"Tax fraud and tax evasion are not victimless crimes: they deprive governments of revenues needed to restore growth and jeopardise citizens' trust in the fairness and integrity of the tax system. Today's commitment by so many countries to implement the new global standard, and to do so quickly, is another major step towards ensuring that tax cheats have nowhere left to hide."
Angel Gurría, Secretary-General OECD, May 6 2014
The OECD publication on February 13 2014 of a global standard for automatic exchange of information (AEoI) on financial accounts is a major step towards a globally coordinated approach to the disclosure of income of individuals and organisations. As such, it is a key part of international efforts to clamp down on tax evasion. The standard provides for mutual exchange of information on account holders with foreign tax residence, account balances, income and gross proceeds from certain financial transactions. It has been developed in partnership between the OECD and the G20 countries, and in close cooperation with the EU. The document is in two parts: Part I contains the introduction to the standard; Part II contains the text of a Model Competent Authority Agreement (CAA) and a Common Reporting and Due Diligence Standard (CRS).
The new standard was endorsed in May 2014 during the OECD's annual Ministerial Council Meeting in Paris and by the G20 Finance Ministers and Central Bank Governors at their meeting in February 2014. More than 44 countries and jurisdictions have now committed to early adoption of the standard, and further countries are expected to do so during 2014. The OECD is working to develop information and guidance on the technical measures necessary to implement the processes of actual information exchange, including compatible transmission systems and standard formats, and to formulate a detailed commentary on the standard to help ensure its consistent application. These are due to be presented in time for the G20 meeting of finance ministers in September 2014, with the early adopters implementing the new regime starting in 2016.
AEoI is not new. The EU Savings Directive, introduced in 2005, provides for AEoI on interest income within the EU and certain non-EU countries and territories, while changes due to take effect in 2017 will broaden the Directive's scope, primarily to remove perceived loopholes. More recently, AEoI has been adopted as the fundamental reporting regime under the US Foreign Account Tax Compliance Act (FATCA). What is new about the CRS is its scale and scope.
Building on FATCA
To build on previous experience, the CRS has been built on a similar approach to intergovernmental information exchange as FATCA. But it is misleading to view the CRS as simply FATCA 2.0 or GATCA (global FATCA). Its scope is much broader; and in some respects solutions already being developed for FATCA may be inconsistent with those necessary for AEoI.
The US statutory rules regarding FATCA do not require information exchange between tax administrations. It is a domestic system aimed at US persons with offshore accounts and investments. Specified types of non-US entities, such as financial institutions, must disclose to the US Internal Revenue Service (IRS) information about their US account holders, along with other similar information. There is a punitive 30% withholding tax on certain US source payments if the foreign entity does not comply with its registration and compliance obligations.
Intergovernmental exchange of information under FATCA is governed by one of two forms of intergovernmental agreement (IGA). In a number of jurisdictions, for an institution to pass information directly to the IRS would breach domestic privacy and data protection legislation. To address this issue, under the Model 1 IGA, institutions first report information to their local tax administration, which then passes it onto the IRS; by contrast, a handful of jurisdictions have agreed with the US to allow their financial institutions to transfer US account information directly to the IRS under a Model 2 IGA. At the time of writing, 34 countries have signed either Model 1 or Model 2 IGAs with the US and another 36 have been substantially agreed.
CRS: Much more than FATCA
To capture all relevant taxpayers, CRS (consistent with FATCA) has been designed with a broad scope across three main areas:
- Reportable income, which includes all types of investment income (including interest, dividends, income from certain insurance contracts, annuities and similar), as well as account balances and sales proceeds from financial assets;
- Financial institutions required to report under the CRS include banks, custodians, brokers, certain collective investment vehicles, trusts and certain insurance companies; and
- Reportable accounts, which include accounts held by individuals and entities (which includes trusts and foundations), and the requirement to look through passive entities to provide information on reportable controlling persons.
While each of these areas are those focused on in FATCA, there are key definitional differences that will result in inconsistent entity and product classification, necessitating a full review of the differences and how they apply to your own entities, your accounts and your customers. Moreover, certain decisions taken in the CRS, such as elimination of account balance thresholds for customer identification and the treatment of investment entity interests traded on an exchange as financial accounts, will greatly expand the scale of the information collected and reported as compared to that under FATCA.
Reportable accounts are financial accounts held by tax residents in relevant CRS reportable countries. A person is considered to have a tax residence in a country if he or she, under the laws of that country, is liable to tax due to domicile, residence, place of management, or any other similar criterion. Where an account holder is a reportable person in respect of multiple participating countries, the entire account balance or value, as well as the entire amount of income or gross proceeds, has to be reported to each participating country. Additional guidance is expected on understanding tax residency and technical solutions for implementation.
The financial information to be reported includes interest, dividends, account balance, income from certain insurance products, sales proceeds from financial assets, and other income generated from assets held in the account or payments made with respect to the account. Reportable accounts include accounts held by individuals and entities (which includes trusts and foundations), and the standard includes a requirement to look through passive entities to report on the relevant controlling persons.
The CRS covers:
- depository institutions – entities that accept deposits in the ordinary course of a banking or similar business;
- custodial institutions – entities that hold, as a substantial portion of their business, financial assets for the account of others;
- investment entities – entities: (i) whose primary business involves certain asset management or financial services for or on behalf of a customer; or (ii) whose gross income is primarily attributable to investing, reinvesting, or trading in financial assets, if the entity is managed by another financial institution; and
- specified insurance companies – insurance companies that issue or are obligated to make payments for cash value insurance contracts or annuity contracts.
