Embedding investments within an Active NFE as a strategy to circumvent CRS

There are 8 types of Active NFEs defined in the Common Reporting Standard

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Establishing an Active NFE to circumvent CRS reporting



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Holding Active NFE


or


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50-50 Asset-Income Active NFE
The use of an Active NFE to embed financial asset investments, may qualify for the exemption of exchange of information under the Common Reporting Standard.

The two types of Active NFEs that are used with the intention of embedding financial asset investments are:
  1. 50-50 Asset-Income: Less than 50% of the NFE’s gross income for the preceding calendar year or other appropriate reporting period is passive income and less than 50% of the assets held by the NFE during the preceding calendar year or other appropriate reporting period are assets that produce or are held for the production of passive income.
  2. Holding Active NFE: At least 80% of the activities of the NFE consist of holding (in whole or in part) the outstanding stock of, or providing financing and services to, one or more subsidiaries that engage in trades or businesses other than the business of a Financial Institution.
    • ...Except that an Entity does not qualify for this status if the Entity functions (or holds itself out) as an investment fund, such as a private equity fund, venture capital fund, leveraged buyout fund, or any investment vehicle whose purpose is to acquire or fund companies and then hold interests in those companies as capital assets for investment purposes.

Embedding investments within a untaxed Active NFE is a terrible strategy to circumvent CRS reporting


1. The OECD will close CRS loophole where investments are embedded within untaxed Active NFE

The 2016 OECD report to the G20 Finance Ministers, updating on automatic exchange of information that it will close real and perceived loopholes of the CRS, otherwise tax evasion will merely be displaced rather than resolved.

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April 2016 OECD report to G20 Finance Ministers
In 2017, the OECD will amend the CRS to close its loopholes. One amendment will ensure untaxed, unsupervised entities cannot be categorised as an Active NFE. This is because the CRS was never supposed to exempt untaxed entities. In the EU Savings Tax Directive, which was the first cross-border automatic exchange of information legislation, any entity whose income was not taxed, was included in its scope.

By ensuring that any untaxed, unsupervised entity cannot be an active NFE, it closes all the loopholes of using any of the untaxed active entities, such as charities, new companies every two years, holding companies, listings on tax haven exchanges, and the 50-50 Asset-Income untaxed company.

The CRS amendment will close the loophole of embedding investments within Active NFEs by excluding effectively untaxed entities from being an Active NFE. Thus, the entity will be categorised as a Passive NFE. As such, the Financial Institution maintaining the Fianancial Account of the Passive NFE will report on the Controlling Persons.
2. Active NFEs can automatically be recategorised as reportable Passive NFEs when business is weaker in any single year

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Due to annual fluctuating income sources, an Active NFE can be categorised as a Passive NFE
50-50 Asset-Income Active NFE: Embed investments where the financial income / financial assets are both less than 50%. The Financial Institution maintaining the financial accounts of the 50-50 Asset-Income Active NFE undertakes a categorisation of the NFE each year. The financial income of the 50-50 Asset-Income NFE may automatically surpass the 50% threshold when the active business has a poor business year. In that event, the NFE switches categorisation from an Active NFE to a Passive NFE. The Financial Institution will then report on the Controlling Persons of the Passive NFE.

Holding Active NFE: Will be categorised as a Passive NFE where less than 80% of its activities (income or asset related) in any year is the direct or indirect holding of subsidiaries that do business or trade.
3. Active NFEs are reported by virtue of Account Holder, even if Controlling Persons are not reported.

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The Financial Institution maintaining the financial accounts of an Active NFE reports on the Account Holder, the entity, if the entity is managed in a reportable jurisdiction.

For instance, a Singapore Active NFE managed by directors resident in Indonesia, would be a reportable jurisdiction person because the Singapore entity is resident in its place of effective management. Therefore the Singapore bank would report on the Account Holder to its authorities on the Active NFE, and this information would be exchanged with Indonesia.

Although no information is reported about Controlling Persons in this report, this will likely trigger an exchange on demand about Controlling Persons from Indonesia to the Singapore Competent Authorities. This is the precise reason for the report by virtue of Account Holders for entities.

Summary: The strategy of embedding investments in an effecively untaxed Active NFE to avoid CRS reporting is ill-advised because:

  1. The OECD will close this loophole in 2017 by amending the CRS so that effectively untaxed entities cannot qualify for Active NFE categorisation. Therefore these entities will be reportable Passive NFEs.
  2. The categorisation of an Active NFE (no Controlling Persons reported) can switch to a Passive NFE (Controlling Persons reported) in the year where Active income falls.
  3. In any event, the Active NFE is currently reported by virtue of the Account Holder, although not the Controlling Persons. This would likely trigger an exchange on demand request concerning the Controlling Persons of the Active NFE.