Family Office: Global Tax Regulatory Trends for High Net Worth Individuals

Tax has always been a hot topic.

With the continuous deepening of the liberalization and mobility of the global economy, global tax regulation has become increasingly transparent. For high-net-worth individuals, how to reasonably and compliantly arrange global asset allocation and tax is a problem that must be rigorously solved.

The contemporary world is an era of economic globalization and digitalization. The liberalization and mobility of the economy continue to deepen, cross-border trade keeps growing, and the world financial system becomes increasingly complex. There is an unprecedented intermingling relationship between countries and between countries and non-state actors. As a result, tax matters, which were originally under the jurisdiction of domestic laws of each country, have continuously entered the international arena, leading to complex multilateral and even global tax issues.

Tax governance implies tax cooperation, and international tax governance implies tax cooperation between countries.

The concept of a global tax dates back to 1884, and then around the time of the establishment of the United Nations in 1945, economists and policymakers often discussed the need for a strong international economic policy to avoid the dangers of another depression and war.

From the 1950s to the 1960s, the idea of a global tax was no longer mentioned and became a casualty of the Cold War, and its implementation was strongly opposed by the US government and many large corporations.

It was not until the 1990s that the global tax began to receive attention again. On the one hand, the United Nations and its reform advocates strongly promoted the imposition of a global tax; on the other hand, the proposal for a global tax still faced strong opposition from many wealthy countries.

In 1989, realizing that money laundering had severely threatened the banking and financial systems, the G7 member countries, the European Union Commission, and eight other countries established the Financial Action Task Force on Money Laundering (FATF).

In 2013, the Base Erosion and Profit Shifting (BEPS) action plan, initiated and implemented by the Organization for Economic Cooperation and Development (OECD), quickly spread globally with the political authority of the G20.

In 2018, the international tax havens BVI and the Cayman Islands successively issued economic substance bills, requiring companies to increase their economic substance. The introduction of this regulation strengthened the tax supervision of multinational companies, increased the operating costs of tax haven companies, and had a positive impact on corporate tax compliance.

history of global tax regulation

Similarly, after the 2008 financial crisis, the US federal fiscal pressure surged. To alleviate the predicament, the Obama administration ultimately signed the Foreign Account Tax Compliance Act (FATCA). This act requires foreign governments to allow financial institutions worldwide to provide tax-related information of taxpayers’ overseas assets to the IRS. It also requires US taxpayers to declare their overseas account assets when they exceed a certain threshold.

Subsequently, more and more countries have taken corresponding actions. The global joint action against tax evasion has thus made further progress, and the Common Reporting Standard (CRS) is an essential part of this action.

The Common Reporting Standard (CRS) was established to provide financial institutions with the content for collecting and reporting information on individual and corporate accounts of foreign tax residents. It offers ample legal protection to promote international tax cooperation and accurately combat cross-border tax evasion.

Next, this article will introduce the key points of FATF, FATCA, CRS, BEPS, and the Economic Substance Act respectively.

The Financial Action Task Force (FATF) was established in 1989 and is headquartered in Paris. It currently has 39 full members, including 37 jurisdictions and 2 regional organizations (the Gulf Cooperation Council and the European Commission). China became an official member of the organization on June 28, 2007.

The FATF’s mission is to continuously assess global money laundering risks and to be responsible for the ongoing update of international standards for anti-money laundering/counter-terrorist financing/counter-proliferation financing (AML/CTF/CPF).

It also continuously strengthens its standards to address new risks, such as the supervision of virtual assets and virtual asset service providers (VASPs) that have spread with the popularity of cryptocurrencies, as well as the supervision of designated non-financial businesses and professions (DNFBPs).

As the most effective international organization against money laundering, the Financial Action Task Force (FATF) has achieved a series of remarkable results since its establishment. The main achievements are:

1. Anti-Money Laundering and Counter-Terrorist Financing Recommendations
2. Publication of a list of non-cooperative countries and territories (NCCTs)

(1) FATCA

In 2007, the United States experienced a subprime mortgage crisis, which subsequently triggered a global financial crisis.

