A stick and carrot approach: FATCA, CRS and QI update

By Troy Andrews and Vinay Mahant

The world of operational taxes has expanded in recent years, for better and worse, with the advent of the US FATCA and OECD CRS. Though these initiatives have a shared goal of promoting tax compliance, the price paid by ‘Financial Institutions’ and tax authorities around the world to comply with the strict due diligence, reporting requirements and policing adherence has been an enormous task. In this month’s article we highlight the application of FATCA and CRS to NZ trusts, an update on Inland Revenue’s approach to audits of FATCA and CRS compliance (what stick will they use?) and the benefits (or carrot) of acting as a Qualified Intermediary. New Zealand is also looking at introducing new specific custodian rules which we touch on.

New Zealand trust problems

FATCA and CRS have been in effect for some time now. Broadly, these regimes aim to improve cross-border tax compliance and promote the global automatic exchange of information by requiring entities that are ‘Financial Institutions’ to conduct due diligence on their account holder base and report certain information about their US / non-resident accounts to relevant tax authorities. A common issue we have seen is applying FATCA and CRS to NZ trusts.

It is important to understand that the term Financial Institution covers legal arrangements such as trusts and partnerships and does not only encompass the ‘traditional’ definition of Financial Institution (i.e. not only banks and custodians).

Many NZ trusts would not fall within the definition of Financial Institution because they are not in the business of investing money on behalf of customers. However, under FATCA and CRS a trust may be deemed to be a Financial Institution by virtue of being managed by an entity that is one. This is a common issue we see in practice as many NZ family trusts could be caught where they have investments in financial assets (e.g. shares and bank deposits) and have a discretionary investment management service (DIMS) provider (such as a wealth advisor / or Bank) that has discretion over its investments.

Inland Revenue has also issued specific guidance that a corporate trustee can also be a Financial Institution (and potentially deem the Trust to also be caught). This is an area where many have not yet turned their minds. From our correspondence with Inland Revenue, their emphasis remains on promoting education of the market in terms of understanding their compliance requirements, however they have begun to carry out a range of basic compliance review activities including following up any parties that they consider should have registered for FATCA/CRS but have failed to do so. Given the closer Inland Revenue scrutiny and road ahead in terms of FATCA/CRS audits (see further below), you should carefully consider how confident you are with your position on these regimes.

We have come across situations where entities have not registered for FATCA on the assumption that it is only applicable if you have ‘US’ account holders – this is a false assumption. Entities need to consider their obligations under FATCA regardless of the fact that they may not have any US account holders. That is, you are still required to register for a FATCA Global Intermediary Identification Number (GIIN) with the Internal Revenue Service and conduct the necessary due diligence procedures even if you don’t have any US customers. Failure to register when you should has financial penalty consequences.

Many in the market are having issues completing FATCA/CRS self-certification forms (including US W-8 forms for FATCA). These forms are quite comprehensive and often require specialist tax advice to complete. This includes understanding your status as a Financial Institution or type of Non-Financial Institution, determining the account holders of a NZ trust and who may need to be disclosed as a ‘controlling person’.

We have also experienced issues with NZ trusts with investments in the US seeking to claim US treaty benefits. In this context it is important to understand what a NZ trust’s status is under US tax principles, i.e. if it is seen as a grantor (flow-through) or complex trust (opaque). This distinction can be difficult to apply in practice but is fundamental to completing the right documentation.

FATCA/CRS audits on the horizon

The success of FATCA and CRS in terms of meeting their goals of achieving better tax compliance will be largely driven by how effectively and consistently they are implemented across the world.

Inland Revenue has made it clear that the OECD will rigorously monitor compliance with CRS. As noted above, Inland Revenue has already commenced conducting basic compliance activities in respect to CRS. From our recent correspondence with Inland Revenue, we understand that the level and degree of their activities will increase over the next year with the frequency and intensity being based on risk assessments undertaken. These will include a mix of tailored questionnaires, desk-based reviews and on-site audits.

