TMF Group explores how educating organisations on the approaching Common Reporting Standard can fix problems presented by discrepancies in the standard’s interpretation across different jurisdictions
The Common Reporting Standard (CRS) calls on jurisdictions at a global level to obtain information from their financial institutions and exchange it with other jurisdictions annually. It was developed in response to a request made by the Group of 20, and approved by the Organisation for Economic Co‑operation and Development (OECD) on July 15, 2014.
CRS sets out the information to be exchanged, the financial institutions required to report, the different types of accounts and taxpayers covered, and common due diligence procedures to be followed by financial institutions.
More than 100 countries are committed to CRS – the majority of which performed the first exchange this year. The remainder are due to commence reporting in 2018 but, as the deadline approaches, some players – particularly in Asian markets – are struggling to make changes to be fully compliant in time.
CRS outlines three stages that need be completed. First, an entity must determine whether it classifies as a financial institution resident in a CRS-participating jurisdiction. To do so, it must undergo a classification process. Although this phase has been developed and standardised by the OECD, every country has implemented CRS into its own legislation, which means discrepancies remain between countries.
Once a legal entity has gone through the classification process as outlined under its local legislation, and has identified whether it is deemed a financial institution, the second stage kicks in. This is the due-diligence process – by far the most labour-intensive part of CRS – which identifies whether financial institutions possess reportable information. Entities undergo a series of steps to identify various financial accounts and whether the account holders are resident in a CRS-participating jurisdiction, which would make them reportable.
“As a financial institution you are supposed to identify the tax residency of your clients and account holders by seeking a declaration from them. What we do is look through all the client information and documentation that we hold for them,” explains a group head for the Foreign Account Tax Compliance Act (Fatca) and CRS at a Hong Kong-based investment bank.
“We then look for discrepancies and any reasons we can identify to have suspicion about the declaration the clients has provided us,” he adds.
As with the initial classification process, although a standard developed by the OECD exists, every country must adapt it to its local laws and legislations, so companies have to deal with different interpretations and thresholds in different jurisdictions.
The third and final stage entails reporting to the local authorities. Once all due diligence is complete, financial institutions can submit the information they have collected. This can be tricky, however, as different local authorities work on different formats, which can present some challenges.
“If everything is fine, we accept the declaration, collect all the information and submit the report to the regulators,” says the group head for Fatca and CRS.
“However, if there are any discrepancies we enter into a discussion with clients, which is the most challenging part because, while we cannot provide them advice, we must still have a meaningful dialogue with them to understand what went wrong,” he adds.
Fatca on steroids
When CRS was first introduced, there was a general misconception within the industry that it was merely an extension of Fatca, which is a US federal law designed to enforce citizens to file yearly reports on their non-US financial accounts to the Internal Revenue Service.
The fundamental difference is the underlying regulatory framework – while Fatca is based on a US law about withholding taxes, CRS is an international agreement merged into local laws and regulations. As a consequence, CRS generates discrepancies between jurisdictions and requires higher levels of investment in knowledge, time and resources.
“I like to call CRS ‘Fatca on steroids’ because Fatca started after a discussion about transparency, and now CRS is taking this to a different level altogether,” says the group head for Fatca and CRS.
“At the beginning we thought CRS would be an extension of Fatca. It has similarity and we hoped it wouldn’t be too complicated,” he adds. This was not to be the case. CRS involves a number of unique complexities, especially in the absence of clear cross-border standards.
Entity classification varies between Fatca and CRS, depending on the financial institution’s jurisdiction, which means an entity performing exactly the same nature of business while holding the same regulatory licence can have different classifications in different jurisdictions. This has significant implications because it means the same entity could be simultaneously classified as a financial institution in country A and as a non-financial institution in country B. This difference in classification means it has become very challenging to accurately interpret rules and apply regulations in multiple jurisdictions.
“The differences between countries makes this process far more complex than it could be. I think the goal for everyone is the same; however, I also understand that regulators must deal with the legal frameworks in their countries and some adjustments have to be made locally,” says Wendy Roest, portfolio manager for compliance and regulatory services at TMF Group.
