This article is from Michael Blicker, a senior consultant in FICO's compliance solutions group.
You would think one system would be enough to manage foreign tax compliance. And, when all we had in place was FATCA* that was true. Now, with CRS** (Common Reporting Standard), some financial institutions are starting to think they need two systems.
Here’s where the trouble started.
In 2010 the IRS (Internal Revenue Service) started to define the details of FATCA (Foreign Account Tax Compliance Act). This process was completed in February 2014 with an agreement on a common reporting format between IRS and OECD (Organization for Economic Co-operation and Development), FATCA reporting Form 8966. At that time, OECD was already working on a global approach to exchange financial information in order to combat tax evasion – AEoI (Automatic Exchange of Information).
Unfortunately, OECD used the FATCA approach as an “inspiration” instead of as a blueprint. The more AEoI changed to simplify the process, the greater the difference grew between both initiatives.
As a result, financial institutions had to set up new processes, and most of the software vendors did not enhance their FATCA compliance solutions to cover the CRS reporting requirements. Life did not get easier. In some cases, the financial institutions had to search for a second solution because the existing FATCA solution was not extensible, even though the two topics are more or less linked together.
Same Goal, Different Rules for FATCA/CRS ComplianceThe differences between FATCA and CRS are numerous, and start with identification:
- For FATCA compliance you’re looking for a hint that the customer is a US person: one country, one search criterion “US” to be checked.
- For CRS compliance you need to match a customer with, at current count, one or more of 94 countries, and you may get multiple country hits for one customer.
Finally, reporting is an issue: In most of the countries, it is a straight-through process for FATCA because of the low amount of customers and the low importance for the financial institutions and competent authorities. CRS reporting is more of a regional topic (e.g., is the customer living and working cross-border). The competent authorities are much more interested in the CRS results than a reciprocal report from the IRS (which is not a Form 8966 report and contains much less information).
Two aspects are of interest: possible additional tax revenue from foreign accounts and additional information on the customers. In several countries, the Competent Authority requires additional information within the report. In addition, the financial institutions are facing technical issues due to the different reporting approaches (protocol, procedures and format), even though it is the same form 8966. To enhance the tax compliance challenge: FATCA and CRS differ in the required reporting content.
This is just scratching the tip of the iceberg, if you will. There are many more aspects to be considered.
Managing FATCA/CRS Regulations with One Tax Compliance & Reporting SystemIf you think you’ll need two systems to deal with this, think again. That approach will only lead to more cost and complication. The best practice is to cover both FATCA and CRS compliance requirements with one system.
Here’s how that works:
- Identification: The different criteria (recommended indicia, or indicators, as well as additional indicia and information to support the identification process) should be defined in a rule engine independent of any country. This means that you first define the search criteria and then you link the countries to this search (e.g., all CRS countries). Every customer only has to be checked once for both initiatives (to avoid different results from two different solutions).
- Verification: The big differences here are the classifications. FATCA has various classifications (also because of the tax withholding), CRS has a limited set of differentiators. This aspect can easily be handled by different workflows for possible CRS-relevant customers and customers with FATCA indicator hits. It’s also important to get a customer-centric view of all final results for both CRS and/or FATCA. A single customer can be a US-person with various tax residencies.
- Reporting: Form 8966 is a schema to be filled by the requested data – either for FATCA or for CRS. The reporting should therefore be kept flexible in three components: schema, data and template definition (e.g., for content) to bring all aspects together. This enables various reporting alternatives without inflexible programming. This approach can also consider different formats and protocols (e.g., report for every country or one report for all countries and split into packages; SFTP or individual communication procedures).
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*The Foreign Account Tax Compliance Act (FATCA) from 2010 enforces the requirements for all US Persons to report non-US financial accounts. The bi-lateral agreements between the IRS (Internal Revenue Service) and different countries (Intergovernmental Agreements/IGA Model 1 and Model 2) delegate the research of such accounts to the national financial institutions in the participating countries. Recalcitrant institutions will be punished with a 30% penalty on all US investments of their customers and the institution itself. Reporting started in 2015.
**Common Reporting Standard (CRS) is the definition to identify the tax residency of the customers of financial institutions based on the AEoI (Automatic Exchange of Information) initiative of the OECD (the legal aspects are defined in “Competent Authority Agreements”/CAA). The approach is based on bi-lateral agreements between two countries. To launch this initiative in 2014, a multi-national agreement was signed by 51 early adopters. Another 43 countries have also signed this agreement since then.