FATCA, CRS & AEOI – Dangerous Maze of Foreign Account Reporting
In the early stages of FATCA (Foreign Account Tax Compliance Act) enforcement, if a US person had unreported foreign accounts, and their bank or Foreign Financial Institution wanted to become compliant they would send the client a FATCA Letter.
Now, with the implementation of CRS (Common Reporting Standard) and an active AEOI rule (Automatic Exchange of Information), there are many more for financial institutions that are both reporting under both FATCA and CRS.
And, even though the United States has not entered into CRS, many of these foreign financial institutions are still sending US persons aka US account holders CRS letters, which could impact getting it to compliance both in the United States and worldwide.
FATCA is the Foreign Account Tax Compliance Act. FATCA is an IRS International Tax Law that is designed to reduce offshore tax evasion and tax fraud. FATCA requires U.S. Taxpayers to disclose unreported foreign bank accounts, foreign financial accounts, and foreign income to the IRS.
Otherwise the Taxpayer may be subject to extremely high fines, penalties, and outstanding tax liabilities.
The Common Reporting Standard is similar in concept to FATCA. The idea behind it is to try to limit or reduce international tax evasion by having foreign financial institutions report information regarding account holders to different countries.
Since CRS is not a US law (and has not yet been ratified by the U.S.) it does not specifically involve reporting the information to the US government. But, with that said — many financial institutions that are getting into compliance with FATCA, are also getting into compliance with CRS.
Similar to FATCA, most foreign financial institutions that are complying with CRS will be requesting much of the same information as the institutions that are complying with FATCA. Oftentimes this will include the date of birth, the place of birth, tax identification numbers in the country of tax residence.
Multiple Jurisdictions, Multiple Reporting Dangers
If a person for example is considered a US account holder and have citizenship or permanent residency in multiple different countries, it can become a very big problem, very quickly.
Why? Because some country tax authorities will be receiving multiple reports from both FATCA and CRS. Moreover, as a dual-citizen or multi-jurisdictional resident – a person may be required complete multiple forms involving both FATCA and CRS.
FATCA and CRS Example
Jim is a US resident who also was dual citizenship in China as well as permanent residency in Hong Kong. Jim believes that the foreign financial institution only believes he is a citizen of China, and only has his Chinese name for reporting purposes. But, Jim forgot that when he opened up his accounts and Hong Kong (while he worked in Hong Kong), he utilized a U.S. address because he did not want the Chinese government to know he had the additional foreign accounts in Hong Kong.
As a result, the foreign financial institution in China may only believe Jim is a Chinese or Hong Kong resident with respect to CRS, but in accordance with FATCA, the institution in Hong Kong may believe Jim is a US resident and reports them accordingly to the IRS.
If Jim was audited in the United States and it becomes clear that he was playing a shell game with his different citizenships/residency in order to avoid US tax, it may lead to significantly high fines and penalties under the willfulness standard – if not reckless disregard.
When it comes to reporting, technology is not on the side of individuals seeking to stay distant and removed from offshore reporting. As provided by the OECD “The Automatic Exchange of Information (AEOI) portal provides a comprehensive overview of the work the OECD and the Global Forum on Transparency and Exchange of Information for Tax Purposes in the area of the automatic exchange of information, in particular with respect to the Common Reporting Standard.”
The following summary is provided by the OECD:
What is AEOI
The automatic exchange of information2 The information which is exchanged automatically is normally collected in the source country on a routine basis, generally through reporting of the payments by the payer (financial institution, employer, etc). Automatic exchange can also be used to transmit other types of useful information such as changes of residence, the purchase or disposition of immovable property, value added tax refunds, etc.
As a result, the tax authority of a taxpayer’s country of residence can check its tax records to verify that taxpayers have accurately reported their foreign source income. In addition, information concerning the acquisition of significant assets may be used to evaluate the net worth of an individual, to see if the reported income reasonably supports the transaction. is understood to involve the systematic and periodic transmission of “bulk” taxpayer information by the source country to the residence country concerning various categories of income (e.g. dividends, interest, royalties, salaries, pensions, etc.).
How does AEOI Work?
The process starts with the provision, by a taxpayer, of information regarding his or her identity to a payer or paying agent and/or with the generation of information by the payer or paying agent (first step). According to domestic rules in the source country, payers and paying agents are required to report to the tax authorities information regarding the identity of the non-resident taxpayer as well as payments made to them (second step).
Once the information has been received by the source country tax authorities the information will be consolidated and bundled according to the country of residence (third step). Next, information is transmitted from the source country to the residence with a sufficient level of encryption. Information may be transmitted electronically or by CD ROMs. If the CD ROMs are sent by mail, it must be done via an international registration system where a mail tracking function is in place (fourth step).
The fifth step in the process is the receipt and decryption of the information by the residence country tax authorities. Next, relevant information will be fed into an automatic or manual matching process. The processing and use of the information varies from country to country depending on the risk assessment parameters, processing and technology systems used. The key aspect is to be able to identify the taxpayer and “match” the information with the domestic records. In this respect many countries have developed sophisticated automatic matching systems, allowing them to run all of the information received through a database to identify matches.
This is often followed up by manual matching of the previously unmatched data. Other countries use only a manual matching system (sixth step). Based on the results of the matching process, the tax authorities may commence compliance action against a taxpayer that may not have complied with reporting obligations, or make a specific request for information from the source country to obtain additional information. In addition to using the specific information received, some countries use the information for more general risk assessment (seventh step).
What is the Legal Basis For AEOI?
The legal basis for the automatic exchange of information is generally (1) the exchange of information provision of a double taxation convention based on Article 26 of the OECD or UN Model Convention, (2) Article 6 of the Convention on Mutual Administrative Assistance in Tax Matters, or (3) for EU member countries, domestic laws implementing EU directives which provide for automatic exchange.
While the treaty law contains the legal basis for automatic exchange including rules on reciprocity some countries require, and others have a policy to require, a special working agreement or memorandum of understanding (MOU) setting forth the terms and conditions of the proposed automatic exchange. Such an MOU typically sets forth the types of information to be exchanged automatically, details about the procedures of sending and receiving information and the appropriate format to use. The OECD has designed a Model Memorandum of Understanding on Automatic Exchange
County Coverage and Income Types
Automatic exchange is widely used both within and outside the European Union (EU) with many non-EU members having extensive automatic exchange relationships. Among the most frequently exchanged income types are: interest, dividends, royalties, income from dependent services and pensions.
All 38 countries (100%) receive information automatically from treaty partners and 33 (85%) of them send information automatically to treaty partners. Denmark, as the country with the largest number of automatic exchange relationships sends information automatically to 70 countries. The charts below give further details on country coverage.
Getting into IRS Offshore Compliance
There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
Golding & Golding: About our International Tax Law Firm
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