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

By Rodrigo Zepeda, CEO, Storm-7 Consulting

INTRODUCTION

The pro forma template ‘Model Mandatory Disclosure Rules for CRS Avoidance Arrangements and Opaque Offshore Structures’ (MMD Rules) were published by the Organisation for Economic Co-operation and Development (OECD) on 9 March 2018. In practice, it may be difficult for firms around the world to fully understand how they will operate. This is because they are somewhat complex and legalistic in nature, they will have to be transposed nationally into domestic legislation, and they carry little in the way of substantive and procedural guidance. 

Apart from brief commentary contained within the MMD Rules in Part 3 (MMD Rules 2018, pp. 23-44), there is only a short (5 pages) question and answer sheet that has been published by the OECD (OECD Questions and Answers). This approach is completely different to that adopted for the implementation of the OECD ‘Common Reporting Standard’ (CRS), which included a very detailed (174 pages) Implementation Handbook (OECD Implementation Handbook).

However, for software, technology, and regulatory technology (RegTech) firms that may be looking to commercially develop MMD Rules firm reporting solutions, the OECD has developed an ‘XML Schema and User Guide’ to support automatic exchange of information (AEOI) under the MMD Rules (OECD 2019). Indeed, the new MMD Rules will provide top FATCA/CRS reporting solutions firms such as Refinitiv and Vistra, with an excellent opportunity to commercially develop new holistic reporting solutions.

IMPLEMENTATION OF THE MMD RULES IN THE UNITED KINGDOM

In the first blog of this Briefing Series, it was noted that AEOI Phase 1 commenced with the introduction of ‘The Foreign Account Tax Compliance Act’ (FATCA) by the United States (US) in 2010 (U.S. Department of the Treasury). AEOI Phase 2 then commenced with the introduction of the CRS on a global scale in 2014. In theory, AEOI Phase 3 will therefore begin with the roll-out of a fully operationalised legal framework in at least one CRS partner jurisdiction, such as the United Kingdom (UK).

This is because once a fully operationalised legal framework is in place, other CRS partner jurisdictions around the world will likely find it much easier to transpose the pro forma template MMD Rules into domestic legislation (via comparative legislative analysis). This is essentially what seemed to happen with the implementation of standard CRS rules in jurisdictions globally. In the UK, ‘The International Tax Enforcement (Disclosable Arrangements) Regulations 2020’ were enacted on 1 July 2020. These were intended to implement the substantive requirements set out in European Union (EU) Directive 2018/822 (DAC 6) within the UK.

However, the application and scope were significantly limited in practice through promulgation of ‘The International Tax Enforcement (Disclosable Arrangements) (Amendment) (No. 2) (EU Exit) Regulations 2020’. The UK Government then undertook a public consultation regarding the implementation of the full new regulatory framework (GOV.UK 2019; HM Revenue & Customs 2019). This new regulatory framework is intended to replace DAC 6 in the UK, and to generally implement the obligations contained within pro forma template MMD Rules.

A draft form of legislation was released for review by the UK Government – ‘The International Tax Enforcement (Disclosable Arrangements) Regulations 2022’ (SI 2022 No.) (DR 2022). It commented that it envisaged that the DR 2022 will come into effect in Summer 2022 (i.e., sometime in July 2022 or August 2022) (HM Revenue & Customs 2019, p. 6). In the consultation document, HM Revenue & Customs (HMRC) stated that the DR 2022 closely follow the MMD Rules, in order to maintain consistency in applying the rules between implementing jurisdictions (HM Revenue & Customs 2019, p. 5). HMRC further noted that:

“This is intended to reduce the reporting burden faced by businesses operating across multiple jurisdictions and has been a key theme of discussions with businesses since the model rules were first published.” (HM Revenue & Customs 2019, p. 5).

Consequently, it is likely that other CRS jurisdictions that implement the MMD Rules via domestic legislation in the future will likely apply a similar approach (although operational differences will likely arise owing to over a hundred CRS reporting jurisdictions around the world).

AN OVERVIEW OF THE DR 2022

The DR 2022 are split into four Parts:

(1) Introductory (DR 2022, Regulations 1-2);

(2) Requirement to disclose CRS avoidance arrangements and opaque offshore structures (DR 2022, Regulations 3-12);

(3) Penalties for breach of obligations (DR 2022, Regulations 13-20); and

(4) Revocations (DR 2022, Regulation 21).

