Expected increase in oversight related to FATCA/CRS
With the recent "shell bank loophole" case, the U.S. Senate revealed schemes to evade FATCA reporting. The report followed another high-profile case, in which an American billionaire used offshore entities to hide $2.7 billion from U.S. tax authorities.
A report published by the U.S. Senate in August 2022 highlighted the recent discovery of schemes to prevent FATCA reporting, also known as the "shell bank loophole". The report came in the wake of another high-profile case, which revealed that an American billionaire was at the head of a scheme involving interposed offshore entities qualifying as financial institutions (FI) to avoid the requirement to identify and report the underlying U.S. beneficial owner. This scheme allowed him to not be reported by these Swiss banks under FATCA and, thus, evade tax of approximately USD 2.7 billion from the U.S. tax authorities, making it the largest ever tax fraud case brought against an individual.
The so-called “shell bank loophole” is quite a simple mechanism. First, an entity is established in an offshore jurisdiction. This entity is then artificially classified as a foreign financial institution (FFI) under FATCA, and thus registered on the IRS portal. As a next step, a bank account is opened in the name of the given entity, meaning that the bank is not required under FATCA to identify and report the underlying U.S. ultimate beneficial owner, i.e. Controlling Persons.
This loophole stems from the fact that the bank is not obliged under FATCA to verify that the offshore FI has filed its own FATCA report disclosing its U.S. owners (even though this could be envisaged in some circumstances from an AML tax-fraud perspective). This mechanism relies on the absence of checks conducted by the IRS when the offshore entity is registered as a FFI and by the tax authorities in the country of residence of said offshore entity. The lack of resources and the large number of FIs prevent the IRS from effectively monitoring Global Intermediary Identification Number (GIIN) applications. This means that tax evaders can set up multiple offshore entities without being subject to any scrutiny. For example, in seven jurisdictions (Cayman Islands, British Virgin Islands, Guernsey, Switzerland, Singapore, Bermuda and Malta), altogether over 120,000 entities are registered on the IRS portal, including over 80,000 in the Cayman Islands alone.
While the U.S. Senate report only deals with FATCA, this avoidance mechanism is also directly applicable for CRS purposes.
In addition to investigating a potential breach of the FATCA and CRS due-diligence obligations (e.g. testing the reasonability of the corporate account holder’s FATCA and CRS status and not merely checking the presence of a GIIN) by the FIs in question, this type of structure should also be subject to analysis from a DAC6 perspective, specifically concerning Hallmark D on CRS avoidance arrangements. This is particularly relevant for closely held private investment vehicles located in offshore jurisdictions and whose fulfilment of the criteria to be treated as financial institutions is dubious.
As the “shell bank loophole” and similar structures are now in the IRS’ and other tax authorities’ focus, it continues to be important that FIs identify such structures among their clients and they must, therefore, carefully define the appropriate governance and due diligence processes and checks to be implemented.
The original news alert of PwC Luxembourg about the “shell bank loophole” case can be reached here.
As the “shell bank loophole” case highlights, compliance with due diligence and reporting requirements continues to be top-of-mind for both regulators and financial institutions. How institutions manage these requirements can be greatly supported by technology, including interactive knowledge databases like the PwC’s Customer & Investor Tax Transparency Compare Tool. It can support in three main areas of focus:
- Various Sources of Information. Given the variety in sources of primary information from the IRS, U.S. Treasury, OECD and local regulatory authorities around the world, institutions are looking for an up-to-date repository of such information in order to centralize their searches. PwC’s CITT Compare Tool will house active links to relevant primary documentation, including the U.S. regulations, Annexes maintained by the OECD, EU Directives as well as local regulations and guidance.
- Different Users with Varying Needs. As diverse as the operational units of financial institutions are, so diverse are their needs when it comes to managing compliance with Customer and Investor Tax Transparency initiatives. On the one hand, our solution provides standardized overviews and on the other individualized and storable searches - tailored towards the user's specific needs.
- Frequent Regulatory Changes. Managing these changes from various sources (IRS, OECD, EU and local authorities) has become a challenging and significant task. Based on a 2-step alert process, CITT Compare Tool users will be made aware of all regulatory changes in an efficient manner. It should be noted that even after 10+ years since FATCA was first passed, we still publish 8-12 weekly headlines in our news alert on this topic, and we do not see this decreasing soon.
Our team is happy to offer a demo and free trial to give financial sector professionals a chance to get familiar with the solution and understand how it can support their compliance with these requirements regionally and globally. Please feel free to contact us.
Mark D. Orlic, Partner
Marton Kovarik, Senior Manager