By David Richardson
President, Mid-Ocean Consulting Ltd.
For over 10 years Mid-Ocean Consulting has been active in structuring international clients affairs in a consistently compliant and transparent manor that optimizes both tax and asset protection, with the minimum of legally mandated reporting. We want to share our research about the new Common Reporting Standards (“CRS”) and the impact it will have henceforward on client confidentiality and financial structures.
As many will know, automatic exchange of information for tax law enforcement purposes started first in Europe with the EU Savings Tax Directive, went international with the US Foreign Accounts Tax Compliance Act, and, from 2017, will go global with the recently-agreed CRS. The CRS provides for annual automatic exchange between governments of financial account information. CRS sets out the financial account information to be exchanged, the financial institutions that need to report, the different types of accounts and taxpayers covered, as well as common due diligence procedures to be followed by financial institutions.
Background To The CRS
As an attack against “tax avoidance and evasion” facilitated by tax planning techniques used by some wealthy individuals and corporations in “tax havens” around the world, the G20 finance ministers endorsed automatic exchange as the new tax transparency standard on April 19, 2013.
On October 29, 2014, 51 jurisdictions, 39 of which were represented at ministerial level, signed a multilateral competent authority agreement to automatically exchange information based on Article 6 of the Multilateral Convention on Mutual Administrative Assistance in Tax Matters. Subsequent signatures of the agreement, including a signing ceremony on the margins of the Organization for Economic Co-operation & Development (OECD) Ministerial meeting of June 2015, brings the total number of jurisdictions to 61 (see below). This agreement specifies the details of what information will be exchanged and when, as set out in the Standard.
Countries that have signed up to the CRS will exchange information “automatically” with one another. The financial information to be reported with respect to reportable accounts includes interest, dividends, account balance, income from certain insurance products, sales proceeds from financial assets and other income generated with respect to assets held in the account or payments made with respect to the account.
Reportable accounts include accounts held by individuals and entities (which includes trusts and foundations), and the standard includes a requirement that financial institutions “look through” passive entities to report on the relevant controlling persons. The financial institutions covered by the standard include custodial institutions, depository institutions, investment entities and specified insurance companies.
What Countries Will Be Subject to CRS
The total number of signatories as at June 4, 2015, was 61, including the following countries and territories:
Albania, Anguilla, Argentina, Aruba, Australia, Austria, Belgium, Bermuda, British Virgin Islands, Canada, Cayman Islands, Chile, Colombia, Costa Rica, Croatia, Curaçao, Cyprus, Czech Republic, Denmark, Estonia, Faroe Islands, Finland, France, Germany, Ghana, Gibraltar, Greece, Guernsey, Hungary, Iceland, India, Indonesia, Ireland, Isle of Man, Italy, Jersey, Korea, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Mauritius, Mexico, Montserrat, Netherlands, New Zealand, Norway, Poland, Portugal, Romania, San Marino, Seychelles, Slovak Republic, Slovenia, South Africa, Spain, Sweden, Switzerland, Turks and Caicos Islands, and the United Kingdom.
A total of 93 jurisdictions committed to sign have endorsed the CRS, a number which is likely to continue to grow. Critically, data will begin to be collected starting 1/1/2016 for the OEDC countries, as 50 countries will start automatic data sharing in 2017, and the balance (including Brazil) come on line in 2018. This means that clients with structures in Barbados, Belgium, Bermuda, BVI, Cayman, Curacao, Cyprus, Denmark, Dominica, Gibraltar, Isle of Man, Ireland, Jersey, Guernsey, Latvia, Liechtenstein, Luxembourg, Malta, Mauritius, Montserrat, Netherlands, San Marino, Seychelles, Trinidad & Tobago, Turks & Caicos, Uruguay, United Kingdom will forever lose their privacy if they do not restructure their global estate by Dec 31, 2015.
Pre-Existing Insurance Exception
The new CRS rules, however, provide the following significant exception:
“Accounts Not Required to be Reviewed, Identified, or Reported. A Preexisting Individual Account that is a Cash Value Insurance Contract or an Annuity Contract is not required to be reviewed, identified or reported, provided the Reporting Financial Institution is effectively prevented by law from selling such Contract to residents of a Reportable Jurisdiction.”
