19 March 2019 - Article
Some time ago we wrote an article on the Foreign Account Tax Compliance Act ('FATCA') which says that although the FATCA 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 report on further information reporting from the OECD which has followed up on the US FATCA initiative with an international automatic multiparty information exchange network under the Common Reporting Standard ('CRS') framework. The CRS principles are similar to those set forth in FATCA inter-governmental agreements implementing FATCA across Europe and in other places. Over 40 countries have signed up as early adopters of CRS, including the UK, and they will start collect information from 2016 for filing in 2017. Over 70 countries have pledged to introduce this by 2017. Truly there will be nowhere in the world to hide apart from some rather exotic jurisdictions and the United States. The US has FATCA and therefore saw no need to sign up to CRS. It believes it is effectively participating through its bilateral information exchange under FATCA inter-government agreements. The OECD does not agree and so the US is classified as a non-participating country.
Some commentators have got very excited about this apparent lacuna in the information exchange network and are pressing clients who want 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 told. Counterintuitively, 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. Most of you will be familiar with having been asked to sign FATCA forms pursuant to the bank due diligence requirements, even for ordinary bank accounts, disclosing whether or not you are a US person. CRS will now require those forms to be expanded slightly to certify your country of residence as well as other tax paying identification numbers. For example, if you have an investment account in the United Kingdom and you are resident in Italy then investment account information will automatically be sent to Italy. For individuals it seems as though it is 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 not too threatening. For individuals it may not demand behavioural changes.
What about Trusts and Companies?
However for clients with trusts and partnership interests which own financial accounts it is necessary to look at the reporting requirements more closely. Here there is a much greater risk arising from information exchange because the information gathered is more extensive, leading to home country audit risks. When FATCA was introduced, STEP with the HMRC consultative committee, generated a compliance decision tree and a similar chart would be very helpful for CRS. 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 ('FI's) and non-financial entities ('NFE's). There are elaborate definitions of which entities are FIs and which NFEs. If the 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 a NFE. However note that if the entity is engaged in an active business then it will be an active NFE and will not be subject to CRS reporting. These are very broad summaries of quite detailed rules so specific application of the rules needs to be checked in case.
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. 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 think it is clear 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.
The significance of this is that the information which is reported to a revenue authority by an FI 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.
If your trust, for example, is in the United States there will be no trust level CRS reporting because the US is not a part of the CRS. A US domestic trust will be treated as subject to US domestic information reporting. There may be exchange of information pursuant to inter-governmental agreements although the categories of information that is subject to exchange is somewhat limited. However, if the US trust has an account relationship, for example, with a German or UK investment advisor 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 the Treasury regulations rather than under the FATCA inter-governmental agreement network. It will still not be subject to CRS reporting. Therefore the same result will apply if it has a securities account outside 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 your 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.
Probably the most pressing source of concern about CRS reporting relates to complex structures beneficially owned by residents of countries with tax administrations which do not measure up to US or western European standards perhaps because tax information leaks outside the tax authority and can be used by others for political or other purposes. This is a very real concern to a number of clients. For these people a 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 country 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.
At the end of the day it probably is for most people another damn form. However the information is spreading more widely than before and in our experience it is very important for clients to understand what is being reported and when. Do not assume that just because it seems to go into the electronic ether it will not be seen by the tax official responsible for processing your tax return.