Customer Tax Integrity - Latest trends
Introduction
In our 2023 summer edition of Keeping up with Tax Banking & Capital Markets, we spoke about ‘Customer Tax Integrity – Insight on the key principles and best practice markets'1.
We highlighted the fact that Financial Institutions (FIs) face an increasing number of regimes, rules, and expectations from various stakeholders to identity risks of tax evasion and aggressive tax avoidance among their customers.
This issue is particularly relevant to banks due to their regulatory, tax and social responsibilities as intermediaries and gatekeepers in the financial system. One could say that banks have become the ancillaries of the tax authorities as they constitute golden data providers in the context of the automatic exchange of information. The various updates of the Directive on Administrative Cooperation (DAC) over the past decade as well as the increasing number of controls and audit by the tax authorities and regulators have the same purpose: More tax transparency to fight tax evasion and aggressive tax planning.
The purpose of this article is to provide you with the latest trends and practical feedback based on the challenges faced by banks to comply with those tax transparency and customer tax integrity requirements.
Latest updates on Administrative Cooperation (DAC)
The European Commission recently launched an open publication and call for evidence until 30 July in the context of an evaluation of the Directive on Administrative Cooperation (DAC) in the field of direct taxation.
The present evaluation will cover the years 2018 to 2022 and does not cover DAC7 and DAC8 evaluation. The Commission will submit a report on the application of DAC to the European Parliament and to the Council.
A first evaluation of the directive was based on a study published in 2019. The conclusions were positive and stating that the directive significantly improved the transparency of tax information and the level of cooperation between EU Member States. This led to positively impact the revenue collection for Member States by improving the detection and emerging tax avoidance strategies (whose identification has been reinforced by DAC6 regulation).
In the report, the Commission identified implementation challenges since some Member States struggled with timely and accurate exchanges of information due to differences in administrative capacity and technical infrastructures. In addition, the quality of the data exchanged by FIs was in some cases relatively low due to their system infrastructure or outdated files and information.
The above challenges could explain why some countries have implemented (like Luxembourg) local governance law requiring their financial institutions to establish a compliance programme including written policies and procedures, systems and controls, detailing how due diligence and reporting obligations are in practice dealt with and documented (including oversight of the delegated functions).
We also witness more and more on-site visits and audits performed by the regulators and tax authorities notably in the field of the tax transparency regulations. The latter invested to build up their workforce and system resources to efficiently deal with the volume of reports filed, allowing them to track faster late submissions and carry out in-depth reviews of data quality of the reports by performing various reconciliations.
On 25 June, the Luxembourg Ministry of Finance announced that Luxembourg's two main tax administrations, the Administration des Contributions Directes (ACD) and the Administration de l'Enregistrement, des Domaines et de la TVA (AED), had agreed to share more data and implement joint controls under the Memorandum. This will be achieved in various ways, such as through the compulsory spontaneous exchange of information above certain thresholds of turnover and deductible expenses. In addition, tax offices will now be able to take part in simultaneous audits (still coordinated centrally), alongside the service des révisions (ACD) and the service anti-fraude (AED). Indeed, there are more and more checks on FATCA and CRS compliance by the tax authorities based on the reporting data. For instance, Luxembourg tax authorities now send automatic queries to FIs in case of missing or inconsistent CRS reports, e.g. filing of a CRS report for the year N-1 year that are not reported any more for the year N.
FIs must answer requests and must support their position by providing supporting documentation, e.g., detailed analysis in case of FATCA/CRS reclassification, structure chart, shareholders’ register.
Another concrete example of controls, the US tax authorities, i.e., the Internal Revenue Service (IRS), notified the Luxembourg Tax Authorities for each report containing missing or invalid US Tax Identification Numbers (TINs) who then liaised with the concerned financial institutions to take appropriate actions to remediate those situations.
This action, launched by the US tax authorities, could be performed in the future by other tax authorities participating in CRS if they estimate that the data received is incomplete or missing, notably the tax identification number of the customer since this reference constitutes the unique key to link the data exchanged in the context of CRS by the Financial Institutions and the tax returns filed by customers.
It is an important challenge for banks and other FIs to obtain missing or up-to-date information for old and inactive accounts.
Referring to the update corner of our previous edition2, FIs are now required to notify the natural persons that are subject to the CRS reporting (i.e., direct investors and Controlling Persons of corporate investors qualifying as Passive NFEs) regarding the information that will be subject to the exchange of information.
Such notification needs to be sent at least one month prior to the filing of the CRS report and must include the personal information that will be exchanged. It has been a challenge for some financial institutions to send letters in due time which can be explained by the volumes of data and the review required further to the data extraction to ensure consistency with e client’s files and the previous CRS reports filed with the tax authorities.
