Germany: FATCA 2.0: The introduction of a global standard on automatic exchange of tax information

According to recent estimates, tax evasion significantly decreases public revenues, and may potentially lead to a serious disruption of the competitive market functions. Combatting international tax evasion is, however, complex despite sitting high on the political agenda. Conceptual approaches to tackling tax evasion include (flat) taxation at source on the one hand and increasing tax transparency on the other hand, enabling the competent tax authorities to ensure appropriate taxation in the taxpayer's (tax) residence country. While just a few years ago European governments were still negotiating tax treaties, for example with Switzerland aiming at taxation at source and avoiding disclosure of assets and income generated offshore, the political mindset has changed and is now leading towards a new standard of multilaterally exchanging tax information between governments around the globe: the Common Reporting Standard (CRS).

Information exchange between governments is not new. Article 26 of the OECD Model Tax Convention already includes a provision on exchange of tax information, but information is generally obtained upon request. What is new now is that exchange of tax information becomes automatic, on a multilateral and comprehensive basis, focusing on information maintained by financial institutions with respect to financial accounts.

Triggered by the experience with offshore investments in the Swiss market in 2010, the US government enacted a law addressing the disclosure of hidden assets in non-US countries by having financial institutions disclose corresponding information to the US tax authorities. This initiative is the Foreign Account Tax Compliance Act (FATCA). In subsequent years FATCA was the accelerator and catalyst for enhanced discussions among governments on how to address FATCA outside the US, particularly by way of negotiating intergovernmental agreements (IGAs) and implementing FATCA into local laws. Such negotiations led to additional and corresponding initiatives in the market, including the CRS.

In April 2013, for example, the finance ministers of France, Germany, Italy, Spain, and the UK outlined an initiative to develop and pilot a multilateral automatic information exchange programme towards the EU Commission. On July 20 2013, G20 leaders endorsed the OECD proposals for a global model of automatic information exchange as the expected new standard on information exchange. On February 13 2014, (so only a few months later) the OECD released the CRS and model Competent Authority Agreement (CAA). The OECD is further expected to deliver a detailed commentary on the new standard, as well as technical solutions to implement the actual information exchange, during the G20 meeting in September 2014.

More than 60 countries and jurisdictions have committed to an early adoption of the CRS, and additional Global Forum members are expected to join this group in the coming months. The early adopters of the CRS will need to comply with a planned effective date of January 1 2016 for new account opening procedures. The initial exchange of information, with a limited scope under the CRS, is planned to start in 2017, while the full scope exchange of information shall begin in 2018.

The CAA can be executed within existing legal frameworks such as article 26 of the OECD Model Tax Convention, or article 6 of the Convention on Mutual Administrative Assistance in Tax Matters. The question of having in place a legal framework and administrative capacities before entering into reciprocal agreements on information exchange is an open issue for a number of countries participating in the initiative.

Within the EU, the current expectation is that the CRS will be implemented through a further enhancement of the EU Savings Directive (EUSD). The advantage over an implementation through the Directive on Administrative Cooperation would be that certain non-EU member states would already be participants under the EUSD. Corresponding press releases by EU governments show that a revised directive is intended to be available already in Q4 2014. EU member countries will need to transfer the EU Directive on the Automatic Exchange of Information into national law, which leaves a very challenging timeline for both financial institutions and governments to implement the new standard on information exchange.

CRS is not the first initiative for enhancing tax compliance which focuses on transparency of tax information rather than on taxation at source, but it nevertheless could also serve for and support future taxation at source regimes (for example, TRACE). CRS clearly is based on the FATCA IGAs but faces a market with both information reporting and taxation at source regimes.

With respect to taxation at source regimes, the market knows particularly the US Qualified Intermediary (QI) program which became effective on January 1 2001. The QI programme allows the US government to collect taxes on US sourced income and certain tax related information through foreign financial institutions (FFIs) and foreign branches of US financial institutions. The IRS announced that withholding obligations under QI and FATCA will be merged and addressed in a revised QI agreement this summer and that certain reporting obligations under FATCA also fulfil certain reporting obligations under QI.