This is an important carve-out for an otherwise legitimate and compliant financial instrument. Not a loophole, insurance is an “intended result”, that is being recognized for what it is; one of the few financial structures that offers substance to the form.
In terms of policy design, “death benefit only” policies (no cash value) add significant further protection as there is no account value to report as defined in the CRS regulations (similar again to FATCA). The goal may also be in designing international no cash value policies with substantial death benefit to fully satisfy a client’s local applicable tax and insurance rules- and may also simultaneously be US compliant, should a client or his or her beneficiaries move to the United States.
STRATEGY: Use of a Puerto Rico as a jurisdiction
A number of jurisdictions offer international life insurance that can at the same time qualify as both tax-exempt and not subject to reporting under the CRS regime, but we wanted to focus on one jurisdiction that is uniquely situated to offer reporting relief to not only U.S. policy holders, as it does now, but to the rest of the world given the impending CRS. That jurisdiction is Puerto Rico.
Puerto Rico is a US Commonwealth Territory that offers a progressive legal structure in the context of financial services with offshore-like flexibility but without the “haven” taint.
From a reporting perspective, insofar as the U.S. is concerned, U.S. policyholders are exempted from FBAR reporting and the PR resident institutions free from FACTA obligations, in that Puerto Rico is a US territory and deemed to be US for this purpose.
Now for non-US clients, Puerto Rico, as a US Territory is off the CRS grid as it is not (and cannot be) a direct party to CRS.
Returning then to the focus on insurance, life insurers in Puerto Rico are NAIC US and Puerto Rican Regulator supervised. The carriers there are not legally licensed to sell insurance locally in Europe, Canada or Latin America, but the exception seems to be on-point availability given the right fact situations. This therefore presumes policy acquisition by a non-native person e.g. a Chilean national cannot take direct ownership of an international policy.
Given that a policy cannot legally be sold to residents of Chile or potentially other countries, clients may require an entity that acquires and takes ownership of the policy.
STRATEGY: Use of a “Flow-through” Puerto Rico LLC
Puerto Rico has recently amended its income tax laws to allow for pass-through entity taxation. Accordingly, a Puerto Rico limited liability company (LLC) can be a corporation for local tax purposes, or a partnership with two or more partners, or it can be a disregarded entity with a single member. A disregarded entity does not have a separate tax existence, but rather is treated for Puerto Rico purposes as being the underlying LLC owner / member.
This means that international clients can now use a disregarded entity Puerto Rico LLC to acquire and own an international variable life insurance policy. As Puerto Rico is not subject to CRS reporting and further, is not subject to FATCA reporting applicable to foreign financial institutions, the Puerto Rico LLC would seem to be a better alternative to a BVI or similar international company.
Once the policy is issued, the LLC could be terminated via a distribution of the policy directly to the international client. Thenceforward, the international client has no offshore company or trust to get caught up in CRS reporting. The client would then own the policy directly. Simple, complaint and confidential.
For clients that already have and wish to maintain companies or trusts in jurisdictions that will be required to make the CRS reporting, the use of a death benefit only (no cash value) policy provides effective CRS protection as the policy has no reporting value for CRS purposes. Thus if the policy is issued prior to January 2016, the pre-existing insurance contract exception discussed above should apply.
International private placement variable life insurance policy can compliantly provide lifetime tax deferral and an income tax-free death benefit upon the death of the life insured under the tax laws of the United States as well as many other countries around the world. The policy also provides ongoing client confidentiality as the insurance company – rather than the client – is the deemed owner of the underlying policy reserve assets.
Asset protection is also very often a factor, and Puerto Rico has very clearly articulated laws that prevent any creditor of a policy owner (or policy beneficiary) from attacking a PR issued policy (unless of course the funding of the policy itself was a void fraudulent conveyance).
In general terms, international private placement variable life insurance, if issued before December 31, 2015, should be grandfathered from any future CRS reporting. A death benefit only policy (which can be US tax compliant under the IRC 7702 cash value accumulation test) would further buttress this position, as it has no cash value for CRS or FATCA reporting purposes. Meaning that even if the policy was deemed not to be grandfathered and was otherwise subject to CRS reporting, there is no value to report.
In addition to the aforementioned, such a policy, if issued from a Puerto Rican based insurer would be exempt from CRS reporting post the December 2015 grandfathering date, as Puerto Rico is altogether exempted as a U.S. Territory.