However, it impacts on a wider range of financial institutions than FATCA, since a number of categories of financial institutions that are excluded from the FATCA Model 1 IGA may not be excluded from the CRS:
- Financial institutions with a local client base;
- Local banks;
- Certain treaty-qualified retirement funds;
- Financial institutions with only low-value accounts;
- Sponsored investment vehicles;
- Some investment advisers and investment managers; and
- Investment trusts.
Hence the CRS will affect more financial institutions than FATCA in any implementing country.
The reporting challenge
For those financial institutions with a significant customer or investor base outside their home country, AEoI means a big increase in the volume of data to be reported to the local tax authority. In integrated regions such as the EU, the sheer scale of reporting will make manual or semi-manual solutions impractical. It is a similar story with due diligence and customer data monitoring, as financial institutions may have to store more than one classification for a customer or investor with multiple tax residences, and track all changes to customer status or residence, to keep up-to-date.
Most financial institutions have dozens, if not hundreds, of legacy systems to attempt to update and align, to capture and validate the required data for annual reporting. They are unlikely to have allocated budget for such work in 2014 and, even if the commitment and funds exist, there is still considerable uncertainty over the scope and timing of the CRS. It is unclear how many countries will formalise the agreements by the end of 2014, or whether 2016 will remain the big bang date for introducing the CRS due diligence requirements. Institutions also have to find ways to deal with any national legal restrictions on collecting additional AEoI data, such as as data protection and confidentiality restrictions.
Systems and programmes built for FATCA cannot simply be extended to comply with the CRS. New fields will be required to capture information to be reported where the reporting schemes are similar but not identical, and there may be different processes for the two regimes. The range of products exempt from documenting or reporting also vary, and institutions may have to reassess whether each product offered creates a reportable account. Finally, some financial institutions have taken steps to limit their burden under FATCA, including closing accounts of US individuals to reduce reporting, or centralising all US investments in one entity. These strategies will not work for the CRS when there will ultimately be many more countries with which to exchange information. Although the tools and analysis developed for FATCA can inform an AEoI programme, the differences are so profound that new processes, systems and controls will undoubtedly be needed.
It is clear, then, that AEoI requires a wholesale review, and a potentially substantial reconstruction, of solutions developed so far to respond to FATCA. In particular, processes for customer acceptance, know-your-customer (KYC) and anti-money laundering (AML) will need to be reviewed and extended, and new systems for reporting relevant data to the tax authorities created. Efficient and effective processes and IT solutions need to be built: these solutions must be sustainable and scalable as more countries enter into the AEoI regime over the months and years ahead. Governance requirements for AEoI processes will be significantly greater than under FATCA, and need to be designed accordingly.
All of this has to be undertaken while institutions are still working to achieve FATCA compliance: the consequence will be the inevitable disruption of systems and processes that have just been established for FATCA. In addition, to the extent that operating models have been defined in part to avoid or minimise operational burdens from such tax reporting requirements, these decisions will need to be re-evaluated in the light of the global scale of AEoI.
Once again, the pace of regulatory change threatens to overwhelm the ability of financial services companies to develop the necessary systems and processes to respond. And while the deadlines are short, the detail cannot be specified until the CRS is fully defined towards the end of the year. In addition, there are in many cases legal limits to what can be pursued on an early timetable: in many jurisdictions, data protection laws prevent companies from collecting the necessary information on account holders in advance of the passage of domestic enabling legislation.
Nevertheless, there are a number of housekeeping actions which can be mounted now, and which should yield benefits in any event. In this regard, businesses should:
- review and overhaul existing customer onboarding systems, KYC and AML processes, documentation standards;
- review and streamline separate systems, and rationalise inconsistent policies and definitions;
- review and overhaul governance arrangements to ensure clear lines of authority and responsibility for compliance; and
- ensure that policies and procedures to manage operational and reputational risk are geared up to capture AEoI issues.
These and similar actions should also feed into the final key priority of ensuring that where business imperatives substantially favour one AEoI implementation methodology over another, the argument is effectively captured in representations to governments. Financial institutions can still influence how AEoI will operate. But the window of opportunity is closing rapidly.
Hans-Jürgen Feyerabend is head of Global Financial Services Tax (KPMG Germany)
Victor Mendoza is head of Global Banking Tax (KPMG Spain)
Jennifer Sponzilli is office managing partner of the US tax practice (KPMG UK)
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
This article represents the views of the authors only, and do not necessarily represent the views or professional advice of KPMG LLP.
Hans-Jürgen is a tax partner in Frankfurt and has more than 24 years of experience in advising financial institutions on a full range of tax matters. He is specialised in banking and finance and asset management and leads KPMG's Global Financial Services Tax practice and also is the industry leader for our Global Investment Management Tax practice.
Hans-Jürgen advises credit institutions, financial services institutions, financial enterprises, clearing institutions, and asset management companies on general tax law. His specialisations include, in particular, the taxation aspects of financial instruments and investment funds as well as tax advice on M&A transactions in the banking sector.
Víctor is a tax partner in Madrid and has been advising on Financial Services taxation for more than 24 years. He is head of the Financial Services Tax practice at KPMG in Spain and the chairman of the KPMG's Global Banking Tax practice.
Víctor advises major domestic and foreign financial institutions in Spain on tax matters relevant to the financial industry. He has also a strong experience advising and implementing cross-border structured finance transactions and M&A.