By Andrew Knight, Partner, Maitland
The Common Reporting Standard (CRS) is well and truly upon all early adopter countries like Luxembourg, with first reports to be filed before June 30 of this year by those Luxembourg investment funds that are regarded as reporting financial institutions.
The Luxembourg fund industry should therefore be in an advanced phase of its implementation of the CRS. The process for doing so is no doubt being made easier by what was learnt from the FATCA implementation process. However, the two processes remain separate and need to be run in parallel and care needs to be taken not to assume that the two are identical in all but name.
One of the fundamental differences between the CRS and FATCA is that, under the CRS, potentially every investor (save for USA investors) is reportable bearing in mind that, for all intents and purposes, the CRS net covers the worldwide investor community. This explains the need for the so-called ‘wider approach’ to the due diligence process. The result is that funds’ data capture systems, in particular their due diligence processes (including their self-certification forms), are having to accommodate a great deal more and varied information than was the case under FATCA.
However, notwithstanding the wider approach on due diligence, a Luxembourg fund should not be reporting on all of its investors but only those who are resident in so-called reportable jurisdictions. This is a little difficult at the moment as it is not yet clear which countries outside the EU will receive information from Luxembourg. All we know for sure is that the USA will not be included because of course the USA has its own special FATCA regime.
The USA route is not a complete solution for Luxembourg
And while we are on the subject of the USA, there is some suggestion that, due to its non-participation in the CRS and the ease with which reporting by the USA under FATCA can be avoided, the USA is the place through which to invest on an entirely confidential basis. Let’s say an EU resident invests in a US entity that in turn invests into a Luxembourg fund. Assuming the US entity is a financial institution, normally the Luxembourg fund would report on neither the US fund nor its investors.
However, Luxembourg has chosen not to treat the USA as a so-called participating jurisdiction. Admittedly, this was after an apparent change of mind, but this is in line with most countries, including Ireland. The result is that, where the US investor is in the form of a so-called managed investment entity, the Luxembourg fund would need to treat it as a passive entity and be required to look behind it so as to report on the so-called controlling persons. Thus, an EU resident would not be able to hide behind the US vehicle for purposes of avoiding Luxembourg reporting. Contrast this with where the US vehicle was to invest in a Swiss entity. The EU investor would be able to achieve anonymity as Switzerland treats the US as a participating jurisdiction. It is possible that Switzerland has thereby stolen a competitive march on Luxembourg.
Getting the timing right
In terms of the timing of reporting, a point that is frequently overlooked is that the reporting of an account in a particular year is dependent upon whether the due diligence on that account was completed in the previous year. This is particularly relevant to pre-existing accounts as, for a Luxembourg fund, only pre-existing accounts held by individuals and of a value of over USD 1 million as at 31 December 2015 needed to be completed by the end of 2016 and thus need to be reported by 30 June of this year. All other pre-existing accounts are only required to be investigated by the end of this year and thus reported by 30 June 2018. Funds would arguably have been doing a disservice to their pre-existing investors by completing the due diligence ahead of time and thus ending up having to report them a year earlier than required.
Sponsorship not available under the CRS
One apparently significant difference between FATCA and the CRS is that under the CRS there is no ability for a fund that is a financial institution to be sponsored by another entity. It would seem that the sponsorship option has been adopted quite widely by the investment fund community under FATCA. A particular advantage of this, besides centralising the FATCA compliance function in a single entity like the management company, was that the sponsored fund would not need to be registered with the Internal Revenue Service (IRS) until such time as it had investors who were US persons who needed to be reported. By the way, there was some confusion leading up to the end of last year regarding this IRS registration requirement as it was frequently thought, incorrectly, that any sponsored investment entity needed to be registered.
Although FATCA sponsored entities are treated as non-reporting, this is misleading as the compliance role is simply taken on by someone else. Thus, the fact that sponsorship is not available under the CRS is not actually a major issue as the sponsorship arrangement can simply be replaced by a third party service arrangement whereby the service provider effectively performs the role of sponsor.
As regards other categories of so-called non-reporting financial institutions, there is one notable difference between FATCA and the CRS in a fund context, namely that fund managers and advisers are no longer capable of being treated as non-reporting. In principle, therefore, managers and advisers that qualify as financial institutions need to carry out the normal CRS due diligence and reporting. This is perhaps not as bad as it seems as, provided the manager or adviser is not itself holding investors’ funds, it will be unlikely to have anything to report. But the fact is that managers and advisers do not have the easy escape route that they had under FATCA.
As regards investor communications, under the CRS there is the same emphasis as there was under FATCA for specific health warnings to be communicated by a financial institution to its account holders. However, the difference is that there will be significantly more reporting under the CRS and thus the need for these health warnings to be communicated is all the more important. The warnings relate principally to the purposes to which the information collected from investors may be put, including the transfer of that information, and are intended to ensure that Luxembourg funds strictly comply with Luxembourg’s data protection laws. Last November ALFI issued a statement to emphasise the need for these warnings to be clearly provided and this was accompanied by revised pro forma self-certification forms.
The final word on this topic should be about the need for a fund to have a clear set of policies and procedures that it applies as part of its CRS compliance programme. While there can be expected to be some indulgence shown by the Luxembourg administration towards non-compliance in these early days of the CRS, it will not be long before audits are carried out to check the level of compliance. One of the first objects of any audit will be to verify whether institutions have in place properly documented policies and procedures and also the records to evidence compliance with those procedures. In the absence of those, it is going to be difficult to prove due compliance with the CRS rules. Non-compliance attracts some stiff financial penalties.