With the world becoming increasingly globalized it is easier for taxpayers to make, hold and manage investments through financial institutions outside their countries of residence. Vast amounts of money are kept offshore and go untaxed to the extent that taxpayers fail to comply with the tax duties of their home jurisdictions. Effective co-operation among tax authorities is critical in the fight against tax evasion and to protect the integrity of tax systems.
Exchange of information among tax authorities – latest developments
The current spontaneous1 exchange of information and the exchange of information on request, which, historically, has been the oldest type of information exchange among tax authorities, are slow, ineffective and do not keep pace with the world of the 21st century. Computerized data processing is the key aspect of effective cooperation; the framework of the OECD's Multilateral Competent Authority Agreement on the Automatic Exchange of Financial Account Information (CRS MCAA) allows, already, for the automatic exchange of information in a standard electronic format – the Common Reporting Standard (CRS). The CRS was developed by the OECD, with the G20 countries, to tackle tax avoidance and evasion and improve tax compliance.
The CRS MCAA provides a standardized and efficient mechanism to facilitate the automatic exchange of information. As with the US Foreign Account Tax Compliance Act (FATCA), the CRS model imposes duties on financial institutions to identify reportable accounts and to obtain the identifying information on the account holder required to be reported for such accounts to their local competent tax authorities. This avoids the need to conclude multiple bilateral agreements. The text and signatories of the CRS MCAA can be found on the OECD website.2
The CRS schema is virtually identical to the FATCA schema in terms of structure and content, with both schemas making use of XML (extensible mark-up language). Thus, for tax authorities and financial institutions that will be reporting and exchanging information under FATCA, the use of the CRS schema will likely not require significant additional investment.3
Schedule for first reporting
Data will be exchanged mostly on an annual basis; for the first time by 30 September 2017 for 2016 data. Over 1,300 bilateral exchange relationships have already been activated with respect to jurisdictions committed to the 2017 timeline. Some jurisdictions will join the system one year later (for instance, Andorra, Austria, Australia, Belize, Brazil, Canada, China, the Cook Islands, Japan, the Marshall Islands, Mauritius, Monaco, Saudi Arabia and Switzerland).
Common standard for reporting information
An effective model for the automatic exchange of information requires a common standard for the information to be reported by financial institutions and exchanged with the jurisdictions of residence. In order to limit opportunities for taxpayers to circumvent the model by shifting assets to institutions or investing in products that are not covered by the model, the reporting regime requires a broad scope covering three aspects: (i) information reported; (ii) account holders subject to reporting; and (iii) reporting financial institutions.4
Financial information reported
The comprehensive reporting regime covers different types of investment income including interest and dividends, and addresses situations where taxpayers seek to hide capital that itself represents income or assets on which tax has been evaded (e.g., by requiring information on account balances). The information reported to the competent tax authorities by financial institutions will include information on capital gains, account balances and income from the sale of financial instruments of each identified passive entity. Passive entities are considered entities with at least 50 percent of their total income generated from financial activities, companies that were established primarily for the purpose of owning shares in other companies and companies that generate more than 50 percent of their gross income from what is referred to as passive activities, i.e., particularly income from dividends, licenses and patents, interest income and rental (or a combination of these). The tax authorities will also learn details about the beneficial owners of such entities.
More precisely, the information to be exchanged is, with respect to each reportable account of another jurisdiction:
|a)||the name, address, jurisdiction(s) of residence, taxpayer identification number TIN(s) and date and place of birth (in the case of an individual) of each reportable person that is an account holder of the account and, in the case of any entity that is an account holder and that, after application of due diligence procedures consistent with the CRS, is identified as having one or more controlling persons that is a reportable person, the name, address, and TIN(s) of the entity and the name, address, TIN(s) and date and place of birth of each reportable person;
|b)||the account number (or functional equivalent in the absence of an account number);
|c)||the name and identifying number (if any) of the reporting financial institution;
|d)||the account balance or value (including, in the case of a cash value insurance contract or annuity contract, the cash value or surrender value) as of the end of the relevant calendar year or other appropriate reporting period or, if the account was closed during such year or period, the closure of the account;
|e)||in the case of any custodial account: (1) the total gross amount of interest, the total gross amount of dividends, and the total gross amount of other income generated with respect to the assets held in the account, in each case paid or credited to the account (or with respect to the account) during the calendar year or other appropriate reporting period; and (2) the total gross proceeds from the sale or redemption of financial assets paid or credited to the account during the calendar year or other appropriate reporting period with respect to which the reporting financial institution acted as a custodian, broker, nominee, or otherwise as an agent for the account holder;
|f)||in the case of any depository account, the total gross amount of interest paid or credited to the account during the calendar year or other appropriate reporting period; and
|g)||in the case of any account not described in subparagraph (e) or (f), the total gross amount paid or credited to the account holder with respect to the account during the calendar year or other appropriate reporting period with respect to which the reporting financial institution is the obligor or debtor, including the aggregate amount of any redemption payments made to the account holder during the calendar year or other appropriate reporting period.|
The term “reportable account” means a financial account that is maintained by a reporting financial institution and that, pursuant to due diligence procedures consistent with the CRS, has been identified as an account that is held by one or more persons that are reportable persons with respect to another jurisdiction or by a passive non-financial entity with one or more controlling persons that are reportable persons with respect to another jurisdiction.
