Tax Evasion Through Multiple Residences Under the Common Reporting Standard: A Call for Enhanced Due Diligence

Shane Callaghan

Vol. 40 Associate Editor

Think only the richest people in the world can buy citizenship?  Think again.  For an investment of $100,000 plus various fees, you can become a citizen of the Caribbean country of Dominica in a matter of months.[1]  Although the practice of buying citizenship is largely confined to the rich, thousands of passports are bought and sold each year.  Hundreds of thousands of residence permits are also sold by countries each year.[2]  Although the modern practice of countries offering citizenship or residency by investment (“CRBI”) began with another Caribbean country, Saint Kitts and Nevis, in 1984, many countries have similar programs.[3]  CRBI is useful for both developed and developing countries alike because it stimulates foreign investment in a country.  This outside investment is particularly important to developing countries looking to “kick-start their economies.”[4] Although there are many legitimate reasons for someone to try to purchase citizenship or residence in a different country, countries are concerned that their citizens are motivated by hiding from taxes or criminal prosecution when they participate in another country’s CRBI program.[5]  In an effort to prevent taxpayers from hiding their assets, the Organisation for Economic Co-Operation and Development (OECD) developed the Common Reporting Standard (CRS) in 2014.[6]  The CRS provided a framework for the automatic exchange of information (AEOI) regarding bank accounts between the tax authorities of participating countries.[7]  The CRS was modeled after a similarly structured act in the United States called the Foreign Account Tax Compliance Act (FATCA), enacted in 2010.[8]  Currently 104 countries are signatories to the CRS.[9]  Some of these countries started reporting in 2017,[10] while other countries have committed to begin in 2018.[11] In implementing the CRS, the OECD is worried that CRBI programs enable individuals to avoid the reporting rules and, in the process, illegally reduce their tax burden.  More specifically, a tax evader could avoid having funds in a bank account in a participating country reported to his home country, where he should be taxed, by only claiming tax residence in his low-tax CBRI country.[12]  Under the CRS, when opening a new account, a financial institution must obtain a self-certification from the prospective account holder of their tax residence(s).  The financial institution only needs to confirm the reasonableness of the self-certification based on other information gathered in opening the account.[13]  After evaluating the information at hand, the financial institution may not rely on the self-certification if it knows or has reason to know that the self-certification is unreliable.[14]  Based on these requirements, the CRS only requires financial institutions to report tax avoidance when they come across it, as opposed to being obligated to actively searching for it.[15]  Therefore, it is important for the OECD and participating countries to regularly update financial institutions about what warning signs to look for based on current trends.[16] In October 2018, as many participating countries are still just beginning to report, the OECD has provided guidance to financial institutions related to tax evasion from multiple tax residence(s).[17]  Under this guidance, the OECD posted a list of CRBI programs it considers high risk to the CRS based on their low personal tax rates and minimal physical presence requirements.[18]  Equipped with this information, financial institutions are more likely to appropriately question a prospective account holder who only claims one of the listed, high risk countries as their tax residence.  If a financial institution doubts a prospective account holder’s self-certification, the OECD has also suggested asking follow-up questions, such as “[i]n which jurisdiction(s) have you filed personal income tax returns during the previous year?”[19] Countries participating in the CRS would benefit from requiring financial institutions to ask these types of questions when there is a red flag for tax evasion with a prospective account holder.  Because of the CRS’ reliance on self-reporting, it is hard for financial institutions to detect tax evasion.  Therefore, a strong reaction is required when a financial institution does identify a red flag.  This would require financial institutions to be more active in determining a prospective account holder’s true tax residence, like the United States requires with FATCA, but only in limited circumstances.[20]  Although the CRS also contains due diligence procedures for existing accounts, financial institutions are in a better position to gather information from an account holder while they are completing the necessary paperwork to open an account.[21] The clearest way to communicate the importance of questioning suspicious prospective account holders would be to officially incorporate a greater due diligence requirement into the CRS for new accounts.  By publishing a second edition of the standard in 2017, the OECD has already shown they are willing to update the CRS over time.[22]  Additionally, Pascal Saint-Amans, head of the OCED’s tax group, already supports “making banks ask tougher questions of anyone claiming to be a tax-resident in a haven.”[23]  Regardless, the OECD has not yet taken steps towards requiring banks to ask tougher questions.  Lastly, to lessen the burden of heighted due diligence requirements for financial institutions, the CRS could also adopt a de minimis exception to limit the scope of reporting requirements.  By excluding small value bank accounts from investigation, like the United States does with FATCA, this exclusion would help focus participating countries’ and financial institutions’ efforts on the taxpayers who actually utilize tax havens, the wealthy.[24]

