OUR INSIGHTS AT A GLANCE
- On 20 February 2020, a draft law was presented to Parliament which introduces some amendments to the Luxembourg legislation governing CRS ("Common Reporting Standards") and FATCA ("Foreign Account Tax Compliance Act"), the two sets of rules dealing with the Automatic Exchange of Information in Luxembourg
- The changes to be introduced with effect as from next year are of importance since Luxembourg reporting financial institutions will be subject to additional obligations and lump sum penalties in case of non-compliance
- The draft law aims to rectify some elements in respect of which the "Global Forum on Transparency and Exchange of Information for Tax Purposes" considered that the Luxembourg legislation was not compliant with the CRS norms
- The automatic exchange of information is more than ever at the heart of the concerns of regulators in most developed countries. It can be anticipated that the tax authorities will be uncompromising in respect to the compliance with the rule and will henceforth have a scale of penalties at their disposal that they will apply rigorously if the market players do not meet the expected level of compliance
In our November 2019 ATOZ blog (Upcoming FATCA - CRS Issues: What the Alternative Fund Industry Needs to Know), we noted that the Luxembourg tax authorities more frequently controlled the correct application of the FATCA (Foreign Account Tax Compliance Act) and CRS (Common Reporting Standards) rules and financially sanctioned proven breaches with increasingly dissuasive fines, whether for delays or for absence of FATCA and CRS reporting (including «zero-reports» under FATCA). More recently, for some service providers, we also witnessed controls on the related documentation and processes implemented by financial institutions in this respect. Thus, it appears that the tax authorities (Administration des Contributions Directes) request all FATCA - CRS procedures from institutions, as well as the self-certification documentation collected from their clients and counterparties.
In our aforementioned previous blog, we insisted on the fact that compliance with these rules is, both from a reputational and a financial point of view, a major issue for the financial sector, especially for the alternative investment fund sector. We also noted with regret that, despite the years that have elapsed since the implementation of these rules, today they still present some technical or educational challenges for clients and their investors.
The introduced changes
On 20 February 2020, the Luxembourg Government proposed a draft law amending the FATCA and CRS rules as from 1 January 2021. Even though it is still draft legislation at this stage, it seems appropriate to us to take stock of the "changes" introduced in order to analyse the current trends and "state of mind" of the tax authorities that this draft law reflects in terms of exchange of information.
The changes resulting from this draft law can be summarised as follows:
- Even in the absence of reportable accounts, a CRS report must be filed
- The necessary documentation must be kept during a time period of 10 years
- The amounts of lump sum penalties applicable in case of absence of reports are specified
- The powers of control of the tax authorities and the type of documents required are specified
It appears that the real changes resulting from the draft law are only few, apart from the obligation to file zero CRS reports. Still, since 2019, the tax authorities already require financial institutions to produce such reports. The other amendments provide some details, not on the new obligations applicable to financial institutions, but on the administrative practice in terms of control and on the applicable penalties.
What do these changes tell us about the current environment?
The explanatory statement of the draft law provides useful elements to understand the state of mind of the tax authorities. It states that the draft law aims to rectify some elements in respect of which the "Global Forum on Transparency and Exchange of Information for Tax Purposes" considered that the Luxembourg legislation was not compliant with the CRS norms.
Therefore, the pressure comes from the OECD and this draft law confirms how seriously the authorities consider the assessment of their legislative framework by third parties. It also confirms that the effectiveness of the exchange of information constitutes an objective criterion of assessment of Luxembourg.
The fact that the Luxembourg authorities provide themselves a legislative framework for some provisions / penalties that could have been enacted through a circular is extremely questionable. Obviously, should the draft law be adopted in its current form, the tax authorities will not be able to ignore their commitment and it will be necessary to carry out the controls set out.
One should also keep in mind that these controls have already started and apply to a scope which is much broader than the only reporting, as they apply to the whole "production" chain, starting from the documentation collected from clients. It becomes crucial for the industries affected by those rules to determine the concrete actions to be taken in order to anticipate the strengthening of controls.
Actions to be taken
Most umbrella funds of alternative investment funds are financial institutions within the meaning of FATCA and CRS. The General Partner of funds and the funds themselves are subject to all requirements imposed by these laws, in terms of both reporting (i.e. all the mechanisms used to transmit information to the foreign authorities adhering to the automatic exchange of information) and "due diligence" (i.e. all the documents and information collected by financial institutions on investors and used for the exchange of information).
As mentioned in our previous blog, the collection of self-certification documents by managers is turning out to be difficult and is, still today, often incomplete. The reasons for these difficulties are well-known and stem essentially from the limited knowledge of these regulations and from the fact that some financial institutions do not perform any consistency checks.
As the review/control of these documents becomes absolutely certain in the end, it is necessary to strengthen the documentation procedures at the level of the financial institutions.
What is often perceived as a mere KYC-like collection of documentation turns out to be, in reality, a complete tax analysis that can only be carried out by automatic exchange of information specialists. Since the draft law is expected to come into force in January 2021, 2020 will have to be devoted to the complete review of documents and procedures in anticipation of future controls.
It is crucial that financial institutions meet their due diligence obligations, but also implement the necessary procedures and secure the production of FATCA and CRS reports. Ultimately, all the participants involved in the back, middle and front office functions of these entities must be aware of the existence of these procedures and apply them at their level.
FATCA and CRS reports are indirectly the result of the collection of information during the due diligence process. The accuracy of reports therefore depends on the quality of the information collected, but also on the effective monitoring of information on payment flows to investors. If the documentation is properly collected and the flows are accurately identified, the production of FATCA and CRS reports will become "trivial".
In view of the accumulation of compliance obligations for traditional investment structures, the real challenge is of course to comply with these multiple obligations, while ensuring that the teams in charge in the field can continue to fulfil their other related responsibilities. This is possible, but only as part of a consistent strategy that is recognised as such by all stakeholders.
A typical alternative investment fund structure involves many entities: one or more General Partner(s), one or more fund(s), intermediary holding companies and investment vehicles. It is necessary for management teams to have mapped all the vehicles of their group as well as the reporting obligations of each of these vehicles. This exercise implies the implementation of procedures at the level of the group of financial institutions. These procedures become essential to organise the issue but also as a means of proof to be transmitted to the tax authorities.
Our experience has shown us that managers have registered entities with the IRS (Internal Revenue Service), de facto qualifying these entities as reporting financial institutions. In the event of failure to produce FATCA and CRS reports, these entities may be subject to fines of up to a lump sum of ten thousand euros per missing report. With such a financial challenge, the mapping exercise becomes crucial for the groups concerned.
Holding companies and target companies set up by alternative investment funds are financial institutions by default. However, they may qualify as non-financial entities if certain conditions are met. In this case, for these entities, the draft law does not introduce any change with regard to their current "obligations" and practices.
What adjustments should be made as priority?
The automatic exchange of information is more than ever at the heart of the concerns of regulators in most developed countries. The tax authorities' reactivity to respond to the OECD pressure in this matter is enlightening.
We consider that it is important to understand the implicit message in the draft law of 20 February. The tax authorities will be uncompromising in respect to the compliance with the rule and will henceforth have a scale of penalties at their disposal that they will apply rigorously if the market players do not meet the expected level of compliance.
In addition, a targeted investment in the consistency and quality of the procedures implemented will not only ensure that an appropriate response to the tax authorities' controls can be delivered, but will also enable the teams in charge to carry out their multiple missions in the most efficient way, without having to do things as they come along in a constantly changing environment.
Originally published April 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.