TAX ALERT CSSF CIRCULAR 15/609

TAX ALERT CSSF CIRCULAR 15/609 DEVELOPMENTS IN THE AREAS OF AUTOMATIC EXCHANGE OF TAX INFORMATION AND OF SANCTIONS AGAINST MONEY LAUNDERING IN TAX MATTERS: THE LAST CALL APRIL 2015 2015

On 27 March 2015 the CSSF released a short circular entitled Developments in the areas of automatic exchange of tax information and of sanctions against money laundering in tax matters. This Circular calls on Luxembourg financial sector professionals to engage in a proactive review of their client accounts and investment instruments in view of the tightening net of cross-border tax cooperation and enforcement tools. Let us briefly review these developments and their concrete implications. AUTOMATIC EXCHANGE OF INFORMATION In the coming twelve months, setting aside the known and relatively innocuous exchange of tax information on employment income / director s fees / pensions under directive 2011/16/UE and under the directive on the taxation of savings income, no less than three powerful look-through reporting tools will come into application. FATCA, 2014 data to be reported in 2015 The original FATCA compliance deadline in U.S. law was 1 July 2014. As a result of the execution of the Luxembourg IGA on 28 March 2014, all Luxembourg FFIs are presumed compliant, unless and until a determination to the contrary would be reached by the IRS. Exchange of information must be operational by 30 September 2015. CRS reporting within the EU, 2016 data to be reported in 2017 CRS designates the Common Reporting Standard developed by the OECD to facilitate cross-border automatic EOI of financial account information. Directly inspired from FATCA, it is currently being implemented under different forms and legal bases. Within the EU, Directive 2014/107/EU amends the administrative cooperation directive 2011/16/EU to provide for a significantly expanded automatic EOI, the terms and structure of which are copied on FATCA to cover most forms of income and assets on accounts. Data collection is set to start as of 1 January 2016, for reporting the following year. CRS reporting under the OECD multilateral convention Separately, at OECD level, 51 jurisdictions (that is EU and non-eu countries) have agreed to an automatic EOI on the basis of the CRS and most of them, including Luxembourg, have even committed to performing a first EOI on this basis in 2017. The legal basis for this exchange already exists in the OECD multilateral convention on administrative assistance in tax matters. 2

In all three cases, with marginal differences, the reporting will occur: BY banks, depositaries, investment entities and insurers; ON existing accounts (at least the significant ones) and all new accounts LOOKING THROUGH any interposed entities up to the natural person beneficial owner(s) TO the tax authorities of the countries of residence of such beneficial owners (via the Luxembourg tax authorities) Life insurance no longer left out In the original administrative cooperation directive 2011/16/EU, the Luxembourg tax authorities would only share the information available to them out of several income categories. Life insurance products are one of these categories, but they were excluded in practice from reporting because of the professional secrecy of insurance companies, which rendered information on life insurance contracts unavailable to the Luxembourg tax authorities. The CRS-based reporting introduced by Directive 2014/107/EU will trump this limitation and capture notably: any Cash Value Insurance Contract, that is any insurance contract (other than an indemnity reinsurance contract between two insurance companies) that has a Cash Value; Cash Value is the greater of (i) the contract value / redemption value, or (ii) the amount the policyholder can borrow under or with regard to the contract, but excluding: o o o o amounts due only because of the death of the insured under a life insurance contract; personal injury or sickness benefit or other benefit providing indemnification of an economic loss incurred upon the occurrence of the event insured against; è (pure) damage insurance coverage is out of scope a refund to the policyholder of a previously paid premium under an Insurance Contract (other than under a life insurance contract) due to policy cancellation or termination, decrease in risk exposure, correction of premium calculation error; or a policyholder dividend based upon the underwriting experience of the contract or group involved. any Annuity Contract, that is a contract under which the issuer agrees to make payments for a period of time determined in whole or in part by reference to the life expectancy of one or more individuals. 3

