Worldwide: Structured Finance: FATCA And The OECD Common Reporting Standard

More than 90 jurisdictions, including all 34 member countries of the Organisation for Economic Co-operation and Development (“OECD”) and the G20 members, have committed to implement the Common Reporting Standard for automatic exchange of tax information (“CRS”). Building on the model created by FATCA, the CRS creates a global standard for the annual automatic exchange of financial account information between the relevant tax authorities.

The major structured product issuer jurisdictions, including the British Virgin Islands, Cayman Islands, Ireland, Luxembourg and the Netherlands, are among a group of over 50 jurisdictions known as the “Early Adopters Group” that have committed to the implementation of the CRS by the end of 2015 and the first exchanges of information in 2017. In terms of the number of potential reporting financial institutions under CRS, the membership of the Early Adopters Group is significant (e.g. financial institutions in the Cayman Islands and Ireland together account for approximately 30% of those entities registered with the IRS for US FATCA). All EU members, with the exception of Austria, are also members of the Early Adopters Group.

The OECD released the full version of the CRS on 21 July 2014. The full version includes commentaries and guidance for implementation by governments and financial institutions, a model Competent Authority Agreement, standards for harmonised technical and information technology modalities (including a standard reporting format) and requirements for secure transmission of data. Each participating jurisdiction will be required to enact domestic legislation or rules to provide for the implementation of the CRS. The Cayman Islands government has indicated that specific regulations will be issued in October 2015 in relation to implementing the CRS in the Cayman Islands. Ireland is also expected to pass relevant regulations later this year. The United States has, so far, not joined the CRS initiative given the extensive network of intergovernmental agreements it has already signed up with respect to FATCA.

CRS COMPLIANCE – FATCA PLUS

Without doubt, the introduction of the CRS will represent an increased compliance burden for financial institutions. With the existing FATCA compliance burden in mind, and with the aim of maximising efficiency and reducing costs for financial institutions, the CRS is closely modelled on the existing FATCA intergovernmental regime. The significant overlap between CRS and FATCA should permit recently introduced FATCA due diligence and reporting procedures to be leveraged. However, the universe of reportable accounts caught by the CRS will be significantly larger than that required to comply with US FATCA (see “Reporting Financial Institutions” below). There are also key differences between FATCA and the CRS that are likely to require additional procedures to ensure compliance (see “Due Diligence and Reporting” below).

In general, the differences between CRS and FATCA reflect the multilateral nature of the CRS and the US specific attributes of FATCA. The standardised approach of the CRS is intended to allow countries to use the exchange system without having to negotiate a separate annex with each counterpart country. The CRS is more closely aligned to ‘UK FATCA’ than US FATCA in terms of account due diligence and related reporting requirements. The principle differences between US FATCA and CRS are:

a. Registration – there is no requirement to register with any foreign tax authority or to obtain any global identification number (such as a GIIN).

b. Withholding – while domestic laws may impose penalties for non-compliance (generally in the form of administrative fines, although some can impose prison sentences), CRS does not impose a punitive withholding tax regime.

c. Client Classification – classification is based on tax residency rather than nationality or citizenship, with a residence address test built on the EU Savings Directive. This has the potential to create some complexity as a client may be taxable in several countries in the relevant reporting period or their identification may contain indicia relating to multiple tax jurisdictions. However, CRS does permit reliance on client self-certification (see “new individual accounts” below).

CRS differs from US FATCA in a number of other ways that will likely increase the number of reportable accounts and change the classification of certain investors. Firstly, CRS does not provide a de minimis threshold for individuals in connection with the required due diligence procedures. Following FATCA, such procedures distinguish between individual accounts and entity accounts as well as provide for a distinction between pre-existing and new accounts. While pre-existing individual accounts must be reviewed regardless of the account balance, there is a distinction between a “Higher Value Account” (a pre-existing individual account with an aggregate balance or value that exceeds US$1m) and a “Lower Value Account” (a pre-existing individual account with an aggregate balance or value that does not exceed US$1m).

For Lower Value Accounts, a permanent residence address test based on documentary evidence or residence determination based on an indicia search is required (conflicting indicia would need to be resolved by self-certification and/or documentary evidence). For High Value Accounts, enhanced due diligence procedures will apply, including a paper record search and an actual knowledge test of the relationship manager for the account. For new individual accounts, the financial institution is required to obtain a self-certification to determine the account holder’s tax residence and must then confirm the reasonableness of such self-certification based on account opening documents (including AML/KYC documents).

