Offshore tax evasion costs governments hundreds of billions of dollars every year in lost tax revenue. To combat such circumvention, 101 countries (and counting) have committed to the Organisation for Economic Co-operation and Development (OECD)-led Common Reporting Standard (CRS) for the AEOI. Over half of the committed jurisdictions already need to document and classify new customers in a manner compliant with CRS, and reporting for those jurisdictions will commence in 2017. The remainder of the jurisdictions will begin reporting in 2018. Such multilateral collaboration is remarkable in an age of increasing data privacy concerns, the UK voting to leave the EU, and strengthening headwinds to global trade and globalization.
What has triggered governments’ crackdown on tax evasion?
Globally, approximately $10 trillion of private wealth was booked in “offshore” centers in 2015, according to the Boston Consulting Group’s report, “Global Wealth 2016.” Offshore can mean any jurisdiction other than where one resides for tax purposes – be that Switzerland, the Cayman Islands, Singapore, the US or anywhere in between. While much offshore investment activity is legal, a material amount erodes tax revenues in countries where the wealth originated. The Panama Papers – the leak of 11.5 million documents from the law firm Mossack Fonseca – shone a light on how extensively offshore structures are used to avoid and evade taxes and demonstrated how even in the cases where the actions were legal, they could impose a reputational risk on the individuals and corporations seeking investment tax havens.
The combination of opaque cross-border tax activity and strained government finances following the financial crisis has contributed to the recent regulatory crackdown that has yielded the US Foreign Account Tax Compliance Act (FATCA) and subsequently UK FATCA and CRS, nearly eliminating the ability to maintain secret bank accounts in most of the world’s tax havens and ushering in an age of so-called international tax transparency. The OECD has spearheaded this multilateral movement and its sister initiative, the Base Erosion and Profit Shifting (BEPS) Action Plan, that seeks to prevent multinational enterprises from shifting profits to lower tax jurisdictions.
The blueprint for the automatic exchange of information is US FATCA, which requires foreign financial institutions to report on US citizen and tax resident accounts directly to the US IRS and/ or local tax authorities (under intergovernmental agreements with the US). This legislation built on cases against Swiss banks that had aided US citizens in evading taxes. Noncompliance with FATCA can yield penalties of 30 percent withholding on certain US sourced payments, which has fortified global adherence.
How are financial institutions grappling with new regulations to ensure compliance?
In a recent survey of senior executives from multinational financial firms conducted by Thomson Reuters, in partnership with Banking Technology, more than half of respondents expressed concern about the reputational risks of FATCA and CRS noncompliance. Their concern is justified. FATCA created a significant regulatory compliance burden for financial institutions, and CRS will significantly amplify the headache. However, according to the same survey, almost half of institutions intend to build a solution in-house to manage FATCA and CRS compliance. These in-house intentions are surprising given that the leading challenge noted by 27 percent of respondents was keeping up with the rapidly changing government regulations in multiple countries.
Even recently, with US and UK FATCA, authorities have made many last-minute changes in guidance before filing deadlines, which has necessitated costly, ongoing updates and maintenance to in-house solutions and increased the risk of noncompliance. Other challenges noted by senior executives responding to the poll were similarly focused on the most cumbersome tasks necessary to ensure compliance: identifying and sourcing necessary customer and account information from various systems, managing internal resources across the organization, ensuring the accuracy of the data, remediating data sourced from multiple systems, and reporting in a timely manner across jurisdictions.
Based on Thomson Reuters work with financial institutions, we have identified a few best practices to help organizations achieve compliance: implementing a centrally managed compliance program; robust data privacy and security protocols, and flexible, scalable processes and systems; an audit trail to defend and share information with authorities if necessary; and appropriate checks and balances to ensure data accuracy and compliance with the latest regulations.
Will multilateral efforts succeed in leveling the global tax playing field?
FATCA’s 30 percent withholding penalty and commitment by US authorities to pursue instances of violation puts teeth behind the regulation, making it harder for US tax residents to dodge taxes. The first test for CRS comes next year when over 50 early adopter countries will commence reporting and intergovernmental exchange of information. As with FATCA, the threat of audits and penalties, along with meaningful reputational risk for noncompliance, will be essential to spur broad- based adherence to CRS.
Reciprocal exchange of information underpins the attractive leveling effect that CRS offers to tax authorities globally. Ironically, after spearheading and enforcing FATCA globally, the US has not yet committed to CRS; its refusal to do so could make the US a more attractive destination for investors, as profiled in a recent piece, “US tax havens: The new Switzerland” by the Financial Times.
Given the trend for greater transparency, rising public outrage at tax evasion, and a strong desire by governments to claw back lost revenues, it’s hard to see AEOI failing to reduce tax evasion. However, in this global game of cat and mouse, innovations will continue; the next offshore frontier may be digital, presenting new challenges for regulators.
Meanwhile, financial institutions need to continue to take action to prepare and navigate greater regulatory complexity to ensure compliance and to protect their customer data and reputations. Ongoing geopolitical uncertainty will make that both more difficult and more important.
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