What is the OECD automatic exchange of information (AEOI) and Common Reporting Standard?

AEOI and the Common Reporting Standard were developed by the 34 member states of the Organization for Economic Cooperation and Development via its permanent "Global Tax Forum".  The framework follows the USA FATCA model.  AEOI was designed to help combat cross border tax evasion by automatically reporting information of accounts held with Financial Institutions including balances, income and gains of all kinds for the year to domestic tax authorities.  The framework is titled the Standard for Automatic Exchange of Financial Account Information in Tax Matters or more commonly referred to as the Common Reporting Standard and covers reporting obligations, due diligence and exemption.

Common Reporting Standard (CRS) Highlights

What countries have agreed to AEOI and the Common Reporting Standard?

For a current list of countries that have agreed to adopt AEOI, please find the following link:

Countries committed to AEOI

When does AEOI begin?

AEOI begins for some Participating Jurisdictions from the 2016 calendar year and others from 2017.  The Participating Jurisdictions beginning from the 2016 calendar year are called the "early adopters".  This includes Anguilla,Argentina, Barbados, Belgium, Bermuda, British Virgin Islands, Bulgaria, Cayman Islands, Colombia, Croatia, Curaçao, Cyprus, Czech Republic, Denmark, Dominica, Estonia, Faroe Islands, Finland, France, Germany, Gibraltar, Greece, Greenland, Guernsey, Hungary, Iceland, India, Ireland,Isle of Man, Italy, Jersey, Korea, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Mauritius, Mexico, Montserrat, Netherlands, Niue, Norway, Poland, Portugal, Romania, San Marino, Seychelles,Slovak Republic, Slovenia, South Africa, Spain, Sweden, Trinidad and Tobago, Turks and Caicos Islands, United Kingdom.

OECD Early Adopters

Reporting for the 2016 calendar year is due by September 2017.

Other Participating Jurisdictions have agreed to implement the framework for the calendar year beginning 2017 with reporting due by September 2018.

Will all of the countries that have agreed to implement AEOI automatically exchange information with each other?

Each country must still sign AEOI agreements with other countries with whom they want to share this information.  It is thought that most countries will first look to existing countries where they have a Tax Information Exchange Agreement (TIEA) or Double Tax Avoidance Agreement (DTAA) in place for instance to begin AEOI.  In some countries this can be a lengthy process.

Financial Institutions in Participating Jurisdictions will be required to collect and report financial information to their domestic tax authorities which will in turn aggregate and report this information to foreign tax authorities of other Participating Jurisdictions with which they have entered into a AEOI agreement.

OECD AEOI Information

Understanding the definitions:

“Financial Institutions” must collect and report Financial Information on their “Reportable Accounts” to the domestic revenue authority. Financial Institutions include custodial institutions (e.g. custodian banks, brokers, etc.), depository institutions (e.g. banks), investment entities (mutual funds, private equity funds, etc.) and specified insurance companies.

The "Financial Information" to be reported with respect to Reportable Accounts includes all types of investment income (including interest, dividends, income from certain insurance contracts and other similar types of income) and also account balances and sales proceeds from financial assets.

“Reportable Account” means an account held by one or more Reportable Persons or by a Passive NFE with one or more Controlling Persons that is a Reportable Person with a Financial Institution.

“Reportable Person” means a Reportable Jurisdiction Person other than: (i) a corporation the stock of which is regularly traded on one or more established securities markets; (ii) any corporation that is a Related Entity of a corporation described in clause (i); (iii) a Governmental Entity; (iv) an International Organization; (v) a Central Bank; or (vi) a Financial Institution.

“Reportable Jurisdiction Person” means an individual or Entity that is resident in a Reportable Jurisdiction under the tax laws of such jurisdiction, or an estate of a decedent that was a resident of a Reportable Jurisdiction. For this purpose, an Entity such as a partnership, limited liability partnership or similar legal arrangement that has no residence for tax purposes shall be treated as resident in the jurisdiction in which its place of effective management is situated.

The “place of effective management” will ordinarily be the place where the most senior person or group of persons (for example a board of directors) makes its decisions, the place where the actions to be taken by the entity as a whole are determined; however, no definitive rule can be given and all relevant facts and circumstances must be examined to determine the place of effective management. An entity may have more than one place of management, but it can have only one place of effective management at any one time.

https://www.oecd.org/tax/transfer-pricing/36221030.pdf

In general when assessing the place of effective management, jurisdictions have adopted the “substance over form” criteria. Therefore, a “nominee” director who merely does what he or she is told and does not give any independent thought or input into his/her decisions as a board member is not going to pass any test.

