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Time to comply: China implements OECD's financial info exchange

Local financial institutions have started carrying out due diligence on customers’ tax residency as devised by the CRS. But some questions still remain

Chinese financial institutions have started carrying out due diligence on customers’ tax residency as devised by the CRS. But some questions still remain

Inside China
Inside China, written by FenXun Partners’ Xusheng Yang and Sue Liu, provides an insight into aspects of the Chinese market that often elude the naked eye.

Yang is a specialist in China’s financial markets and institutions, having started his career at the China Securities Regulatory Commission and then co-founding FenXun in 2009. Liu’s practice focuses primarily on the asset management industry, and she has previously worked as an associate at Skadden Arps Slate Meagher & Flom in New York.

On May 9 2017, six Chinese administrative and regulatory agencies jointly promulgated the Administrative Measures for Due Diligence on Non-Resident Financial Account Tax-Related Information (the Measures). These became effective on July 1, a significant step forward made by China in implementing the OECD's common reporting standards (CRS) for the automatic exchange of information (AEOI).

The OECD's initiative to create a multilateral automatic information exchange framework aims to combat offshore tax evasion by improving information exchange and transparency in the global financial system. Under the AEOI framework, tax-related financial information will be exchanged automatically among participating jurisdictions on an annual basis. By June 2017, 101 jurisdictions had committed to the CRS, 50 of which have undertaken to start exchanging information in September 2017. China signed the CRS Multilateral Competent Authority Agreement on December 5 2016 and has committed to start the exchange of information in September 2018. All major economic financial hubs have committed to the CRS, with the exception of the US.

As required by the Measures, financial institutions established in China have started due diligence review of customers' tax residency and are now collecting information on accounts opened/held by non-Chinese residents. Although the Measures are expected to affect a relatively small group of entities and individuals, a certain level of confusion and anxiety has been observed in a wider group of businesses and high net worth individuals.

Scope of the Measures

The AEOI framework does not create extraterritorial jurisdiction. Each participating jurisdiction adopts the CRS into its own legal and regulatory regime, and regulated entities are required to comply with domestic laws and regulations. As such, Chinese financial institutions are obligated to comply with the Measures and other CRS related rules and regulations that may be promulgated by Chinese regulators in the days to come. Chinese financial institutions are to report the required information to the State Administration of Taxation of China (SAT), which will in turn administer the exchange of information with relevant authorities of other jurisdictions. Chinese financial institutions are not obligated to report any information to foreign authorities and the SAT is not authorised to collect information directly from foreign institutions.

The Measures impose due diligence and reporting obligations on financial institutions established in China. The term financial institution refers to savings depository institutions, custodian institutions, investment institutions and certain insurance institutions. More specifically, the term expressly includes (i) commercial banks, rural credit cooperatives and policy banks; (ii) securities companies; (iii) futures companies; (iv) securities investment fund management companies, private fund management companies and partnerships engaging in private fund management; (v) insurance companies offering insurance products with cash value or annuity products, and insurance asset management companies; and (vi) trust companies.


Passive NFEs attract extra attention as they are regarded as susceptible to being used as intermediaries for cross-border tax evasion


The term expressly excludes (i) financial asset management companies; (ii) finance companies; (iii) financial leasing companies; (iv) auto financing companies; (v) consumer financing companies; (vi) currency brokerages; and (vii) securities registration and settlement institutions. Persons that are not reporting financial institutions under the Measures are not required to act even if they have relevant information regarding tax residents of foreign jurisdictions.

The Measures are applicable to monetary and financial assets held in financial accounts. Real properties and other personal properties are not reportable, regardless of their value. Securities interests held outside of financial accounts maintained at reporting financial institutions are not reportable either. Instead, the realisation of the value of such non-reportable assets will be reportable. For instance, when a cash consideration for non-reportable assets is paid into a bank account upon transfer, this cash income becomes reportable. However, certain (i) retirement benefit accounts; (ii) social security benefit accounts; (iii) term life insurance contracts; and (iv) accounts opened for judicial orders and rulings, asset transactions, mortgage tax and insurance payments and tax payments are exempted. These exclusions and exemptions make good sense since the purpose of AEOI is tax collection, not wealth detection.

Only non-resident held accounts are reportable. Reporting financial institutions are not required or authorised to collect or report account information of Chinese tax residents (unless they can be regarded as tax residents of foreign jurisdictions). Under the Measures, reporting financial institutions are required to conduct due diligence of all accounts (other than certain expressly exempted accounts) to determine the residency of the account holders or controlling persons. Starting from July 1, reporting financial institutions are required to identify the tax residency of account holders when opening new accounts. In respect of accounts opened on or before June 30 2017, reporting financial institutions are required to complete the review of individual account holders with an aggregate balance of $1 million or more by December 31 2017, and complete a review of entity account holders or controlling persons with an aggregate balance of $250,000 or more by December 31 2018. Aggregation applies to the balance of all financial accounts maintained by an account holder or controlling person with the applicable financial institution and its affiliated entities.