Account holders subject to reporting
The comprehensive reporting regime requires reporting on individuals; it also is designed to restrict opportunities for taxpayers to circumvent reporting by using interposed legal entities or arrangements. This means that financial institutions must check shell companies, trusts and similar arrangements, including taxable entities, to cover situations where taxpayers seek to hide the principal but are willing to pay income tax.
Financial institutions required to report
The comprehensive reporting regime covers banks and other financial institutions such as brokers, certain collective investment vehicles and insurance companies.
Implementation of CRS MCAA in the Czech Republic
The Czech Republic has taken into account the recent anti-tax avoidance developments in the EU and the OECD and is committed to global standards. New legislation implements the annual automatic exchange of information in compliance with FATCA and the EU Savings Directive, thus creating a new method for the exchange of information among financial institutions and tax authorities.
How it will work in practice
For instance, in the Czech Republic, if a foreign entity is owned by a Czech tax resident, the Czech tax authorities will be informed of its foreign accounts and income, including details of its beneficial owner, despite the fact that the entity is a foreign tax resident. The same will apply vice versa in cases where Czech passive entities are owned by foreign tax residents.
Czech financial institutions will provide the relevant electronic data on the tax non-resident’s financial accounts to the Czech General Financial Directorate which will automatically share the data with the competent tax authorities of the country where the client is a tax resident.
Czech tax residents must be prepared to communicate with foreign financial institutions regarding their tax residency based on this new scheme. Czech residents are obliged to tax their worldwide taxable income, including foreign employment income, dividends, interest, capital gains and other taxable payments. To date, the Czech tax authorities have had no effective tool to verify such foreign sourced income.
Confidentiality and data safeguards
The confidentiality of taxpayer information is a fundamental cornerstone of tax information exchange. Taxpayers and tax administrations have a legal right to expect that sensitive financial information remains confidential and the CRS therefore contains extensive guidance on the confidentiality and safeguarding of data.
Reporting financial institutions and taxpayers face a significant challenge. Today, 108 jurisdictions, including many “tax havens” (Barbados, Bermuda, the British Virgin Islands, the Cayman Islands, Guernsey, Monserrat, Liechtenstein, Seychelles, Nauru, the Turks & Caicos Islands, etc.), participate in the automatic exchange of financial account information. The sharing of data on capital gains, account balances, income from the sale of financial instruments and data on the beneficial owners of passive entities (for the year 2016 already) will aid in the effective verification of income tax returns and improve tax transparency. Consequently, tax authorities will no longer have to rely only on spontaneous exchanges of data or journalists revealing secret information and causing scandals the likes of the Panama Papers.
1 Exchange on request is the furnishing by the requested state of information relating to a particular case to an applicant state which has specifically requested it;
Spontaneous exchange is the passing on of information obtained during examination of a taxpayer's affairs or otherwise, which might be of interest to the receiving state;
Automatic exchange is the systematic sending of information concerning specified items of income or capital from one party to another.
3 The detailed information and definitions of terms can be found in the CRS Implementation Handbook at: www.oecd.org/tax.
4 The text of the CRS Multilateral Competent Authority Agreement can be found at: http://www.oecd.org/tax/automatic-exchange/international-framework-for-the-crs/multilateral-competent-authority-agreement.pdf.
*Rostislav Frelich is a tax advisor in the Tax Practice Group in the Prague office of PETERKA & PARTNERS advokatni kancelar s.r.o. Mr. Frelich can be contacted at email@example.com.