CRS: Are you ready?
Tax Alert - September 2016
By Troy Andrews and Vinay Mahant
The next wave of compliance for Financial Institutions is getting closer with Inland Revenue having recently released its proposed legislation to implement CRS (Common Reporting Standard) in New Zealand. CRS aims to improve cross-border tax compliance and promote the global automatic exchange of information ("AEOI"). CRS builds on the US FATCA (Foreign Account Tax Compliance Act) that was enacted to combat offshore tax evasion by US persons. Though CRS is built on similar principles, it is not the same, being based on universal OECD principles and is not US centric.
CRS is intended to apply to Financial Institutions that would otherwise fall within the ambit of FATCA. There are essentially four types of Financial Institution (which is similar to FATCA):
- Depository institution;
- Custodial institution;
- Specified insurance company; and
- Investment entity.
Currently 101 jurisdictions, including New Zealand, have committed to exchange information under CRS. New Zealand has committed to complete its first exchange by 30 September 2018. We have summarised the key dates for reporting:
- New Zealand reporting Financial Institutions are expected to commence applying due diligence procedures from 1 July 2017.
- The first reporting period will be for the 9-month period to 31 March 2018. Going forward, the annual reporting period will be to 31 March each year (which is consistent with FATCA).
- Financial Institutions must submit their AEOI reporting to Inland Revenue by 30 June of the respective year.
- A 3-month grace period will be in effect for the first two annual reporting periods to allow Financial Institutions additional time to conduct due diligence procedures. However, any reportable information gathered during the grace period will need to be reported in the current year’s AEOI report.
- A common IT information exchange system is currently being developed by the OECD for encrypting and transmitting data between jurisdictions. It is hoped that this system will be more user friendly than the current FATCA reporting mechanism.
A particular area of focus in implementing CRS is that the list of reportable jurisdictions committed to entering into agreements to promote the AEOI is expected to evolve over time. Inland Revenue intends to publish a list of participating jurisdictions periodically to help Financial Institutions identify reportable accounts. The evolving list of participating jurisdictions could result in increased compliance costs as ongoing monitoring and subsequent updates to due diligence and reporting may be required each time a new jurisdiction signs up for AEOI. To minimise compliance costs, a wider approach to due diligence and reporting that allows Financial Institutions to identify all non-resident account holders irrespective of whether the account is from a reportable jurisdiction is proposed and is expected to be mandatory.
Inland Revenue has proposed to filter the information reported to limit the exchange of information to relevant reportable jurisdictions with the option for Financial Institutions to filter information themselves if they wish to. There are privacy issues involved with this information which Inland Revenue is currently working through. Inland Revenue has also raised potentially using this information for other purposes such as reviewing non-resident withholding tax rates and compliance.
In our view, the wider approach is a practical response to the global nature of CRS due diligence and should enable Financial Institutions to take a global approach that is consistent with the rest of the participating jurisdictions and should reduce ongoing operational costs. CRS also provides Financial Institutions with certain options, such as choices around the currency used to determine account balance thresholds, to reduce compliance costs.
A particular focus for many New Zealand taxpayers has been applying the scope of FATCA to various New Zealand trusts. We understand that Inland Revenue intends to update its FATCA trust guidance notes to clarify any differences to CRS. They also intend on publishing general guidance as well as specific guidance on due diligence procedures, reporting requirements and the application of CRS to particular business structures (e.g. partnerships and collective investment vehicles). Inland Revenue has asked for any other areas Financial Institutions would like further guidance on.
To ensure CRS effectively achieves its objective of improving cross-border tax compliance, the OECD will conduct regular peer reviews and other forms of monitoring to ensure that jurisdictions correctly implement the standard and that global consistency is maintained. Such monitoring or audit activity has yet to take effect for FATCA although this is expected to change now that the best endeavours period has come to an end. Financial Institutions should expect CRS compliance to be more strictly monitored (although there is a similar introductory period of 2 years to help with the transition). In our view, the peer review will be a meaningful part of ensuring jurisdictions implement CRS correctly.
It is proposed that the penalties for non-compliance will be civil in nature other than penalties for knowledge based offences. To promote compliance, it is proposed that penalties will be extended beyond reporting Financial Institutions and include account holders and controlling persons. For trusts this could include the settlor, trustees and beneficiaries. Such penalties are not currently in place for FATCA but this extension is expected to also apply for FATCA. This is potentially very wide ranging and will require a massive education of a wide population.
For example, a graduate who leaves New Zealand to go on an OE and subsequently becomes a non-resident could potentially be caught if they do not disclose their change in circumstance to each Financial Institution they have an account with. The proposed penalty for non-compliance by account holders and controlling persons is $1,000. This is a new development in a reporting framework and in our view will be a large challenge to impose fairly. We expect this area to be a discussion point before legislation is finalised.
As CRS compliance is expected to be monitored strictly, Financial Institutions should seek to consider their CRS status early and build a robust system to integrate CRS governance into their operations to avoid any penalties for non-compliance.
Inland Revenue is also calling for submissions on what Financial Institutions might qualify as being exempt. However, CRS is very strict on the criteria for exemptions and a FATCA exemption will not automatically mean there will be a CRS exemption. To put this in perspective, the average number of entity exemptions that jurisdictions have obtained is “two” as the driver is a universal system. The message is simple; you can’t ignore CRS as it has the potential to bite you.
We expect that Financial Institutions should generally be able to leverage off investments they have already made for FATCA to make CRS an easier transition. However, there are differences and it won’t be as simple as extending FATCA to all jurisdictions. An example of a difference is a CRS rule that deems an investment entity in a non-participating jurisdiction to be a passive Non-Financial Entity and potentially a reportable account. Given its global focus and the fact that its implementation is likely to be closely monitored; Financial Institutions should be proactively seeking to establish their systems under CRS sooner rather than later.