CRS weaknesses under consideration by OECD

Loopholes which should be closed

Updated 20.2.2016

1. False or dual residency certificate

The indicia list to be expanded to include a 7th element of previous residencies changed in last ten years.

Assume the individual is dual resident resident in the previous residence jurisdiction. If Account holder wishes to contest the indicia, the indicia can be cured by self-certification of the account holder and proving the account holder is no longer tax liable in the previous reportable jurisdiction by means official documentation such as tax clearance certificate. Previous residencies changed more than 10 years ago will not count as an idicia.

2. Mini EU FATCA against USA

a EU mini FATCA against USA which will PDF document impose a 35% withholding tax on the recalcitrant USA. EU Parliament to propose that every EU FI making an EU source financial payment to any US FI must withhold 35% on the gross payment unless the FI agrees to exchange information as per the FATCA IGA promises for reciprocal reporting.

FATCA IGA reciprocal reporting was supposed to be equivalent to the CRS. However, the reciprocal promises were made by Treasury which is not the judicial branch of government. Long before FATCA, the US Congress authorized that the only information which may be automatically exchanged is depository interest for non-resident alien individuals (and in some cases corporations) who are resident in a country that the USA has a bilateral tax agreement or other convention.

The IRS falsely propagates that it reciprocates information making a level playing field. However, they omit to mention that the information is restricted to interest for individuals.

3. CRS jurisdiction advisors on accounts in USA and other non-participating jurisdictions

Custodial Institution which potentially can hold assets

Commentary page 160 par(10) states Custodial Institution is an entity that substantially earns income attributable to related financial services, such as "fees for providing financial advice with respect to Financial Assets held in (or potentially to be held in) custody by the entity"

So banks, or other financial institutions, which potential can hold the assets and advise on accounts held by US custodian or US depository FI and subsequently earn advisory fees on those USA accounts, will be deemed to be a Custodial Institution. The USA, or other non-participating jurisdiction account will be deemed to be a Custodial Account. The bank in the CRS reporting jurisdiction will have reporting obligations on the account maintained in the USA.

This deeming of a custodial institution will likely be extended to investment entities receiving advisory fees for accounts maintained in the USA and other non-participating jurisdictions.

4. Shifting to unrelated custodial accounts in non-participating Jurisdiction

CRS banks advise customers to close accounts and open new account with USA custodian such as Pershing. Bank continues to have a relationship with customer as if the account was still maintained with the bank.

The following are examples of situations where it is expected that an anti-avoidance rule would apply: Shift Maintenance of an Account: A Reporting Financial Institution advises a customer to maintain an account with a Related Entity in a non-Participating Jurisdiction that enables the Reporting Financial Institution to avoid reporting while offering to provide services and retain customer relations as if the account was maintained by the Reporting Financial Institution itself. In such a case, the Reporting Financial Institution should be considered to maintain the account and have the resulting reporting and due diligence requirements.

The OECD will redact the word "related" so that any bank advising clients to shift account to custodians such as Pershing will maintain the account. Note importantly - this will include investment entities such as fund advisors.

5. Abuse Bilateral Option to base CAA

The OECD should redact the bilateral / TIEA option that jurisdictions can base their Competent Authority Agreements on as a legal basis to automatically exchange information. These jurisdictions will be obligated to sign the Multilateral Convention of Mutual Assistance in Tax Matters. Furthermore, these countries seem unaware that they must not self-assess the data safeguards and confidentiality of information of potential partner jurisdictions because the OECD will publish a list of which jurisdictions are been deemed by the OECD to have satisfactory data safeguards and confidentiality in place for Competent Authority Agreements.

Bahamas has publicly stated that the bilateral option gives them the ability to choose which partners to select based on subjective factors such as confidentiality concerns and longer time needed to implement the Standard.

Panama has insisted on six unacceptable conditions before signing any common reporting standard competent authority agreement.

Hong Kong states it will only sign bilateral tax treaties with countries with Hong Kong’s trading and investment partners to facilitate business and minimize the incidence of double taxation.