[1] Kim Gittleson, Where is the Cheapest Place to Buy Citizenship?, BBC (June 4, 2014), https://www.bbc.com/news/business-27674135. [2] A Home in the Country, The Economist, Sept. 29, 2018, at 56. [3] For example, close to half of the EU’s member states have some form of investment residency or citizenship program.  Jon Henley, Citizenship for Sale: How Tycoons Can Go Shopping for a New Passport, The Guardian (June 2, 2018, 1:00 PM), https://www.theguardian.com/world/2018/jun/02/citizenship-by-investment-passport-super-rich-nationality. [4] Supra note 2 at 56. [5] Id. [6] Organisation for Economic Co-operation and Development (OECD), Standard for Automatic Exchange of Financial Account Information in Tax Matters 3 (2d ed. 2017) [hereinafter Common Reporting Standard]. [7] See Common Reporting Standard 910. [8] 26 U.S.C. §§ 1471–74. [9] Signatories of the Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information and Intended First Information Exchange Date, OECD (Oct. 29, 2018), https://www.oecd.org/tax/automatic-exchange/international-framework-for-the-crs/MCAA-Signatories.pdf. [10] CRS by Jurisdiction 2017, OECD, https://www.oecd.org/tax/automatic-exchange/crs-implementation-and-assistance/crs-by-jurisdiction/#d.en.345489. [11] CRS by Jurisdiction 2018, OECD, https://www.oecd.org/tax/automatic-exchange/crs-implementation-and-assistance/crs-by-jurisdiction/crs-by-jurisdiction-2018.htm. [12] A Home in the Country, The Economist, Sept. 29, 2018, at 56.  Passive income, such as interest, dividends, and royalties, are normally taxed at residence, whereas active income is taxed at in the taxing jurisdiction where it is produced.  E.g., Reuven S. Avi-Yonah, The Structure of International Taxation: A Proposal for Simplification, 74 Tex. L. Rev. 1301, 1306 (1996). [13] Common Reporting Standard, supra note 6, at 37 (Sec. IV(A)). [14] Common Reporting Standard, supra note 6, at 42 (Sec. VII(A)).  In determining whether a financial institution “knows,” a reasonable person standard is used.  Id. at 149 (Sec. VII, cmt. 3).  A financial institution needs to consider conflicting information on the prospective account holder’s self-certification and any other information provided to the financial institution that is inconsistent with the person’s claim.  Id. at 150 (Sec. VII, cmt. 4). [15] Common Reporting Standard, supra note 6, at 133 (Sec. IV, cmt. 23) (“Reporting Financial Institutions are not expected to carry out an independent legal analysis of relevant tax laws to confirm the reasonableness of a self-certification”).  See id. at 133–34 (Sec. IV, cmt. 25) (requiring “a reasonable explanation and documentation (as appropriate) supporting the reasonableness of the self-certification . . .” if a self-certification initially looks suspicious). [16] See, e.g., Sweet Deserts, The Economist, Sept. 29, 2018, at 58 (stating that many banks have incorrectly accepted a value-added tax registration number as proof that the account holder’s income taxation is controlled by the United Arab Emirates). [17] Residence/Citizenship by Investment Schemes, OECD (Oct. 22, 2018), http://www.oecd.org/tax/automatic-exchange/crs-implementation-and-assistance/residence-citizenship-by-investment/. [18] Id. [19] Other suggested questions include directly asking “Do you hold residence rights in any other jurisdictions?” or using a more indirect approach by asking “Have you spent more than 90 days in any other jurisdiction(s) during the previous year?” Id. (Frequently Asked Questions, What Should Financial Institutions Do?). [20] 26 U.S.C. § 1471(b)(1)(A) (“to obtain such information regarding each holder of each account maintained by such institution as necessary to determine which (if any) of such accounts are United States accounts”). [21] Common Reporting Standard, supra note 6, at 31–37 (Sec. III). [22] Common Reporting Standard, supra note 6, at 3. [23] Sweet Deserts, The Economist, Sept. 29, 2018, at 58. [24] The current exemption amount for accounts held by individuals under FATCA is $50,000.  26 U.S.C. § 1471(d)(1)(B)(ii). The views expressed in this post represent the views of the post’s author only.