Towards Global Automatic Exchange of Information?
By TreatyPro Editorial
15 May, 2013
This feature explores the various plurilateral efforts underway to achieve more standardization in the exchange of information (EoI) for tax purposes between national revenue authorities, including the European Union (EU) Savings Tax Directive, the United States Foreign Account Tax Compliance Act (FATCA) and the Organisation for Economic Cooperation and Developmentâs (OECDâs) lesser known tax treaty TRACE project.
The OECD defines the automatic exchange of information as the systematic and periodic transmission of âbulkâ taxpayer information by the source country to the residence country concerning various categories of income (e.g. dividends, interest, royalties, salaries, pensions, etc.).
At the moment however, the OECDâs âinternational standardâ for exchange of information for tax purposes enshrined in Article 26 of the Model Tax Convention â which is the nearest thing to a global standard on EoI â is based on exchange of information by request.
Nevertheless, the OECD has a long history of encouraging information exchange between revenue authorities and its work in this area is focused on promoting automatic information exchange for countries wishing to use it as a compliance tool, although it claims to have no plans to use automatic information exchange as the standard.
To confuse the picture however, legislation in the US and at EU level is moving the world towards more widespread adoption of EoI on an automatic basis, which ironically could be underpinned by the OECDâs TRACE initiative.
The EU Savings Tax Directive (STD)
As originally drafted, the STD aimed at a uniform information exchange regime to apply across the Union, with all countries agreeing to report interest on savings paid to the citizens of other Member States to those States' tax authorities.
Because of resistance from EU Member States with strong traditions of banking secrecy, the Commission had to allow Austria, Luxembourg and Belgium to apply a withholding tax (initially at 15%, then 20% and from July 2011, 35% ). Many of the UK's offshore financial centres have been forced to join the STD, along with the Netherlands Antilles (as was), Aruba and some European centres (Andorra, Monaco, Liechtenstein and San Marino). Most of these places took the withholding tax route, as did Switzerland, which was the hardest nut for the EU to crack.
The STD applies to many types of return on savings instruments, all loosely described as interest, when received by individuals, but does not affect interest paid to companies. Under the information exchange system, the identity of recipients is known to their home tax authorities; but when tax is withheld, the identity of the recipient is not reported, thus preserving confidentiality.
The savings tax directive has applied in 42 jurisdictions since July 1, 2005. These include 27 member states, 5 non-EU 'third countries' (Switzerland, Liechtenstein, Monaco, Andorra and San Marino) and 10 dependent and associated non-EU territories (Anguilla, Aruba, the British Virgin Islands, the Cayman Islands, Guernsey, the Isle of Man, Jersey, Montserrat, the Netherlands Antilles and the Turks and Caicos Islands).
The STD requires banks and other paying agents to obtain customersâ Tax Identification Numbers (TINs) where possible. Whatever information the banks have, they will pass on to the tax authorities in the clientâs country of residence, along with information about the income they have been paid.
The minimum amount of information that 'paying agents' (banks and other financial institutions) are required to pass on to the 'competent authorities' of member states consists of: identity and residence of the beneficial owner; name and address of the paying agent; account number of the beneficial owner; and interest payment data including the amount of interest income earned, plus information regarding any proceeds from sale, redemption or refunds.
Some countries or territories have issued sets of regulations to their financial institutions which define the extent of the information an individual is required to give. In the absence of this local legislation, there is no obligation placed on banks or other paying agents to request the TIN; agents are permitted to rely on passports or identity cards, or other documentary proof of identity that is in their possession.
Under the withholding tax option, banks and other paying agents automatically deduct tax from interest and other savings income earned and pass it to their local tax authority, indicating how much of the total amount relates to customers in each Member State. The local tax authority then keeps 25% of the total amount collected and remits 75% to the various tax authorities within the Member States. The receiving country gets a bulk payment which is not broken down in terms of the individuals who are covered.
Reports have suggested that the revenues raised from withholding taxes so far have fallen well below EU expectations. This is because the directive as it stands is fairly easy for investors to circumvent, either by channelling assets into business entities which are not covered by the rules, such as a company or partnership, or by parking savings in jurisdictions not included in the directive, like Dubai or Hong Kong. Individual countries have released figures showing returns that are perhaps on the low side, while there is plentiful anecdotal evidence to suggest that most investors have either fled to jurisdictions which don't apply the Directive, or have re-arranged their deposits so as to avoid the Directive.