6. Pre-existing individual insurance if prevented by law from being sold to reportable jurisdiction residents

Redact the exemption of pre-existing individual Cash Value Insurance Contracts where the Reporting Financial Institution is effectively prevented by law from selling such contracts to residents of a Reportable Jurisdiction.

Commentary page 110 par(2) - A Reporting Financial Institution is 'effectively prevented by law' from selling Cash Value Insurance Contracts or Annuity Contracts to residents of a Reportable Jurisdiction. This creates planning opportunities where residents can own insurance contracts the same way that cross-border residents can access non-UCITS despite the restriction on sales.

7. Irrevocable Insurance

The OECD should include in scope irrevocable insurance policies that are investment-linked.

Several offshore insurance companies created a new type of policy that never existed prior to the CRS. They advocate an irrevocable investment-linked insurance policy where the policyholder cannot access the policy assets and the only payable amount is a death benefit. This new type of insurance product is promoted as having no Cash Value and hence is not reportable under the CRS. The OECD considers these as equivalent to irrevocable trusts. The Commentary will be amended - Payments solely by reason of the death of an individual insured under a life insurance contract unless it is an investment linked policy. Note that the Standard already states if no person can access the Cash Value, the Account Holder reported is any person named as the owner in the contract and any person with a vested entitlement to payment under the terms of the contract.

8. Ownership and income of property

The CRS is implemented in the EU under the Directive for Administrative Assistance (DAC). This contains additional categories of income and capital not in the CRS, . Some of these additional categories of income and capital will be included in the CRS amendments.

Ownership and income of property may be reportable. However, this extra category of income and capital is only included as a payment subject to due diligence for reporting if the information is available. This if available condition may be redacted.

9. Directors Fees and Employment Income

The CRS is implemented in the EU under the Directive for Administrative Assistance (DAC). This contains additional categories of income and capital not in the CRS. Some of these will be included in the CRS amendments.

For instance, establishing a charitable foundation where Council directors receiving (unlimited) fees or salaries, will now be included as equity interest or controlling persons. However, this extra category of income and capital is only included as a payment subject to due diligence for reporting if the information is available. This if available condition may be redacted.

10. Unsupervised untaxed entities cannot be investment entities

Untaxed entities that are not subject to financial supervision should not be an investment entity.

The Standard defines which Participating Jurisdiction an untaxed entity is considered to be resident. Commentary page 159 par(4) - Where a Financial Institution (other than a trust) does not have a residence for tax purposes, it is considered to be subject to the jurisdiction of a Participating Jurisdiction and it is, thus, a Participating Jurisdiction Financial Institution if :

  • It is incorporated under the laws of the Participating Jurisdiction; is there a missing 'and' here?
  • It has its place of management (including effective management) in the Participating Jurisdiction; or
  • It is subject to financial supervision in the Participating Jurisdiction.

This will invariable be a loophole. How is the Participating Jurisdiction able to enforce reporting by the Financial Institution 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, due to (b) above (but not (a?)). This investment entity will invariably not report on itself. The EU Savings Tax Directive tackled this weakness by making the economic operator report on payments made to a cross-border Paying Agent Upon Receipt.

11. Entities cannot be Active NFEs if effectively untaxed

The Standard should follow the amended EU Savings Tax Directive which included any entity that is effectively untaxed. Effectively untaxed could be subject to tax of 5% or less.

This will prevent an account holder utilising their untaxed offshore active NFE to hold investments

12. Trust distributions via loans

Deem loans from trusts as a reportable distribution. Trusts invariably make distributions to beneficiaries as loans. These loans are never repaid

It remains to be seen how the OECD will include loans from underlying companies owned by trusts, if the underlying company is a passive NFE.

13. Include debtors of Passive NFEs as Controlling Persons

Include debtors as controlling persons for Passive NFEs, equivalent to debt interest for investment entities.

For investment entities, debt interest is a reportable account holder. Yet controlling persons of Passive NFEs do not include debtors. This creates a loophole where debtors could provide capital to a Passive NFE owned by a trust, in lieu of a settlement to a trust and not be reportable.

14. Indicia telephone include number same as Financial Institution's jurisdiction

All telephone numbers will be indicia, irrespective if one or more are in the same jurisdiction of the Financial Institution.

