CRS and Trusts: An Uneasy Alliance

By Andrew Knight, Partner, Luxembourg and Anthony Markham, Partner, Isle of Man, Maitland Group (09/06/2015)

CRS – An Exercise in Logistics?

In recent years there has been a global movement toward achieving greater transparency regarding taxpayers’ wealth through the automatic exchange of information between countries. The most recent development on this front is the OECD’s Standard for Automatic Exchange of Financial Account Information in Tax Matters, generally referred to in its abbreviated form of the ‘Common Reporting Standard’ (CRS). 

CRS is an extension of the reporting regime introduced by the US Foreign Account Tax Compliance Act (FATCA). It is now widely recognised that FATCA has imposed a set of compliance obligations that are complex and costly to implement.

But at least under FATCA each country throughout the world only has to cope with the exchange of information in relation to one other country, namely the US. US FATCA is in effect two-dimensional. In contrast, the CRS is multi-dimensional in that any one particular country will potentially be required to exchange information with (and also receive information from) the over one hundred countries who have committed to apply the CRS. The gathering and transmission of information between countries will present considerable challenges to governments that are not necessarily well versed in logistical exercises of this sort.

CRS – Greater Uniformity in Application?

To some extent the increased logistical complexities of multilateral information exchange are ameliorated by a greater degree of standardisation of the rules. There is a single form of model intergovernmental agreement, known as the Competent Authority Agreement (CAA), and a detailed OECD Commentary. But these do not resolve a number of questions regarding trusts and the risk is that countries will form different views on how the CRS applies to trusts. As will be seen from the remainder of this article, without clearer guidance from the OECD, there is considerable scope for differing views to emerge.

Trust FATCA and CRS!

At the time FATCA was first enacted, there was nothing to suggest (including in the legislative history) that trusts would be treated as financial institutions and thereby bear the full weight of FATCA due diligence and reporting obligations. Nor would one reasonably have expected this to be the case. Trusts are not obvious candidates for ‘financial institution’ status and the notion that a ‘financial account’ includes an award made to a discretionary beneficiary requires a degree of imaginative thought. Nevertheless, the drafters of the detailed US FATCA regulations clearly felt that trusts and their trustees should themselves, rather than the financial institutions with whom they hold accounts, be given the principal role in delivering on the objective of worldwide transparency in the context of trusts.

The CRS has adopted the same approach on trusts. Trusts are highlighted as a target at the very outset in the introduction to the CRS with emphasis on the fact that reportable accounts include accounts maintained by entities that are trusts. In short, there is a clear and unavoidable objective to ensure that trusts are included in the worldwide reporting regime.

A trust will be classified as a ‘Financial Institution’ in the form of an ‘Investment Entity’ where its trustee is a professional trustee company or where it otherwise meets the requirements of such status (for example, if it has an investment portfolio managed by a Financial Institution). It will be a ‘Non-Financial Entity’ and probably a ‘Passive NFE’ where its trustees consist only of individuals or private trustee companies and it does not otherwise meet the requirements of Financial Institution status.

In the case of a trust which is a Financial Institution, the trustee will take the initiative to review its ‘account holders’ and report on those that are resident in any country that has signed up to the CRS. In relation to a trust, the ‘account holders’ are defined to include settlors, beneficiaries and persons exercising ultimate effective control over the trust.

In the case of a trust that is a Passive NFE, the trustee will be required to respond to requests from financial institutions (notably banks and investment funds), with whom the trust holds an account, to confirm the trust’s status as a Passive NFE. In such cases, the enquiring Financial Institution has an obligation to identify the ‘Controlling Persons’ of the Passive NFE, to determine their residence and, where they are resident in a CRS country, to report on the account.  ‘Controlling Persons’ are defined to include settlors, protectors, beneficiaries and persons exercising ultimate effective control over the trust.

Invariably therefore, settlors, beneficiaries, and in some cases protectors, will be the subject of reporting. Only those individuals who can prove residence in a country that has not adopted the CRS will escape reporting. The number of those countries is diminishing.

Financial Accounts Maintained by a Trust

A ‘Financial Account’ is defined as an ‘equity or debt interest’ in the trust. The simple piece is the debt interest. Any advance of funds to a trust will be a financial account and a lender in a CRS country will be disclosed.