The DR 2022 have been structured to incorporate the main substantive obligations and definitions contained in the MMD Rules. Consequently, they are not legally self-contained, in the sense that they must be read in conjunction with the relevant text taken from the MMD Rules. The main objective under the MMD Rules is to provide domestic tax administrations (DTAs) with information on:

(1) a ‘CRS Avoidance Arrangement’ (Arrangement); or

(2) an ‘Opaque Offshore Structure’ (Structure) (MMD Rules 2018, p. 9).

These were defined and discussed in Part II of this blog series.

Intermediaries (Promoters and Service Providers)

An intermediary in the DR 2022 is defined according to the MMD Rules (DR 2022, Regulations 2(2)-(3), Schedule 2) (Intermediary). In Part II of this blog series, it was seen that this includes both a ‘Promoter’ and a ‘Service Provider’ (MMD Rules 2018, Rule 1.3).

A Promoter includes any person that is responsible for the design or marketing of an Arrangement or Structure (MMD Rules 2018, Rule 1.3(a)).

A Service Provider includes any person that provides ‘Relevant Services’ for an Arrangement or Structure, in circumstances where the person providing such services could reasonably be expected to know that these constitute either, a CRS Avoidance Arrangement, or an Opaque Offshore Structure (MMD Rules 2018, Rule 1.3(b)).

Relevant Services means providing either assistance or advice with respect to the design, marketing, implementation, or organisation of an Arrangement or Structure (MMD Rules 2018, Rule 1.4(k)). This is a very broad definition. For example, it may cover firms that may assist in implementing Arrangements or Structures, such as firms that help to provide shell office services, or run shell offices, or maintain shell office properties. It may cover firms that may assist in organising Arrangements or Structures, such as accounting firms that maintain accounts for firms involved in offshore structures.

In theory, it may even cover advertising and marketing firms that are used by firms to market and promote their professional consulting, corporate services, tax structuring and planning, trust structuring and planning, and tax avoidance services to potential new clients. Indeed, the broad definition of Intermediary may include entities (including branches) such as accountants; accounting firms; banks; financial planners; financial services firms; investment advisors; law firms; lawyers; tax advisors; trusts; and trust and company service providers (TCSPs).

The MMD Rules note that the knowledge and actions of an Intermediary will be deemed to include those of any employees acting in the course of their employment, as well as contractors (MMD Rules 2018, p. 33). This means that Intermediaries will not be able to use networks of independent third-party contractors situated in a range of offshore jurisdictions, to allow them to ‘hide’ the services they provide, or to avoid incurring liability under the operation of the MMD Rules. It also means that such Intermediaries will likely be required to ‘map out’ the third-party contractors that they use, to allow them to carry out a gap analysis to identify whether the work and/or operations of such contractors will be covered by the new legal framework.

POTENTIAL OPERATIONAL CHALLENGES UNDER THE DR 2022/MMD RULES

Regulatory compliance under this new legal framework is made highly problematic for firms that may not even know, or may not believe, that they are covered by the DR 2022. If a person is an Intermediary with respect to an Arrangement or Structure, such person falls under a legal obligation to disclose that Arrangement or Structure to its DTA, if it makes that Arrangement or Structure available for implementation, or it provides Relevant Services (DR 2022, Regulations 3(1)(a)(i)-3(1)(a)(ii); MMD Rules 2018, Rule 2.1).

Under FATCA/CRS reporting and compliance, covered firms were required to analyse their internal operations in order to identify those individuals and entities that were required to be reported on to DTAs. The CRS identification process was facilitated by the provision of a range of operational definitions that identified different types of entities, such as exempt persons, Financial Institutions, and Non-Financial Institutions (NFIs) such as Active Non-Financial Entities (NFEs) and Passive NFEs.

The identification process is much more convoluted under the MMD Rules. This is because individuals and firms will first be required to analyse whether they themselves fall within the definition of Intermediaries. They will then be required to analyse their full range of services provided to identify which of their products and services may be ‘in scope’, i.e., fall within the definition of a reportable Arrangement or Structure.