In the European market the EUSD provides for a (limited) automatic exchange of information on savings income since July 1 2005. Unlike the US QI programme, the EUSD constitutes a mutual exchange of information aiming at the effective taxation of cross-border interest income and revenues applied by EU member states. While generally entitled to receive information from the other member states, Luxembourg and Austria were, however, entitled during a transitional period to levy a withholding tax instead of providing information; 75% of the revenue of such withholding tax is being transferred to the investor's state of residence. In 2004 a similar EUSD status was agreed for Switzerland, Andorra, Liechtenstein, Monaco and San Marino. EU member states' dependent or associated territories have been included since 2005 with a similar treatment. In January 2013, the new Administrative Cooperation Directive entered into force providing for a further automatic exchange of available information as of January 1 2015 on income from employment, director's fees, life insurance products, pensions, and immovable property. In addition to these European directives the UK has introduced further initiatives for automatic information exchange with its crown dependencies and overseas territories (cf. UK-FATCA / CDOT Agreements).

The current political momentum around the CRS is driven by the implementation of FATCA. With FATCA the US government enacted a comprehensive exchange of tax information regime with respect to which a number of countries around the globe declared the intention to take an intergovernmental approach to compliance. Most of these countries will pass local legislation intended to meet the objectives of FATCA (Model I Agreement). Certain other countries including Switzerland, Japan, Bermuda, Austria and Chile intend to take an intergovernmental approach to the legislation under different terms (Model II Agreement). FATCA implementation now involves the interaction of both the regulations in the US and the IGAs with related local legislation providing a complex framework of rules for globally operating financial institutions to comply with. By the end of April 2014, 27 jurisdictions had signed Model I IGAs and five jurisdictions signed Model II IGAs. In addition, 34 jurisdictions had reached agreements in substance and are therefore treated as having IGAs in effect.

The CRS introduces its requirements on top of these global and local implementation programmes aiming at a uniform global standard of information exchange. As the CRS is coming, however, only now that other programmes have already started, it remains to be seen to what extent CRS can function as a framework for a single and globally unified information exchange standard. In particular, the US is currently not among the early adopters and it will be interesting to see how the US positions FATCA within the global approach towards CRS.

The CRS and the CAA establish a new global standard which will require financial institutions to play a central role in providing the tax authorities with greater access and insight into financial account data maintained by financial institutions. It sets out the financial account information to be exchanged, the financial institutions that need to report, the different types of accounts and taxpayers covered, as well as common due diligence procedures to be followed by financial institutions.

The overall structure and a fair amount of detailed requirements are similar compared with FATCA. However, the CRS has its own specifications and overall will require higher IT and operational efforts for implementation and continuing compliance.

The standard consists of complex rules and requirements which can be grouped into three areas: 1) scope and governance: defining which financial institutions should be subject to the CRS rules and how compliance should be governed; 2) due diligence: detailing the procedures and documentation requirements that financial institutions should follow in order to classify financial accounts and corresponding account holders; and 3) reporting: specifying the (data) elements and timelines for performing CRS reporting.

With respect to the scope, financial institutions under the CRS include depository institutions, custodial institutions, investment entities and specified insurance companies. According to this broad definition, banks and custodians are clearly within the scope of the CRS. In addition, other financial institutions such as brokers, certain collective investment vehicles (CIVs) and certain insurance companies should also comply with the CRS. From a general point of view, the CRS definition is almost identical to the definition under FATCA. Differences include, for example, certain investment entities which qualify as financial institutions under FATCA but are not located in partner countries and should be classified as passive non-financial entities under the CRS. Other differences include the provision of certain exempt statuses and certain non-reporting financial institutions. Once classified as a financial institution under FATCA, such institutions are generally required to register with the IRS to obtain a Global Intermediary Identification Number (GIIN). Such registration is, however, not required under CRS.

