19 July 2018 - Events
Most readers should by now be familiar with the regular litany of updates about CRS and FATCA from enthusiastic government revenue officials accompanied by the regular chorus of wailing from those who see this as the end of civilisation. Regardless of the merits or otherwise of information exchange, the OECD member states have reacted to the tax evasion strategies promulgated by Swiss and other banks in the decades leading up to the 2000s by harnessing the information exchange capabilities already present in many international tax agreements to destroy bank secrecy. Most observers expected some governmental reaction to the aggressive marketing of tax evasion by some banks, and the OECD has been pointing the way for many years.
As always with government initiatives, it is dangerous to ignore them but the devil is in the detail. Having accepted that no bank to which you would wish to entrust your money is going to keep it secret from your government revenue authority, you need to focus on exactly what is going to be disclosed. The AEOI implementation is complicated, particularly since there are two similar but not entirely compatible components: the OECD common reporting system or CRS and the US foreign account tax compliance act or FATCA as applied in Europe and internationally through the inter-governmental agreement network. AEOI operates unfairly in some ways, but does offer opportunities to plan the information flow.
The biggest challenge is likely to come from EU governments sharing tax information about sensitive individuals with corrupt governments. There are virtually no safeguards on the information once it enters the AEOI network. For example, a payment from a charitable foundation to support a human rights campaigner in a repressive regime may get reported to that country's tax authority where it may not remain secret. Filippo Noseda in our firm has assembled a credible basis for a challenge if the right candidate presents him or herself.
In the meantime, clients need to use the opportunity to plan disclosure through the financial institution registration facilities. Clients can use this for their own trust and corporate structures to control the information flow in order to ensure it is accurate. Some of the most intrusive and unpleasant audits by the IRS that the US team in our firm has seen have arisen from information that was disclosed either by Swiss banks pursuant to the US Department of Justice prosecution program, or through well publicised leaks such as the Falciani disclosure. Banks, when faced with the possibility of prosecution, do not hesitate to dump all possible customer information on the IRS or other revenue authority. Much of that information is inaccurate, or partially accurate and unsurprisingly are attempts were made to link it to individual taxpayers, the returns usually do not match the information. Completely compliant taxpayers then face months or years of responding to quite aggressive audit enquiry. At the end of the day success can seem like a rather hollow victory since the result only proves that the taxpayer had indeed reported information correctly.
Avoiding this ordeal is an extremely worthwhile goal. The key is ensuring that the information reported by your fund or your trust matches the information on your return, whether it is a US or a European tax return. Here the key difference is between reporting by passive entities and reporting entities. Passive entities do not file AEOI reports directly but rely on the banks to report the component income streams. These are very unlikely to match the income reported on a tax return.
For example, if a trust has a brokerage account with $3,000 of dividend income, $6,000 of capital gains and $1,800 of interest income and it has three beneficiaries, then the banks will all generate reports showing that each beneficiary received $1,000 dividends, $2,000 gains and $600 interest income. In practice the trustee may have decided to accumulate the gains and reinvest them, and distributed only the dividend income, using the interest income to pay trustee expenses and expenses of a house used by the beneficiaries. The relevant revenue authority (whether it is the US or an EU country) will not be able to match the income shown on the returns with the FATCA and CRS reports it receives.
If the trust investments are professionally managed, even if the trust has individual trustees, then it is certainly appropriate for the trustees to report directly to their home jurisdiction (either onshore or offshore) as a 'financial institution' (FI) which will then be shared with each beneficiary tax jurisdiction. Crucially this means that the banks and brokerage houses involved will not file reports but will just note that the trust is a reporting FI. The trust's report will then report the net amount distributed and confirm this to the beneficiaries so that their tax returns will match the report filed by the trustee.
There are a number of areas where the FATCA and CRS rules differ for no particularly good reason. One important area is the reporting required for protectors. If your trust has a protector then under the FATCA rules (applicable if the protector is US) the FATCA report from an FI trustee only needs to identify distributions made if the protector is a beneficiary. Under the CRS rules, however, the protector must be reported even if the protector is not a beneficiary and he or she is treated as controlling and therefore owning all of the trust income and accounts. This onerous requirement will undoubtedly lead to misleading reports. We think that this requirement is not authorised under the text of the CRS or the commentary, and has only been added as an afterthought by OECD staff, but adopted by EU implementation. At a recent town hall meeting with HMRC we raised this issue and although there was some sympathy, the UK government attitude is that they are following the OECD lead on this. However, they acknowledged that future implementation guidance might relax this requirement. Hence our view that we do actually need more guidance in this area.