The Model Mandatory Disclosure Rules (‘AEOI PHASE 3’) Briefing Series: PART I

By Rodrigo Zepeda, CEO, Storm-7 Consulting

This multi-part series of blogs will introduce readers to what have been generally referred to as the ‘Model Mandatory Disclosure Rules’ (MMD Rules). Their full title is the ‘Model Mandatory Disclosure Rules for CRS Avoidance Arrangements and Opaque Offshore Structures’. This Briefing Series will provide background context as to what these new rules are, why they are in the process of being introduced, and why they are now such a significant issue for banks and financial services firms operating around the world.

This Briefing Series will aim to cover a summary analysis of the template MMD Rules, a summary legal analysis of their application in the United Kingdom (UK), and strategic operational and implementation commentary. Most importantly, it will seek to show why authorised firms around the world will likely need to adjust/change their internal tax reporting and compliance frameworks to cater to new, and much more demanding, internal anti-tax evasion detection, prevention, and compliance frameworks.

BACKGROUND CONTEXT

Many readers may not be familiar with the MMD Rules, yet they form one of the most significant developments in the future of global ‘Automatic Exchange of Information’ (AEOI) reporting frameworks. In short, AEOI refers to the automatic cross-border sharing of information by tax administrations. This can be undertaken on a reciprocal, or non-reciprocal bilateral basis between two tax administrations, or it can also be undertaken multilaterally between multiple tax administrations. AEOI reporting usually refers to the reporting of certain information that is legally obliged to be reported by individuals or firms to national tax administrations. Global AEOI reporting frameworks can historically be broken down into two distinct phases. The global implementation of the MMD Rules will usher in a new AEOI Phase 3 around the world.

AEOI PHASE 1: ‘FATCA’

This Phase began when the ‘Foreign Account Tax Compliance Act’ (FATCA) was enacted by Congress in the United States (US) in 2010, in order to address non-compliance by US taxpayers using foreign accounts, i.e., to combat tax evasion by US citizens and US institutions (U.S. Department of the Treasury). FATCA required certain ‘Foreign Financial Institutions’ (FFIs) to report to the US Internal Revenue Service (IRS) information concerning financial accounts held by US taxpayers (individuals or entities) (U.S. Department of the Treasury). Under international law, the US Government has no legal power or authority to command foreign sovereign nation States, or such FFIs, to obey domestic US tax laws. However, in practice, FFIs were essentially ‘forced’ to obey FATCA because they would be subject to extremely severe financial penalties if they did not comply, i.e., 30% withholding on all payments made by US institutions to non-compliant financial accounts. Consequently, FATCA introduced a new era of what essentially amounted to the unilateral imposition of extraterritorial jurisdiction by the US Government on foreign individuals and firms, with respect to potential tax evasion activities.

AEOI PHASE 2: THE COMMON REPORTING STANDARD (‘GATCA’)

FATCA proved to be unbelievably effective in practice. So much so, that many other countries around the world came together to develop a similar global tax framework for themselves. The ‘Common Reporting Standard’ (CRS) was a standard template developed by the Organisation for Economic Co-operation and Development (OECD) and published on 15 July 2014. Phase 2 began with the introduction of this new standard reporting framework and its subsequent adoption by committed States around the world. This standard template essentially sought to replicate the FATCA framework on a multilateral global basis, which is why it was sometimes referred to as ‘GATCA’, i.e., global FATCA. There were, however, many differences between the FATCA and CRS frameworks, the main one being that CRS frameworks were implemented on a global multilateral basis between multiple tax authorities around the world, i.e., sharing of information not just with the US, but with all signatory tax authorities globally. The CRS was implemented domestically within each State by transposing the standard template into national law.

GLOBAL AEOI REPORTING AND COMPLIANCE FRAMEWORKS

There can be absolutely no doubt that FATCA and CRS reporting and compliance for firms operating around the world was brutal. The tax and compliance frameworks were highly complex and legalistic in nature, they required significant interpretation at domestic and institutional levels, and required firms to adopt complex manual or automatic software-based reporting and compliance frameworks that were often very costly. What is more, CRS reporting was implemented in different waves of jurisdictions undertaking first exchanges, which made reporting frameworks even more complicated (OECD AEOI commitments).

It is little wonder then, that many firms breathed a sigh of relief when FATCA/CRS reporting and compliance frameworks had finally been implemented, as they believed that many of the problems that they had faced were essentially over. However, what many firms still do not seem to realise, is that in reality AEOI Phases 1 and 2 are just the beginning. FATCA/CRS reporting and compliance is simply a tool, the underlying objective of this process is for States around the world to be able to effectively identify tax evaders around the world, to reduce and minimise tax evasion, and to prosecute criminal offenders. This means that FATCA/CRS reporting and compliance is set to become increasingly more sophisticated in nature.