MONEY LAUNDERING The fourth directive on the prevention of the use of the financial system for the purpose of money laundering and terrorist financing is well on its way to final adoption, having already been approved by a first unanimous vote by the Council of Ministers of the EU on 21 April 2015. In the latest draft version of the directive, the eleventh point of the preliminary whereas section reads: It is important expressly to highlight that tax crimes relating to direct and indirect taxes are included in the broad definition of criminal activity in this Directive, in line with the revised FATF Recommendations. Given that different tax offences may be designated in each Member State as constituting criminal activity punishable by means of the sanctions as referred to in point (4)(f) of Article 3 of this Directive, national law definitions of tax crimes may diverge. While no harmonisation of the definitions of tax crimes in Member States national law is sought, Member States should allow, to the greatest extent possible under their national law, the exchange of information or the provision of assistance between EU Financial Intelligence Units (FIUs). Article 3(4), in turn, defines criminal activity predicate to money laundering as follows: criminal activity means any kind of criminal involvement in the commission of the following serious crimes: (a) acts set out in Articles 1 to 4 of Framework Decision 2002/475/JHA; (b) any of the offences referred in Article 3 (1)(a) of the 1988 United Nations Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances; (c) the activities of criminal organisations as defined in Article 1 of Council Joint Action 98/733/JHA ; (d) fraud affecting the Union s financial interests, where it is at least serious, as defined in Article 1(1) and Article 2(1) of the Convention on the protection of the European Communities financial interests; (e) corruption; (f) all offences, including tax crimes relating to direct taxes and indirect taxes and as defined in the national law of the Member States, which are punishable by deprivation of liberty or a detention order for a maximum of more than one year or, as regards Member States that have a minimum threshold for offences in their legal system, all offences punishable by deprivation of liberty or a detention order for a minimum of more than six months; While the preliminary whereas seems to imply that tax crimes must necessarily be considered as predicate offences to money laundering, in the actual operative provision tax crimes remain included in the last catch-all clause and thus must be mandatorily included by Member States only insofar as the standard prison term threshold is met (although, of course, Member States have the possibility, and are clearly strongly encouraged, to go beyond the requirements of the directive and include tax crimes altogether). The historical ambiguity over inclusion of tax crimes as predicate offences to money laundering is thus not finally resolved, as it would have been if tax crimes had been 4

included in a new, stand-alone point (f) in article 3(4), separate from the catch-all clause which would have become point (g). In Luxembourg, where aggravated tax fraud (escroquerie fiscale) is punishable by a jail term of one month to five years per 396(5) of the Abgabenordnung, the minimum prison term threshold of six months is not met and it will thus legally be a decision of the Luxembourg legislator, when implementing the new directive, to include aggravated tax fraud within the ambit of predicate offences to money laundering. This circumstance does not, however, alter the fact that the inclusion of tax offences is recommended by the FATF and could therefore separately be a point on which peer pressure can be exerted politically. More broadly, the new directive is expected to strengthen compliance requirements in a variety of respects, including the establishment of a beneficial ownership register for legal entities and certain trusts, and more severe penalties for professionals who would fail to comply with the required customer due diligence obligations. OTHER NOTEWORTHY EVOLUTIONS Parent-subsidiary directive takes an anti-abuse turn The EU Parent-Subsidiary Directive 2011/96/EU of 30 November 2011 was recently amended by: Directive 2014/86/EU of 8 July 2014, which aims at avoiding situations of double non-taxation deriving from mismatches in the tax treatment of profit distributions between Member States; and Directive 2015/121 of 27 January 2015, which further adds a de minimis General Anti-Abuse Rule (GAAR) to the EU Parent-Subsidiary regime. This GAAR in effect reflects a choice by EU countries in favour of one of several solutions proposed by the OECD in its works on Base Erosion and Profit Shifting (BEPS) Action Plan 6 on Preventing Treaty Abuse, that is, in favour of a general motive test to which it adds an economic reality check. The GAAR is targeted at: bearing in mind that: an arrangement or a series of arrangements which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of this Directive, are not genuine having regard to all relevant facts and circumstances. an arrangement or a series of arrangements shall be regarded as not genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality. Given that this new GAAR will essentially if not exclusively have a bearing in a crossborder context, its implementation will need to take account of the long-standing caselaw of the Court of Justice of the European Union under which tax restrictions to the freedom of establishment are legitimate only to the extent they target wholly artificial arrangements 1. Arguably, there is a difference between a wholly artificial arrangement and an arrangement that is not put into place for valid commercial reasons which reflect economic reality. 1 ECJ 12 September 2006, Cadbury Schweppes plc & Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue, C-196/04. See also ECJ, 22 May 2008, aff. C-162/07, and 20 June 2013, aff. C-653/11. 5