Are you ready?
When CRS was first introduced, some local authorities were better prepared than others. Territories such as Hong Kong, Singapore, Japan, South Korea, Australia and New Zealand had clear instructions ready for a while, making CRS considerably easier to implement. “They understood the rules. There’s still not a great amount of detail but to the extent that they need to they understood the rules, and their clients are co-operating in terms of the various declarations that they must perform,” says a senior banker at a global bank in Singapore. “Of course there are still things we need to explain to the clients and, accordingly, we need co-operation with them before we can proceed.”
In other Asian countries, CRS remains a complicated issue, with India, China, the Philippines, Indonesia, Thailand and Malaysia among those further behind after having failed to issue guidance in a timely manner.
“For example, China has a registration deadline and legislation that says all financial institutions have to be registered by the end of the year, but the how, where and why are still slightly sketchy,” says Roest. “Clearly this put extra pressure on the financial institutions because it’s very difficult to get ready in time and get everything in order if you are not entirely sure of the details.”
Part of the problem lies with the different approaches regulators took to promoting and educating people on CRS adoption in their respective countries.
“Hong Kong and Singapore have been very good at this; they have flyers and notices that are easy and simple to understand,” says the senior banker. “This is what we suggest other countries should do: come up with something very simple and easily understood, and on that basis we can then take the discussion forward with the client.”
Lobbying efforts are under way to push regulatory authorities to standardise all of these different rules.
“Regulators claim that when they drafted these CRS rules they needed to streamline them with existing regulation in their own jurisdictions, hence a lot of differences remain,” says the group head for Fatca and CRS.
“I have been in touch with many regulatory authorities in many countries and this has been one of the most important aspects I’ve talked to them about – they should standardise at least certain major items, so we can work with largely similar rules,” he continues.
In a number of cases globally, governments have pushed back registration deadlines at the very last minute because they were not ready. Roest notes that this is something that could happen again in Asia if some of the technical infrastructures were not going to be ready on time.
Given CRS is a new piece of legislation, it is difficult to know what the consequences would be for non-compliant companies.
The most common sanction is financial penalties. Fines could range from $5,000–25,000 in Malaysia, from $7,500 to two years’ imprisonment in Singapore, from $6,400 to three years in prison in Hong Kong, and from $4,500 to the possibility of imprisonment in Japan. Australia and New Zealand can also impose heavy fines of up to $76,000.
CRS does not leave much room for interpretation when it comes to responsibility. Regulators have been very clear that it is one thing to make a mistake and another to make a fraudulent declaration. The same logic applies to financial institutions that are supposed to perform due diligence to ensure all the declarations provided by their client are reasonable.
In the case of a financial institution working with a services provider, obligations under CRS lie with the institution, while the services provider is only accountable for the work they perform.
Banks are actively lobbying regulators to change this. In their view, tax lawyers, consultants, chartered accountants and fund administrators are performing an activity they have been appointed to, and should be held accountable and responsible.
At the forefront of regulatory challenges
TMF Group’s approach starts with the education of its clients to help them understand the obligations of the CRS regime. To achieve this, TMF’s 6,500 experts serving more than 15,000 clients in over 80 countries provide a full range of services to help firms remain compliant with CRS – from classification and due diligence to annual reporting for financial institutions.
“Initially, there has been a lot of confusion in the market and among financial institutions. The main question from a lot of people is about understanding that, unlike Fatca – which applies to US citizens – CRS works differently,” Roest says.
“We can tell that people are very eager to learn, which is great, but there is definitely a lack of knowledge. This means everyone must work together to ensure there is a clear comprehension of the CRS system. We’ve already seen a lot of collaborative effort between advisory firms, banks and financial institutions to make sure that everyone has the same understanding.”
While larger corporations often have in-house teams to keep them aware of regulatory changes, smaller and mid-sized firms frequently lack the resources to do so. In these cases, TMF Group can provide help to ensure clear understanding of all CRS obligations.
Overall, relative optimism prevails among market participants in Asia. CRS compliance may be uneven, but progress is undeniable.