Customer Tax Integrity – Insight on the key principles and best practice markets

For a number of years, FIs have been at the forefront of the broad tax transparency and responsible tax agenda. The Directive on Administrative Cooperation (DAC) allowed tax authorities and regulators of  the Member States to facilitate administrative cooperation in the field of taxation.

This has been brought to the fore by a range of factors going back to the global financial crisis and since then in the form of the Panama and paradise papers, the CumEx scandal in Europe as well as a range of individual instances where FIs have been seen to be engaging in or facilitating aggressive tax avoidance and / or evasion. 

More recently, the US Senate published a report last August highlighting the existence of schemes to prevent FATCA reporting, also known as the "shell bank loophole". If you wish to have more information, please consult our article from the previous edition.

The FIs are now seen as key players in ensuring that tax transparency and responsible tax agendas are applied and up to date. FIs are expected to conduct their tax affairs in an ethical and social manner when dealing with clients and counterparts. 

There has been a constantly evolving regulatory landscape that has emerged in recent years that is framing the requirements and expectations of FIs in dealing with this agenda. 

• International level 

At the international level, we have seen the emergence of the FATCA and CRS rules, as well as the OECD’s focus via its Task Force on Tax Crimes and Other Crimes (TFTC) resulting in its 'Fighting Tax Crime – Ten Global Principles' and 'Ending the Shell Game: Cracking down on the Professionals who enable Tax and White-Collar Crimes' publications which seek to define the international tax and regulatory models required to tackle all forms of tax crime. These areas also align with the Financial Action Task Force international standards on preventing global money laundering and terrorist financing. On the ESG front we have seen a range of developments including the UN Principles of Responsible Banking as well as the emergence of the GRI 207 standard and WEF / IBC Metric.

• EU level 

At EU level we have seen a number of developments with the designation of tax evasion as a predicate money laundering offence. The cooperation between the Member States via the automatic exchange of information has been reinforced in the field of taxation. The DAC Directive has subsequently seen its scope widened considerably in recent years, with the seventh amendment (DAC 7 and DAC 8 currently under preparation respectively targeting digital platform operators and crypto operators). The various updates made over the past decade have the same purpose: more tax transparency to fight tax evasion and aggressive tax planning.

• Focus on Luxembourg

Pursuant to the law of 23 December 2016, tax crime became a primary offence in Luxembourg as from 1 January 2017 and is part of the AML KYC obligations. The Financial Intelligence Unit (FIU) and the Financial Sector Supervisory Authority (CSSF) co-signed two circulars in 2017 and 2020 containing indicators of tax evasion in order to help the actors of the financial sector to consider the tax aspects as part of their onboarding and due diligence obligations. 

For all the new business relationships since 1 January 2017, whatever the level of risk, FIs must obtain information on the purpose and intended nature of the relationship, as well as on the source of funds, to assess the financial situation of the prospective client from a tax offence risk point of view. For existing business relationships, this information must be obtained at appropriate times on a risk-sensitive basis.

Furthermore, the Luxembourg FATCA/CRS governance law came into force on 1 January 2021, imposes on Luxembourg FIs to establish a compliance program including written policies and procedures, systems and controls detailing how due diligence and reporting obligations are in practice dealt with and documented.

More recently, the CSSF has issued the Circular 22/807 which, as from 30 June 2022,  introduced various requirements for the banks. The banks should notably ensure the implementation of efficient processes and procedures to prevent fraud and ensure the compliance with the anti-money laundering (AML) and the financing of terrorism (FT) rules/obligations. For the bank itself as well as for their clients, complex structures and unusual or potentially non - transparent activities should be subject to an in depth-analysis considering (i) the extent to which the structure is or will be established in a territory which complies with the EU standards on tax transparency and on the fight with anti-money laundering and (ii) the extent to which the structure could be used to hide the identity of the ultimate beneficial owner. Pursuant to the outcome of the analysis performed, the bank may have to file a Suspicious Activity Report to the Financial Intelligence Unit but also to consider the potential impact from a FATCA/CRS reporting perspective (e.g. in case the UBOs were not correctly reported as Controlling Persons) and DAC6 perspective, i.e. whether it falls under the definition of a cross-border reportable arrangement notably in light of the category D hallmarks.