One of the indicia is one or more telephone numbers in a Reportable Jurisdiction and no telephone number in the jurisdiction of the Reporting Financial Institution. It is simple to negate this indicia by establishing a skype forwarding number which has its country code in the same jurisdiction of the Financial Institution.

Clarifying ambiguities and misunderstandings

Updated 22.1.2016

  1. Equity interest of settlor for irrevocable trusts

    Settlors of irrevocable trust will have equity interest, with the entire property value of trust being reported. Some lawyers have incorrectly interpreted that Settlors without equitable rights have no equity interest according to the CRS.

  2. Equity interest of Protector for irrevocable trusts

    Protectors are specifically included as controlling persons of NFE trusts but not as having equity interest in an investment entity trust.

  3. Custodian banks for insurance policies will categorically not have reporting obligations because custodian bank accounts of insurance contracts are exempt from the definition of Custodial Account.

    Confusingly, the FATCA definition of custodial institution includes insurance contracts.

    To confound this issue further, AML guidelines usually oblige custodial banks know who the ultimate beneficial policyholders are and hence they will report on the beneficial owners because the custodian banks do not believe the insurer owns the assets.

    For Example the HMRC guidelines incorrectly state "A Cash Value Insurance Contract or an Annuity Contract is not considered to be a Custodial Account, but these could be assets held in a Custodial Account. Where they are assets in a Custodial Account, the Insurer will only need to provide the Custodian with the cash/surrender value of the Cash Value Insurance Contract".

  4. Dividend income from an Active NFE passive is passive income

    The CRS will clarify that dividend income from Active NFEs are to be categorised as passive income

    Contrary, FATCA states that if dividends can be shown as deriving from underlying active activities, then the dividends can be categorised as active income.

  5. Many jurisdiction Standard guidelines incorrectly state trusts are investment entities if managed by corporate trustees, irrespective of income test

    Several Jurisdiction CRS guidelines incorrectly omit the income test for categorising a trust as an investment entity if the trust is administered by a corporate trustee. This error derives from some FATCA IGAs, for example, Singapore. Some authorities incorrectly consider that trusts administer on behalf of others, whereas it's only the trustee that administrates on behalf of others, not the trust.

  6. Corporate Directors of companies.

    The Standard's guidance will clarify that Corporate Directors are not investment entities as they do not administer on behalf of others

  7. Certain Active NFEs as investment entities if pass the income test

    Redact the clause in Section VIII A(6) - 'Investment Entity' does not include an Entity that is an Active NFE because it meets any of the criteria in sub-par D(9)(d) through (g) namely holding, new, financial services to group.

    This a redundant exemption only causes confusion causing incorrect interpretation that charities and holding companies cannot be an investment entity and therefore do not need to do the income and management test to see if it is an investment entity.

  8. Loans and other extensions of credit

    A depository Institution includes an entity that makes personal, mortgage, industrial, or other loans or provides other extensions of credit. Therefore a loan and other extensions of credit is considered a negative depository account balance.

Awaiting clarification

Updated 19.1.2016

1. Holding Companies and trusts

An Active NFE holding company is defined as substantially all of the activities of the NFE consist of holding the outstanding stock of subsidiaries that engage in trade or business other than the business of a Financial Institution.

  1. Commentary page 197 par(130) Subsidiary means any entity whose outstanding stock is either directly or indirectly held by the NFE. Concerning the term indirectly, is a NFE entity or trust an Active NFE holding company if it holds an underlying company which in turn holds Active NFEs as per D(9)(d)? The argument against this is the top parent entity or trust does not hold directly any entity engaged in business or trade.
  2. Is there a 50% threshold of ownership or management of a subsidiary?
  3. Why holding companies owning subsidiaries engaged only in trade or business and not other Active NFEs?
  4. What is meant by the term activities, e.g. income, revenue, effort, staff, etc.?

2. Does closure of account include transfer of equity

  1. Transfer of equity in an investment entity is considered closure of account. What about transfer of equity in a passive NFE?
  2. What about (temporary) assigning of insurance policy?