Common Reporting Standards – a practical review. (CRS)

>A. INTRODUCTION

The Common Reporting Standard (CRS) has been initiated
by the Organization for Economic Cooperation and Development (OECD) aiming at
improving international tax compliance and preventing tax evasion, through the
automatic exchange of information between the countries that implement CRS. The
participating countries are listed in Appendix I.

Although the CRS
was largely based on the FATCA Model 1 IGA, there are many differences between
the two reporting regimes. Please refer to Appendix II.

The CRS is applied by all authorized credit institutions and other financial institutions, which are
located in countries that participate in the CRS, and applies to all account (individuals
and entities). It requires the financial institutions that are in countries
which implement the CRS, to submit information on financial accounts that are
held by account holders who are tax residents of countries which implement CRS.

B. THE PRACTICE

For the purpose of identifying tax residence, the
financial institutions are required to obtain from the direct and indirect
account holders, self-certifications which include the country of tax residence
and tax identification number(s) as well as the Entity’s classification, if the
account holder is an Entity.

If the information collected by
the financial institutions indicates that the account holder (individual or Entity)
is resident in a reportable jurisdiction, the reporting financial institution
must treat the account as a reportable account and information will be shared
with the country in which the individual or Entity is a tax resident. In some
cases, depending on the classification given to the Entity, the standard
requires to look through the Entity and report on the individuals that
ultimately control the Entity (controlling persons). This is explained in more
detail in section C of this report.

Without the self-certification,
the financial institution cannot open any new account and in the case of
pre-existing accounts, if no self-certification is provided the financial
institutions are obliged to consider the account holders as reportable persons.
As a consequence, financial institutions will report to the Tax Department the
information they already have for the undocumented accounts and The Tax
Department will in turn forward the information to the foreign tax authorities.

The first reporting in Cyprus will
occur in 2017 and will cover the year 2016.

C. ENTITY CLASSIFICATION

The CRS provides a wide definition of the term “Entity”
which includes all types of corporate vehicles, trusts, partnerships and other
similar structures.

All Entities need to be classified under CRS and
this classification will determine whether the controlling persons of the Entity
would have to be identified and reporter or not. The first classification that
needs to be made is whether the Entity is a Financial Institution (FI) or a Non-Financial
Entity (NFE).

Financial Institutions (FI)

The term Financial Institution means a Custodial
Institution, a Depository Institution, an Investment Entity, or a Specified
Insurance Company.

Custodial
Institution means any Entity that holds, as a
substantial portion of its business, Financial Assets for the account of
others. An Entity holds Financial Assets for the account of others as a
substantial portion of its business if the Entity’s gross income attributable
to the holding of Financial Assets and related financial services equals or
exceeds 20% of the Entity’s gross income during the shorter of:

the three-year
period that ends on 31 December (or the final day of a non-calendar year
accounting period) prior to the year in which the determination is being made;
or

the period during
which the Entity has been in existence.

Depository
Institution means any Entity that accepts
deposits in the ordinary course of a banking or similar business.

Investment Entity means any Entity:

a) That primarily conducts as a business one or more
of the following activities or operations for or on behalf of a customer:

i) trading in money market
instruments (cheques, bills, certificates of deposit, derivatives, etc.);
foreign exchange; exchange, interest rate and index instruments; transferable
securities; or commodity futures trading;

ii) individual and collective portfolio management; or

iii) otherwise investing,
administering, or managing Financial Assets or money on behalf of other
persons; or

b) The gross income of which is primarily attributable
to investing, reinvesting, or trading in Financial Assets, if the Entity is
managed by another Entity that is a Depository Institution, a Custodial
Institution, a Specified Insurance Company, or an Investment Entity.

Non-Financial
Institutions (NFE)

Entities
that do not fit any of the FI definitions are likely to be either Active
Non-Financial Entities (Active NFE)
or Passive Non-Financial Entities (Passive
NFE).

For
Active NFEs the reporting will be done in the jurisdiction where the Entity
is a tax resident, while for Passive NFEs there is a requirement to look
through the Entity so that the reporting will be done in the jurisdiction where
the controlling person is a tax resident.

The Controlling Persons of an Entity are the
natural persons (that means people, rather than organisations) who have control
over your Entity. An Entity may have several Controlling Persons. Generally,
the person who has control over an Entity is the one who has a controlling
ownership interest. Typically, this means that they own a certain percentage,
for example, 25% of the Entity.

An Entity will be classified as Active NFE if it meets any of the
following criteria:

a) less than 50% of the NFE’s
gross income for the preceding calendar year or other appropriate reporting
period is passive income[*]
and less than 50% of the assets held by the NFE during the preceding calendar
year or other appropriate reporting period are assets that produce or are held
for the production of passive income;

b) the stock of the NFE is
regularly traded on an established securities market or the NFE is a Related Entity
of an Entity the stock of which is regularly traded on an established
securities market;

c) the NFE is a Governmental Entity,
an International Organisation, a Central Bank, or an Entity wholly owned by one
or more of the foregoing;

d) substantially all of the
activities of the NFE consist of holding (in whole or in part) the outstanding
stock of, or providing financing and services to, one or more subsidiaries that
engage in trades or businesses other than the business of a Financial
Institution, except that an Entity does not qualify for this status if the Entity
functions (or holds itself out) as an investment fund, such as a private equity
fund, venture capital fund, leveraged buyout fund, or any investment vehicle
whose purpose is to acquire or fund companies and then hold interests in those
companies as capital assets for investment purposes;