The concept of equity interest also applies fairly readily to a trust where the beneficiaries have defined shares of the trust fund. Less straightforward is the way it has been extended in the CRS to the interest of a settlor, a beneficiary, or any other natural person exercising ultimate effective control over the trust. The CRS Commentary explains that purely discretionary beneficiaries should only be considered to be account holders in relation to a particular reporting period if there has been a distribution to them during that reporting period, the implication being that the ‘account’ is the award.

Although a helpful explanation, it has the important consequence that awards made in 2015 may already be exposed to reporting, on the basis that they constitute ‘pre-existing accounts’ as at 31 December 2015. The reports will start landing on tax authorities’ desks in the course of 2017. In certain circumstances an argument could be made that such an account ‘closes’ before the end of the year such as to render it no longer a pre-existing account. However, the question of account closures is a vexed one in the context of discretionary awards and further guidance on the point would be welcome.

The question of closure is also relevant because, until closed, the account remains reportable and because the closure is itself a reportable event as is the account balance at closure. The CRS Commentary provides no guidance at all on closure of accounts in the context of trust awards. While there are various possible approaches to closure, the most simple (and therefore the most attractive) is that an account ‘closes’ immediately after the last award in any particular reporting period. A distribution in a subsequent year would be treated as the opening of a new account for the same beneficiary and would similarly be treated as closed at the end of that year. However, other constructions are possible and may depend upon the particular circumstances of the trust in question.

The value of an account treated as held by a discretionary beneficiary will be the amount of all the awards made to that beneficiary in a particular reporting period (normally, but not always, a calendar year).

As regards settlors, the CRS Commentary is clear that they are account holders and no distinction is drawn between settlors of irrevocable and revocable trusts. Settlors resident in a CRS jurisdiction need to understand that trusts that are financial institutions in CRS jurisdictions will file reports on them. While the account of a settlor of an irrevocable trust should be treated as having no value, the CRS does not provide an exemption for reporting on individual accounts with no value.  

Controlling Persons of a Trust

As already noted, a financial institution which maintains an account with a trust that is a Passive NFE is obliged to identify the ‘Controlling Persons’ of the trust. If a Controlling Person is resident in a CRS country, that person and the account will be reported to that country. This would include where the NFE trust in question is itself not resident in a country that has signed up to the CRS (although most international finance centres offering trusts have committed to participate in the CRS).

The term ‘Controlling Persons’ is defined in the case of a trust as meaning “the settlor, the trustees, the protector (if any), the beneficiaries or class of beneficiaries, and any other natural person exercising ultimate effective control over the trust”. From this definition it is clear that a person can be a Controlling Person of a trust without exercising any actual control over it (eg, a beneficiary).

The process for identification of Controlling Persons is set out in the CRS rules which also set out what due diligence is required of the enquiring financial institution.  The CRS requires the term ‘Controlling Person’ to be interpreted in a manner consistent with the Financial Action Task Force Recommendations and, for most purposes, a Financial Institution may rely upon its AML/KYC enquiries to establish the identity of Controlling Persons. The question arises whether a person who is a Controlling Person for AML/KYC purposes is always a Controlling Person for CRS purposes. The point becomes critical when considering whether the limited situations under the AML rules where it is not necessary to drill through entities to ultimate individual beneficial owners can be extended in a CRS context to entities that are Financial Institutions or even ‘Active NFEs’.

Where a Controlling Person resides in a CRS country, the Financial Institution in question will treat the account as a reportable account and will report, inter alia, the identity of the Controlling Person and the full value of the account in question. Thus, unlike in the case of a trust that is an FI, the report filed by an FI regarding a Passive NFE trust does not necessarily reflect the value of a Controlling Person’s interest in a trust.

CRS – A Trigger for Voluntary Disclosure

The impending explosion of disclosures due to the CRS is causing increased attention to be paid to the possibility of a taxpayer taking advantage of available voluntary disclosure programmes (VDP) in order to regularise their tax position before a formal tax audit becomes a real possibility. A number of countries offer a VDP and the EU Commission has recently encouraged EU members that do not currently have a VDP to put one in place. Taxpayers should seriously consider participating in a VDP not only for their own peace of mind and that of their heirs but also to avoid having their accounts closed. Banks are increasingly insisting on clients taking advantage of an available VDP and failure to do so may result in the clients receiving a cheque in the post for the balance on their account with limited scope for presenting such a cheque elsewhere for payment.