Lights, camera, action! After a lengthy gestation period, the OECD’s Common Reporting Standard is live and in the middle of the first reporting season. Geoff Woodhouse Partner and Head of the High Net Worth & Family Offices sector at Moore Stephens LLP discusses how the CRS will work in practice, what advantages it holds for clients as well as the potential bear traps that should be identified.
IFC: Can you outline what the CRS is and its place in the global financial industry?
GW: The Common Report Standard (CRS) is a game changer in the global fight against tax evasion. It aims to increase transparency through the automatic exchange of financial information between participating jurisdictions. More than 100 jurisdictions have already committed to adopting CRS and there are more than 50 early adopters, with the first automatic information exchanges taking place this year.
CRS works in a similar way to the United States FATCA regulations, although it does not itself impose withholding taxes for non-compliance.
Whilst the United States has no immediate plans to adopt CRS, it is already receiving financial account information through the FATCA regulations. There are very few holdouts. Most of the 100-plus countries adopting the CRS have signed a multinational convention, however, a few have elected instead to strike deals one country at a time. This leaves a lot of leakage.
IFC: Does the cost of CRS implementation justify the wider benefits?
GW: CRS is a very clever regulation and we all stand to benefit from winning the global fight against tax evasion. Hence, politically the costs of implementation will easily be justified in the long run. Entering the global arena shortly after the implementation of FATCA, many financial institutions have easily been able to adapt their existing due diligence and reporting systems to deal with CRS.
The tax authorities in many CRS jurisdictions, HMRC in United Kingdom included, have taken a sensible, consultative and structured approach to CRS reporting, by building a single reporting portal to deal with all forms of Automatic Exchange of Information – FATCA, CRS, and reporting by the Crown Dependencies and Overseas Territories. The heavily regulated players – the banks, custodians, investment managers, funds and insurance companies – have invested greatly in sophisticated due diligence and reporting portals to deal with CRS. It is the less regulated players – charities, family offices and smaller trusts who have struggled to deal with their registration and reporting obligations.
A charity will be classified as a financial institution where it meets the financial assets test and is managed by a financial institution, for example, where it has appointed discretionary fund managers. Despite the best efforts of the tax authorities, professional advisers, banks and investment managers, many smaller charities remain blissfully unaware of their obligations, are not equipped with a team of compliance officers, and will struggle to adequately identify beneficiaries and other account holders who are resident in CRS jurisdictions.
Unlike FATCA, which included widely cast exemptions for the sector, charities are firmly within the lights of CRS and most of our charity clients see the regulations as an impenetrable fog. Unlike FATCA, which is underpinned by a raft of standard forms (the W-8 series included), there is no such standardisation for CRS, and our charity clients have been inundated with a confusing array of bespoke forms from their banks and investment managers. That’s great for the professional advisers, ourselves included, who have welcomed a spike in CRS enquiries, but bad for the over-stretched charity trustees, who shoulder the burden of reporting. Family offices and smaller trustees face a similar dilemma, since they lack the bench strength of compliance officers, although most of them have already coped with the FATCA regulations, knew what was coming, and are simply treating CRS as FATCA ‘on speed’.
IFC: How are clients responding to multiple jurisdictional issues?
GW: One of the great challenges of the OECD in casting the CRS was doing exactly what it says on the tin by introducing common standards across the globe, equally applicable in each CRS jurisdiction, despite jealously guarded local regulation and anomalous reporting requirements. Here’s where the holdouts who have not signed a multinational convention don’t help themselves.
IFC: How are clients responding to confidentiality concerns?
GW: The OECD is committed to maintaining privacy and CRS is designed so that sensitive data such as account holders’ names and addresses, taxpayer identification numbers and account balances are reported to the tax authorities in the CRS jurisdiction. The information is then exchanged from government to government, so that such information is not available to the general public. Understandably, some clients wish to control the information flow, so that they take the responsibility for reporting sensitive data rather than relying on third parties. For this reason, some clients have chosen to restructure their operations so that they are themselves classified as financial institutions under CRS, with consequent reporting requirements, rather than passive NFEs, where the ultimate responsibility for reporting rests with their counterparties.
IFC: What are the most difficult implementation issues?
GW: In our experience, the most difficult issues for clients during the initial implementation phase have include the classification of investment entities. In most cases, the classification of investment entities who primarily conduct as a business investing, administering or managing funds, for and on behalf of a customer (the activities test) has been relatively straightforward. This category includes investment funds, investment managers and fund administrators. The classification of entities under the managed investor test has been much more difficult, particularly for trusts. This is where the gross income is primarily attributable to investing, reinvesting or trading financial assets, and the entity is itself managed by a financial institution. The practical application of the managed investor test requires much further consideration. An entity will be an investment entity if it is investing for its own account, is managed by a financial institution and meets the financial assets test. In particular, the precise definition of ‘managed by’ will vary from jurisdiction to jurisdiction, and will, for example, include those cases where a financial institution acts as a discretionary investment manager or a corporate trustee. Where an entity is managed by a mix of institutions and individuals, it will meet the definition if one of the institutions is a financial institution.
Another difficulty is identifying equity interests in trusts. The most likely scenario in which a trust will be a financial
institution is if it falls within the definition of an investment entity under the managed investor test. In this case, the financial accounts are most likely to comprise the equity interests in the trust. The holders of the equity interests will be treated as account holders for reporting purposes.
The equity interests are held by a trustee, settlor or beneficiary or any other person (such as a protector) exercising ultimate effective control over the trust. A discretionary beneficiary will only be treated as an account holder in the years in which it receives a distribution from the trust, and the trustees will report the value of distributions made to reportable persons. A settlor or mandatory beneficiary will always be an account holder, and the trustee reports their account balance, as well as gross payments paid or credited during the year. Unless otherwise defined (for example where a beneficiary has a defined equity interest), their account value will be the total value of all trust property.
IFC: What do you think the future with CRS will hold?
GW: The fog is clearing and the global financial community is rightly taking the view that the Common Reporting Standard is clever regulation which will play a major part in the global fight against tax evasion. With the continued help and support of the tax authorities, practitioners and organisations like STEP, we are entering a bright new world of tax transparency.
Geoff is partner and head of the High Net Worth & Family Offices sector at Moore Stephens LLP, specialising in assurance and advisory services for family offices and international corporates. His clients include institutional and family wealth funds, as well as specialist investment funds and global corporates. With over 30 years’ experience, Geoff and his team advise clients on residence and domicile, international tax, estate planning, philanthropy, trust and corporate structures as well as financial reporting under IFRS and US GAAP, valuation, custody, risk management, performance measurement and internal control over financial reporting. Geoff is dual qualified in United Kingdom and United States.