e) the NFE is not yet operating a
business and has no prior operating history, (a “start-up NFE”) but is investing
capital into assets with the intent to operate a business other than that of a
Financial Institution, provided that the NFE does not qualify for this
exception after the date that is 24 months after the date of the initial
organisation of the NFE;

f) the NFE was not a Financial
Institution in the past five years, and is in the process of liquidating its
assets or is reorganising with the intent to continue or recommence operations
in a business other than that of a Financial Institution;

g) the NFE primarily engages in
financing and hedging transactions with, or for, Related Entities that are not
Financial Institutions, and does not provide financing or hedging services to
any Entity that is not a Related Entity, provided that the group of any such
Related Entities is primarily engaged in a business other than that of a
Financial Institution; or

h) the NFE meets all of the
following requirements (a “non-profit NFE”) : (i) it is established and
operated in its jurisdiction of residence exclusively for religious,
charitable, scientific, artistic, cultural, athletic, or educational purposes;
or it is established and operated in its jurisdiction of residence and it is a
professional organisation, business league, chamber of commerce, labour organisation,
agricultural or horticultural organisation, civic league or an organisation
operated exclusively for the promotion of social welfare;

(ii) it is exempt from income tax in its
jurisdiction of residence; (iii) it has no shareholders or members who have a
proprietary or beneficial interest in its income or assets; (iv) the applicable
laws of the NFE’s jurisdiction of residence or the NFE’s formation documents do
not permit any income or assets of the NFE to be distributed to, or applied for
the benefit of, a private person or non-charitable Entity other than pursuant
to the conduct of the NFE’s charitable activities, or as payment of reasonable
compensation for services rendered, or as payment representing the fair market
value of property which the NFE has purchased; and (v) the applicable laws of
the NFE’s jurisdiction of residence or the NFE’s formation documents require
that, upon the NFE’s liquidation or dissolution, all of its assets be
distributed to a Governmental Entity or other non-profit organisation, or
escheat to the government of the NFE’s jurisdiction of residence or any
political subdivision.

Under the CRS, a Passive NFE means any: (i) NFE that is not an Active NFE; and (ii)
Investment Entity located in a Non-Participating Jurisdiction and managed by
another Financial Institution.

In section D of this report we provide examples on
how to classify a Company for better understanding.

D. EXAMPLES

1. Investment Portfolio Company:

Investment Company’s Y majority income is derived
from investing, re-investing and trading in financial assets and these
financial assets are managed by a bank or asset manager based on a
discretionary asset management mandate. Investment Company Y qualifies as Financial Institution based on the “Investment
Entity” definition. In the absence of a discretionary investment mandate
agreement, Investment Company Y will be classified as a Passive NFE since the majority of its income represents passive
income.

2. Holding Company that is a member of a non-financial
group:

Holding Company X is the parent entity of 3
subsidiaries that are in the business of operating grain terminals. The sole
activity of Holding Company X is to hold the stock of these subsidiary companies.
Holding Company X is privately owned and is not traded on an established
securities market. Holding Company X was formed as part of the original
structure of the business and was not formed in connection with any sort of
investment purpose such as private equity, venture capital, etc. Holding
Company X qualifies as Active NFE as
the company’s primary purpose is to hold the stock of its subsidiaries and
these subsidiaries are engaged in a business that is not financial in nature.

3.Active Trading Company:

Company’s F business consists of production of
fertilizers. Company F has been very successful over the last five years and
has been able to invest its profits into securities. Therefore, in addition to
income received from the sale fertilizers, Company F also earns passive income
(i.e. interest and dividends) on its investments. In the prior year, Company F
earned gross income of EUR 1,000,000 from the sale of fertilizers and EUR 50,000
of interest and dividends on its investments. On December 31 of the prior year,
Company F had assets of EUR 20,000,000 of which EUR 2,000,000 is invested into
securities and the remaining EUR 18,000,000 consists of equipment, inventory
and other assets that are used in the daily production of the fertilizers. Company
F qualifies as an Active NFE by
reason of income and assets because less than 50% (50,000 / 1,050,000 = 4.76%)
of the gross income in the prior year is Passive Income and less than 50%
(2,000,000 / 20,000,000 = 10%) of the assets held produce or are held for the
production of Passive Income.

4. Real Estate Company:

Company R does not engage in active business but only invests
in real estate and receives rental income and/or realises capital gains on the
sale of such property. Company R would be a Passive NFE since more than 50% of its total income is passive
income and/or more than 50% of its total assets are assets that produce or may
produce passive income.

5. Financing Company:

The principal activity of Company F is the provision
of financing to other related entities which are non-financial. Company F
should be classified as Active NFE,
since the company’s income is primarily derived from the provision of loans to
non-FI related entities which are not part of a Financial Group. If
Company F also provides loans to unrelated parties and the interest received
from this type of loans is greater than Company’s F active income, Company F
may be classified as a Financial
Institution.

E. CONCLUSION

In broad terms,
financial institutions report information to the tax office of the jurisdiction
in which they are located. The information consists of details of financial
assets they hold on behalf of taxpayers (individual or entities) from
jurisdictions with which their tax office will exchange information. This
process requires high level of regulations and the ability to correctly
classify each entity either as Financial Institution, Active NFE or Passive NFE
and which will also determine whether the beneficiaries are reportable or not.
For this reason it is necessary to have solid tax advice that will do a
holistic review of each entity’s characteristics.