A new wave of global tax compliance regulation is a game changer in the way asset owners and investment management companies report activities.
Globalization of financial markets has made it increasingly simple to make, hold and manage investments outside an asset owner's own tax domicile. A standard on automatic exchange of information will significantly increase international tax co-operation with the aim of helping governments curb the loss of tax revenues. While the impact will be felt more heavily by investment managers, banks and insurance companies, the variation and evolution of regulation across international jurisdictions might also impact pension funds and other asset owners.
In the U.S., the Foreign Account Tax Compliance Act, which took effect for financial institutional reporting this year, was designed to tackle undeclared taxes from U.S. citizens with foreign investments. From an implementation perspective FATCA presented significant challenges for financial institutions.
With so much focus on FATCA, a new global regulatory regime designed to enforce tax compliance and developed by the Organization for Economic Co-operation and Development might have crept up unnoticed on many asset owners, investment management firms and custodial banks. While this new standard can trace its origins to FATCA, even sometimes being referred to in the finance industry as “global FATCA,” the OECD common reporting standard and FATCA are completely independent of each other.
Although pension funds and some other asset owners typically don't pay taxes in their domiciled jurisdictions, they face a new, complex array of global compliance reporting beyond the FATCA requirements of the IRS affecting U.S.-based institutional investors.
With vast amounts of investments managed through institutions outside the domicile of asset owners, the new OECD common reporting standard of automatic exchange of information, like FATCA, is designed to combat tax evasion and protect the integrity of tax systems.
The new common reporting standard involves the systematic and periodic transmission of “bulk” taxpayer information by the source country to the residence country. The information includes various categories of income, including interest and dividends as well as account balance and selling proceeds from financial assets and tax residency. Through the reporting, countries hosting investment activity can transmit investor details to domicile countries, indicating any neglect to comply with taxation.
For pension fund and other asset owners as well as investment management companies, due diligence is required in particular when investing across jurisdictions. In practical terms, investment managers and asset owners will need to disclose their tax residency, and the financial institutions with which they deal will need to collect, validate and report this information to local tax authorities that, in turn, will then automatically exchange this information with other tax authorities, as affected, around the globe. Failure to comply will invariably result in action by tax authorities against the asset owners and the potential of hefty fines for financial institutions.
For financial institutions, ever more robust management and ongoing updating of client data for all firms is essential, and it is more important than ever to be supported by technology that enables them to efficiently manage the resulting cost of compliance. While the impact will be felt more heavily by investment managers, banks and insurance companies, the variation and evolution of regulation across international jurisdictions might also impact pension funds and other asset owners.
A common misconception is that the common reporting standard is an extension of FATCA, but this is not the case. Scratch beneath the surface of the common reporting standard and it quickly becomes clear that its scope and requirements might present some significant challenges. While the automatic exchange of information standard has no direct legal power, jurisdictions globally are using it as a foundation to construct their own local regulations. Unlike FATCA, which is a single piece of regulation, the automatic exchange of information standard has variations in the underlying regulations across jurisdictions. As a result, the devil will be in the details for asset owners and money management firms.
Built on previous regulations for sharing tax data, more than 90 jurisdictions have so far committed to implement the common reporting standard, with more likely to follow. Reporting in 58 jurisdictions starts in March 2017 and the remaining jurisdictions start a year later. The early reporters include the U.K., France, Germany, India, Ireland, South Africa, Spain, Bermuda, British Virgin Islands and Cayman Islands.
However, don't fall into the trap of thinking that means you have plenty of time. For the early adopter jurisdictions, due diligence procedures need to be in place by the end of 2015. A notable exception to this list is the U.S., which so far has not signed up to the common reporting standard, most likely because FATCA should address the issue from a U.S. perspective. Opinion is divided, but many industry commentators believe the U.S., as an important OECD member country, will eventually join the common reporting standard to support reciprocity.
When you understand the scope of the common reporting standard, you begin to realize that, in many ways, it is no joke that FATCA was indeed just the warmup act. The common reporting standard has arrived at a time when financial institutions already face a range of significant economic and regulatory challenges, testing many financial institutions' capability and capacity to deliver. Financial institutions must have robust, automated, flexible, cost-effective control regimes in place to meet new global compliance requirements.
The common reporting standard"s reach extends to possibly requiring some underlying individuals, who ultimately exercise control over an entity, to provide passports and personal tax documentation to financial institutions as part of their compliance with the global common reporting standard.
Many aspects of the common reporting standard have key differences to FATCA. So it comes as little surprise that the common reporting standard will require at least 20 times the administrative work of FATCA. There is no doubting the common reporting standard has significantly increased the scope and complexity of compliance.
A question investment managers and asset owners should ask themselves is how to provide resources to comply with the short- and longer-term requirements. Compliance will come at a cost, but failure to comply would be more costly. n
Jon Wood is London-based vice president, financial market solutions, Genpact Ltd.
This article originally appeared in the September 21, 2015 print issue as, "New global tax crackdown could impact asset owners".