Canada LP with Mexican partners

Unsupervised, untaxed investment entity loophole to be closed
It is becoming known in the press that Canadian entities are being used as a tax haven.

It is expected the OECD will close this loohole by ensuring an untaxed, unsupervised entity cannot be an Investment Entity. Thererfore the FI mainaitning the account must treat the entity as a NFE and look-through to the controlling persons, i.e. beneficial owners.

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1. A primary CRS loophole is untaxed Investment Entities that are not subject to financial supervision.

These should not be an investment entity because the Participating Jurisdiction in which the investment entity is tax resident is unable to enforce reporting if it is not subject to financial supervision. For example, the Participating Jurisdiction for a German owner and director of a BVI company is Germany. This German tax resident Investment Entity can easily not undertake its obligations to report on itself.

Similarly, a Mexican resident establishes a Canadian LP. The Mexican ensures the LP's Limited (managing) partner is a Mexican resident entity. The general partners are Mexicans. The Canadian LP is therefore tax resident in Mexico. The Canadian LP is a Mexican resident investment entity if it passes the income and management tests. This Mexican investment entity will not report on its partners who have equity interest if they are resident in same jurisdiction as the LLP.

The EU Savings Tax Directive tackled this weakness by mandating the economic operator report when making a payment to a cross-border Paying Agent Upon Receipt, yet in the CRS, the Investment Entity is not reported on as it is a non-reportable person because it is a Financial Institution.

If the CRS is amended so that an untaxed, unsupervised entity cannot be an investment entity, then the Canadian LLP will be considered a NFE and the FI maintaining the LP's financial assets will have reporting obligations, not the LP.

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3. IFRSA on Investment Entities where Entities that, by design, may have only one single investor (such as those types of entities mentioned above) may not qualify as investment entities, because of the criterion that requires them to have multiple unrelated investor.

More and more CRS guidelines, eg Holland, exclude entities where there is only one shareholder or beneficial owner from being an investment entity. Also entities where the beneficial owner is restricted to a single family, is also excluded from being an Investment Entity.
4. The origin of closing this loophole is derived from the EU Savings Tax Directive (EUSD), the first international automatic exchange of information. The EUSD made interposed entities between the financial institution and the individual a Paying Agent Upon Receipt (PAUR). The PAUR had reporting obligations. This is the same as the CRS investment entity. Yet the EU Commission in drafting the EUSD, recognised that the PAUR was owned by the tax dodger and thus the tax dodger would not likely report on himself. Therefore the EUSD obliged the financial institution (economic operator) making a payment to the PAUR would be obliged to report that a payment was made to the PAUR, in effect placing the PAUR on the radar. No such reporting obligation exists in the CRS.

As the CRS does not want duplicate reporting, the easiest way to tackle this loophole / weakness is through an amedment to the CRS. The change will ensure that an untaxed investment entity (PAUR in EUSD) which are not supervised, cannot be an investment entity. The change will mean that the FI, such as a Depository Institution (economic operator in EUSD), would have to look through the entity to the controlling persons if the entity is not an Active NFE.

The EUSD describes a Paying Agent Upon Receipt as follows:

What is the concept of "paying agent upon receipt"? Why does the directive contain this concept?

Paying agents under the directive (every person who pays interest to individuals in the framework of a professional activity such as a financial institution, a bank or an independent asset manager) are ordinarily obliged to report information on the identity of the owner of the interest to their tax authorities, who pass the information to the Member State of residence of the beneficial owner, at the time when the interest payment is made to that beneficial owner (paying agents established in states or territories which apply the withholding tax are obliged to withhold a tax instead of communicating information). These agents could be defined as the normal paying agents "upon distribution" within the framework of the directive.

However, in order to avoid a situation where individuals could circumvent the directive by interposing, between normal paying agents and themselves, certain non-corporate entities such as untaxed associations and investment clubs, the current directive already assimilates those entities to paying agents. It obliges them to act as paying agents at the moment when they receive an interest payment from an upstream economic operator, regardless of the actual distribution of any sum to the individual beneficial owner ("paying agent upon receipt" rule).

The EU Savings Tax Directive Article 2(Par 4)(sub par 3)

An economic operator paying interest to, or securing interest for, such an entity established in another Member State which is considered a paying agent under this paragraph shall communicate the name and address of the entity and the total amount of interest paid to, or secured for, the entity to the competent authority of its Member State of establishment, which shall pass this information on to the competent authority of the Member State where the entity is established.