For pre-existing entity accounts, the financial institution must determine whether the entity itself is a “Reportable Person”: essentially an individual or an entity that is resident in a reportable jurisdiction under the tax laws of that jurisdiction (other than those entity types that are similarly exempt under FATCA, such as government entities and financial institutions). It must also be determined whether the entity is a passive non-financial entity (NFE) and, if so, the residency of the controlling person(s) must also be ascertained. Where existing AML/KYC information is insufficient to make this determination, the entity must provide a self-certification to establish whether the entity is a Reportable Person. Importantly, each participating jurisdiction may opt to allow financial institutions to apply a threshold to make preexisting entity accounts below US$250,000 (or local currency equivalent) exempt from review. New entity accounts are subject to the same due diligence requirements as pre-existing entity accounts. However, the option for the US$250,000 (or local currency equivalent) threshold does not apply as it is less complicated to obtain selfcertifications for such new accounts.

REPORTING FINANCIAL INSTITUTIONS

The financial institutions covered by the CRS are broadly the same as FATCA and include custodial institutions, depository institutions, investment entities and specified insurance companies. However, the categories of financial institutions that are excluded from reporting (“Non-Reporting Financial Institution”) are not as broad as those provided for under US FATCA. Non-Reporting Financial Institutions include:

a. government entities, international organisations or central banks;

b. broad participation retirement funds, narrow participation retirement funds, pension funds of a governmental entity, international organisation or central bank, or a qualified credit card issuer;

c. entities that:

i. present a low risk of being used to evade tax;

ii. have substantially similar characteristics to any of the entities described in (a) and (b) above; and

iii. are defined in domestic law as a Non-Reporting Financial Institution, provided that the status of such an entity as a Non-Reporting Financial Institution does not frustrate the purposes of the CRS;

d. exempt collective investment vehicles; or

e. trusts, if the trustee is a reporting financial institution and reports all necessary information.

The list above does not include certain of the “Exempt Beneficial Owners” and “Deemed Compliant Financial Institutions” identified by US FATCA as being low risk entities and, therefore, exempt from GIIN registration and reporting. Of particular note to practitioners in the structured finance market, is the lack of any equivalent to the limited life debt investment entity (“LLDIE”) exemption provided under the US regulations.

The LLDIE exemption was available to structured finance issuers that issued one or more classes of debt or equity interests to investors pursuant to a trust indenture, trust deed or similar agreement, where all such interests were issued on or before 17 January 2013. The relevant financial institution also had to satisfy five other tests, including the requirement that substantially all of the assets of the financial institution consist of debt instruments or interests therein.

The LLDIE exemption was specifically crafted with CDO and CLO vehicles in mind, with the intention that the significant number of ‘old and cold’ CDO and CLO vehicles in existence would be excluded from the requirement to register for a GIIN and report under US FATCA (in practice these entities which are low risk from a tax evasion perspective would be unable to report due to the structured nature of their transaction documents).

At first glance, it is difficult to see how an LLDIE could satisfy all of the requirements of a “low risk” entity as detailed in (c) above. For LLDIEs which have issued all of their securities into the clearing systems, this should not prove too much of an issue as it is generally expected that clearing systems will be financial institutions in their own right and so will not be reportable persons. However for those LLDIEs which have issued securities in certificated form, it will be interesting to see how the art of achieving the impossible can be managed in practice.

DUE DILIGENCE AND REPORTING

It is important to note that the CRS represents a minimum set of requirements and that it is open to each jurisdiction to implement a wider approach (for example, to extend due diligence requirements to cover local residents). This wider approach is intended to permit financial institutions to obtain due diligence from and maintain records in respect of accounts of residents of jurisdictions that have committed to implement the CRS, but have not yet done so. The perceived advantage of this wider approach being reduced cost for the financial institution as it would not be required to perform additional due diligence on existing accounts each time a new jurisdiction joins the CRS.

The CRS reporting XML schema is based on the FATCA schema (i.e. Form 8966 and the XML schema), but also contains elements of the OECD standard transmission format that are not essential for CRS reporting. Following a declaration from the IRS that the FATCA schema would be revised in 2016 to align it with the CRS schema, several member jurisdictions declared an intention to enhance the reporting schema with certain local data requirements. If these local enhancements are implemented, the CRS schema may become less “standard” than originally planned.

IMPLEMENTATION TIMELINE

For structured product vehicles based in Early Adopter jurisdictions, the following dates will apply:

1 January 2016 – implement due diligence procedures to determine the tax residency of all account holders. Pre-existing accounts will be those maintained on 31 December 2015 and new accounts would be those opened from 1 January 2016.

31 December 2016 – due diligence for identifying High Value preexisting individual accounts to be completed.

March 2017 – initial reporting to local Competent Authority expected to begin.

30 September 2017 – initial exchange of information between Competent Authorities.

31 December 2017 – due diligence for identifying Low Value preexisting individual accounts and entity accounts to be completed.