Netherlands 

The DNB (Dutch Central Bank) has issued guidance on 'Best practices in respect of customer tax integrity management for Banks'. Although the guidelines are not legally binding, banks apply the guidance as they see fit. The guidance provides practical tools to be used to mitigate the risk of dealing with or facilitating customers in engaging in tax evasion or aggressive tax avoidance. A key focus of these guidelines is on carrying out a systematic integrity risk assessment combined with a bank’s own tax integrity risk appetite. Furthermore, other control mechanisms such as due diligence and customer and transaction monitoring are required to mitigate the risk of tax evasion / aggressive tax avoidance.

Germany

Emerging rules relevant to the area under review include the 'Defence against Tax Havens Act' which seeks to achieve greater tax fairness across international borders. It includes targeted defensive measures that aim to encourage tax havens to implement international standards to prevent tax evasion and avoidance as well as seeking to deter individuals and corporates from continuing to deal or instigate business relationships with such tax havens.

UK

The UK has in place for a number of years now its Disclosure of Tax Avoidance Scheme (DOTAS) rules, which are very similar to the DAC 6 rules but apply to domestic transactions. In the wake of the Global Financial Crisis, the Code of Practice on Taxation for Banks was introduced. Thissought to ensure that Financial Institutions, when operating on their own account or when working with their clients in respect of tax matters, put in place effective governance to ensure that at all times those tax affairs are managed in a manner that is consistent with legislative intent and does not involve any form of aggressive avoidance. This was added to by Corporate Criminal Offence (CCO) rules introduced in the Criminal Finances Act 2017 which create a number of corporate criminal offences for organisations who fail to prevent their staff or associates from unlawfully facilitating tax evasion.

Whilst the various areas we have been exploring share a number of commonalities in terms of objective, approach and desired outcome they have not to date been pulled together under one banner or label. However, an overarching term has started to emerge and that is the concept of Customer Tax Integrity which borrows from the guidance that has been issued by the DNB in the Netherlands. 

It increasingly acts as a 'wrapper' term for the various regimes, guidance and expectation being placed on Financial Institutions, stemming from their role as key intermediaries in the financial system, in terms of mitigating the risk of them engaging in or facilitating tax evasion or aggressive tax avoidance.

It is important for the banks to understand the key principles, their obligations and the nice-to-have practice towards the various regimes and regulations to assess how they are operationally impacted. The impact assessment should constitute a reliable basis to build an efficient operating model based on their exposure, the typology of their clients and the tax risk appetite of the organisations (e.g. no entry of relations with clients having corporate structure with offshore entities).

It implies to have lines of defence who have been trained and are aware of the strategy of the bank as well as equipped with the appropriate supporting documentation. The supporting documentation evidencing the controls to be performed should be adapted to the typology of the clients they may face. The controls performed at the onboarding of a Private Wealth Client should not be the same as the ones performed for Private Equity or Real Estate Clients. It is also true for the onboarding for the Professional of the Financial Sector that would act as counterpart for its underlying clients. 

As part of the onboarding, it is also important to leverage on the interactions of the different regulations by adopting a holistic approach in the review of the clients’ files. For instance, it is important to perform the reasonableness test of the FATCA/CRS status of a corporate client in light of publicly available information and the AML/KYC package shared.

Should there be any atypical elements and/or red flags, which would have been determined upfront as part of the tax governance, the first line of defence should escalate the file to have an enhanced review by the compliance team acting as second line of defence. On the other side, clients’ files presenting no atypical elements and in line with the risk appetite of the bank should be subject to simplified review.

The risk assessment of the client considering the tax aspects as well should determine the frequency of the update and review of the clients’ documentation. As part of the monitoring of the clients’ relationship, the change of circumstances should be closely identified (e.g. change of tax residency, atypical transactions etc…) and analysed.

For instance, if a bank identifies the use of a fake tax residency by one of its clients due to inconsistent documentation provided, it has an impact on the CRS report which is based on the tax residency but this also constitutes an indicia of tax fraud to be reported to the FIU and may also be considered as a cross-border reportable arrangement under DAC6.