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What will the tax authorities learn?

Automatic Exchange of Financial Account Information among tax authorities worldwide applies to 2016 data 

Today, 108 jurisdictions, including many tax havens (the British Virgin Islands, the Cayman Islands, Gibraltar, Guernsey, the Isle of Man, Liechtenstein, Seychelles, etc.), participate in the automatic exchange of financial account information. The sharing of data on capital gains, account balances, income from the sale of financial instruments and data on the beneficial owners of passive entities (for the year 2016 already) will aid in the effective verification of income tax returns and improve tax transparency. Consequently, tax authorities will no longer have to rely only on spontaneous exchanges of data or journalists revealing secret information and causing scandals the likes of the Panama Papers. 

Background 

With the world becoming increasingly globalized it is easier for taxpayers to make, hold and manage investments through financial institutions outside their countries of residence. Vast amounts of money are kept offshore and go untaxed to the extent that taxpayers fail to comply with the tax duties of their home jurisdictions. Co-operation among tax authorities is critical in the fight against tax evasion and to protect the integrity of tax systems.

Exchange of information among tax authorities – latest developments 

The current exchange of information on demand, which, historically, has been the oldest type of information exchange among tax authorities, is slow, ineffective and does not keep pace with the world of the 21st century. Computerized data processing is the key aspect of effective cooperation; the framework of the OECD’s Multilateral Competent Authority Agreement on the Automatic Exchange of Financial Account Information (CRS MCAA) allows, already, for the automatic exchange of information in a standard electronic format – the Common Reporting Standard (CRS).

The CRS MCAA provides a standardized and efficient mechanism to facilitate the automatic exchange of information. As with the US Foreign Account Tax Compliance Act (FATCA), the CRS model imposes duties on financial institutions to identify reportable accounts and to obtain the identifying information on the account holder required to be reported for such accounts to their local tax authorities. This avoids the need to conclude several bilateral agreements. The text and signatories of the MCAA can be found on the OECD webpages.1

1 http://www.oecd.org/tax/automatic-exchange/international-framework-for-the-crs/

Schedule for first reporting 

Data will be exchanged mostly on an annual basis, for the first time by 30 September 2017 for 2016 data. Over 1,300 bilateral exchange relationships have already been activated with respect to jurisdictions committed to the 2017 timeline. Some jurisdictions will join the system one year later (for instance, Andorra, Belize, the Cook Islands and China).

Common standard for reporting information 

An effective model for the automatic exchange of information requires a common standard for the information to be reported by financial institutions and exchanged with the jurisdictions of residence. In order to limit opportunities for taxpayers to circumvent the model by shifting assets to institutions or investing in products that are not covered by the model, the reporting regime requires a broad scope across three dimensions:

(i) Financial information reported

The comprehensive reporting regime covers different types of investment income including interest and dividends, and addresses situations where taxpayers seek to hide capital that itself represents income or assets on which tax has been evaded (e.g., by requiring information on account balances). The information reported to the tax authorities by financial institutions will include information on capital gains, account balances and income from the sale of financial instruments of each identified passive entity. Passive entities are considered entities with at least 50 percent of their total income generated from financial activities, companies that were established primarily for the purpose of owning shares in other companies and companies that generate more than 50 percent of their gross income from what is referred to as passive activities, i.e., particularly income from dividends, licenses and patents, interest income and rental (or a combination of these). The tax authorities will also learn details about the beneficial owners of such entities.

(ii) Account holders subject to reporting

The comprehensive reporting regime requires reporting on individuals; it should also be designed to restrict opportunities for taxpayers to circumvent reporting by using interposed legal entities or arrangements. This means that financial institutions must check shell companies, trusts and similar arrangements, including taxable entities, to cover situations where taxpayers seek to hide the principal but are willing to pay income tax.

(iii) Financial institutions required to report

The comprehensive reporting regime covers banks and other financial institutions such as brokers, certain collective investment vehicles and insurance companies.

Implementation of CRS MCAA in the Czech Republic 

The Czech Republic has taken into account the recent anti-tax avoidance developments in the EU and the OECD and is committed to global standards. New legislation implements the annual automatic exchange of information in compliance with FATCA and the EU Savings Directive, thus creating a new method for the exchange of information among financial institutions and tax authorities.

How it will work in practice 

For instance, in the Czech Republic, if a foreign entity is owned by a Czech tax resident, the Czech tax authorities will be informed of its foreign accounts and income, including details of its beneficial owner, despite the fact that the entity is a foreign tax resident. The same will apply vice versa in cases where Czech passive entities are owned by foreign tax residents.

Czech financial institutions will provide the relevant electronic data on the tax non-resident’s income to the Czech General Financial Directorate which will automatically share the data with the tax authorities of the country where the client is a tax resident.

Czech tax residents must be prepared to communicate with foreign financial institutions regarding their tax residency based on this new scheme. Czech residents are obliged to tax their worldwide taxable income, including foreign employment income, dividends, interest, capital gains and other taxable payments. To date, the Czech tax authorities have had no effective tool to verify such foreign sourced income.

Conclusion 

Reporting financial institutions and taxpayers face a significant challenge. Financial institutions and taxpayers who generate income from assets in the 108 jurisdictions which participate in the MCAA should pay special attention to

the newly-introduced global standard on the exchange of information. It provides tax authorities with additional effective tools for reviewing tax compliance.