The Common Reporting Standard is new to everyone filing this year. It’s been described to me by a senior finance industry person as “like an exam in a subject we don’t care about other than passing, but all become experts in for a short time”. I’m not sure if that’s a widespread opinion, but it’s certainly got people working hard this time of year and boning up on what needs done even at this late stage. Maybe the ‘cramming for an exam’ analogy is apt. So here is some help to get it right at the last minute based on what we’ve seen not quite working so well from our work with financial services businesses in Guernsey.A. Getting the double review for Account Holders right
It is not the case that where a Non-Financial Entity is tax resident in the same jurisdiction as the Financial Institution (FI) that is reporting, it is automatically out of scope. A second review needs to take place.
While it’s correct that there is no need to report an Account Holder to the jurisdiction in which the FI is filing, unless you undertake the second part of the review – whether the controlling persons of a Passive NFE are tax resident in another reportable jurisdiction – the account holder cannot be considered unnecessary to report. The same goes for Financial Institutions in a Non-Reporting Jurisdiction – which are treated like Passive NFE’s – clearly or they’d never be reported.
B. Correctly classifying Active NFE’s
There are a lot of ways in which an NFE can be considered Active rather than Passive (please contact us if you’d like a decision tree). These are listed here in roughly the quantum order we’re seeing them in Guernsey:
- Doesn’t meet the passive income proportion test or the ‘assets that might produce passive income’ test
- New entity (less than 2 years) that doesn’t intend to be an FI
- It is an ‘operating business’
- Most of its activities (80%) are related to holding the shares in subsidiaries or providing loans to subsidiaries and those subsidiaries are not FI’s
- Entity liquidating and wasn’t an FI in the last 5 years
- Entity only provides finance or hedging for related entities that are not FI’s
- Entities own shares are regularly traded on an Established Securities Market (not the TISE)
- Is a government entity, international organisation, central bank or a subsidiary of one
- Is a recognised charity
It was a little surprising to us that item 4 didn’t feature higher in the list given the number of intermediary holding companies administered in Guernsey. This would lead us to believe that – for example – a trust which holds debt and equity in subsidiaries making property investments (themselves Passive NFE’s) but which isn’t considered a ‘Type B’ Investment Entity (see Section C) is most likely being considered a Passive NFE because it meets the criteria listed in item 1 above. If it meets criteria 4 on this list it can still be an Active NFE. Similarly a holding structure above an Active NFE will also likely be Active under this section.
C. Applying the two step test correctly for considering whether an entity is a ‘Type B’ Investment Entity
The relevant bit of the CRS to whether an entity is an Investment Entity reads as follows:
a) that primarily conducts as a business one or more of the following activities or operations for or on behalf of a customer:
i) trading in money market instruments (cheques, bills, certificates of deposit, derivatives, etc.); foreign exchange; exchange, interest rate and index instruments; transferable securities; or commodity futures trading;
ii) individual and collective portfolio management; or
iii) otherwise investing, administering, or managing Financial Assets or money on behalf of other persons; or
b) the gross income of which is primarily attributable to investing, reinvesting, or trading in Financial Assets, if the Entity is managed by another Entity that is a Depository Institution, a Custodial Institution, a Specified Insurance Company, or an Investment Entity described in subparagraph A(6)(a).
It’s normally fairly clear cut in Guernsey if an entity is a ‘Type A’ entity. The ‘on behalf of a customer’ generally gives you a clue that it’s going to cover a lot of licensed firms operating in Guernsey in the Finance Sector. A Fiduciary licensee, for example, is almost certainly going to be a Type A Investment Entity. It is worth considering though, that should a majority of its client base be NFE’s holding non-financial assets rather than FI’s that its possible the Trust Company might fail the ‘primarily’ part of the Type A classification and be therefore a Passive NFE itself.
It’s the ‘Type B’ that will often make clients of such firms also Investment Entities – and therefore Financial Institutions. It’s clear that there is a two part qualification for this:
1) It has to be ‘managed by’ another Financial Institution – entities that aren’t such as those with totally independent Boards or Individual Independent Trustees for example are unlikely to meet this
2) Most of its income has to come from Financial Assets.
It’s this second sub-part that seems to be causing some confusion. Please note that its income based, not asset based and the same ‘or assets that might generate that sort of income’ addendum that applies to Passive NFE’s (see section B, item 1) does not apply here. Just having financial assets alone does not trigger its income being primarily from investing, reinvesting or trading in financial assets. It is also true that for the purposes of income – there is no ‘looking through’ structures. A Trust at the top of a structure where the subsidiaries all produce Passive or Active income will still potentially be an FI if it receives the income from them by dividend or interest.
