FATCA/CDOT/CRS Reporting: Making sense out of complexity

the UK has introduced its own version of FATCA applicable to financial institutions in Crown Dependencies and Overseas Territories

Financial institutions (FIs) across the world have been set a new task: help tax authorities combat tax evasion. FIs now have to identify their customers with overseas tax residencies and report information on their balances and income to the tax authorities. Providing data that can be compared to the tax returns authorities receive from tax payers makes it harder for assets to go unreported and therefore tax evaded.

This might seem like a straightforward enough process, but tax residency has not previously been requested among the mass of customer data collected at on-boarding to tackle financial crime, identify theft, fraud, anti-money laundering and terrorist financing. Tax residency can vary by country and requires financial institutions to collect additional information from their new or existing customers. This can be an expensive and complex modification to existing customers.

The Foreign Account Tax Compliance Act (FATCA) for US tax payer reporting, and the Common Reporting System (CRS) for overseas tax residency, have both set challenges in terms of compliance and have resulted in significant sums spent by many financial institutions. They have also presented a new reporting obligation with countries setting their own local processes and reporting requirements. This means the variations are extensive and therefore challenging for any multi-geography institution to comply with in an effective and cost-efficient manner.

In addition, the UK has introduced its own version of FATCA applicable to financial institutions in Crown Dependencies and Overseas Territories. This may appear to have a more localized impact, but with something like 44% of all IRS-registered FIs present in the nine CDOT countries, plus the UK, affected this

means nearly 80,000 FIs are impacted. Many of the countries impacted are subsidiaries of the US, Europe, Asia and other countries who may not be fully aware of the new regulations, and reporting is due on both 2014 and 2015 data in 2016.

This may have been manageable when reporting the relatively low number of US persons under FATCA, but the CRS exponentially expands the volumes and challenges for financial institutions. For some FIs, reportable numbers will grow from a few tens of reportable persons to many thousands. and CRS has a particularly large impact in some jurisdictions, such as Luxembourg, which had relatively low numbers affected by FATCA reporting.

This article identifies some of the main challenges and how they can be approached so firms can ensure they are compliant.

THE REPORTING TASK

By definition, reporting is simply ensuring the correct information is given about the right customer, to the relevant tax authority/s in the specified format/s by the required deadline. This makes it sound like a simple process, but it can be anything but.

To report effectively requires well thought through operational capabilities and technology solutions. The below outlines some of the areas that must be taken into consideration:

What data to use: There is a huge wealth of data to tackle. Efficient tax reporting means picking out the relevant data from a potentially very complex environment of customer data sources, plus transactional systems to produce the asset balances and income data required.

How to physically report: The reportable data must be produced in the correct format for the relevant tax authority, with all rules applied for data validation, mandatory fields and formats.

Governance and oversight: Ensure that all reporting activities are undertaken effectively and at the right time to meet the deadline.

Data analytics: Manage any reporting risks as analytics help to identify content that may be incorrect or inaccurate.

How to submit correctly: Submitting processes varies from country to country. For example IRS submissions via IDES, there is a specific encryption process to follow.

Post-submission query management: Submitting the report is not the end of the process, it is the beginning for tax authorities. Effective query-handling processes in place for in-bound contacts from both tax authorities as well as from the reported customers themselves.

Hitting deadlines: The key to staying on top of regime changes and new country guidance.

UNDERSTANDING THE CONSEQUENCES OF REPORTING

There are moments when reporting is actually the whole point of FATCA appears to some extent to have been overlooked by some financial institutions as they concentrated efforts on understanding the complex rules and customer classification. After all, the IRS wants the information about US tax payers and all the indicia searches, on-boarding documentation changes and classification activity were only required in order to identify who needed to be reported and what to report about them.

The same applies to both Crown Dependencies and Overseas Territories (CDOT) in 2016 and CRS reporting to 2017. The primary purpose of these regimes is the annual reporting from the financial institutions to the tax authorities, once the reportable customers have been identified.

It is also the case that many of the risks presented by reporting may not have been fully considered by many reporting FIs in the design of the reporting processes. Misreporting is a real risk and is easier to do than imagined. There are plentiful opportunities to get things wrong by missing reporting deadlines, having submissions rejected, reporting incorrect information about customers, not reporting those who should be reported, reporting those who should not, sending information to the wrong tax authority etc. The focus to date however has often been on the process of reporting, i.e. generating the XML, rather than the content itself.

Hard-won customer relationships could readily be threatened as a result of misreporting, as well as the risk of institutional-level reputational damage if AEI

reporting is not performed correctly or accurately.