At present FATCA/CRS reporting seems to reflect simply another compliance reporting framework for authorised firms - report the information required to the relevant tax authority and the firm is compliant. However, tax evasion is a substantive crime, in an identical way to money laundering. Current anti-money laundering (AML) reporting and compliance frameworks are now highly developed and complex in nature, and typically require authorised firms to implement AML detection and monitoring frameworks internally using a risk-based approach (RBA) (Financial Action Task Force 2014). The focus under developed AML frameworks, is not simply to report suspicious activities, transactions, or accounts, but also to put in place monitoring mechanisms, detection mechanisms, and preventative mechanisms.

AML frameworks have evolved from reporting frameworks to more advanced detection and prevention frameworks. Consequently, as the next AEOI Phase 3 evolves, authorised firms will be increasingly required to undertake internal tax evasion investigations and cooperate with domestic and international tax authorities. Moreover, for larger firms, they will very likely be forced to implement a preventative RBA to identifying potential tax evasion, otherwise they may face conduct risk issues (i.e., some, or even many, of their clients may be subject to regulatory investigation and prosecution by tax authorities), and they themselves may even be prosecuted and fined.

FATCA/CRS reporting and compliance will therefore very likely become much more operationally strategic in nature. This situation is exacerbated by the fact that certain jurisdictions such as the UK, have now introduced new types of corporate criminal offences via domestic legislation. In the UK, the most pertinent is the corporate offence of failure to prevent facilitation of tax evasion, which is now contained in PART 3 of the Criminal Finances Act 2017 (c.22) (covered in more detail later).

In short, this means that even though authorised firms may be compliant with their FATCA/CRS reporting obligations, the new MMD Rules may identify a number of existing clients who may subsequently be prosecuted by domestic authorities for committing substantive criminal tax evasion offences. The greater the number of such clients identified at firms, the greater is the risk that the firm itself may be subsequently prosecuted for failure to prevent facilitation of tax evasion.

That is why the new MMD Rules herald the introduction of a new AEOI Phase 3 which will likely see a transition to preventative RBA to identify potential tax evasion within firms, as opposed to simply FACTA/CRS reporting. At present, many firms around the world seem to be completely unaware of this forthcoming change in direction. This is my personal assessment which is based on a very large number of personnel/firms that I have quizzed on this area when undertaking face-to-face AEOI (FATCA and CRS) in-house training courses for firms situated all around the world in Africa, Europe, the Middle East, and South America.

AEOI PHASE 3: THE MMD RULES

The MMD Rules are a standard template document which is 47 pages long which was published by the OECD on 9 March 2018 (OECD 2018). They seem to have received little attention in the literature, and there generally seems to be little understanding by firms about how they will operate in practice. In short, whilst the FATCA/CRS global compliance frameworks seek to oblige authorised firms to report information about financial accounts and structures to tax authorities, the MMD Rules target those potentially facilitating tax evasion instead.

Tax evaders directly profit from tax evasion by not paying taxes to tax authorities that they are legally obliged to pay. Tax facilitators indirectly profit from tax evasion by charging fees to official or unofficial clients to facilitate tax evasion in some way, e.g., by hiding funds for clients in complex chains of offshore structures. The general policy behind the MMD Rules, is that whilst FATCA/CRS can potentially identify tax evaders, the MMD Rules will target those individuals and entities that actually facilitate or help tax evaders, e.g., complicit accounting firms, solicitors’ firms, offshore trusts and taxation specialist firms.

In this way, once implemented, the new MMD Rules will provide a much more granular ‘map’ of potential tax evasion activities that are occurring around the world. Domestic tax authorities and criminal prosecution authorities around the world, have traditionally focused on building cases against the tax evaders themselves. However, the MMD Rules adopt a different approach, in that they target those individuals and firms that may potentially facilitate the tax evaders, and now paint a target on their backs as well.

From a policy perspective, this is intended to make facilitating tax evasion a riskier proposition, so that the MMD Rules may act as a criminal deterrent. It is also intended to provide tax authorities with new and unprecedented information that tax authorities can then use to precisely identify modern tax evasion mechanisms, practices, trends, and developments. Legally, the pro forma template MMD Rules are transposed into domestic legislation. In the UK, these are in draft form – ‘The International Tax Enforcement (Disclosable Arrangements) Regulations 2022’ (SI 2022 No.).

These are intended to replace the current legislative framework, namely 'The International Tax Enforcement (Disclosable Arrangements) Regulations 2020' (SI 2020 No. 25). This approach is likely to make understanding and interpreting the application of the MMD Rules difficult in practice, because each jurisdiction may implement them in slightly different ways, with different definitions, obligations, penalties, and procedures. This is precisely what happened around the world when States implemented the CRS pro forma template via domestic legislation.

TO BE CONTINUED

In the next blog, I will endeavour to explain the functioning of the MMD Rules in practical ways, so readers can fully understand and grasp the types of behaviours and practices they will target, and how firms may be affected worldwide.