In order to quickly address the fiscal deficit, the U.S. government turned its attention to the overseas financial accounts hidden in tax havens by U.S. residents, attempting to alleviate fiscal pressure by collecting the “hidden” personal taxes that had not been paid, without easily increasing taxes. As a result, the FATCA bill was born.

(II) CRS

In 2012, five European countries, including the UK, France, Germany, Italy, and Spain, signed an intergovernmental agreement with the United States under FATCA.

Inspired by FATCA, the five European countries announced in April 2013 that they would develop and pilot a multilateral automatic exchange of tax information mechanism for financial accounts based on Model 1 of the US FATCA intergovernmental agreement, and received support and approval from the Council of the European Union, with the intention of extending the system to the EU and even globally.

In September 2013, at the St. Petersburg Summit, a formal request was made to the OECD to develop a set of unified reporting standards for the automatic exchange of tax information on financial accounts worldwide, similar to the US FATCA system.

Special Financial Action Task Force on Anti-Money Laundering

The process of CRS information exchange mainly includes two parts:

First, financial institutions in one country (region) identify accounts opened by individuals and businesses who are tax residents of another country (region) through due diligence procedures, and annually report to the competent authorities of the country (region) where the financial institution is located, including information such as the account holder’s name, taxpayer identification number, address, account number, balance, interest, dividends, and income from the sale of financial assets;

Second, the tax authorities of the country (region) where the financial institution is located carry out information exchange with the tax authorities of the resident country (region) of the account holder.

(1) BEPS

BEPS refers to the strategy of tax planning that takes advantage of the differences in tax systems and mismatched rules between different tax jurisdictions. The purpose of BEPS is to artificially cause taxable profits to “disappear” or transfer profits to low-tax countries (regions) with little or no substantive business operations, thereby achieving the goal of not paying or paying less corporate income tax.

There are many reasons for the emergence of BEPS, and the following three are typical:

FATCA and CRS

Firstly, countries independently exercise their tax sovereignty, leading to mismatches in domestic tax systems. For example, expenses that can be deducted in Country A may not be considered taxable income when received by Country B;

Secondly, international tax rules are not well-established. With the development of the digital economy and technology, the originally widely applicable tax principles and methods have become outdated or have loopholes;

Thirdly, there is a lack of effective mechanisms for international tax cooperation, such as information exchange and mutual assistance in tax administration.

(II) Economic Substance Act

In 2015, the OECD released the final report of the fifth action plan of the BEPS project – “Considering Transparency and Substantial Factors to Effectively Combat Harmful Tax Practices,” which elevated the standard of substantial activity to an important position.

Subsequently, the EU began to release the “blacklist” and “greylist” of uncooperative tax jurisdictions from 2016.

In the process of determining the list of uncooperative tax jurisdictions, the EU Corporate Tax Behavior Guidelines Group (Code of Conduct Group) identified three key factors, one of which is economic substance.

The British Virgin Islands (hereinafter referred to as “BVI”) and the Cayman Islands successively issued the “Economic Substance (Companies and Limited Partnerships) Act” and the “International Tax Cooperation (Economic Substance) Act” in 2018, along with a series of amendments, regulations, and implementation guidelines, officially opening the legislative chapter of the substantive activity standard.

The legislation of the substantive activity standard is an important progress in the tax system reform of tax havens for more than 20 years, marking the first time that the standard has been truly reflected in the legislation of tax havens since the OECD’s “1998 Report” proposed the substantive activity standard.

Since the 19th century, global tax regulation has been a focus of attention, but there has been no substantive legislation to regulate it due to reasons such as economic conditions, technological level, and political factors at the time.

Nowadays, the increasing transparency of global taxation poses a serious challenge to high-net-worth individuals. How to reasonably arrange global asset allocation and tax planning is a major issue that needs to be resolved by high-net-worth individuals.

BEPS and economic substance legislation