Passive non-financial institutions

When reviewing the tax residency of entity account holders, reporting financial institutions are also required to identify passive non-financial institutions (passive NFEs). Passive NFEs attract extra attention because they are regarded as susceptible to being used as intermediaries for cross-border tax evasion. The term passive NFE refers to an institution where (i) more than 50% of the income in the preceding calendar year is passive income (such as dividends, interest, rent, and royalties) or income from transfers of financial assets that produce such passive income; (ii) more than 50% of the assets held during the preceding calendar year are financial assets that produce passive income; or (iii) an investment entity whose tax jurisdiction does not implement the CRS. Passive NFEs do not include (i) list companies and their affiliates; (ii) government agencies or institutions preforming public services; (iii) holding companies established for the sole purpose of holding stocks of, or providing financing and services to, non-financial institutions; (iv) an entity that has been established for less than 24 months and has not started operation; (v) an entity in the process of dissolution or reorganisation; (vi) an entity that provides financing or hedging to affiliated entities within a company group that consists solely of non-financial institutions; and (vii) not-for-profit organisations.

Where the controlling persons of a passive NFE are identified as non-Chinese tax residents, a reporting financial institution is required to collect and record information concerning the passive NFE and its controlling persons. The term controlling person is broadly defined to include any individual (i) holding, directly or indirectly, more than 25% of the stock or voting rights of a company; (ii) controlling the company through human resource or financing arrangements; or (iii) that is part of the senior management personnel.

The controlling person of partnership is a person holding more than 25% of the partnership interest. The controlling person of a trust is the settlor, trustee, beneficiary or any other person exercising effective control. The controlling person of a fund is a person holding more than 25% of the fund interest or that otherwise controls the fund.

Residency criteria

The residency of a person of interest under the Measures refers to tax residency. Under Chinese income tax laws, a resident entity refers to an entity established in China or an entity established in accordance with laws or a foreign jurisdiction but is effectively managed by an entity established in China. In respect of a natural person, a resident generally refers to a person domiciled in China, or a person who is not domiciled in China but has resided there for more than a year (meaning residing in China for 365 days in any tax year, excluding a temporary absence of fewer than 30 days at any one time or 90 days in aggregate in total in any tax year).

Because tax residency is determined pursuant to the domestic laws of a participating jurisdiction, it is possible that a person may be considered a tax resident of multiple jurisdictions.

Other important factors

Self-certification

When conducting due diligence review under the Measures, reporting financial institutions are generally allowed to rely on self-certification produced by account holders and controlling persons. However, when opening new accounts, reporting financial institutions should review the reasonableness of such self-certification against other available information and seek reasonable clarification from account holders with respect to apparent discrepancies.

The self-certification forms are created based on OECD sample tax residency self-certification forms.

Reportable information

Information to be reported by financial institutions to the SAT includes (i) identification and residency information; (ii) account balance or net value; and (iii) interest and other income in the calendar year.

In order to comply with the Measures, reporting financial institutions are required to register on the SAT's website by December 31 2017, and thereafter conduct their annual reports by May 31 of each year.

Enforcement

The Measures were jointly promulgated by the SAT, the Ministry of Finance, the People's Bank of China, the China Banking Regulatory Commission, the China Securities Regulatory Commission and the China Insurance Regulatory Commission.

Their implementation and enforcement have the backing of all relevant regulatory agencies of reporting financial institutions. Reporting financial institutions which do not comply with the Measures may face administrative penalties, including the suspension or revocation of their business licence, and a ban of the responsible directors and other senior management from the financial services industry.

CRS and Fatca

The CRS can trace their origins to the US Foreign Account Tax Compliance Act (Fatca), which was enacted in 2010 as part of the HIRE Act and became effective in 2014. Fatca generally requires foreign financial institutions and certain non-financial foreign entities to report the foreign assets held by their US account holders or be subject to a 30% withholding penalty on certain payments.


Chinese residents may still be affected by the CRS even though their onshore accounts are not subject to reporting under the Measures


The US has not participated in the AEOI framework. Instead, it relies on separate bilateral agreements entered into with offshore jurisdictions to collect information on financial accounts held by US persons offshore. Although China and the US had reached an agreement in substance in respect of Fatca in June 2014, no definitive agreement had been developed and Chinese institutions are not currently required to comply with Fatca. However, US tax residents are not expressly excluded from the Measures, which means that due diligence review and information collection may still be conducted with respect to US tax residents, but information exchange will not be conducted until further action by the Chinese and US governments.

Chinese residents may still be affected by the CRS, even though their onshore financial accounts are not subject to reporting under the Measures.

Reporting financial institutions are not required or authorised to collect and report account information concerning Chinese tax residents (unless a Chinese tax resident is also considered a tax resident of foreign jurisdictions). However, if a Chinese tax resident maintains financial accounts offshore in a CRS jurisdiction, that offshore account information may be collected and reported by the relevant foreign financial institutions, and disclosed to the Chinese tax authorities on an annual basis upon automatic exchange of information between China and the foreign jurisdiction. The offshore account information may constitute a basis for tax assessment and collection of offshore assets. Although participating jurisdictions have committed to implementing the CRS in accordance with the parameters set out by the OECD, to understand how a foreign jurisdiction implements the CRS, one would need to study its domestic laws and regulations.

The first attempt at information exchange under the AEOI is planned for next month. Although China will not participate in this highly anticipated first batch of information exchange, many Chinese businesses and individuals are acutely aware of its potential impact and will be watching carefully.

By Sue Liu, partner at FenXun Partners (Beijing)

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