Automatic exchange of financial account information

The Government recently introduced into the Legislative Council a bill to provide a legal framework for the implementation of automatic exchange of financial account information in tax matters (“AEOI”).  This would have significant implications both for financial institutions and, in a cosmopolitan city like Hong Kong, for many of their valued customers.

The Inland Revenue (Amendment) Bill 2016 (“Bill”) is intended to enable Hong Kong to catch up with the international standard for AEOI, and to enhance tax transparency and combat cross-border tax evasion.

Most financial institutions (“FIs”) are expected to start conducting due diligence procedures in respect of their financial accounts in 2017, to notify the Hong Kong Inland Revenue Department (“IRD”) if they have a reportable account, and to file account information with IRD annually, commencing in May 2018. IRD expects to make the first exchanges of information with reportable jurisdictions in September 2018. End 2018 is the latest time for such purpose permitted by the Global Forum on Transparency and Exchange of Information for Tax Purposes.

In brief outline, under the OECD standard for AEOI, FIs are required to:

• conduct due diligence procedures, to identify reportable accounts held by tax residents of reportable jurisdictions (i.e. non-Hong Kong tax residents who are liable to tax by reason of residence in an AEOI partner jurisdiction);
• collect reportable information in respect of these accounts; and
• report such information to IRD.

IRD would then exchange the information with its counterparts in the reportable jurisdictions on an annual basis.

Reporting FIs

These would comprise:

• depository institutions (including authorized institutions under the Banking Ordinance, such as banks);
• custodial institutions;
• investment entities (including securities and futures brokers, asset managers, leveraged foreign exchange traders, and authorized collective investment schemes); and
• specified insurance companies.

Only FIs which are resident in Hong Kong would be subject to the reporting requirements. In the case of an FI which is a company, it would be “resident in Hong Kong”, if it is incorporated in Hong Kong or, if incorporated outside Hong Kong, it is normally managed or controlled in Hong Kong.

It includes the Hong Kong branch of a financial institution that is not resident in Hong Kong.

Reportable jurisdictions

The Government intends to conduct AEOI only with jurisdictions with which Hong Kong has signed a comprehensive avoidance of double taxation agreement (“CDTA”) or a tax information exchange agreement (“TIEA”) on a bilateral basis. Signed CDTAs counterparties include Mainland China, the United Kingdom, Canada, France, Japan and Korea. Signed TIEAs counterparties include the United States.

The reportable jurisdictions would be listed in a Schedule to the Inland Revenue Ordinance.

AEOI jurisdictions would be expected to meet certain requirements for the protection of taxpayers’ privacy and confidentiality of the information exchanged and for ensuring proper use of the information exchanged. The Government says that safeguards would include:

• the information exchanged should be foreseeably relevant, and fishing expeditions are not allowed;
• there would  be no obligation to supply information under certain circumstances, e.g., where the information would disclose trade, business, industrial, commercial or professional secret or trade process, or which would be covered by legal professional privilege. (In light of the information to be exchanged (see below), it is difficult to see how this would apply.)

Reportable accounts

Account holders would be responsible for identifying their own tax residence. FIs would be required to perform a “reasonableness test” (see “Due diligence requirements” below).

The Government says that in general, whether an individual or entity is a tax resident of a jurisdiction is determined with regard to the person’s physical presence or stay in a place (e.g., whether over 183 days in a tax year) or, in the case of a company, the place of incorporation or where its central management and control lies. That a person has paid taxes in a jurisdiction (e.g., value-added tax, withholding tax or capital gains tax) does not automatically render the person a tax resident of that jurisdiction. The tax residence of individual account holders may change from one year to another, and tax laws differ amongst jurisdictions. Individual account holders would be responsible to verify and update their tax residence status and seek legal advice as necessary.

“Financial accounts” include:

• depository accounts (including commercial, “checking” (the U.S. term is used), savings and time accounts);
• custodial accounts (basically accounts that hold financial assets for others);
• subject  to certain exceptions, any ownership interest or debt interest in the FI.

Due diligence requirements

The Bill provides that FIs must establish, maintain and apply procedures to identify financial accounts held by tax residents of the reportable jurisdictions (“targeted approach”), and collect the reportable information.  Alternatively, FIs may adopt a “wider approach”, and identify (and keep information of) financial accounts held by all non-Hong Kong tax residents.

FIs would be required to review pre-existing individual low value accounts (with a balance of not exceeding HK$7,800,000) based on their record of the current residence address of the account holder which is in turn based on “documentary evidence” (e.g., a valid identification issued by an authorized government body). Failing which, and for pre-existing individual high value accounts, FIs would be required to review their electronically searchable databases for certain indicia. In certain cases, a further paper record search would be required.

For pre-existing entity accounts with a balance exceeding HK$1,950,000, the FI would need to review the information maintained for regulatory or customer relationship purposes to determine the account holder’s residence. A pre-existing entity account with a balance not exceeding that value would not be required to be reviewed, identified or reported.

On the opening of a new account, the FI would need to obtain a self-certification from the account applicant to identify his, her or its tax residence. The FI would need to confirm the reasonableness of the self-certification (“reasonableness test”) based on the information obtained by it in connection with the opening of the account. IRD would promulgate guidelines in this regard, together with a sample self-certification form.