The presence of the qualification valid in the latter wording, together with the more flexible condition that tax optimization be one of the main purposes of such arrangement, concur in sliding towards a possibility for the tax authorities to revisit management decisions, which some Member States accept (think of the French acte anormal de gestion ) and which others refuse (Belgium, Luxembourg, for example). This could appear as a stretch vis-à-vis the classical notion of abuse of (tax) law, which targets a setup that is put into place for the (one) main purpose of avoiding tax and has little or no economic reality. Compatibility with domestic law definitions of the abuse of law in tax matters may hence also be at issue. Automatic exchange of information on tax rulings The OECD s Base Erosion and Profit Shifting (BEPS) project and current EU legislation provide for spontaneous exchange of information on tax rulings, but only in certain circumstances. In order to tackle corporate tax avoidance, the European Commission presented on 18 March 2015 a package of tax transparency measures, of which a key element is a proposal to introduce an automatic exchange of information between Member States on their tax rulings through a Council Directive amending the Directive 2011/16/EU as regards mandatory exchange of information in the field of taxation. The proposal sets a strict timeline: every three months, national tax authorities would have to send to all other Member States a pre-defined set of reasonably detailed information following a standard format on all cross-border tax rulings. This would cover (i) the name of the taxpayer (and group, where this applies), (ii) a description of the issues addressed in the tax ruling, (iii) a description of the criteria used to determine an advance pricing arrangement, (iv) identification of the Member State(s) most likely to be affected and (v) identification of any other taxpayer likely to be affected (apart from natural persons). Member States would then be able to ask for more detailed information on a particular ruling, where relevant. In addition, Member States would have to provide every year statistics to the Commission on the volume of information exchanged on tax rulings. The proposal covers all advance cross-border tax rulings and all advance pricing arrangements that Member States have issued to companies and entities since 2005, to the extent still valid, but purely domestic tax rulings and tax rulings issued to natural persons would be out of scope. In order to avoid divergent interpretations of what constitutes a tax ruling, the Commission has included a clear and very wide definition. 6

ASSESSMENT Beyond technicalities, it is fairly clear from the above developments that by the beginning of 2016 paper-only, mailbox-type entities will cease to be of any meaningful usefulness to corporate taxpayers in their operations with EU member countries, to say the least. Financial sector professionals are hence invited to take the necessary steps to avoid exposure for themselves and, where possible, for their clients. In this second case, those meaningful entities and clients where a dedicated effort at ongoing compliance with these new tax rules is warranted must be identified and warned. Such an effort should start with a thorough assessment of vulnerability to legal risks and threats, so as to determine whether (and how) the operational reality of the business concerned can be adjusted in due time and/or whether (and how) any interposed vulnerable entities or structures need to be eliminated. In view of: the rapidly changing tax legislation at both domestic and international levels, the significant potential for inconsistent implementation of some of the measures discussed above by the Member States, the resulting increased risk of cross-border conundrums where a necessary step for purposes of country A would trigger a significant issue in country B, the time needed to accommodate operational reality in this exercise, it is advisable to perform the above assessment and agree on actions required within a fairly short timeframe. Separately, corporate and individual clients who have frequently resorted to advance tax agreements in the past may want to revisit such structures to identify which ones are effectively still valid and which others no longer are. For further information feel free to contact the following persons: LIONEL NOGUERA lnoguera@bonnschmitt.net ANNE SELBERT aselbert@bonnschmitt.net KATHARINA MÜLLER kmueller@bonnschmitt.net PATRICK ANDERSSON pandersson@bonnschmitt.net *** BONN & SCHMITT APRIL 2015 7

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