Common Misunderstandings About Anti Tax Evasion Rules

I n October 2016, the State Administration of Taxation released the draft version of the Measures for the Administration of Due Diligence on Tax Information of Non-resident Financial Accounts and asked for public comments. It was an effort to conform to the requirements of the Common Reporting Standard (CRS).

The CRS, which the organization for Economic Cooperation and Development (OECD) developed in 2014, is an outgrowth of economic globalization. It facilitates the automatic exchange of tax-related information from financial accounts across borders in an effort to combat tax evasion. In the following article, the author relies on the European experience of international tax data exchanges to examine 10 areas of frequent misunderstandings of the CRS framework and the worldwide effort to prevent tax evasion.

Misunderstanding 1: The CRS is Global Taxation
Global taxation means that a taxpayer's worldwide income should be declared in the country where he or she resides. This worldwide tax liability is also described as full or unlimited tax liability. Worldwide taxation refers to income tax, and the CRS is designed to increase the transparency of overseas accounts held by a country’s taxpayers through cross-border automatic exchanges of tax-related information on financial accounts. This is to allow tax authorities to accurately apply taxes on overseas income in accordance with the law of the land. However, a taxpayer’s assets held overseas are not the objective of the CRS guidelines. The objective is to assess the taxable income, and assets that do not produce income should not trigger worldwide taxation.

Case Study
In the following case, an individual we will call Mr. Wang is a tax resident in China who has deposits in a Swiss bank. Assuming his bank account balance is US$1.5 million when the standard takes effect and it generates interest income of US$40,000 in the same tax year. Under the CRS information exchange rules, Mr. Wang’s account information would be declared and exchanged with China's tax authorities. However, this does not mean that the US$1.5 million would be subject to income tax levied by Chinese tax authorities. Tax authorities would be concerned with ensuring the taxable income of US$40,000 generated from the US$1.5 million is in fact taxed in China.

According to requirements of the Notice on Income Individual Income Tax Policy on Savings Deposit Interest (issued by the Ministry of Finance and the State Administration of Taxation in 2008, Tax Document No.132), interest income on individual savings deposits are exempt from individual income tax. However, the document does not specify whether interest income on offshore savings deposits are entitled to the same tax treatment.

Misunderstanding 2: Corporate Account Balances Below US$250,000
For business or institutional accounts, financial institutions should conduct due diligence inspections on existing balances and the extent of increases in funds in those accounts. This requirement starts from the time when the country where the financial institutions are based begins to implement the CRS provisions. A financial institution may choose to exempt itself from due diligence and filing requirements if the balance in the account is less than US$250,000. If the account balance exceeds US$250,000, the financial institution needs to conduct due diligence and determine whether it is an account that requires a declaration.

Whether account holders can enjoy the US$250,000 cutoff depends on whether there are corresponding tax exemptions in the financial institution's home country. Moreover, the exemption threshold is not mandatory, and the financial institutions can decide to apply the US$250,000 threshold according to the actual situation. In practice, some financial institutions may consider not applying this threshold and instead conduct due diligence on all deposits in order to avoid regulatory complications.

Misunderstanding 3: Individual Accounts of Less than US$1 Million
Under the CRS, due diligence is required for individual accounts, whether new or existing, and regardless of the balance, including zero or negative balances. There are no provisions for excluding accounts of less than US$1 million.

Financial institutions often have a large number of individual accounts. This means they must adopt a uniform standard for account due diligence, resulting in significant compliance costs. In view of this, the CRS provides the threshold of US$1 million for the division of individual accounts into high-value individual accounts and low-value ones as these are subject to different due diligence procedures. Financial institutions may choose to apply relatively simplified due diligence procedures (such as residence address testing) for low-value individual accounts, in order to reduce the compliance burden on financial institutions. Due diligence on low-value individual accounts usually lags that of high-value individual accounts by one year, allowing financial institutions more time to meet their compliance obligations with their low-value individual accounts.

However, it should be noted that financial institutions may also choose not to apply the above-mentioned procedural requirement. Instead, they may adopt a uniform compliance procedure for all accounts. It is possible to complete due diligence and information declarations on all high and low-value individual accounts in the first declaring period of the CRS. In practice, the internal policies of the financial institutions take precedence.

Misunderstanding 4: Non-financial Assets
Under the CRS, the core of automatic exchanges of tax information is the sharing of financial account information, not financial asset information. A financial account may involve both financial assets and non-financial assets. The need for a declaration does not depend solely on the financial assets themselves. If a financial account requires declaration, all assets held under the account, financial or non-financial, must be declared and the information exchanged.

Case Study
Another individual whose surname is Wang is a tax resident of China. He owns a private investment company set up in the Cayman Islands, and 80% of the assets held by this company are financial while 20% are non-financial. Under the CRS guidelines, if the company belongs to a financial institution (such as an investment company), when the same company declares its financial account the financial and non-financial assets must be declared.

Misunderstanding 5: Offshore Trusts
Offshore trusts have incomparable advantages over other investment frameworks in terms of asset segregation and preservation, tax optimization and privacy of information. Therefore, they are favored by many high net worth individuals and families in their global asset allocation. Under the CRS, a trust may be treated as a financial institution with due diligence required on its account holder (including the principal and beneficiaries), or it may be treated as a passive non-financial institution. If a financial institution holds an account, there is a requirement that information be provided on the person who actually controls the trust, such as the principal and the beneficiary.

However, the inclusion of a trust in the declaration system under the CRS does not result in the trust losing its key advantages. From the point of view of China's tax authorities, although the relevant financial account information of China’s tax residents’ overseas trusts will be declared and exchanged with Chinese authorities, this does not mean that the trusts will lose their secrecy. Only the tax authorities have access to the asset information under the CRS, and there are strict confidentiality requirements for information exchanges.

Misunderstanding 6:  The Safety of Deposits in China
Some people believe that after the implementation of CRS, tax residents in China can sit back and relax as long as they deposit their money in a Chinese financial institution. They believe their money will not be affected by the declaration of information under the CRS and that Chinese tax authorities will not be aware of the information regarding these accounts. Indeed, under China’s CRS regulations, financial institutions need only declare information about accounts held by non-Chinese tax residents. However, even though information exchanges apply to non-residents now, Chinese residents will no doubt be included in the future.

The State Council's Legislative Affairs Office promulgated the draft version of the Revised Tax Collection and Management Law of the People’s Republic of China in January 2015, and that specifically added more provisions on tax information disclosure. Article 32 of the tax provisions stipulates that banks and other financial institutions shall provide tax authorities wi