Additionally, other criteria such as the following are important in establishing the place of effective management and to support the "substance over form” criteria:

  • Residence of the directors
  • Place where the board meetings are held and key decisions made
  • Frequency of board meetings
  • Level of involvement in the key decisions of the company by the directors (i.e. minutes should reflect that the directors are applying their minds and considering important information in directing the companies)
  • Place where statutory books and accounts are prepared and maintained
  • Location of the “principal office” address

https://www.oecd.org/tax/exchange-of-tax-information/Status_of_convention.pdf

“Reportable Jurisdiction” means a jurisdiction (i) with which an agreement is in place pursuant to which there is an obligation in place to provide the information specified in Section I, and (ii) which is identified in a published list.

“Participating Jurisdiction” means a jurisdiction (i) with which an agreement is in place pursuant to which it will provide the information specified in Section I, and (ii) which is identified in a published list.

“NFE” means any Entity that is not a Financial Institution (i.e. “Non-Financial Entity”)

“Passive NFE” means any: (i) NFE that is not an Active NFE; or (ii) an Investment Entity described in subparagraph A(6)(b) that is not a Participating Jurisdiction Financial Institution.

The term “Active NFE” means any NFE that meets any of the following criteria:

  • Less than 50 per cent of the NFE’s gross income for the preceding calendar year or other appropriate reporting period is passive income and less than 50 per cent of the assets held by the NFE during the preceding calendar year or other appropriate reporting period are assets that produce or are held for the production of passive income;
  • The stock of the NFE is regularly traded on an established securities market or the NFE is a Related Entity of an Entity the stock of which is regularly traded on an established securities market;
  • The NFE is a Governmental Entity, an International Organization, a Central Bank , or an Entity wholly owned by one or more of the foregoing;
  • Substantially all of the activities of the NFE consist of holding (in whole or in part) the outstanding stock of, or providing financing and services to, one or more subsidiaries that engage in trades or businesses other than the business of a Financial Institution, except that an NFE does not qualify for this status if the NFE functions (or holds itself out) as an investment fund, such as a private equity fund, venture capital fund, leveraged buyout fund, or any investment vehicle whose purpose is to acquire or fund companies and then hold interests in those companies as capital assets for investment purposes;
  • The NFE is not yet operating a business and has no prior operating history, but is investing capital into assets with the intent to operate a business other than that of a Financial Institution provided that the NFE does not qualify for this exception after the date that is 24 months after the date of the initial organization of the NFE;
  • The NFE was not a Financial Institution in the past five years, and is in the process of liquidating its assets or is reorganizing with the intent to continue or recommence operations in a business other than that of a Financial Institution;
  • The NFE primarily engages in financing and hedging transactions with, or for, Related Entities that are not Financial Institutions, and does not provide financing or hedging services to any Entity that is not a Related Entity, provided that the group of any such Related Entities is primarily engaged in a business other than that of a Financial Institution; or
  • The NFE meets all of the following requirements:
    • It is established and operated in its jurisdiction of residence exclusively for religious, charitable, scientific, artistic, cultural, athletic, or educational purposes; or it is established and operated in its jurisdiction of residence and it is a professional organization, business league, chamber of commerce, labour organization, agricultural or horticultural organization, civic league or an organization operated exclusively for the promotion of social welfare;
    • It is exempt from income tax in its jurisdiction of residence;
    • It has no shareholders or members who have a proprietary or beneficial interest in its income or assets;
    • The applicable laws of the NFE’s jurisdiction of residence or the NFE’s formation documents do not permit any income or assets of the NFE to be distributed to, or applied for the benefit of, a private person or non-charitable Entity other than pursuant to the conduct of the NFE’s charitable activities, or as payment of reasonable compensation for services rendered, or as payment representing the fair market value of property which the NFE has purchased; and
    • The applicable laws of the NFE’s jurisdiction of residence or the NFE’s formation documents require that, upon the NFE’s liquidation or dissolution, all of its assets be distributed to a Governmental Entity or other non-profit organization, or escheat to the government of the NFE’s jurisdiction of residence or any political subdivision thereof.

“Controlling Persons” means the natural persons who exercise control over an Entity. In the case of a trust, such term means the settlor, the trustees, the protector (if any) the beneficiaries or class of beneficiaries, and any other natural person exercising ultimate effective control over the trust, and in the case of a legal arrangement other than a trust, such term means persons in equivalent or similar positions. The term “Controlling Persons” must be interpreted in a manner consistent with the Financial Action Task Force Recommendations (i.e. the natural person “beneficial owner” behind any “nominee shareholder”, etc.).

Note: “beneficial owner” in countries is generally viewed to be an individual that benefits or exercises control of some minimum amount;  international standards (i.e. FATF) set this threshold at 25% but some countries have thresholds as low as 5%.

So how will all of this work in practice?

