OECD: the automatic exchange of information – another burden without benefits for financial institutions

March 2014 | SPOTLIGHT | CORPORATE TAX

Financier Worldwide Magazine

In 2008 the United States became aware that a number of American nationals were evading US taxes by placing their money in offshore bank accounts. UBS, a Swiss bank, offered Americans to hold their money in Swiss bank accounts with the assurance that these accounts would be off limits for the IRS due to strict Swiss bank secrecy laws. However, following a penal case brought by the IRS against UBS in 2009 and some strong-arm tactics, UBS agreed as part of a settlement to voluntarily divulge details about its US account holders to the IRS.

Simultaneously the US announced a general amnesty for all Americans who reported details about their offshore bank accounts. At least 17,000 Americans subsequently voluntarily reported their hidden assets.

Following this success, and in order to tackle the issue of offshore bank accounts more structurally, the US introduced the Foreign Account Tax Compliance Act (FATCA) in 2010. FATCA requires every foreign financial institution (FFI) to review its clients and to identify potential US account holders. The penalty for non-compliance is stiff: non-cooperative financial institutions will potentially be confronted with a 30 percent withholding on all payments received from financial institutions that do cooperate (participating FFIs). From a legal and tax perspective this legislation is exceptional; it is the first tax law with an extraterritorial reach.

IGAs watered down the impact of FATCA but created a nightmare for US financial institutions

The FATCA requirements created a significant impact on all financial institutions worldwide. Not only banks, insurance companies and asset managers were affected, pension funds, central banks, charities and churches were also potentially classified as financial institutions for FATCA purposes. Under pressure from other countries, the US entered into a series of intergovernmental agreements (IGAs) to limit requirements for additional client due diligence to institutions where there was medium to high likelihood of finding tax evading clients. Institutions and products that are unlikely to be used by US taxpayers to evade tax were excluded from the due diligence and reporting requirements.

The IGAs require reciprocity from the United States; i.e., the United States will have to report ‘foreign’ accounts to their treaty partners. Specific US guidance in this area is still lacking and reciprocity will likely require Congressional approval. The impact on US financial centres with many non-US account holders, such as Miami and New York, will surely be felt. In addition to potential capital flight, the administrative ramifications of reciprocity for American banks will be significant. It remains to be seen how firm the resolve of Congress will be on this issue once the US banking lobby has done its work.

OECD countries have embraced the FATCA initiative

The success of FATCA surprised other countries. For many years countries have discussed within the Organisation of Economic Cooperation and Development and the European Union how automatic exchange of information could be the solution to combat large scale tax evasion. However, countries with strong banking secrecy reputations like Austria and Luxembourg successfully blocked any meaningful progress.

The OECD used the momentum created by FATCA to initiate the introduction of a standard for the automatic exchange of information.

On 20 July 2013, the G20 Finance Ministers and Central Bank Governors endorsed the OECD proposals for a global model of automatic exchange in a multilateral context. On 6 September the G20 leaders reinforced this message: “Calling on all other jurisdictions to join us by the earliest possible date, we are committed to automatic exchange of information as the new global standard, which must ensure confidentiality and the proper use of information exchanged, and we fully support the OECD work with G20 countries aimed at presenting such a single global standard for automatic exchange by February 2014 and to finalizing technical modalities of effective automatic exchange by mid-2014.” (CTPA/CFA/WP10/BAG(2013)4, p.6.)

Key requirements for automatic exchange of information

The framework contains: (i) a common standard on information reporting, due diligence and exchange of information; (ii) a legal and operational basis for the exchange of information; and (iii) common or compatible technical solutions.

The common due diligence process will require financial institutions to identify all account holders that are resident in another country. On these account holders, the financial institution will have to report to their local tax authorities account details such as name, tax identification number and interest and dividends received, as well as gross proceeds on the sale of stocks.

This all has to be done within the IT format that is currently being developed as a standard for reporting.

Timelines

The G20 plan established ambitious timelines. On 13 February 2014 the OECD issued the Standard for Automatic Exchange of Financial Account Information which includes the common reporting standard and the competent authority agreement. In the summer of 2014 the agreement on the IT standards should become available as well as the interpretative guidance for the common reporting standards.

The OECD has expressed its intention to start the exchange of information at the end of 2015, which probably means that the client identification processes should be in place by January 2015.

Substantial costs of FATCA and the common reporting standards

The implementation of FATCA has had a substantial cost impact for many large financial institutions outside the United States. It required a full analysis of the client and product portfolio with implementation of new policies and procedures for client due diligence and counterparty evaluation.

The big cost driver after the initial implementation will be the handling of every US account holder that is detected.

In this respect, the impact of the Common Reporting Standard is expected to be larger still. At a recent OECD meeting a large financial institution complained that a preliminary internal review showed that the number of reportable accounts would increase more than 100-fold due to the substantial number of account holders in other (European) countries and because of the lack of thresholds in the Common Reporting Standard.

The capacity constraints will be substantial. Financial institutions are confronted with a multitude of new regulations that need to be implemented within a relatively short period and which will create additional operational risks.

A potentially bigger risk is that clients decide to relocate their assets from financial institutions that are required to report to non-reporting entities. If this deposit base shift is material, the effect on the valuation of banks or client portfolios could be substantial.

A big unknown is the impact of the Common Reporting Standard on those US financial institutions that traditionally have provided banking services in the US to foreigners. Reports to treaty partners may ignite an unwelcome capital flight out of the United States.

Conclusion

With the introduction of the Common Reporting Standard in the coming years, financial institutions will evolve ever more towards becoming the administrators for governments. This will require substantial investments in terms of money and management attention and could lead to a potentially damaging diversion of money flows.

It is questionable whether the anticipated additional tax revenues will be commensurate to the cost for the industry.

Bas de Mik is a partner at Berns & de Mik Tax Consultants and Pieter van den Akker is a senior partner at International KYC. Mr de Mik can be contacted on +31 (0) 643 290 695or by email: cfa-fiscaal-advies@demik.info. Mr van den Akker can be contacted on +31 20 305 1188 or by email: pieter@i-kyc.com.

Bas de Mik

Berns & de Mik Tax Consultants

Pieter van den Akker

International KYC