FATCA/CRS status quo - Business as usual or still an operational challenge?

Even after almost a decade since the implementation of these regulations, it seems that FATCA and CRS have still not become business as usual especially in the asset management industry where many administrative processes are decentralised and outsourced across several jurisdictions and service providers, each having different procedures and IT systems.   

From an operational perspective, while the filing of the report itself should in principle be relatively straightforward, the path to go there could be quite challenging from understanding which products or entities are in scope to the determination of the reportable population, the maintenance of accurate data over the time of the commercial relationship, as well as to the difficulty to obtain the accurate financial data on time. Therefore, it is rare in practice that the reporting process is as smooth and painless as a simple "press the button” on a reporting software.  

The first step in the reporting value chain is to determine which products should be reported. This is often straightforward for commonly marketed financial products (bank accounts, life insurance policy, shares in regulated funds) but the analysis may be more challenging for complex or structured products (alternative investment funds, derivatives, warrants, capitalisation instruments) which require ad hoc tax analysis with rules that may be interpreted differently depending on the jurisdiction in scope.

Once the FI knows “what” should be reported, the difficulty grows with the determination of the “who”. This results from the fact that the review of the FATCA/CRS documentation provided by the client/investor is often allocated to AML/KYC teams (internally or externally), whereas these persons are not tax experts and have not been sufficiently trained to assess whether the provided documentation is in line with the applicable FATCA/CRS regulations. Indeed, in many cases, this process is viewed as a mere “check-the-box" while the FATCA/CRS laws require that a comprehensive plausibility check is performed, by comparing the information contained on those tax forms with the ones included in the AML/KYC file of the client or that are publicly available. In addition, it is also important to understand the rules behind those tax regulations to also ensure that the tax classification of the client is in line with its AML/KYC profile and to keep in mind that this review may also impact other tax processes (DAC 6, US withholding tax, ATAD 2, some investor tax reporting to name a few).

The second difficulty lies on when an FI needs to renew that documentation. Indeed, the forms are supposed to be valid indefinitely until a change of circumstances occurs. On one hand, the client/investor is supposed to pro-actively update the FI but on the other hand, the latter still has the obligations to put in place processes to detect those changes and to ask for a new documentation within 90 days in such a case. KYC officers and client/investor relationship managers do not always have clear guidance on what could qualify as a change of circumstances, leading to indicia or KYC documented changes not properly assessed from a FATCA/CRS perspective.

On the pure reporting aspects, there are often different accounting and KYC systems involved, depending on the investment strategy of the asset managers or their service providers or reliance on some legacy systems for banks and insurers that grew externally. Manual workarounds are thus often required that result in an increased risk of data quality. For example, the same client/investor is identified differently, and some changes of circumstances are taken into consideration in one system but not in the other. The value of the financial accounts reported may not as well match other types of tax reporting (e.g., K-1 or partnership tax returns) as final audited data may not be available at the time of the reporting deadline or not extracted from a system (especially for holding companies). In addition to the quality impact of the reporting, this also creates frustration at the level of the client/investor.

The Luxembourg tax authorities (Administration des Contributions Directes, “ACD”) are aware of those operational constraints and of the difference of quality of the FIs and service providers involved in that process. The ACD put in place a specific department to deal with those regulations and (as their foreign counterparts) are now very effective at detecting missing reports and prompt to issue late filing penalties. At the same time, their controls that were initially only covering the reception of a report became more focused on the quality of the information exchanged and its consistency over time. 

There is a general trend at the level of tax authorities around the globe towards increased information requests and more granular controls. The OECD is also demanding tax authorities to conduct more audits and to focus their controls on what could be perceived as CRS avoidance mechanisms or loopholes. In that respect, the governance around client/investor tax onboarding is a key point of attention. On-site visits are currently being carried out in Luxembourg for the period 2020-2022 but also in other countries such as Ireland and Germany. In addition, countries like Cayman Islands, British Virgin Islands, the United Arab Emirates, Guernsey, and Bermuda collect additional information (regarding governance and reconciliation) from FIs in the form of a CRS Compliance Form. 

In general, FIs subject to an on-site review are selected based on the results of a risk assessment and/or randomly and need to provide a list of documents (including written policies and procedures, training plans, etc.) within a few weeks, prior to the on-site visit. The deadline of a few weeks to provide the requested documentation might be too short if such documentation does not exist yet or is not easily accessible from a central database. The on-site inspections include, among other things, a review of a sample of clients/investors, interviews with relevant employees as well as a review of the policies, procedures, controls and IT systems in place to ensure compliance with on-boarding, due diligence and reporting obligations.  At the same time, regulators in Luxembourg and abroad (e.g., in France and in the Netherlands) also show more and more interest and include questions related to FATCA/CRS compliance in their annual AML/CFT questionnaires.

In Luxembourg, one of the main gaps identified by the tax authorities is with respect to the so-called “Register of Actions” as introduced by the FATCA/CRS law of 18 June 2020. The ACD verifies how the controls of the documentation are documented, e.g., whether there are any check lists or automatic controls in place and whether there is a reconciliation of the reporting with the FATCA/CRS documentation of account holders, the full investor register/population of clients as well as the previous years’ reporting. 

Apart from the “Register of Actions”, the tax authorities are also increasingly challenging the FATCA/CRS classification of entities, i.e., whether the FATCA and CRS status of each entity is properly documented and communicated to financial counterparts. 

At this stage, to our knowledge, the tax authorities have not issued any official finding letters or penalties yet. However, they have already verbally asked FIs to amend their reports. In addition, based on the outcome of the FATCA/CRS audits, the Luxembourg tax authorities might update their FATCA/CRS guidance as well.

The use of technology and AI and the implementation of DAC 8/the amendments to the CRS will enable tax authorities all over the world to perform more automated and granular controls and to identify any gaps very quickly. At the same time, we also see a trend at the level of tax authorities to rely more and more on independent reviewers (as it is required already under the QI Regime) to conduct compliance reviews.

The increasing controls from tax authorities worldwide show that these topics are high on their agenda. For most market participants, FATCA and CRS have not become business as usual yet due to lack of tax expertise, dedicated technology and governance. Therefore, it is key to onboard experts and/or train people accordingly. In addition, data management workflows need to be streamlined, and processes and systems centralised. These investments are necessary for FATCA and CRS to smoothen the reporting value chain and to limit the potential risk in terms of financial penalties and relationship with clients/investors, tax authorities and regulators.