Taxation is how states raise funds to pay for and fund the public service. Given the vast sums involved, large organisations and individuals have in the past sought ways to avoid paying tax through leveraging the global banking system so they are out of reach of local tax authorities.
As reported by the Washington Post, US$1.38 trillion is directed each year by corporations to tax havens that charge little-to-no tax, with governments missing out on $245 billion in tax as a result. In addition, researchers found countries losing $182 billion due to wealthy individuals moving funds to tax havens. Authorities have sought to close loopholes exploited by these types of companies and individuals through the Foreign Account Tax Compliance Act (FATCA). The Organisation for Economic Co-operation and Development (OECD), an organisation with 37 member states including the United States, also introduced the Common Reporting Standard (CRS) for similar purposes.
FATCA and CRS seeks to combat tax avoidance via foreign banks and other financial service providers. They achieve this by gathering information and reporting the required information for financial institutions, entities and individuals in participating countries. Like FATCA, the CRS seeks to fight tax evasion and to protect the integrity of participating country tax systems.
Today, given the significant advantages FATCA and CRS bestow on both the US and local tax authorities (including South Africa), organisations and reporting institutions are required to conform to these regulatory statues.
Below, we discuss why entities – institutions or organisations that are required to report required information – are classified, how they are classified, the information needed, and lastly, a brief overview of the self-certification process.
Why entities are classified
Only certain entities are reportable under FATCA and CRS. The emphasis of these different regulatory standards is to determine the correct classification of each entity. This is because they inform the reporting financial institution, typically the local tax authority like the South African Revenue Service or Internal Revenue Service in the United States – which clients are reportable, which client is classified as which entity and what information is required to be collected.
How an entity is classified
Based on these key standards, it is critical to determine which accounts should be reported and information required to be reported to the tax authority. To do so, the entity itself must be classified. Entity refers to the institution doing the reporting, and how it generates its income. The different types of entities, as broken down by FATCA and CRS, are:
- Financial institution: An entity which generates income from the provision of goods and services that are financial in nature
- Non-financial entity (NFE): There are two types of NFEs
- Active NFE: An entity which generates over 50% of its income through active income, money received through the performance of a service
- Passive NFE: An entity which generates the majority of its income through passive income, funds derived from rent, limited partnership or other enterprises where a person is not actively involved.
What entity information is required
The information needed by the reporting authority depends on how the entity is classified. The information required includes a series of data points that help the relevant tax authority identify the entity, controlling persons, determine whether that entity is reportable, and if so, what the entity’s tax obligations are. To obtain this information, a self-certification would generally be collected from the account holder.
The self-certification process
Self-certification is the process where a financial institution requests their account holders to certify several details about themselves so they can determine the country or countries in which the entity or the controlling persons are a tax resident of, and by implication, where tax may be owed.
All reporting financial institutions are legally required to collect and report certain information relating to their account holders. Reporting financial institutions must ask account holders to provide certain information so they may determine whether their specific details or selection thereof need to be reported, as stipulated by FATCA and/or CRS.
New clients must complete a self-certification form when a new account is opened unless that information is already in the financial institution’s possession. When an account holder`s personal details change, they are required to advise the reporting financial institution of any change in circumstances which affects the holders’ jurisdiction or leads the information to being incorrect. This is important as the reporting financial institution provides this information to the local tax authority. If details do change, the account holder would need to provide an updated self-certification.
To learn how Letsema’s Governance, Risk and Compliance team can help your organisation navigate the complexities of FATCA and CRS, email GRC@letsema.co.za or info@letsema.co.za.
