Introduction

In our modern, globally connected world, it’s increasingly common for people to handle their wealth and investments across different countries. However, this international approach brings with it a greater demand for openness, especially concerning tax matters. International systems like FATCA (Foreign Account Tax Compliance Act) and the OECD’s Common Reporting Standard (CRS) have been created to make sure everyone fulfills their tax duties, regardless of where their assets are located. Whether your focus is on planning your estate or handling investments around the world, it’s vital to understand the CRS. This article will explain what the CRS is, why it’s important, and how it might affect your financial plans.

Understanding Due Diligence within the CRS Framework

Due diligence, in the context of the Common Reporting Standard (CRS), refers to the process that Financial Institutions must carry out. This process is essential for them to determine if any of the accounts they manage need to be reported under the CRS.

For CRS purposes, Financial Institutions are required to follow a specific set of steps. These steps are designed to help them figure out if an account holder is a tax resident in a different country. This identification process is crucial for determining which accounts must be reported to the relevant tax authority. The tax authority can then share this information with other countries as part of international agreements.

These due diligence procedures are critical for pinpointing accounts held by individuals who are residents in locations that exchange information under CRS agreements. These procedures are put in place to make sure that all necessary financial account details are reported correctly and shared in line with CRS rules.

Fundamental Aspects of CRS Due Diligence for Financial Institutions

AML/KYC (Anti-Money Laundering/Know Your Customer)

Anti-Money Laundering (AML) and Know Your Customer (KYC) procedures are essential elements of due diligence under the CRS framework. AML refers to a series of protocols, rules, and laws aimed at stopping the creation of income from unlawful actions. Conversely, KYC involves confirming the identity of clients and evaluating possible risks of illegal intentions within the financial system.

• Importance: AML/KYC verifications are crucial for ensuring that financial institutions are able to identify and prevent activities related to money laundering. By verifying the identity of individuals holding accounts and gaining an understanding of their financial dealings, these procedures assist institutions in preventing their systems from being exploited for illegal purposes. Regarding CRS, these checks are important for making sure institutions possess correct details about the tax residence of account holders.
• Implementation: Typically, institutions gather identification documents, such as passports or government-issued ID cards. They might also conduct checks against international watchlists. Furthermore, they evaluate the financial conduct of the customer, watching out for unusual or questionable transactions that could be signs of unlawful activities.

Account Type Identification

The next essential step in CRS due diligence is to identify the type of account. How an account is classified is significant because it determines the specific due diligence actions that must be taken. Accounts are generally categorized as individual, entity, or trust accounts. Each of these categories has its own specific reporting rules.

• Importance: Correctly classifying accounts is vital to ensure that the right CRS regulations are applied. For example, the due diligence steps for individual accounts are different from those for entity accounts. Incorrect classification could result in not following the rules or reporting information incorrectly, which could lead to penalties.
• Implementation: Financial institutions are required to assess the details of the account. This includes the information about the account holder and the nature of the account itself. A key part of CRS due diligence involves working out if an account is considered ‘pre-existing’ or ‘newly opened.’ This difference is important because it affects the due diligence actions needed. For CRS purposes, an account is pre-existing if it was set up before June 30, 2017. For FATCA rules, the date is before June 30, 2014. Furthermore, the due diligence needed also differs based on whether the account holder is an individual or an entity. When accounts are held by individuals, the due diligence process is further broken down based on the account’s value. Accounts with lower values, usually those below a certain limit, have simpler review steps. In contrast, High-Value Accounts need a more detailed and thorough review. This approach allows financial institutions to use their resources effectively, concentrating more on accounts that have a higher risk of not meeting the rules.

Determining Account Ownership

A key step in the CRS due diligence process is to determine who the account holder is. This means confirming who actually owns or controls the account and figuring out where they are considered a tax resident. This step is vital because CRS reporting rules are based on where the account holder pays their taxes.

• Importance: Correctly identifying the account holder is significant for financial institutions to meet their CRS reporting duties. Whether account details need to be reported to tax authorities depends on the account holder’s tax residency.
• Implementation: Typically, institutions will gather and check identity information like names, addresses, birthdates, and Tax Identification Numbers (TINs). For accounts held by entities, it’s also necessary to identify the people who control the entity, especially for entities that are considered passive non-financial entities (NFEs). In these cases, the tax residency of the people who control the entity is important.

Due Diligence Procedures for Personal Accounts

The specific due diligence requirements for personal accounts under CRS are further broken down depending on two main factors: whether the account existed before a particular date or was newly opened, and the account’s financial value.