Step 1: Financial Institution (i.e. bank, etc.) will first seek to determine if an Account Holder is an Active NFE or a Passive NFE based on the above definitions/criteria. Account holders will generally make a self assessment by a declaration which will be the basis for reporting by the Financial Institution unless the Financial Institution has reason to believe such declaration is false for any reason whereby they may investigate further, request more information/proof, etc.

Scenario 1: Account Holder is an Active NFE – life will be much easier for Active NFE’s as reporting on the account will be restricted to the jurisdiction where the “Active NFE” is either tax resident (i.e. where it files a tax return) or for tax exempt companies (like IBCs, BVI companies, etc.), the information on the account will be sent to the jurisdiction where the directors confirm the company has its “place of effective management”.

Thus, the main concern with Active NFE’s will usually be to make sure that the entity does not establish a tax residency in a high taxing jurisdiction. Otherwise, information relating to the financial account will be reported to the tax authorities in that high taxing jurisdiction.  As one can imagine the tax authorities in that high taxing jurisdiction may be interested to learn that they have a previously unreported tax resident in their jurisdiction especially if it has sizeable income/assets.

Scenario 2: Account Holder is a Passive NFE – reporting will focus on the “Controlling Persons”. Looking at the definition of “Controlling Person”, we begin to see the law and norms established by hundreds of years of precedent as regards trust law for instance seemingly being wholly disregarded as the definition of “Controlling Person” even seems to include a Settlor of an irrevocable trust, a potential object of a discretionary trust (i.e. a potential beneficiary that has not yet been selected and has not yet received any benefit). Assuming the trust is being administered properly, this is simply not possible and in any case it will be interesting to see how this information is treated once received. Regardless, this is the definition and every Financial Institution in a country that is a signatory to this convention must use that definition.

STEP 2: The Financial Institution will check to see if the Account Holder of a Reportable Account is resident in a country which is a Reportable Jurisdiction (i.e. has an AOEI Agreement with the jurisdiction of the Financial Institution where the Financial Account is located) for an Active NFE and for a Passive NFE the Financial Institution will ascertain the “Controlling Persons” and whether any of those persons is resident in a Reportable Jurisdiction.

STEP 3: the Financial Institution will send information on the Reportable Accounts as above to domestic tax authorities.

STEP 4: Domestic Tax authorities will transmit standardized information (account balance, income, dividends, capital gains, etc. for the year) to other Participating Jurisdictions with which they have such an agreement in place in bulk on a yearly basis by September for the previous calendar year (presumably to allow time for accounts to be prepared for the prior year before reporting).

Conclusion

It is definitely time for anyone with a “Passive NFE” or an “Active NFE” that could be deemed to have its “place of effective management” in a country where the Active NFE is not filing a tax return at present to consider restructuring the entity in such a way that it removes or at least reduces to the greatest extent possibly the chances of it being deemed a tax resident in an undesired jurisdiction.

Anyone with an account with a Financial Institution in an early adopter country needs to ensure their structure is set up in a compliant manner before the end of 2015 to avoid tax risks.

Each situation must be considered independently, but where tax mitigation or deferral is an objective, there are generally four main criteria to consider as a starting point:

  1. The “residency” of the entity. This requires consideration of the rules on establishing “residency” of a foreign company in any jurisdiction where any connected party is located.
  2. Consideration of any “controlled foreign corporation” rules where a shareholder/beneficial owner/beneficiary is a resident.
  3. Any “anti-avoidance” rules where a shareholder/beneficial owner/beneficiary is a resident.
  4. Any existing bilateral treaties (DTAA/TIEA) between the countries and terms of same as these countries will likely be the first to conclude AEOI agreements.

Sterling Services and Solutions

Sterling is a boutique offshore services provider focused on providing compliant solutions to our clients that will hold up under scrutiny for the long term. We welcome intermediaries as well and can jointly help devise the best solutions for the end user clients.  Sterling holds multiple licenses and provides a broad suite of services in order to allow us to provide compliant solutions for as broad a cross section of clients in as many different circumstances as possible, keeping in mind that requirements, circumstance and laws are ever changing over time. This allows us to be your partners for the long term.  Some examples of the compliant structures and services we can provide are as follows:

  1. Managed offshore companies structures as Active NFE's
  2. Offshore trusts
  3. Offshore foundations
  4. Special purpose vehicles
  5. Listed structures on the Seychelles Securities Exchange ("Trop-X")
  6. Licensed mutual funds and private investment companies
  7. Pension schemes
  8. Insurance wrappers (projected by end of 2015)

Whether you are with an existing services provider who cannot deliver the necessary products and services to provide you with a compliant structure in the new world we now live it or are looking to set up a new structure in a compliant manner, Sterling is the answer to your requirements.

Contact us now for a free initial consultation!