The due diligence procedure is likely to be the most burdensome obligation for financial institutions. The CRS has adopted similar due diligence procedures and requirements to those under FATCA. However, since the focus is no longer limited to US account holders and non-participating foreign financial institutions (NPFFIs), but is expanded to identify the tax residents of any partner jurisdiction, the number of impacted clients is significantly higher than under FATCA. Moreover, while under FATCA certain funds or smaller banks escaped implementation by saying they did not maintain relationships with US investors or customers, such institutions would now be brought into scope for the first time.

According to the current timeline agreed by the early adopters, the accounts opened on or after January 1 2016 will be new accounts and should go through the enhanced new account opening procedures which require a self-certification as mandatory documentation. Furthermore, new accounts of pre-existing clients will not be treated as pre-existing accounts for CRS purposes. The accounts outstanding on December 31 2015 are treated as pre-existing accounts and should be reviewed according to the applicable procedures. As FATCA did already, CRS also takes a risk-based approach: high value accounts will be subject to the enhanced review procedures and should be reviewed by December 31 2016, while the remaining pre-existing accounts, if not eligible for any exemption, should be reviewed by December 31 2017. De minimis rules are provided only for certain pre-existing entity accounts but are not available for any individual accounts as under FATCA.

Reporting is the core component given that exchanging tax information is the ultimate goal of the CRS. Similar to FATCA, CRS reporting takes a phased-in approach: the first reporting will be required in 2017 on new accounts and high value pre-existing accounts covering only basic account and account holder information as well as certain income payments. Starting in 2018, full reporting will be required on all reportable accounts, also including information on gross proceeds. Reporting is likely to be performed based on a similar data schema as under FATCA and to be provided to the local tax authorities. The data elements to be reported per country are, however, subject to the individual CAA concluded between the relevant partner jurisdictions specifying the information to be provided or obtained within such automatic information exchange. Deviating information to be provided or exchanged will lead to a higher complexity within implementation.

Unlike FATCA, the CRS does not contain a concept of "non-compliant financial institutions" and does not levy punitive taxation. The enforcement of the CRS lies within each partner jurisdiction and corresponding local laws; implementation of the CRS is likely to be subject to local penalties. The OECD CRS requirements are understood to constitute minimum requirements and partner jurisdictions may expand such requirements as deemed necessary or appropriate.

Although the CRS contains similar requirements as under FATCA, there are remarkable differences which will require additional amendments of IT systems and processes and result in higher implementation and continuing compliance efforts. Particularly considering that a number of further countries will follow the early adopters, the CRS is expected to be a key compliance requirement over the next five years. In addressing the CRS, a flexible and strategic approach is therefore recommended.

The implementation of FATCA, CDOT agreements, the revised QI-agreement and CRS will further raise questions on how to best and most efficiently address the new tax transparency landscape. Within such a new environment further questions around data quality, data security and focus of business and compliance functions on their individual and core purposes will be raised. Other regulatory initiatives also addressing customer or investor due diligence and reporting should be considered jointly.

To the extent it has been under FATCA, limiting business to non-US investors and customers is not a viable solution under the CRS anymore. Going forward tax information will be made transparent and will be shared among governments globally. Banking secrecy will not survive, at least not with respect to tax information to be provided to the tax authorities. As a result, compliance requirements will increase and markets will also change. Market participants will have to be prepared: the Common Reporting Standard is coming, it requires a strategic and flexible approach, but there is a lot to leverage from FATCA.

Karl Kuepper PwC Tel: +49 69 9585 5708 Fax: +49 69 9585 1894 karl.kuepper@de.pwc.com www.pwc.de Karl is a partner with PwC in the financial services tax team in Frankfurt, Germany, where he leads the Tax Operations Group and PwC initiatives around FATCA and CRS. He has more than 14 years of working experience in international tax and regulatory fund structuring, transactions, private banking and legal advice (corporate, commercial, M&A transactions, arbitration proceedings). Projects include large scale structuring projects, transactions particularly with respect to US investments as well as ICC arbitration proceedings. Karl is a qualified German tax attorney and holds a PhD in investment tax laws.