Based on our recent experience, we have seen that a minority of clients have reacted to the notification letters. Most of the time to indicate a change of address, often in the same country than the previous address which then does not significantly impact the reporting, or to inform about a change in the ownership structure which impacts the controlling persons to be reported.
Some of the FIs, in the context of the amended CRS Law further to the DAC7 requirements, have used the momentum to send notification letters to clients to comply with this new requirement and also urged clients to provide new documentation and information to regularise their situations.
Cornerstone of customer tax integrity
Referring to our previous article3, it is important to understand tax transparency elements of a client constitutes key pillars of client tax integrity as part of the overall risk assessment. For instance, it can be reassuring that the bank account is recognised by the tax authorities in the client’s country of tax residence through the CRS reporting mechanism.
On the contrary, 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 Financial Intelligence Unit (FIU) and may also be considered as a cross-border reportable arrangement under DAC6.
For corporate investors, it is required 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. Unjustified Active Non-Financial Foreign Entity Active NFFE) status could be used in order to dissimulate and avoid the CRS reporting of the Ultimate Beneficial Owners. This mechanism constitutes a cross-border reportable arrangement under DAC6 considering the category D hallmark as well as an indicator of tax fraud explicitly mentioned in the Circular 17/650 of the Commission de Surveillance du Secteur Finance (“CFSS”).
The FIU issued its Activity Report which covers the years 2021 and 2022 in which we can find some interesting statistics which prove the increasing number of Suspicious Activity Report (SAR) and Suspicious Transaction Report (STR) over the last three years.
The categories of reported primary offences that have significantly increased are fraud and tax criminal offence which constitute the top 3 categories reported with the “Other category” in case no sufficient information is available to allocate the report into a specific category.
It clearly proves where the areas of risks are for banks and the other professionals of the financial sector with respect to customer tax integrity at onboarding and during the client’s relationship.
Nevertheless, Professionals of the Financial Sector (PSF) should not issue SAR or STR as early as the first indicator of laundering of a primary offence is encountered but must carry out an analysis on the legitimacy of the client’s situation based on KYC before declaring any suspicion.
It is particularly important to understand the background of the client by notably considering its sector. For instance, what is considered as a complex structure for the benefit of a dedicated High-Net Worth Individual (HNWI) may not be seen as complex for standard investment structures in the Alternative Fund Industry with various Limited partners.
With respect to the fund industry, the 20/744 CSSF Circular provides tax fraud indicators in the context of collective investment entities that should be taken into consideration by professionals of the financial sector in light of other tax integrity pillars.
This assessment should notably cover some characteristics of investor base as well as the rationale and complexity of the structure down the chain including intermediary layers between funds and the portfolio company.
The 20/744 CSSF Circular also targets structures or actors that could use portfolio management techniques to create tax arbitrage or tax refund which could constitute aggravated tax fraud.
It notably includes securities lending transactions between two stakeholders that would take place for instance before a dividend distribution to benefit from a reduced withholding tax rate since the temporary holder benefits from a double tax treaty that the beneficial owner would not be entitled to.
In the Tax Reclaim area, the relief at source with the FASTER Directive (please refer to our previous edition) should enable mitigation of those specific risks in the future. On 14 May 2024, the EU Ministers of Finance reached a political agreement on the FASTER Directive. The formal adoption will take place after the European Parliament has adopted its second opinion.
The Directive has changed from the original June 2023 proposal, reflecting various amendments made during the interinstitutional negotiations. The reporting obligations and liability for Certified Financial Intermediaries remain, but additional criteria for exemption have been introduced, as the flexibility to register at group level or individually.
The date from which the FASTER provisions apply has been pushed back from 1 January 2027 to 1 January 2030. Member States must adopt the provisions by 31 December 2028.
Next steps
Our subject-matter experts are available to discuss the above updates in more detail and help you implement appropriate actions. Our expert team can assist you with:
- Setting-up your tax governance function
- Performing a one-off onboarding health check which covers the following modules:
- Drafting or reviewing procedures and the control matrix
- Performing due diligence review of a sample of clients/investors
- Reviewing the annual FATCA and CRS reporting
- Performing continuous operational tax assistance:
- Organisation of basic and/or advanced training
- Tax hotline services
- Tax watch services
- Identification of tax reclaim opportunities.
Contact us
Murielle Filipucci
Tax Partner, Global Banking & Capital Markets Tax Leader, PwC Luxembourg
Tel: +352 62133 31 18
Nenad Ilic
Tax Partner, Banking & Capital Markets Tax Leader, PwC Luxembourg
Tel: +352 62133 24 70