The shape of Inland Revenue’s final audit programme will also depend on the OECD’s recommended approach. Inland Revenue will provide more details on its approach following the OECD Global Forum’s final recommendations.

In light of this, Financial Institutions should be reviewing their existing approach and testing this in line with best practices. This would include, amongst other things, having a centralised document covering policies and procedures, reviewing the process and review of self-certifications and client on-boarding and systems mapping to cover things such as changes in circumstances.

We are increasingly helping Financial Institutions understand their key risk areas by conducting ‘healthcheck’ reviews to help identify and remediate issues in advance of expected Inland Revenue audit activity. This is a clear signal that FATCA/CRS compliance has matured into its normal state as part of ‘business as usual’ rather than being project based. The new challenge for Financial Institutions will be to expand their internal risk and governance functions to also help monitor their ongoing compliance.

The US Qualified Intermediary (QI) regime

Where FATCA aims to promote tax compliance of US citizens/residents with offshore assets, the QI regime is directed towards tax compliance of non-US persons receiving US sourced income (e.g. dividends and interest income from the US). Some could see it as a “carrot” for operational tax compliance rather than the “stick” of FATCA and CRS compliance.

A ‘Qualified Intermediary’ is an entity that acts as agent for another person such as a custodian, broker or nominee. A non-US intermediary may enter into an agreement with the US IRS to obtain ‘QI status’ whereby US custodians are able to rely on the QI’s certification of its underlying client’s identity and tax residency status for the purpose of applying the correct double tax treaty rates. QI status is seen as a ‘privilege’ by the IRS as it is essentially relying on the QI’s documentation of its underlying clients (e.g. QI validating US tax forms such as the W-8BEN and W-8BEN-E). Many US withholding agents are also now requiring non-US persons to invest in the US through QIs for compliance purposes.

A ‘big stick’ that was hanging over the industry was that any accounts that were not ‘documented’ by a US custodian would suffer a 30% withholding tax on gross proceeds as a penalty / incentive for getting the underlying beneficial owner documented. In what was seen as a positive development for financial institutions, the US announced in December 2018 that this requirement was to be eliminated.

We have summarised some of the key benefits of becoming a QI:

(1)   You are able to provide your clients with reduced US withholding while at the same time not having to disclose confidential client information to upstream US custodians or the IRS.

(2)   Collective refund procedures for over withholding.

(3)   Simplified documentation process. A QI is able to document its account holders using ‘documentary evidence’ (that is already collected for AML) such as a NZ passport instead of complex US tax forms (e.g. W-8BEN-E).

(4)   Customers should receive a more efficient service in terms of quicker income reporting.

(5)   Streamlined administration of US withholding tax and information reporting.

(6)   A competitive advantage to expand business to a wider pool of customers that seek investments in the US through a QI.

The above highlights the significant benefits of acting as a QI for your customers. As with FATCA, there are compliance requirements to become a QI such as having policies and procedures and income reporting obligations. A further layer of compliance involves having to have an independent periodic review conducted every 3 years to certify compliance with the IRS.

Inland Revenue policy developments for custodians

Inland Revenue has recently released a consultation document on policy developments in relation to investment income withholding and reporting requirements for intermediary entities that provide investment products.

The proposals largely aim to provide flexibility / clarity in terms of the withholding and income reporting rules in the context of custodial institutions. Some examples of the changes proposed include, allowing payers and custodians to determine themselves which entity is best placed to carry out withholding and establishing a mechanism similar to the US QI regime for NZ custodians that pay income offshore at an aggregated level.

Please contact us if you would like to discuss any of the above in further detail.

September 2019 Tax Alert contents

·         What's on the tax policy work programme

·         A stick and carrot approach: FATCA, CRS and QI update

·         Customs is also interested in your transfer pricing 

·         Taxing telecommunication tools

·         Mileage reimbursements revisited - again!

·         Follow the rules when deducting bad debts

·         Recent developments

·         Deloitte Insights app