FIs would also need to obtain a self-certification from an entity account holder to establish whether it is a passive NFE. “Passive NFEs” are non- financial institutions which satisfy certain conditions, including that 50% or more of its gross income is passive income. Self-certification is not required if the FI has information in its possession or that is publicly available, based on which it can reasonably determine the account holder’s status.

FIs would need to keep the evidence relied on, or a record of the steps taken, for carrying out the due diligence procedures, and sufficient records to enable the correctness and accuracy of their returns to be readily ascertained, for 6 years.

Reportable information

The reportable information would include:

(a)       the name, address, jurisdiction of residence, taxpayer identification number (“TIN”) and (if applicable) date and place of birth of each reportable person, i.e., (i) the account holder who is an individual reportable person, or (ii) an account holder that is an entity reportable person, or (iii) an entity account holder and its controlling reportable persons, if one of its controlling persons is a reportable person;

(b)       the account number (or functional equivalent);

(c)       the account balance or value as of the end of the relevant calendar year (or other reporting period) or, if the account was closed during such year (or period), the closure of the account. This would include, in the case of a cash value insurance contract or annuity contract, the cash value or surrender value;

(d)       in the case of a custodial account:

1. the total gross amount of interest, the total gross amount of dividends, and the total gross amount of other income generated with respect to the assets held in the account, in each case paid or credited to the account (or with respect to the account) during the calendar year (or other reporting period); and
2. the total gross proceeds from the sale or redemption of financial assets paid or credited to the account during the calendar year (or other reporting period) in respect of which the FI acted as a custodian, broker, nominee, or otherwise as an agent for the account holder;

(e)       in the case of a depository account, the total gross amount of interest paid or credited to the account during the calendar year (or other reporting period);

(f)        in the case of an account not described in paragraph (d) or (e) above, the total gross amount paid or credited to the account holder with respect to the account during the calendar year (or other reporting period) in respect of which the FI is the obligor or debtor, including the aggregate amount of any redemption payments made to the account holder during the calendar year (or other reporting period); and

(g)       the name and identifying number (if any) of the FI.

FIs would not be required to report TIN or date of birth in respect of pre-existing accounts if the information is not in their records and is not otherwise required to be collected by the FIs under Hong Kong law. (It is not clear why the new law would not spell out the latter requirement.) However, FIs would be required to use reasonable efforts to obtain the TIN and date of birth in respect of pre-existing accounts by the end of the second calendar year following the year in which such accounts were identified as reportable accounts. FIs would not be required to report TIN if a TIN is not issued by the AEOI partner or the domestic law of the AEOI partner does not require the collection of TIN.

FIs are not required to report place of birth for both pre-existing and new accounts, unless the FIs are otherwise required to obtain and report it under Hong Kong law and it is available in the electronically searchable data maintained by the FIs.

IRD would provide a secure AEOI Portal for FIs to submit notifications and file AEOI returns electronically. The portal would permit updating of account information, submission of returns, and amendment of returns. FIs would be required to use digital certificate for authentication.

The new law would empower IRD to enter the business premises of FIs and inspect their compliance system and process, if the inspection is reasonably required for the purpose of checking its compliance with the due diligence and reporting obligations, upon 7 days’ prior notice by IRD.

Exemptions

Certain FIs and accounts (non-reporting FIs and excluded accounts), which present a low risk of being used for tax evasion, would be exempted from reporting.

Non-reporting FIs would include, e.g., the Mandatory Provident Fund Schemes and the Occupational Retirement Schemes.

An authorized collective investment scheme is exempted, if all of the interests in the scheme are held by or through any of the following:

1. individuals who are not reportable persons;
2. entities that are not reportable persons and are passive NFEs with controlling persons who are not reportable persons.

Excluded accounts would include certain retirement or pension accounts, and dormant accounts.

Sanctions

For non-compliance with the due diligence or reporting obligations without reasonable excuse, an FI would be subject to a fine at level 3 (HK$10,000). For non-compliance with the requirements to file returns or non-compliance with a notice for rectification, there would be a further fine of not exceeding HK$500 for every day or part of a day during which the offence continues after conviction.

If the offence was committed with the consent or connivance of a director of the FI, or other officer concerned in its management, that director or officer would also commit the offence.

An employee of, or a person engaged to work for, an FI would be held liable if he or she, with intent to defraud, causes or allows the FI to provide misleading, false or inaccurate information. The penalty is:

• on summary conviction, a fine at level 3 and imprisonment for 6 months; or
• on indictment, a fine at level 5 (HK$50,000) and imprisonment for 3 years.

It would be an offence for an account holder to provide, knowingly or in a reckless manner, misleading, false or incorrect information in a material particular in making a self-certification to an FI. The penalty is a fine at level 3.

Related issues

FIs would need to comply with the data protection principles in Schedule 1 to the Personal Data (Privacy) Ordinance. Accordingly, they would need, e.g., to inform their customers of the possible use of the information collected for AEOI purposes. FIs would also need to take all reasonably practicable steps to ensure that the personal data are accurate. Customers will be entitled to request access to and correction of their personal data.

It may be noted that the collection of personal data from FIs, and the exchange of such information by IRD with other jurisdictions with which Hong Kong has signed a CDTA or TIEA, is exempt from the Data Protection Principles 3 and 6 of the Personal Data (Privacy) Ordinance.