The European Commission has been well aware of the directiveâs loopholes for some time, and presented new proposals to fill them as early as 2008. The Commissionâs proposal seeks to improve the Directive, so as to better ensure the taxation of interest payments which are channelled through intermediate tax-exempted structures. It is also proposed to extend the scope of the Directive to income equivalent to interest obtained through investments in some innovative financial products as well as in certain life insurance products.
In July 2011, the Commission asked the Council for authorization to begin negotiating changes to agreements signed in 2004 by Switzerland, Liechtenstein, Monaco, Andorra and San Marino on the taxation of savings income received by European Union (EU) residents under the Savings Tax Directive. However, this has been a long, hard slog for the Commission so far, and in reality not much headway has been made since 2008 towards its goal of strengthening the directive. This is because certain EU member states fear that moves towards universal automatic exchange of information under the revised STD will erode their banking secrecy laws, notably Austria and Luxembourg.
In January, EU Tax Commissioner Algirdas Semeta reiterated calls for Austria and Luxembourg to give up their blockade of plans for a new Savings Tax Directive. Using the opportunity of his Dublin visit for a sideswipe at Austria and Luxembourg, Semeta urged both countries to stop blocking plans to reform the STD, and urged the Irish EU Presidency to achieve "swift progress" on this issue, which, he pointed out, is currently being blocked by just two member states.
Back in May last year, Luxembourg's Finance Minister Luc Frieden defended his decision to block the European Commission's plans to negotiate new and stronger savings tax agreements with third countries, insisting that given recent developments, the automatic exchange of tax information is not necessarily the only solution to combating tax evasion.
However, in recent weeks both countries have hinted at a climbdown.
On May 4, Frieden made clear that the withholding tax model "has no future," as an instrument under the Savings Tax Directive with which to combat tax evasion and ensure tax compliance. Frieden defended the Principality's change of stance, and in particular its decision to apply from 2015 an automatic exchange of information provision for interest payments made to individuals resident in European Union (EU) countries, other than Luxembourg. The u-turn was made in view of ongoing negotiations with the US on a Foreign Account Tax Compliance Act (FATCA) agreement (see below).
The Austrian Government has so far been less forthcoming on the matter of automatic information exchange, but towards the end of April Chancellor Werner Faymann confirmed Austria's willingness "to participate constructively" in negotiations between the EU and third states on an automatic exchange of banking information. However, Faymann reiterated that Austrian banking secrecy for Austrian taxpayers must not be affected by any considerations at EU level, and the mechanism must remain in its current form.
The Foreign Account Tax Compliance Act (FATCA)
As offshore tax evasion comes under increased international scrutiny, the United States Treasury Department has continued to ramp up efforts "to promote global tax transparency" through implementation of the Foreign Account Tax Compliance Act (FATCA), and believes that its efforts are building momentum worldwide.
Enacted by Congress in March 2010, FATCA is intended to ensure that the Internal Revenue Service (IRS) obtains information on financial accounts held abroad at foreign financial institutions (FFIs) by US taxpayers. Failure by an FFI to register with the IRS by January 1, 2014, and subsequently disclose information, will result in a requirement, from next year, to withhold 30% tax on US-source income.
Under the legislation, a participating FFI will have to enter into an agreement with the US Internal Revenue Service (IRS) to provide the name, address and TIN of each account holder who is a specified US person; and, in the case of any account holder which is a US-owned foreign entity, the name, address, and TIN of each substantial US owner of such entity. The account number is also required to be provided, together with the account balance or value, and the gross receipts and gross withdrawals or payments from the account.
Treasury says that it has been working with Governments and FFIs to put into operation the information reporting and withholding tax provisions within FATCA. For example, Treasury has published two model intergovernmental agreements (IGAs) that serve as a basis for concluding bilateral agreements with jurisdictions to implement FATCA. Treasury has been working to streamline the process of entering into an IGA so that any interested jurisdiction may enter into an IGA prior to January 1, 2014.
The Department is currently engaged with more than 75 jurisdictions and has already concluded bilateral agreements with the United Kingdom, Denmark, Mexico, Ireland and Switzerland, and has initialled bilateral agreements with Spain, Italy, Norway and Germany. Treasury has confirmed that it will "continue to engage willing partners worldwide to ensure implementation of FATCA."
In addition, earlier this year, Treasury and the IRS issued comprehensive final FATCA regulations. These regulations provide certainty for Governments and FFIs by finalizing the step-by-step process for US account identification, information reporting and withholding requirements for FFIs, other foreign entities and US withholding agents.
