Who Is An Equity Interest Holder Of A Trust Qualifying As A Reporting FI
At the core of the CRS rules lies the obligation imposed on reporting financial institutions (FIs), including trusts, to identify their financial accounts in order to determine whether such accounts qualify as reportable accounts.The term “Financial Account” is defined in the CRS as an account maintained by an FI and includes, in the case of an Investment Entity, any equity or debt interest in the FI (Section VIII.C.1 CRS, p. 50).
An “Equity Interest,” in the case of a trust, is considered to be held by any person treated as a settlor or beneficiary of all or a portion of the trust, as well as any other natural person exercising ultimate effective control over the trust.
The identification of financial accounts and reportable persons is a critical process, as it determines the scope of an FI’s reporting obligations.
In its initial version, the Swiss CRS Guidance issued by the Swiss Federal Tax Administration adhered closely to the CRS, defining the equity interest holders of a trust that qualifies as an FI as the settlor, the beneficiary, or any other natural person exercising ultimate effective control over the trust.
It should be noted that equity interest account holders are not subject to a look-through approach where the account holder is a reporting FI, except in the case of a non-participating investment entity, which is treated as a Passive NFE.
How Switzerland Misapplied CRS Look-Through Rules for Trusts
A novelty introduced by the Revised Swiss CRS Guidance, inspired by the OECD CRS Implementation Handbook, is the obligation imposed on trusts to look through all entity account holders.While the CRS itself provides that an account holder qualifying as a Financial Institution (FI) is a non-reportable person, the Implementation Handbook states that where an equity interest (such as that held by a settlor, beneficiary, or any other natural person exercising ultimate effective control over the trust) is held by an entity, the equity interest holders are instead the controlling persons of that entity.Accordingly, a trust is required to look through a settlor, trustee, protector, or beneficiary that is an entity in order to identify the relevant controlling persons. This effectively results in FI-equity interest holders of an FI-trust being treated as Passive Non-Financial Entities rather than as true FIs.In 2021, the SIF amended its CRS guidelines in direct conflict with the CRS. The Swiss Federal Tax Administration adopted the views set out in the OECD Implementation Handbook and included a section in the Revised Swiss CRS Guidance addressing FI-trusts’ obligation to look through entity account holders and report on their controlling persons.As a result, the SIF incorrectly revised its position, imposing an obligation on FI-trusts to look through a settlor, trustee, protector, or beneficiary that is itself an FI entity in order to identify the relevant controlling persons. This again equates to treating FI-equity interest holders of an FI-trust as Passive NFEs rather than as true FIs.This position is justified by reference to the OECD CRS Implementation Handbook, with the conclusion that the FI status of an entity does not serve as a “blocker” with respect to FI-trusts’ reporting obligations.
The Core CRS / FATCA Principle: No Look-Through of Financial Institutions
Under the CRS and FATCA, Financial Institutions are defined as non-reportable persons. This is because the rules are designed to prevent duplicate and redundant reporting.
If a Financial Institution were required to look through its FI financial accounts, the FI being looked through would also have a reporting obligation. The OECD has stated that reporting responsibility should rest with the Financial Institution closest to the reportable person, as it is best positioned to know its account holder.
By obliging FI-trusts to look through FI equity interests, the SIF approach results in duplicate and redundant reporting, which is contrary to a core principle of the CRS.
Where Switzerland Misinterpreted the CRS Implementation Handbook
CRS Implementation Handbook, pp. 109–110, paragraphs 254–256Chapter 6.3: The treatment of a trust that is a Reporting Financial Institution under the CRS Identifying the Reportable Accounts of a trust that is a Reporting Financial Institution
254. The debt and equity interests of a trust constitute Reportable Accounts where they are held by a Reportable Person. The CRS defines the following entities as non-reportable persons: Financial Institutions, regularly traded central banks, international organisations, and government entities.(iv) Applying the due diligence rules256. Where an equity interest (such as an interest held by a settlor, beneficiary, or any other natural person exercising ultimate effective control over the trust) is held by an Entity, the equity interest holder is instead identified as the Controlling Persons of that Entity.Accordingly, the trust is required to apply a look-through approach to a settlor, trustee, protector, or beneficiary that is an Entity in order to identify the relevant Controlling Persons. This look-through obligation should correspond to the obligation to identify the beneficial owner of a trust under domestic AML/KYC procedures.Notably, nowhere—emphatically nowhere—does the Implementation Handbook provision on identifying the reportable accounts of trusts suggest that the term “Entity” includes non-reportable entities such as Financial Institutions.
CRS Treatment of Financial Institutions as Equity Interest Holders
CRS due diligence for pre-existing entities requires reporting only accounts held by Reportable Persons. Non-reportable entities—such as Financial Institutions (including custodial institutions), central banks, government entities, international organisations, and regularly traded corporations—must not be looked through.CRS, p. 38 Only reportable accounts are subject to due diligence. Accounts held by non-reportable entities—namely Financial Institutions, central banks, government entities, international organisations, and regularly traded corporations—are not subject to due-diligence procedures.CRS, p. 41 Section VI (Due Diligence for New Entity Accounts) requires a determination of whether an entity account is a reportable account. Where the account holder is a non-reportable entity—such as a Financial Institution, central bank, government entity, international organisation, or regularly traded corporation—the entity must not be looked through.Against this background, it is unclear why the SIF disregards the CRS requirement that entities qualifying as non-reportable must not be subject to a look-through approach by reporting FI trusts.
CRS Commentary on Financial Institutions Holding Equity Interests
Despite CRS Commentary paragraph 178 being explicit that this should not be done, State Secretariat for International Finance – SIF instructs Financial Institution trusts to look through all entities, including non-reportable entities such as Custodial Institutions.CRS Commentary, page 178, subparagraph C(4) – Equity Interest:69. The definition of the term “Equity Interest” specifically addresses interests in partnerships and trusts. In the case of a trust that is a Financial Institution, an “Equity Interest” is considered to be held by any person treated as a settlor or beneficiary of all or a portion of the trust, or by any other natural person exercising ultimate effective control over the trust.70. Where Equity Interests are held through a Custodial Institution, the Custodial Institution is responsible for reporting, not the Investment Entity.The following example illustrates how such reporting must be carried out:Reportable Person A holds shares in investment fund L.A holds the shares in custody with custodian Y.Investment fund L is an Investment Entity and, from its perspective, its shares constitute Financial Accounts (i.e. Equity Interests in an Investment Entity).L must treat custodian Y as its Account Holder. As Y is a Financial Institution (i.e. a Custodial Institution), and Financial Institutions are not Reportable Persons, such shares are not subject to reporting by investment fund L.For custodian Y, the shares held for A are Financial Assets held in a Custodial Account. As a Custodial Institution, Y is responsible for reporting the shares it holds on behalf of A.
OECD CRS FAQ On Equity Interest Of A Financial Institution Held By A Financial Institution
This position is also reflected in the OECD CRS FAQ on General Reporting Requirements. Page 2, Question 7, which addresses the look-through requirement, refers to an “entity” and does not specify a Financial Institution entity.
Hong Kong vs Switzerland: Look-Through Rules for Trust Equity Interests
Other major jurisdictions’ CRS guidelines on how they handle the “look-through” aspect of the Implementation Handbook on Entity Equity Interests of FI trusts
Under the CRS Implementation Handbook, equity interests in a trust that is a Financial Institution (FI) are considered to be held by any person treated as a settlor or beneficiary of all or a portion of the trust, or by any other natural person exercising ultimate effective control over the trust. The reference to any other natural person exercising ultimate effective control over the trust will, at a minimum, include the trustee as an equity interest holder.
A discretionary beneficiary will only be treated as an account holder in the years in which they receive a distribution from the trust.
Where a settlor, beneficiary, or other person exercising ultimate effective control over the trust is itself an entity, that entity must be looked through, and the ultimate natural controlling person(s) behind that entity must be treated as the equity interest holder.
Currently, it is the IRD’s understanding that the term “entity” used in this context does not include a person excluded from the definition of a reportable person.
Entities that are not reportable persons include all Financial Institutions (FIs).