Pre-existing Personal Accounts with Lower Balances

For personal accounts that were already established and are considered to have lower balances (typically those with balances under a set amount, often around USD 1 million), a simpler review process is used.

• Importance: This less complex approach to due diligence helps financial institutions manage their reporting responsibilities in an efficient way. It allows them to concentrate their efforts and resources on accounts that may represent a higher level of risk.
• Implementation: Institutions will examine the details they already possess for these accounts, such as KYC information gathered when the account was first opened. If the information on file is consistent and there are no indications that the account holder’s situation has changed, then no further action or reporting may be deemed necessary.

Pre-existing Personal Accounts with Higher Balances

Personal accounts holding higher values (generally, balances exceeding USD 1 million) are subject to a more detailed and comprehensive review.

• Importance: Given the increased potential risk associated with these higher-value accounts, a more in-depth review is essential. This ensures that all relevant details are accurately captured and correctly reported.
• Implementation: This process includes conducting electronic searches for additional information, manually reviewing any paper-based records, and possibly requesting further details directly from the account holder. Institutions might also need to check files maintained by relationship managers, especially if these files contain additional information that isn’t included in the standard electronic records.

Self-Certification for New Personal Accounts

When new personal accounts are opened, CRS mandates that the individual opening the account must provide a self-declaration confirming their tax residency status right from the start.

• Importance: Using self-confirmation is a proactive way to handle due diligence. It makes sure that the financial institution has correct and current information right from the beginning.
• Implementation: The person opening the account provides a declaration about their tax residency, usually by completing a standard form. The financial institution then needs to check this information to make sure it seems reasonable, based on the documents provided and what the institution already knows about the customer. This information is then stored and used to decide if the account needs to be reported under CRS regulations.

Due Diligence Procedures for Entity Accounts

Similar to personal accounts, the due diligence process for accounts held by organizations is also separated into those that were opened before a specific date (pre-existing) and those that are new. Each category has its own set of tailored procedures.

Pre-existing Entity Accounts

For organizational accounts that are already in place, the due diligence requirements depend on both the account balance and how the organization is classified.

• Importance: It is significant to correctly classify organizations as either financial institutions, active NFEs, or passive NFEs. This classification is essential for working out the CRS reporting responsibilities. Incorrect classification can lead to not following the rules or reporting information inaccurately.
• Implementation: Institutions are required to check their records to determine how the organization should be classified. If the organization is a passive NFE, it’s also necessary to identify and confirm the details of the individuals who control it. The institution also needs to assess if the organization’s classification, and the tax residencies of the controlling individuals, have changed since the account was first opened.

New Entity Accounts

For new organizational accounts being opened, financial institutions must get a self-certification from the organization at the time the account is set up.

• Importance: Getting correct self-certification from organizations is important to ensure that the financial institution can properly classify the organization. It also helps to identify any individuals in control who might need to be reported under CRS rules.
• Implementation: The organization provides a self-certification document. This document includes details about how it is classified and the tax residency of any individuals who control it. The institution then has to validate this information and keep it for CRS reporting purposes.

Due Diligence Procedures for Accounts in Trusts

Accounts held within trusts present unique complexities because of the various parties involved. These include the individuals who create the trust (settlors), those who manage it (trustees), and those who benefit from it (beneficiaries). Each of these parties may have different tax residency statuses, which makes the process of due diligence more complicated.

Individuals Setting up the Trust (Settlors)

The settlor of a trust is the person who establishes it and transfers assets into it.

• Importance: Identifying the settlor is very important because their tax residency might trigger reporting responsibilities under CRS. This depends on the specific rules of the jurisdiction and how the trust is structured.
• Implementation: The financial institution has to confirm the identity and tax residency of the settlor. It’s important to ensure this information is correctly recorded for CRS reporting.

Individuals or Entities Receiving Benefits (Beneficiaries)

Beneficiaries are the individuals or entities who are entitled to receive benefits from the trust.

• Importance: It’s essential for CRS compliance to identify the beneficiaries and determine their tax residency. This information is important in deciding whether the trust needs to report to tax authorities.
• Implementation: The institution must collect and verify details about all beneficiaries, including their tax residency and their connection to the trust. This process might involve reviewing the trust document itself and any other relevant legal papers.

Conclusion

The Common Reporting Standard plays a significant role in planning estates across countries. It makes sure that financial accounts are clear and that taxes are paid correctly, even when money crosses borders. Keeping up to date with what the CRS requires can help you avoid expensive errors and ensure that your assets are managed properly. If you need assistance understanding how the CRS affects your estate plan, Samoa Offshore Legal is here to help. Get in touch today!