Additionally, to limit market disruption, reduce administrative burdens and provide certainty, the final regulations provide relief from withholding with respect to certain grandfathered obligations and from reporting for certain non-financial or low-risk entities.
However, the inclusion in President Obama's 2013 budget of "reciprocal" regulations, which will impose FATCA-style disclosure on US financial institutions directed at benefitting foreign IGA partners, may set the cat amongst the pigeons in Congress, where there is already a head of discontent in respect of FATCA.
Indeed, on May 8, Senator Rand Paul (R â Kentucky) introduced a bill to repeal the provisions of the Foreign Account Tax Compliance Act (FATCA) that, as he wrote in a letter to other Senators, "undermine Americans' constitutional privacy protections and add burdensome regulations with a negative economic impact on the United States."
Paul is reported to have recently been attempting to block all new US tax treaties with foreign countries, and has been particularly opposed to the tax information exchange contemplated within the proposed IGAs.
In his letter, he disclosed that he intended "to offer a bill to repeal certain provisions of FATCA. The intent of this law was to prevent tax evasion by increasing access to overseas bank accounts held by US citizens. However, any law enforcement benefits have been vastly outweighed by the deleterious effects of FATCA on economic growth and the financial privacy of Americans."
He noted that FATCA "has had the practical effect of forcing FFIs to relinquish any association with American customers, and to avoid direct investment in the US. It goes without saying that overseas investment in the US is an important engine of our economic growth and prosperity. FATCA endangers an estimated USD25 trillion in foreign capital currently invested in the US."
He confirmed as "even more troubling" the consequence that "the implementation of FATCA has allowed the Treasury to make independent decisions with respect to the privacy of US citizens. In order to implement this law, Treasury has initiated IGAs, citing the intent to engage in reciprocal information sharing with other nations."
"The Treasury," he concluded, "without the consent and authority of Congress, will force US financial institutions to provide the bank account information of private customers to foreign nations. Such a requirement not only diminishes US privacy protections, but also imposes billions of dollars in compliance costs here at home."
On introducing the bill into the Senate, he confirmed his belief that "tax evasion is a problem that should be addressed," but that FATCA is "a textbook example of a bad law that doesn't achieve its stated purpose but does manage to unleash a host of unanticipated destructive consequences."
An anti-FATCA bill probably doesnât have the support to pass Congress while the Democrats control the Senate, but anti-FATCA sentiment is unlikely to dissipate within the Republican Party, and its future repeal cannot therefore be entirely ruled out, should the Republicans regain a Senate majority while retaining control of the House of Representatives.
The OECD Treaty Relief and Compliance Enhancement (TRACE) Project
Most individuals, companies and financial institutions conducting business across borders are probably well aware of the efforts by Governments to crack down on international tax avoidance through initiatives like the EUSTD and the FATCA. However, one project that seems to have slipped under the radar is the OECDâs TRACE.
Formerly known as the Collective Investment Vehicle Project, TRACE stands for Treaty Relief and Compliance Enhancement and envisages the introduction of a simplified process for foreign portfolio investors to obtain the tax benefits of bilateral conventions for avoidance of double taxation.
More than 3,000 double tax treaties have been concluded worldwide to facilitate cross border portfolio investment, which, according to the OECD, totals some USD35 trillion. These double tax agreements entitle investors to reduced rates of withholding tax on dividend, interest or royalty income. However, as the OECD itself has observed: âWhile the vast majority of publicly traded securities is now held through a complex network of domestic and foreign intermediaries, few countries have adapted their withholding tax collection and relief procedures to recognize this multi-tiered holding environment. It is therefore often difficult or impossible to make an effective claim for withholding tax relief.â
Work on the TRACE project started about six years ago when the OECD Committee on Fiscal Affairs (CFA) and the Business and Industry Advisory Committee (BIAC) to the OECD agreed in 2006 to work on improving the process by which portfolio investors may claim treaty benefits. The objectives of the work on procedures were two-fold: to develop treaty relief systems that are as efficient as possible, in order to minimise administrative costs and allocate the costs to the appropriate parties; and to identify solutions that enhance the ability of both source and residence countries to ensure proper compliance with tax obligations.
An Informal Consultative Group (ICG) was then formed made up of government representatives and of experts from the business community and in 2009, the CFA released for public comment two reports by the ICG: The Report on the âGranting of Treaty Benefits with respect to the Income of Collective Investment Vehiclesâ, and the Report on âPossible Improvements to Procedures for Tax Relief for Cross-Border Investorsâ makes a number of recommendations on âbest practicesâ regarding procedures for making and granting claims for treaty benefits for intermediated structures.
