmental agreement with the US.
If the structure remains in a CRS-compliant country instead, it will be very important for the trust or other investment entity to be classified as a reporting FI, so that the flow of information is controlled – but exactly how much needs to be disclosed needs clarification.
At the end of the day, the CRS information document is or will soon be, for most people, little more than another #[email protected]!# form that needs to be filled in.
It’s important to remember, though, that the information being gathered in this way will be spread more widely than has been the case with previous tax info-gathering undertakings. For this reason, it is extremely important that one’s clients understand what is being reported, and when.
And neither the holder of the overseas account or accounts in question nor his or her tax adviser ought to assume that, just because the data gathered under the CRS compliance programme seems to vanish without a trace into the electronic ether, it is unlikely to be seen by the tax office responsible for the account holder’s tax return.
Richard Cassell is a partner in the London office of Withers, the London-based international law firm that specialises in tax, trust and estate planning for wealthy and high-net-worth individuals. He was one of the first tax experts anywhere to sound the alarm about the potential ramifications for expat Americans of FATCA in early 2010 – when it was still deeply hidden inside a 2010 domestic jobs bill, known as the Hiring Incentives to Restore Employment (HIRE) Act, that at that point was quietly working its way through the US Congress.