One of the key themes in attempts at a coordinated reform of the global financial system since the economic crisis has been the pursuit of greater international transparency. In an increasingly globalized world, it is correspondingly easier for taxpayers to move assets into offshore financial institutions in order to potentially evade – tax.
A significant recent development has been the move towards automatic exchange of information between sovereign authorities, replacing the earlier standard of information exchange on request. At the Cannes Summit in 2011, the G20 agreed to consider exchanging information automatically for tax purposes on a voluntary basis. In 2012, in the context of implementing their response to the US Foreign Account Tax Compliance Act (FATCA), the so-called EU5 (France, Germany, Italy, Spain, UK) developed a model inter-governmental agreement (IGA) with the US providing for automatic information exchange.1
In April 2013, the EU5 agreed to work towards a multilateral exchange facility between their countries as part of the creation of a new international standard. The G20 Finance Ministers and Central Bank Governors’ Meeting in Washington welcomed these moves:
“More needs to be done to address the issues of international tax avoidance and evasion, in particular through tax havens, as well as non-cooperative jurisdictions… We urge all jurisdictions to move towards exchanging information automatically with their treaty partners… We look forward to the Organisation for Economic Cooperation and Development (“OECD”) working with G20 countries … in developing a new multilateral standard on automatic exchange of information, taking into account country-specific characteristics.”2
In May 2013 the OECD, which had previously revised its Tax Convention to bring it in line with the international standard on exchange of information, called on all jurisdictions to move towards automatic exchange of information and to “improve the availability, the quality and the accuracy of information on beneficial ownership, in order to effectively act against tax fraud and evasion.”3 Also in May, the EU Council agreed to give priority to efforts to extend automatic exchange of information at the EU and global level and welcomed the on-going efforts made by the G8, G20 and OECD to develop a global standard.4 At a meeting in St Petersburg in September 2013, the G20 announced that they expected to begin automatic exchange of information (AEoI) by the end of 2015.5
Different models of automatic exchange are possible, with different potential implications for systems and processes. In the FATCA context, the model IGA exists in two basic forms. Model 1 provides for financial institutions in the participating countries to transfer customer account information to their domestic tax authorities, which in turn exchange details between themselves and third-party governments. This approach was adopted in part to ease legal and other concerns over directly revealing details of citizens’ financial affairs to a third-party government. By contrast, Model 2 envisages direct automatic information exchange with the US Internal Revenue Service. This approach is also being adopted in the OECD’s Treaty Relief and Compliance Enhancement package, which allows withholding tax relief at the source on portfolio investments.
The structure adopted has important implications for how institutions design and implement the relevant systems. But a number of general consequences are clear:
- there is an ever-increasing need for financial institutions to implement effective Know Your Customer regimes, not only for Anti-Money Laundering (AML) and sanctions purposes but now for tax reporting as well.
- this will include establishing:
- where the customer is resident for tax purposes
- whether an individual customer holds US citizenship
- the type of business operated by corporate entities.
In particular, it should be noted that information gathered for AML purposes may not be sufficient to meet tax reporting requirements without additional due diligence. Remediation in respect of existing customers may very well be necessary in many cases.
As the move to a new standard of AEoI gains momentum, a number of potentially significant issues still need to be resolved, including:
- if the AEoI regime is unilateral, then what is the enforcement mechanism for foreign financial institutions?
- what is the penalty structure for noncompliance and will some countries impose stricter penalty structures based on local law?
- does the AEoI conflict with applicable data protection laws?
- is the AEoI reporting requirement fully reciprocal, partially reciprocal or nonreciprocal?
- even with OECD model agreements, how much consistency will be achieved with other bi-lateral agreements already negotiated?
It is likely that reporting may need to be directed to the local tax authority. Nevertheless, the mechanism and structure of the reporting process needs to be fully understood and synchronized if possible with existing reporting requirements.
It is clear that these new approaches are having a significant impact, and are reshaping the international tax environment and the policies of a number of important players. In May 2013, Austria, Luxembourg and Singapore were among nine countries which signed up to the OECD Tax Convention; Switzerland, one of the world’s biggest offshore financial centers, followed suit in October. José Ángel Gurría, OECD Secretary-General, commented that this “sends a clear and strong signal that Switzerland is part of the community of states which consider international tax co-operation as a necessity.”6
Banking secrecy, ‘tax havens’ and their potential use for tax evasion appear to be rapidly disappearing with these new emerging global standards. Financial institutions will be expected to play their part in facilitating the necessary AEoI.
As specific measures continue to evolve, financial services companies will need to develop and implement appropriate responses; it is important that they maintain awareness of proposals under discussion and their potential implementation timetables in order to formulate effective steps that may need to be taken.
Many systems and processes can be reviewed now to determine whether they can be readily modified. In particular, many financial companies are presently implementing their responses to FATCA, and it is important that any new measures to satisfy AEoI regimes are integrated with the FATCA process, to foster consistency and avoid duplication. The tax function needs to work closely with other functions such as AML and compliance to determine tax requirements are accurately interpreted and built into processes affected.
Key areas for review include:
- onboarding forms and policies and procedures will need to be redesigned to capture necessary data
- specific new tax forms introduced by tax authorities will need to be set up for information capture and transmission
- IT systems will need to be updated, and so should benefit from review, updating and data cleansing in readiness
- monitoring arrangements to capture changes in customer information and status can be developed alongside periodic reviews done as part of AML compliance.
An assurance and attestation framework should be designed to:
- determine that the firm is compliant with the regulations
- monitor compliance and identify instances of non-compliance
- provide a governance and reporting structure that enables divisions and legal entities to document, record and report on their compliance; and therefore
- give sufficient comfort to key stakeholders that they can attest to the firm’s compliance.
Financial services companies face significantly increasing regulatory and reputational risk, and corresponding risk of financial penalties. They are also under growing scrutiny from external stakeholders. This means that boards are taking much greater interest in these areas too, a trend which we expect to continue. Consequently, it is increasingly important that companies should be developing the necessary frameworks now to facilitate the smoothest possible implementation of specific measures when they are required.
1 cf Model Intergovernmental Agreement to Improve Tax Compliance and to Implement FATCA, US Treasury July 2012
2 Para 14, Final Communiqué, 19 April 2013.
3 Chair’s Summary – OECD Ministerial Council Meeting, 29-30 May 2013
4 Council conclusions, 22 May 2013
5 Tax Annex to the St Petersburg G20 Leaders’ Declaration, September 2013
6 Switzerland signs Multilateral Convention on Mutual Administrative Assistance in Tax Matters, OECD 15 October 2013