The latter of these two reports recommends that countries develop systems for claiming treaty benefits that allow authorised intermediaries to make claims on behalf of investors on a "pooled" basis. One of the major benefits of such a system (variations on which have been adopted by a few countries over the past decade), is that information on the beneficial owner of the income is maintained by the intermediary at the bottom of the chain, rather than being passed up the chain of intermediaries.
However, as the name suggests, TRACE is as much about tax compliance as it is about standardizing process to claim tax treaty benefits. So in order to encourage compliance in the residence state, the ICG also recommended that financial institutions that wish to make use of the "pooled" treaty claim system must report investor-specific information on the beneficial owners of the income directly to source countries (i.e. not through the chain of intermediaries.) By agreeing to report this information as a condition of benefitting from the streamlined claims of procedure, financial intermediaries can contribute greatly to the ability of governments to ensure through exchange of information, that investors' tax obligations are met in both source and residence countries on the ever-increasing flows of cross border investment income.
In recognition of the fact that TRACE can become a new addition to tax collectorsâ compliance arsenal, in January 2013 the CFA endorsed the Implementation Package and approved further work in two areas, including: exploiting synergies between TRACE, FATCA, the Common Model for Residence Country Reporting and any EU follow-up work on the FISCO Feasibility Study; and developing a plan for a multi-country adoption of the Authorised Intermediary system and assisting countries progress towards adoption.
Other Multilateral Developments â The âG5â and Cooperation Between the IRS, the ATO, and HMRC
In April, the UK, France, Germany, Italy, and Spain agreed to develop and pilot a major new multilateral tax information exchange program, intended to tackle international tax evasion in a way that is said to minimize costs for both businesses and governments.
The initiative is outlined in a joint letter to EUâs Algirdas Å emeta, signed by the G5's finance ministers. In it, the ministers point to the anti-evasion agendas of both the European Union and the US as key steps forward.
The Commission supported the G5 in discussions with the US Government on a possible intergovernmental approach to FATCA, and a model agreement was developed and published last July. It is on this model that the pilot will be based. Once it is up and running, a wide range of financial information will be automatically exchanged between the G5.
According to the letter, the aim of the pilot is that it "will not only help in catching and deterring tax evaders but will also provide a template as to the wider multilateral agreement we hope to see in due course." Other EU member states will be invited to join the scheme, with the "hope that Europe can take a lead in promoting a global system of automatic information exchange, removing the hiding places for those who would seek to evade paying their taxes."
In a demonstration of the ever improving lines of communication between national tax authorities, it was announced on May 10 that the tax administrations from the US, Australia and the UK have developed a plan to share tax information involving trusts and companies holding assets on behalf of residents in jurisdictions worldwide.
The IRS, the Australian Taxation Office and HM Revenue & Customs are each said to have acquired a substantial amount of data revealing extensive use of such entities organized in a number of jurisdictions including Singapore, the British Virgin Islands, Cayman Islands and the Cook Islands. The data contains both the identities of the individual owners of these entities, as well as the advisors who assisted in establishing the entity structure.
The three tax offices have been working together to analyse this data and have uncovered information that may be relevant to tax administrations of other jurisdictions. Thus, they have developed a plan for sharing the data, as well as their preliminary analysis, if requested by those other tax administrations.
"This is part of a wider effort by the IRS and other tax administrations to pursue international tax evasion," said IRS Acting Commissioner Steven T. Miller. "Our cooperative work with the UK and Australia reflects a bigger goal of leaving no safe haven for people trying to illegally evade taxes."
It cannot be denied that momentum towards more exchange of tax information between revenue authorities on an automatic basis is growing. However, despite calls for a united governmental front to combat international tax evasion, the picture at the moment looks to be somewhat fragmented as Governments forge ahead with their own initiatives, even if these do complement each other to a large degree. Financial institutions with international clients therefore need to remain ever vigilant of this situation.
But is the proposition of global automatic exchange of information realistic? It is going to be a tall order to put the systems in place for information to be transmitted in a standardized format between every revenue authority in the world, especially given the lack of administrative capacity in many developing countries. Furthermore, there will need to be a lot of haranguing and cajoling from the likes of the OECD, the EU and the US to be done before countries with banking secrecy laws are persuaded to sign up. Also, while there isnât enough political support at the moment for repealing FATCA, a world without it is certainly not out of the question in the longer-term for the reasons given above, and this could deal the campaign a hefty blow, if not entirely kill it off.
But certainly, it is closer now than ever before.
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