With increasing globalization and the ease of conducting international financial transactions, the G20 countries requested the OECD to develop a transparent system that would allow jurisdictions to combat off-shore tax evasion and non-compliance effectively. Although exchange of information was not a foreign concept, CRS is one example of an international evolution towards automatic exchange of information (AEOI) based on pre-defined formats. Another such an example is country by country reporting.

Drawing inspiration from the Foreign Account Tax Compliance Act (FATCA) in the USA, the OECD Council approved the Common Reporting Standards (“CRS”) in 2014, enabling the automatic exchange of financial information between jurisdictions.

How does it work? 

A Financial Institution (e.g. a bank) in jurisdiction A collects select information and reports it to its local competent authority. Based on this information, the local competent authority of jurisdiction A will exchange the account information of persons who are tax resident in a different jurisdiction (e.g. jurisdiction B). This information will be exchanged directly with the competent authority of the jurisdiction B on an annual basis and it will include the following information:

1. 1. Name, address, TIN, date and place of birth of the Reportable Person
   2. Account number
   3. Name and identifying number of the Reporting Financial Institution 
   4. The balance of the account at the end of the relevant calendar year
   5. Gains from sale of financial assets, if any.

Upon the receipt of the above information, the tax authority of the jurisdiction B will determine whether the taxpayer discloses his income accurately and if sufficient tax is paid. This process ensures that the taxpayer fairly discloses his income in jurisdiction B and jurisdiction B rightfully receives tax that is due from the taxpayer.

Legal instruments 

A country implementing CRS adopts certain legal instruments. It includes the Multilateral Competent Authority Agreement on Automatic Exchange of Financial Information (“MCAA”) and the Multilateral Convention on Mutual Administrative Assistance in Tax Matters (“MAC”). 

The MCAA includes the rules of exchange of information between foreign jurisdictions and also provides the infrastructure to safeguard confidential information being exchanged. As on 25 November 2020, 105 countries are signatories of the MCAA with the first exchange of information having started in September 2017.

CRS in the UAE

The UAE has opted for the widest approach for CRS and the UAE Ministry of Finance (“UAE MoF”) acts as the Competent Authority in charge of CRS implementation and ultimately enables the exchange of information with foreign jurisdictions. Moreover, it has ratified both the MCAA and MAC in 2018. 

The UAE has appointed multiple Regulatory Authorities for implementing CRS in the UAE, these authorities are:

1. The UAE Central Bank
2. The Securities & Commodities Authority
3. The Insurance Authority 
4. Financial Free Zone Authorities such as ADGM and DIFC.
5. The Ministry of Finance

With the recent merger of the Insurance Authority with the UAE Central bank, the UAE may have at least five sets of Regulations for CRS purposes.

The first exchange of information between the UAE MoF and the participating reportable jurisdictions with UAE has taken place on 30 September 2018. The USA is excluded from the CRS as, as mentioned above, it adopted its own set of legislation.

Impact on Financial Institutions 

Financial institutions hold a fundamental role in the effective implementation of CRS in the country. They are intermediaries through which the regulatory authorities collect information required for exchange of information purposes.

Reportable Financial Institutions include Custodial, Depository, Investment and Insurance Institutions. 

In order to determine whether a pre-existing or new account is a Reportable Account, the Financial Institutions are required to put due diligence measures in place and collect relevant information from their clients (e.g. tax residency, TIN). These due diligence measures can be incorporated into existing AML measures, KYC policies, or by obtaining and validating self-certifications from account holders.

If an Account holder is a Passive Non-Financial Entities (“Passive NFE”), the Financial Institution must also identify the identity of the natural person(s) who exercise control of the legal person via a controlling ownership. The Financial Action Task Force (‘FATF’) recommendation determines that controlling ownership interest can be based on a threshold, for example, a natural person owning more than 25% of the legal entity would be identified as the Controlling Person. If no person can be determined through ownership, Financial Institutions must also determine if a person exerts control over the legal entity through other means.

Another aspect that Financial Institutions have to consider is OECD’s analysis of high-risk CBI/RBI schemes when completing due diligence procedures. Citizen by Investment (‘CBI’) or Resident by Investment (‘RBI’) schemes allow individuals to obtain citizenship or resident status by making local investments. The OECD has established a list of countries that offer such schemes which includes the UAE and Bahrain.

Additionally, financial institutions are required to submit an annual report (by 30th June in the UAE) to their regulatory authorities describing the due diligence procedures in place, the number of reportable accounts, the amounts within these accounts (in USD), and other information. 

Due to their important roles in the information collection processes, Financial Institutions may incur heavy compliance costs and spend more time on validation and reporting. 

The UAE Cabinet recently published Cabinet Resolution No. 5/11 of 2020 Session No. (11) which imposes a penalty of AED 1,000 on any financial institution that opens a new account without obtaining a valid self-certification or for failing to validate such self-certification. 

In recent times, the UAE has taken a stricter approach towards compliance, on the one hand reinforcing the penalty framework, and on the other hand enforcing stricter compliance on financial institutions.

Impact on account holders 

New and/or pre-existing account holders are requested to provide a self-certification which contains information of the individual’s name, place of birth and jurisdictions the customer is tax resident.

Entities have to provide a more comprehensive self-certification form with special emphasis on entities that are Passive NFEs (which helps identify Controlling Persons).

It is crucial for individuals to determine and inform their tax residency in the self-declaration form as in principle, the financial institutions are not permitted to assist the individual in this process. 

The UAE has recently expanded the definition for being a tax residence in the UAE. In case of new individuals accounts, documentary evidence of a valid UAE residence visa must be available. 

Enhanced Due Diligence procedures will be carried out by the respective Financial Institution for account holders with a valid residency visa of more than 5 years and if the Financial Institution cannot validate the self-certification provided by this individual.

To discourage account holders from providing inaccurate or insufficient self-certifications, a fine amounting to AED 20,000 may be imposed on the account holder (or the controlling person).

Pitfalls

Despite the clear Common Reporting Standards, certain structures may still lead to non reporting of financial accounts. In addition, the tax residency criteria may differ from one jurisdiction to another, and unlike for international tax, there are no treaties providing tie breaker rules. This means amongst others that persons can have dual residences, and that for example a person who has acquired residency (or citizenship) by investment could be considered as a resident in the country of investment, whereas he is actually a tax resident in another country.

The UAE however, has recently updated its tax residency definition to to take into account these RBI/CBI schemes. 

Despite the rules becoming stricter and the enforcement more intense, there are still a number of service providers which propose structures to avoid CRS reporting which will ultimately not reach their goal. 

Ultimately, much confidence is placed in the due diligence process with the banks. Compliance is not always straightforward for financial institutions, who depend on the information disclosed to them and might not have much additional information to compare with. Amending submitted reports is also not an easy process.

Errors in CRS reporting may lead to incorrect exchange of information and affect account holders in the long run. A convenient and lenient correction process can encourage Financial Institutions to disclose errors without the fear of facing penalties.

Ultimately, the stricter enforcement of CRS is another step towards transparency taken by the UAE and individuals and businesses need to analyze their structures from this point of view, even more so today than when CRS was introduced in the UAE.