This complex process will be different for the different types of firms potentially covered, such as accountants, lawyers, and tax advisors. What is more, if a bank does not normally provide such services, but does occasionally provide such services for high net worth individuals (HNWIs), then the bank may now be potentially in scope with respect to such services. Banks and financial services firms may therefore have to perform internal review operations to determine whether HNWI services they provide are in-scope.

Furthermore, firms should note that such information must be disclosed thirty days after the Intermediary makes the Arrangement/Structure available for implementation, or it provides Relevant Services (DR 2022, Regulation 4; MMD Rules 2018, Rules 2.2(a)-(b)). This is a short notification time frame which may be difficult to implement for covered firms that operate on a multinational basis, and which may be providing in-scope services. This may not be as problematic in situations where a covered firm has launched a new product or service, and there is a clear and discernable point where it may be made available for new clients.

However, it may be much more problematic where an employee within a firm is simply advising an existing client with respect to a product or service it has offered in the past. This situation will not have been covered (i.e., regulated) previously. However, it may now be covered by the new MMD Rules, and therefore require timely due diligence and disclosure to be undertaken by the firm employee to the DTA. It may also affect client confidentiality and disclosure provisions contained in pre-existing client engagement agreements.

If Intermediaries fail to disclose the required information to HMRC they will breach the DR 2022, and they will incur liability vis-a-vis potential financial penalties to be imposed by HMRC. These can be £600 per day (i.e., approximately £18,000 per month, or £216,000 per year) for each offence (DR 2022, Regulation 13(1)(a)(ii)). HMRC have the power to commence proceedings up to 6 years after the date on which a person became liable to a penalty (DR 2022, Regulation 17(1)(b)).

So, say an Intermediary has intentionally failed to disclose an Arrangement/Structure, and HMRC successfully prosecutes the firm five years later, in theory such a firm might be liable to pay a penalty of £1,080,000 plus legal costs for a single offence. For multiple intentional offences, an Intermediary might potentially be fined millions by HMRC, the firm would invariably loose existing clients, and this could then significantly impact future revenues through extensive negative reputational damage incurred in the media.

In addition, HMRC officers have the power to require a person who the officer reasonably suspects is an Intermediary, to provide such information or documents as the officer reasonably requires as specified by written notice (DR 2022, Regulation 11(1)). This obligation also extends to a ‘reportable taxpayer’, which is any actual or potential user of an Arrangement, or a natural person whose identity as Beneficial Owner cannot be accurately determined because of a Structure (MMD Rules 2018, Rule 1.4(l)).

This provides HMRC, as a DTA, with significant investigatory powers. For example, say HMRC has internally implemented new algorithm-based software programmes to identify patterns, trends, connections, connectors, individuals, and firms all pertaining to potential tax evasion. HMRC would then be in a position to identify potential sectoral patterns and trends based on existing exchanged AEOI CRS data, e.g., Big Data analysis based on AEOI data from 110 CRS participating jurisdictions. By way of illustrative example, it may identify TCSPs and law firms as being high risk sectors.

If such tax evasion programmes indicate that certain TCSPs and law firms should be reporting information but in fact are not, it would then have the power to request further information from such TCSPs and law firms, and use this information to launch formal investigations, or to bring formal charges for breach of DR 2022 obligations. HMRC would also have the power to be able to ‘drill down’ further in such investigations, by requesting additional granular information on a range of firm clients, i.e., reportable taxpayers.

With AEOI frameworks now in place across all CRS partner jurisdictions around the world, in theory, DTAs will now be able to rapidly request further information to support domestic regulatory investigations from other partner jurisdictions. Consequently, once the new AEOI Phase 3 is significantly underway, FATCA/CRS reporting and compliance is very likely to transition away from a pure reporting function, and to move more towards a holistic, integrated risk-based approach to monitoring, detecting, and preventing certain financial crime (i.e., tax evasion, money laundering) as a whole.

TO BE CONTINUED

In the final blog, I will provide legal analysis of the new corporate offence of failure to prevent facilitation of tax evasion in the UK, and how it interacts with existing FATCA/CRS frameworks and new MMD Rules. Readers will be able to envisage how the new AEOI Phase 3 will potentially operate in practice around the world.