The fight against tax evasion is a hot topic on an international level, where laws are constantly evolving to address even its most complex facets. One of the approaches identified at a global level is to strengthen the exchange of information via tax cooperation frameworks.
At the European level, the set of Directives on Administrative Cooperation (DAC) have put in place different rules and mechanisms to exchange information through different ways (upon request, spontaneous or automatic), targeting different actors (including financial institutions, operators, third-party providers) and aiming to collect diverse types of information (e.g., income, balance, interest, profits, cross-border arrangements).
For financial and non-financial companies operating on an international level, the right application of these obligations can become a real challenge as it necessitates deep changes to IT systems and data privacy management processes, existing procedures and policies, and even to service level agreements. Companies are facing direct questions from clients and tax authorities and therefore need quick access to high levels of expertise.
FATCA and CRS: latest updates
The legal framework around the exchange of information is constantly evolving. Locally, the Common Reporting Standard (CRS) law has been amended and a nil report became mandatory since January 2021. On top of that, both FATCA (Foreign Account Tax Compliance Act) and CRS laws have been amended, introducing the obligation for Reporting Financial Institutions to maintain Records of Steps (“Registre des Actions”) undertaken and evidence relied upon to ensure the execution of reporting and due diligence procedures for 10 years after the end of the year.
On the other side of the globe, in December 2022, the Internal Revenue Service (IRS) provided temporary relief to certain Foreign Financial Institutions from the requirement to report US Tax Identification Numbers (TIN) for certain accounts that were established prior to the implementation of FATCA and its associated inter-governmental agreements (IGAs).
This change allows Reporting Financial Institutions not to be treated as non-compliant because they have not received the US TIN of pre-existing account holders (which was only mandatory as of 2014). Reporting Financial Institutions holding accounts missing a US TIN must takes specific actions to be eligible for this relief.
Also in December 2022, Luxembourg's Official Gazette published a Grand-Ducal Regulation amending the CRS list of participating and reportable jurisdictions for the year 2022 and subsequent years. Five jurisdictions were added: Jamaica, Moldova, Montenegro, Thailand and Uganda.
Finally, in January 2023, the IRS issued a new series of codes to be used in case where the TIN had not been obtained in specified scenarios.
Expected evolutions for the near future
In addition to the local updates, the European Commission has been working on two other Directives. On 25 March 2021, the 7th Directive on Administrative Cooperation (DAC 7) has been published in the Official Journal of the European Union. Even if this Directive has not yet been transposed into Luxembourg law yet, it may still enter into application retroactively as of 1 January 2023. The main purpose of this Directive is to organize the reporting and automatic exchange of data relating specifically to sellers on digital platforms.
In the continuation of this topic, the European Commission proposed the 8th Directive on Administrative Cooperation (DAC 8) in December 2022. It includes certain provisions on reporting and exchange of information related to crypto-assets for direct tax purposes. The objective of this Directive is to improve the existing provisions of the current DAC 2 application by ensuring the disclosure of information related to crypto-assets and revenues generated by crypto-asset service providers.
In a near future, potential additional tax-related reporting requirements could emerge. For example, due to upcoming ESG rules, we may expect tax incentives that could lead to exchange of information on specific financial instruments.
Increase of government oversight
There has been an increase in government inquiries regarding the enforcement of regulations in multiple jurisdictions since the implementation of the exchange of information.
At the same time, tax authorities have more and more inquiries related to the correct application of the regulations, including questions on the processes and policies in place, the governance framework, and the quality level of data provided.
At a global level, a strengthening of the oversight of application of tax transparency provisions from tax authorities has been observed. For example, if a company does not properly apply the instructions provided by the tax authorities after the first reminder, there is no second chance or additional reminder to react. The penalties are applied straight after the deadline indicated by the tax authorities.
Additionally, the level of penalties in the current regulations has already increased, and based on draft laws, it may potentially continue to grow.
How to be adaptable in an evolving environment
The challenge of remaining compliant in this evolving environment of tax transparency duties depends on several factors: the business and its size, as well as the sector.
Large financial institutions, such as commercial and private banks, insurance companies and international investment funds, tend to struggle with the management of large volumes of qualitative and up-to-date data. For private equity and real estate groups, the main challenge is quite different. Due to their presence across multiple countries and the need to take decisions in short periods of time, it is crucial for them to be quickly informed about local specificities, and to be able to put in place the right measures to be compliant.
Even if the main challenge could be different, the aspects mentioned below should be considered by tax professionals to adapt to tax transparency regulations:
Tax data management
A leading-edge data management strategy is one of the key elements that underpin a successful and intelligent tax function. Providing accurate data is in the centre of tax transparency requirements. Being able to drive a data management project across different systems and services through the tax prism is therefore fundamental.
The tax functions should be involved in the design of IT applications and definition of the life cycle of data related to tax transparency, which encompasses the collection, maintenance and extraction of tax information.
On top of being tax experts, tax professionals should have the right level of IT knowledge including system capabilities and limitations.
Cost and risk management
For cost saving and efficiency reasons, tax professionals should also contemplate alternative solutions supporting the compliance with tax transparency laws.
Nowadays, it is also the duty of the tax function to be able to select external experts equipped with dedicated tools, and to identify (parts of) processes that could be simplified, automatized or outsourced.
Outsourcing a part of the process (e.g., TIN review, report generation and filing) may also reduce the risks of providing clients and tax authorities with wrong or inaccurate data.
Operations
From an operational point of view, the challenge is double. Tax resources should ensure that all actions related to the exchange of information are well documented in up-to-date policies, procedures, and, at the same time, that the people from front to back office are properly applying these actions.
In order to reduce the risk of gaps between written policies and their application, tax resources should be involved in relevant training sessions and conduct appropriate internal tax health checks.
As an example, for CRS, documenting all actions and means taken in the context of exchange of information in the Records of Steps will also help to demonstrate proper application of tax transparency regulations in case of inquiries from tax authorities.
Extended scope
Tax transparency duties are connected with other requirements, such as the General Data Protection Regulation (GDPR) and Anti-Money Laundering (AML).
For example, in the case of automatic exchange of information with tax authorities involving personal data of individuals, GDPR is applicable and the information exchanged should be aligned with the AML documentation collected from customers. If a company has exchanged too much or wrong information, it may be exposed to GDPR and AML sanctions.
If tax resources cannot be expert in all topics related to tax transparency, they should verify that they have captured the big pictures of associated obligations and received enough awareness from local experts who can bring them appropriate knowledge.
Expanding knowledge beyond taxation
Fighting against tax evasion is a sensitive topic and due to the changing regulatory environment, digital tax administrations and heightened transparency requisites have increased the need for tax professionals to be agile.
On top of being experts in their field of expertise, tax resources must continue to improve their knowledge of non-tax-oriented topics, such as data management, IT systems capabilities, third-party providers selection and new technologies (e.g., crypto-assets, blockchain).
In financial and non-financial companies, the tax function has never had a more critical role, and it is not expected to change. To help tax professionals succeed in this era of rapid change, EY’s internationally coordinated network of tax professionals provides integrated services across all tax disciplines: from business tax, international tax, transaction tax, to tax-related challenges including people, compliance and reporting.