These risks can be managed via the use of plausibility checks, data analytics and other techniques which we see coming more to the foreground in future years when the reporting mechanisms themselves become routing, but the core responsibility for the content will reside with the reporting financial institution.

As tax authorities process and analyse the information that has been submitted to them by the reporting FIs they will identify their own activities consequent on the information they have received. If someone receives a tax demand based on inaccurate information then they will not be too happy with the reporting FI that submitted the data and the tax authority will have its confidence in the reporting FI undermined.

We are still in the early days of Automatic Exchange of Information, despite FATCA having been around since at least 2008. With 2015 seeing the first reporting of US persons under FATCA we have transitioned from the assessment/classification stage into the business as usual operational environment.

With additional items reportable under FATCA from 2016, plus the CDOT reporting coming into effect, there are further changes imminent. Adding to this is CRS reporting from 2017 when volumes will substantially increase and place genuine challenges on the ability of reporting FIs to accurately and efficiently report the required information to tax authorities about their customers.

THE REPORTING EXPERIENCE SO FAR

2015 was a difficult year for many reporting FIs across the globe as teams tried to get to grips with their reporting obligations which many realised were more complex and more varied than perhaps they had anticipated. Combined with delayed, and sometimes unclear directions from tax reporting authorities, caused many used local or tactical solutions to produce and submit the reports.

It is probably fair to state that the reporting was a lot more complex than it was expected to be, perhaps mainly caused by the international variations in reporting processes and formats across different countries.

Part of this came from many tax authorities designing a reporting environment that was often designed to minimise the impact on the reporting FIs in their country such as leveraging existing reporting processes, or adding local reference data, aligning reporting dates with other domestic reporting submission activity, or making use of existing tax authority portals for report submission. For many countries we are still awaiting formal guidance notes and specifications for reporting submissions.

FATCA/CDOT/CRS Reporting: Making sense out of complexity

FATCA/CDOT/CRS Reporting: Making sense out of complexity

The CDOT reporting requirements have overlapping requirements with U.S. FATCA, but there are significant differences between 2015 and 2016 reporting, making the CDOT reporting more nuanced.

The cumulative effect of this for a multi-national financial series organisation is to present a diverse and complex reporting environment with different reporting deadlines, different reportable information requirements and different reporting formats. Being realistic about this, we may expect a complex reporting environment to be present for the long term.

Fortunately, the reportable customers in 2015 were relatively few in number and in many cases there were no US persons to report. Those with reporting obligations found themselves needing to generate reports in an XML format to the specification of the schema issued by the tax authorities.

There were a number of different approaches to this, from internal IT capability used, to the licensing of reporting technology solutions and the use of third parties to generate the XML from the source reportable data.

The lessons learned from 2015 show that reporting is a topic not to be underestimated, but also that 2016 will be relatively more straightforward than subsequent years: in 2016. In 2016 most of the reporting will still be for FATCA purposes, with some reporting FIs needing to report under CDOT. We can expect volumes to be higher than 2015, but in the tens or hundreds to report perhaps, rather than thousands.

2017, when the early adopter CRS countries come on line, and 2018 when the remaining committed CRS participating countries start to report, will be the real challenge as volumes of reportable customers and therefore the potential for reporting risks increases significantly.

DON’T FORGET CDOT

CDOT refers to the intergovernmental agreements between the UK and ten countries, the Crown Dependencies and Overseas Territories. This is a similar concept to FATCA that applies to UK tax residents holding funds in the included countries, but as there are reciprocal agreements between the UK and Jersey, Guernsey, the Isle of Man and Gibraltar that there are impacts on UK financial institutions too.

Under CDOT, an FI is wider and includes some that were excluded for FATCA (e.g., charities). According to the IRS GIIN list there are over 51,000 registered GIINs in these ten jurisdictions, more than 30 percent of the global total, add in the UK FIs which have reciprocal arrangements and over 70,000 FFIs are in scope.

The CDOT reporting requirements have overlapping requirements with US. FATCA, but there are significant differences between 2015 and 2016 reporting, making the CDOT reporting more nuanced. The CDOT specified person definition is wider than FATCA and the indicia are based on residency/tax residency rather than citizenship as under FATCA.

It is imperative FIs carefully note these differences and also to recognise that in 2016 some financial institutions will be reporting their US. clients under FATCA and their UK tax residents under CDOT, a foretaste of CRS reporting in 2017.

It is probably true to say that many, perhaps most, people (including some tax authorities) have underestimated the impact and challenge faced by FATCA, CDOT and CRS compliance. There may be few business benefits to the financial institution from getting it right but there are a lot more disadvantages in getting it wrong.

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Paper commissioned by Thomson Reuters, written by: David Watts, Director in EY’s Operational Tax & Technology practice