Professional Interpretation

On May 19, 2017, the State Administration of Taxation of the People’s Republic of China along with the Ministry of Finance, PBOC, CBRC, CSRC and CIRC released the “Measures on the Due Diligence of Non-resident Financial Account Information in Tax Matters” (hereinafter referred to as the “Measures”) that take effect from July 1, 2017. This means that domestic financial institutions in China will conduct due diligence on deposit accounts, custodian accounts, equity interest or debt interest of the investment institutions and insurance contracts or annuity contracts with cash values. In fact, in September 2014, China has decided to comply with CRS. On July 1, 2015,     the Standing Committee of National People’s Congress approved the “Multilateral Convention on Mutual Administrative Assistance in Tax Matters”. On December 17, 2015, China signed the “Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information”. The measures released on May 19 is regarded as fulfilling the obligations laid down in “Multilateral Competent Authority Agreement on Automatic Exchange of Financial Account Information”.

The implementation of CRS raises new requirements of asset allocation and overseas investment planning for domestic resident especially high net worth individuals. Our professional team of Family Office Advisory hereby offers brief analysis of CRS to assist client to tackle the implications of CRS through financial assets self-examination, entrustment relationship sorting, trust and insurance plan design, accounts transfer and cancellation etc.

A. What is CRS?

CRS, which stands for Common Reporting Standard, is part of automatic exchange standard of financial account information in tax matters. It was released by the Organization for Economic Co-operation and Development(OECD) in July 2014, aiming to enhance tax transparency through international cooperation and combat tax evasion of cross-border financial accounts. CRS requires the participating countries to conduct periodical automatic information exchange to disclose financial status of foreign account holders to their local tax authorities. Two conditions need to be met to implement CRS, which are: (a) the country or region has committed to comply with CRS; (b) the participating country or region has committed to “voluntary matching” of information.

At present, 101 countries and regions have committed to implement multilateral automatic information exchange, among which 54 countries and regions committed to conduct the first information exchange from September 1, 2017; 47 countries and regions committed to conduct the first information exchange from September 1, 2018.

B. Implications of CRS for Residents in China

The implementation of CRS will have impact on individuals that own overseas financial assets, have investment in overseas shell company, establish companies overseas for international trade, set up overseas family trust, purchase overseas insurance policies etc.

Taking the “tax haven” Canada as an example, Canada has committed to implement CRS in September 2018. If implemented as scheduled, Canada will have full-scale tax information exchange with China. Financial institutions in Canada will identify bank accounts held by tax residents of China through corresponding procedures and transfer such information through relevant authority to its counterpart in China. Tax authorities in China will then compare the financial information transferred back with overseas assets declared by taxpayers. If found to have concealed assets, relevant individuals will be imposed punishment accordingly.

“Chinese version” of CRS, aiming to realize impartial information exchange, mainly focus on conducting due diligence on accounts of non-resident, but may have impact on residents as well. As nationality is not the criteria to determine the tax resident, residents in China could be non-tax residents. China adopts criterion of domicile and duration of stay in determining tax residents. Individuals who domiciled within the borders of China or who is not domiciled, but lives in China for no less than one year shall be considered as tax residents of China. According to the Enterprise Income Tax Law of the People’s Republic of China, an enterprise which is set up under the law of a foreign country (region) and whose actual management organ is not within the territory of China but who has organs or establishments within the territory of China, or who does not have any organ or establishment within the territory of China but who has incomes sourced in China, is non-resident enterprise. For instance, an individual who set up a company in a country with preferential tax policies and received payment overseas, but obtained the actual incomes sourced in China, will be target of due diligence of “Chinese version” of CRS.

C. How to tackle the implementation CRS?

CRS seems to be a taxation issue, however, could be a fundamental reform that involves international governance rules around the globe. Especially for Chinese investors, it is an opportunity to thoroughly review their own asset, structure, nationality and residence planning and global allocation of business. CRS sets the rigid requirements for assets self-examination. Investors thus must have conception of asset allocation, understand risks encountered and take steps to diagnose and deal with such risks in advance.

a. Financial Assets Self-examination

Individuals that directly hold financial assets and investment insurance overseas, or hold such assets through companies or trust structures, of which personal financial account information is within the scope of information exchange, are advised to conduct self-examination of financial assets as soon as possible.

b. Sorting out entrustment relationship

CRS requires prudent due diligence on clients. Therefore, financial institutions need to identify the ultimate controlling owner of entrustment structure as the actual entity to be reported. The rationale for entrustment structure is to preserve wealth, thus if it may be prone to punishment, entrusted party is advised to sort out the entrustment relationship as soon as possible.

c. Trust & insurance plan design

According to the rules of CRS, relevant information of established family trust is also required to be disclosed, including the trustor of family trust (settlor), protector, trustee (normally trust institutions) and beneficiary. However, reasonable and sophisticated application of family trust and insurance solutions could serve to defer taxation, avoid tax and debt.

d. Accounts transfer and cancellation

Despite that 101 countries and regions have committed to comply with CRS, the implementation progress in participating countries and regions varies. Meanwhile, participating countries and regions may have varied reservation on implementation. Hence, taxpayers could choose to transfer the accounts to the U.S. or other countries or regions that have not committed to conduct information exchange.

e. Taxation counseling

For those who need to register financial accounts overseas to make investment and asset allocation in countries and regions that committed to comprehensively implement CRS, legitimate taxation planning could be conducted to lower the actual tax burden. For instance, tax liability and declaration rules in tax laws vary widely in accordance with the legal arrangements of foreign investment. Furthermore, reasonable transfer pricing is a frequently used means for transnational companies to avoid tax.

f. Tax residence identity choice&planning

The core of CRS is the identity of tax resident rather than legal resident. Investors may alter the habitual residence to obtain the tax resident identity in countries or regions that have no income tax or special taxation regime.

The implementation of CRS will expose the domestic and overseas accounts, but there is still plenty of room for planning. Individuals that may be influenced are advised to take measures immediately to maximize own legitimate interests.