A taxing issue

So much has been happening in the world of international tax compliance that it can be hard keeping up with every new development. Things are not made any easier by the number of acronyms we’re all expected to recognise.

Unfortunately, just like the money laundering rules, the new international tax compliance regime applies to all solicitors (and our clients). Ignorance is not an option. In this article, I explain where the UK now stands in a changing and increasingly complex global tax landscape, and how the various initiatives in place around the world should inform the tax planning advice you give your clients.

FATCA

The Foreign Account Tax Compliance Act (FATCA) rules are designed to help the US authorities locate their citizens’ offshore assets. US citizens are liable to US tax on their worldwide income and gains, so have an obligation to report all their assets to the Internal Revenue Service (IRS).

The FATCA rules were implemented into UK law by section 222 of the Finance Act 2013 and the International Tax Compliance (United States of America) Regulations 2014.

Just in case any US citizen has forgotten (honestly or otherwise) to report their offshore assets, the new FATCA rules ensure the IRS gets the relevant information regardless. The basic idea behind FATCA is to ensure that financial institutions (FIs) identify and report on their US clients to the IRS.

In the UK, FATCA operates by ensuring that any UK-resident FI reports on its US clients to HM Revenue & Customs (HMRC), which in turn passes the information on to the IRS. The only contact UK FIs have with the IRS is to obtain a global intermediary identification number (GIIN). Thereafter, all FATCA compliance is done in the UK, via HMRC’s online reporting system.

Clearly, this was too good an opportunity for the UK government to miss. Following the USA’s example, the UK introduced the International Tax Compliance (Crown Dependencies and Gibraltar) Regulations 2014 (known as DOT). These regulations, which came into force on 31 March 2014, introduce FATCA-style reporting to the UK’s crown dependencies (Jersey, Guernsey and the Isle of Man) and Gibraltar.

The regulations require FIs in the relevant territories to report any accounts belonging to UK residents that were in existence on or after 30 June 2014. The reporting is not actually due to start, however, until 1 January 2016. Presumably, the back-dating is to deal with anyone who closes their offshore account before the reporting obligation starts: so, a financial institution may well have to make a report on an account that was open on 30 June 2014, but has since been closed.

Reciprocal exchange of information rules apply. So, the UK will give information to the authorities in the UK’s crown dependencies and Gibraltar on any account held in the UK for a resident of one of those jurisdictions.

This contrasts with the automatic tax information exchange agreements the UK has signed with its overseas territories. The agreement with the Cayman Islands came first, followed by Bermuda, Montserrat, the Turks and Caicos Islands, Anguilla and the British Virgin Islands (BVI). These agreements are non-reciprocal, meaning the reporting is all one-way: from the overseas territory to the UK.

Again, reporting is not due to start until 1 January 2016, but FIs in the countries affected are already changing their due diligence in order to comply. Therefore, if you have clients with dealings in any of the countries listed above, they can expect to start receiving letters (if they haven’t already done so) informing them of the new reporting requirements.

EU and OECD initiatives

Tax compliance is not just a concern for the US or the UK. The Organisation for Economic Co-operation and Development (OECD) has introduced the Common Reporting Standard (CRS), a global standard for the automatic exchange of financial account information. In October 2014, 45 jurisdictions signed up to the CRS, agreeing to start exchanging information under the CRS from 2017. A further four jurisdictions have now signed up to start exchanging information from 2018.

Following the publication of the CRS, the EU started work on its implementation in Europe via Council Directive 2011/16/EU on Administrative Cooperation (known as DAC). The DAC makes the automatic exchange of financial account information mandatory between EU member states. All FIs in the EU have to carry out due diligence for identifying reportable accounts, held by both EU residents and anyone resident in a CRS-reportable jurisdiction outside the EU.

The international ‘umbrella’ regulations

These different initiatives all deal with the automatic exchange of financial account information between the UK and other jurisdictions.

The International Tax Compliance Regulations 2015, which came into force on 15 April 2015, are an ‘umbrella’ set of regulations that deal with the UK’s various exchange of information rules. The regulations cover:

• the US-UK FATCA agreement;
• the Crown Dependencies and Gibraltar Regulations;
• the CRS; and
• the DAC.