D. Getting the Account Holders Right
There is no de minimus shareholding percentage that rules an Account Holder out of the reporting remit. The 25% threshold only applies to consideration over whether Controlling Person consideration applies. It’s also worth noting on the subject of that 25% figure that the CRS says that controlling persons are anyone owning more than the threshold OR exercising control over the entity. Its up to you to know your client and who is pulling the strings even if the numbers and names say different.
E. Looking through nominees
You can’t just get around the due diligence or reporting requirements of the CRS by relying on nominee entities being part of a Regulated Financial Services business that will be reporting. The Account holder is the beneficial owner. It’s also true where things are held under declarations of trust or via individuals or NFE’s.
It’s written in several places within the CRS that you look through agents and nominees to determine who holds the account – the beneficial owner under AML parlance. If you set up a Financial Institution just to try and do just this you also don’t get around the rules. There’s an anti-avoidance provision written into the reporting requirements that would otherwise exempt an FI from reporting this information.
F. Reporting on Active NFE’s
There seems to be a common misconception that Active NFE’s are outside the remit of reporting for an FI. This is incorrect. They are outside the requirement of consideration as to whether controlling persons bring them into the reporting remit only. An Active NFE which is tax resident in a reporting jurisdiction other than that in which the FI is filing is still in scope for reporting. This is consistent with the very helpful and user friendly diagram put together by John J Ryan Jr for STEP which is reproduced below:
If you walk things through the logical process outlined in the OECD’s CRS Implementation Handbook its clear this is correct.
A Reportable Person is defined as an individual or entity who is tax resident in a reportable jurisdiction other than:
a) a corporation the stock of which is regularly traded on one or more established securities markets;
b) any corporation that is a Related Entity of a corporation described previously;
c) a Governmental Entity;
d) an International Organisation;
e) a Central Bank; or
f) a Financial Institution.
Financial Institutions are out of scope, but Active NFE’s aren’t.
This then takes us right back to Section A and the second part of the review necessary. This is explained in the following diagram from the OECD’s CRS Implementation Handbook:
Clearly this bit only applies to the Passive NFE’s left in scope but if the Active NFE’s were not still in scope after the first test, there’d hardly be much point in making that clear. Incredibly we’ve seen tax advices from well respected accountancy firms which are getting this wrong and telling clients that Active NFE’s don’t need to be reported, full stop. They do if they are tax resident in another reporting jurisdiction.
G. Debt interests in a Type B Investment Entity
Guernsey didn’t issue any jurisdiction specific information on how to interpret ‘Debt Interest’ and the CRS left it to jurisdictions to decide (p213 of the Implementation Handbook). We anticipate this being a rolling target for now. We’ve seen in practice a bit of a mixed bag. Some include debt interests only where they are secured. Some only where there is a significant amount despite no clarity on any sort of de minimus. Some classify certain preference shares as debt, others don’t. It’s an area we’d like to see more guidance released on to bring practice together – but not one we’re willing to stick our neck out on!
In the meantime we’d recommend that you document your own approach to this and have it approved appropriately, then apply it consistently. Don’t ignore it altogether which we have seen done. Make sure your data collection system has mechanisms within it for identifying these BEFORE determining which FI’s are out of the reporting remit. This means collection of numbers before finalising the scoping under due diligence rules. These accounts are equally valid to that decision as Equity accounts but often not as easy to tell whether present in a lot of client management systems used in Guernsey. Mainly as its highly dependant on the user flagging them up.
H. Nil returns
Some jurisdictions require them (Guernsey, Ireland etc). Some don’t (British Virgin Islands, United Kingdom, etc). Some jurisdictions will come back to you asking questions if you register an entity as an FI then don’t file a return. Be prepared and know what needs done through each reporting portal you need to use.
I. Trusts with multiple Trustees
Having more than one Trustee on a trust within the reporting remit opens up a few unusual avenues. Firstly as an entity it is treated as tax resident in the places that each of the Trustees are tax resident – which itself could be more than one jurisdiction. If the Trust is an FI, then the Trustees will be responsible for filing in potentially multiple jurisdictions on the same Trust. It can cloud the issue of whether the Trust is truly ‘managed by’ an FI alone where some Trustees are not FI’s themselves – though really practical management of the affairs should be a good guide.
It also opens up the possibility of having a trust that can confuse data collection systems. An example will help explain. On the one hand – say for an FI from Switzerland acting as a Trustee – it could appear to be an FI resident in a non-reportable jurisdiction (which would normally be treated like a Passive NFE on the Reporting Trustee’s own return). With full information showing there are two FI trustees and the other is resident in Guernsey – which of course is a reportable jurisdiction – then its clear the trust is actually within the reporting framework and should be filing its own return rather than being simply a reportable account on the Guernsey Trustees own Type A Investment.
This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors