Common Reporting Standard – protectors are in the firing line

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By Andrew Knight*

In line with tightening global tax transparency, the OECD’s Common Reporting Standard (CRS) is fully in play in South Africa and in a number of the principal trust jurisdictions. Protectors are potentially in the firing line to be reported on for tax purposes. Family trusts and their protectors should not delay in seeking advice about the impact of the CRS as the first round of reporting is imminent.

Frequently the protector of a family trust is a friend of the family who has accepted the role of protecting the interests of the beneficiaries and ensuring that the intended purposes of the trust are properly fulfilled. While protectors have certain fiduciary powers and obligations, their position is often unremunerated and, as protectors, they generally do not have any economic interest in the trust assets.

Andrew Knight, Maitland

The CRS should be all about ensuring a flow of information between tax authorities where that information is relevant to their residents’ tax affairs. The fact that someone is a protector would not generally be relevant to their tax affairs.

However, protectors are at risk of being reported under the CRS particularly where they are considered to be exercising control over the trust. This could result in the protector being investigated by the tax authorities in circumstances where the protector is entirely tax compliant. All protectors would therefore be well advised to have their position as protector analysed. A review of the CRS classification of the trust and the trust deed would be the first step.

Which trusts are affected?

The fact is that trusts generally are targeted by the CRS and almost any trust outside the United States with a protector will be affected by this issue, provided the trustees are in a CRS jurisdiction and regardless of the governing law of the trust.

How are protectors affected by the CRS?

In many cases, trusts are classified as financial institutions, particularly if they have a professional corporate trustee or their assets are managed on a discretionary basis by a professional manager. A trust that is a financial institution is deemed to maintain financial accounts. Such trusts, through their trustees, are obliged to gather the relevant information from their account holders and, where reportable, pass it on to their tax authorities.

Where a trust is a financial institution it is likely to be one in the form of an investment entity. A financial account in relation to an investment entity includes an equity interest in that entity. So, what is an equity interest in relation to a trust?

As the concepts of financial institution, investment entity and financial accounts do not sit easily with a family trust, rules have had to be specifically designed so that they can apply in a trust context. And it is a bit like trying to hammer a square peg into a round hole.

Even so, particularly bearing in mind the introductory comments above, protectors reading this article may well be saying to themselves that they certainly do not hold an equity interest. But protectors should be aware that here the CRS peg is hammered particularly hard as the CRS deems the following people to hold an equity interest:

    1. the settlor
    2. the beneficiaries
    3. anyone else exercising ultimate effective control over the trust.

It is the third category that potentially affects a protector. Can it be said that a protector is “exercising ultimate effective control” over a trust? The OECD, through its Frequently Asked Questions (FAQs), state that any protector should be treated as an account holder irrespective of whether they exercise effective control over the trust.

Our view at Maitland is that the OECD position is not consistent with the CRS rules that the OECD itself have formulated. Most CRS countries (the Cayman Islands is a notable exception) have not adopted the OECD FAQs as part of local law. Thus, the OECD position may in many cases not be an accurate statement of the law and it would not be correct to follow it. But it shows us what we are up against. Some trustees may find it easier to follow the advice of the OECD in the FAQ rather than to perform the factual analysis required to determine whether the protector is indeed exercising a sufficient degree of control to be treated as holding an equity interest.

Do protectors exercise ultimate effective control?

Trustees should consider this question carefully before taking the view that the protector is subject to reporting particularly as there may be circumstances in which the entire value of the trust would be reported to the protector’s tax authorities.

Fortunately, there will be many instances where a protector’s powers will be such that they do not place ultimate effective control in the hands of the protector and, even if they do, there is still the question as to whether the protector actually exercises those powers. But the position can only be clarified in each case by an examination of the terms of the trust deed and of the other factual circumstances surrounding the role actually played by the protector.

Where there is doubt as to the impact of the current powers of a protector as set out in the trust deed, steps could be taken to create greater certainty by removing or modifying certain powers. Consideration could also be given to dispensing with the protector role altogether. However, in many cases it may be possible to retain a protector without adverse reporting consequences.

When are protectors treated as controlling persons?

In some cases, a trust will not be a financial institution. This is where, for example, its trustees are individuals or the financial situation of the trust does not meet the requirements for financial institution status. In most of these cases, the trust will instead be classed as a “passive non-financial entity”.

In such a situation, the trustee has no reporting obligations. Instead the obligations shift to other financial institutions (for example banks or investment funds) with whom the trust holds an account. If the trust has a wholly owned subsidiary with a managed investment portfolio, that entity is also likely to be a financial institution with reporting obligations. In such cases, the underlying company is required to identify the controlling persons of the trust and, if relevant, file reports regarding them.

Where a trust is a passive non-financial entity, any protector is treated as a controlling person. This follows directly from the wording of the CRS rules, which specifically state that a protector is a controlling person regardless of whether or not they actually exercise any control. Thus, the bank will report the protector as someone with control over the trust’s bank account and this information (which will include the account balance and movements on the account) is likely to end up with the tax authorities in the country of the protector’s residence.

It can readily be seen that the protector of a trust that is a financial institution is in a better position as regards CRS reporting compared with where the trust is a passive non-financial entity. In the former situation, legitimate measures can be taken to ensure that unnecessary reporting does not happen. In the latter, termination of the protector role may be the only remedy.

Next steps for protectors

Reporting in South Africa and many trust jurisdictions will start to be made by trustees in the next few months. Protectors would be well advised to verify whether their trusts are financial institutions and, if so, whether their powers under the trust deed are such as to render them reportable. It may well not be too late to take remedial action.

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