The regulations came into force for the purposes of the FATCA rules on 15 April 2015. The remainder come into force on 1 January 2016. The regulations bring together the reporting obligations and due diligence requirements under the various agreements signed by the UK.

HMRC guidance

HMRC has issued helpful guidance notes on this plethora of new international rules, entitled ‘Automatic Exchange of Financial Account Information’. Although still in draft form, the most recent version (14 September 2015) can be found at tinyurl.com/nmkrqc7.

The ‘wider approach’

When clients ask which jurisdictions these regulations apply to, it is probably easier to look for the jurisdictions that are not covered. Of the most well-known tax havens, only Panama is missing, with the Cayman Islands, Bermuda and the BVI all included. Even the Vatican State has signed up.

This could lead to FIs having to keep a list of CRS jurisdictions, and updating it whenever a new jurisdiction signs up. To avoid this, the HMRC guidance explains the concept of the ‘wider approach’. This requires FIs to capture and maintain information on the tax residence of all account holders, not just those that live in a reporting jurisdiction. Whilst no report may be required initially for those account holders who live in a jurisdiction not covered by the reporting rules, HMRC’s ‘expectation [is] that under the CRS more jurisdictions will reach agreement with the UK over time’. In other words, even if no report is needed now, it may well be needed in a year or two. FIs are obliged therefore to identify and record the territory in which a person is tax-resident, irrespective of whether any reporting is required, and to keep that information for six years.

FIs need to follow a basic four-stage process for each of the regimes, even if there are slight differences in approach.

1. Undertake a review of the financial accounts they hold.
2. Identify any reportable accounts.
3. Apply the due diligence rules to those accounts.
4. Produce the relevant report on those reportable accounts.

Some accounts are excluded from the reporting rules, such as ISAs, child trust funds, premium bonds and fixed interest savings certificates. The full list of excluded accounts can be found at AEIM101820 in the HMRC guidance notes.

There is also an exclusion for low-value dormant accounts. Where the account contains less than US$1,000 (or local equivalent), the FI holding that account does not need to do the required due diligence if the account is dormant. This means there has been no activity on the account for three years and no contact from the customer for six years. However, if the client then gets in touch (eg to claim their money), the due diligence requirements immediately revive.

Bank accounts belonging to deceased persons are also excluded, provided the FI holding the account has formal notification of the account holder’s death, such as a copy of the death certificate or the deceased’s will (see AEIM101840). Once such documentation has been provided, there is no reporting in the year of death or any subsequent year. The guidance notes don’t address the possibility of someone getting hold of a relative’s will, where that relative hasn’t actually died. The guidance also fails to consider the possibility of someone providing a copy of their own will to the bank, in order to avoid the reporting obligations. One can only hope the banks themselves are alert to these possibilities.

The practitioner’s perspective

Much mention has been made of FIs, and it would be easy to assume that the rules discussed only apply to banks, deposit-takers and similar. After all, if the aim were to let the UK and other tax authorities know where people have placed their money, surely the banks would be the best people to ask.

The different agreements all contain the same four categories of FI:

• custodial institution;
• depository institution;
• investment entities; and
• specified insurance companies.

The problem for private client practitioners comes in the definition of ‘financial institution’, particularly the ‘investment entity’ category. As the guidance explains: ‘Trusts are treated as entities by all of the agreements for automatic exchange of information’ (see AEIM100700).

Any ‘entity’ (including a trust) is classed as an investment entity, if either:

• it is conducting an investment business on behalf of customers; or
• it is managed by an FI and more than 50% of its income comes from investments or trading.

The first category is unlikely to be relevant to private client trusts, but the latter will catch any trust that has funds under discretionary management with an FI, such as a bank, stock broker or investment house. If more than 50% of the trust’s income comes from its investments, the trust itself is classed as an ‘investment entity’, and comes within all the reporting obligations explained above. Whilst most trust practitioners would view the term ‘managed by’ as referring to the trustees, all the exchange of information rules look at whether the trust’s assets are ‘managed by’ an FI.

