>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.

F. HOW KINANIS LLC CAN ASSIST

statements which are necessary to the Entity’s classification

classification (Financial Institution, Active or Passive NFE) and provide all

necessary documents to the bank for this purpose

planning

Disclaimer

This

publication has been prepared as a general guide and for information purposes

only. It is not a substitution for professional advice. One must not rely on it

without receiving independent advice based on the particular facts of his/her

own case.  No responsibility can be accepted by the authors or the

publishers for any loss occasioned by acting or refraining from acting on the

basis of this publication.

January 2017

APPENDIX I: STATUS OF COMMITMENTS (101 jurisdictions have committed)

JURISDICTIONS

UNDERTAKING FIRST EXCHANGES BY 2017 (54)

Anguilla, Argentina, Barbados, Belgium,

Bermuda, British Virgin Islands, Bulgaria, Cayman Islands, Colombia, Croatia,

Curaçao, Cyprus, Czech Republic, Denmark, Estonia, Faroe Islands, Finland,

France, Germany, Gibraltar, Greece, Greenland, Guernsey, Hungary, Iceland,

India, Ireland, Isle of Man, Italy, Jersey, Korea, Latvia, Liechtenstein,

Lithuania, Luxembourg, Malta, Mexico, Montserrat, Netherlands, Niue, Norway,

Poland, Portugal, Romania, San Marino, Seychelles, Slovak Republic, Slovenia,

South Africa, Spain, Sweden, Trinidad and Tobago, Turks and Caicos Islands,

United Kingdom

JURISDICTIONS

UNDERTAKING FIRST EXCHANGES BY 2018 (47)

Albania, Andorra, Antigua and Barbuda, Aruba,

Australia, Austria, The Bahamas, Bahrain, Belize, Brazil, Brunei Darussalam,

Canada, Chile, China, Cook Islands, Costa Rica, Dominica, Ghana, Grenada, Hong

Kong (China), Indonesia, Israel, Japan, Kuwait, Lebanon, Marshall Islands,

Macao (China), Malaysia, Mauritius, Monaco, Nauru, New Zealand, Panama, Qatar,

Russia, Saint Kitts and Nevis, Samoa, Saint Lucia, Saint Vincent and the

Grenadines, Saudi Arabia, Singapore, Sint Maarten, Switzerland, Turkey, United

Arab Emirates, Uruguay, Vanuatu

APPENDIX

II: FATCA Vs CRS

FATCA                    CRS

[*]

Passive income would include the portion of gross income that consists of: a)

dividends; b) interest; c) income equivalent to interest; d) rents and

royalties, other than rents and royalties derived in the course of carrying out

active business, at least in part by employees of the NFE; e) annuities; f) the

excess of gains over losses from the sale or exchange of Financial Assets that

gives rise to the passive income we described earlier; g) the excess of gains

over losses from transactions (including futures, forwards, options, and

similar transactions) in any Financial Assets; h) the excess of foreign

currency gains over foreign currency losses; i) net income from swaps; or j)

amounts received under cash value insurance contracts.