The guidance notes and HMRC’s FATCA-specific guidance (tinyurl.com/nutvaht) make it clear that trusts that have investment advisers on an advisory-only basis are not ‘financial institutions’, and are not therefore caught by the new reporting rules.

Some trusts will have professional trustees, such as a law firm’s trust company. The reporting obligation will then fall on that corporate trustee in respect of each trust it is managing. It doesn’t matter whether the corporate trustee makes a separate charge for acting. The guidance notes explain at AEIM100780 that if a corporate trustee does not charge, but a related entity (such as the law firm) does, it means the corporate trustee is an FI for the purposes of all the reporting rules.

When the rules were first published, there were concerns as to whether the definition of ‘deposit institution’ would be wide enough to catch solicitors who hold clients’ funds in their accounts (such as for property purchases or as part of the administration of an estate). Fortunately, these fears proved unfounded, as the guidance notes explain at AEIM100740:

‘A Depository Institution is an institution that accepts deposits in the ordinary course of a banking or similar business … solicitors would not be expected to fall within this definition.’

Trusts that are not financial entities

Where an entity does not fall into any of the categories of ‘financial institution’, it will be classified as a non-financial entity (NFE) or, for FATCA only, a non-financial foreign entity (NFFE). This means that any trust that doesn’t have funds under discretionary management, or that has less than 50% of its income coming from investments, will be a NFE or NFFE.

This doesn’t mean that those trusts can ignore the new rules completely. They are still under an obligation to review their status, check that they are not within the definition of financial entity, and confirm that status to other FIs they are dealing with.

In practice, most banks are now sending lengthy FATCA forms to new clients that wish to open a bank account. If the form is not returned completed, the bank account is simply not opened. In many cases, these forms are being sent to all prospective customers, irrespective of whether it is a personal, corporate or trust account that they wish to open. Reports are circulating of some banks that are refusing to open new trust accounts, simply because they don’t want to have to apply the new due diligence rules to those accounts.

For those customers who are NFEs / NFFEs, usually most of the form is totally irrelevant. They must still return the form to confirm their NFE / NFFE status, however.

What steps do solicitors need to take?

Solicitors need to alert their clients to these new rules. In some cases, clients will already be in receipt of letters from any offshore institutions they are dealing with, explaining that reporting will commence soon (usually from January 2016).

In other cases, it may be a surprise for clients to hear that any FI they deal with now has an obligation to obtain certain information. The FI will need to obtain sufficient information to ascertain where each of their customers are resident and then, if the customer is resident in a CRS-reporting jurisdiction, the FI will need to report:

• the customer’s name and address;
• the date of birth (for individuals);
• the customer’s social security, national insurance or tax ID number;
• the account number or equivalent; and
• the account balance or value.

Trust clients will almost certainly need help in ascertaining whether the trust falls into the category of ‘financial institution’ (and will therefore have to comply with the new rules), or whether it is a NFE / NFFE (which do not need to comply).

Those law firms with corporate trustees will need to undertake this due diligence for every trust that they manage.

What does it mean for clients?

For those clients who are UK-resident but non-domiciled, and eligible for the remittance basis of taxation, little should change. Clients in that position are perfectly entitled to have assets offshore and do not need to report those assets to HMRC (only taxable remittances of offshore income or gains need to be reported). But, for those clients who are taxed on the arising (worldwide) basis, the report from an offshore jurisdiction is likely to result in enquiries from HMRC. Given the proposals to remove the remittance basis for anyone who has been in the UK for 15 years, many more clients may find their offshore affairs under scrutiny.

At the same time as introducing these reporting rules, HMRC has announced the early closure at the end of 2015 of the disclosure facilities (such as the Liechtenstein Disclosure Facility and the Crown Dependencies Disclosure Facility) that clients could use to report undisclosed funds without risk of criminal prosecution. Additional penalties have been introduced for clients with undisclosed offshore funds, including in the Finance Act 2015, which contain increased financial penalties for anyone who placed their assets in a country that does not have exchange of information provisions with the UK.

The message is clear. Legitimate offshore planning is fine. Hiding funds offshore is not.