Background and legislative framework

Over recent years governments around the world have agreed international standards for the automatic sharing of financial account information between global fiscal authorities, with the aim of reducing tax evasion.

As part of its commitment to international transparency standards, the Cayman Islands government is a signatory to:

  • a Model 1B intergovernmental agreement with the United States which provides the framework for the implementation of the US Foreign Account Tax Compliance Act in the Cayman Islands; and
  • the Organisation for Economic Cooperation and Development-sponsored Multilateral Competent Authority Agreement and certain bilateral agreements or tax treaties regarding the Common Reporting Standard (CRS) on the automatic exchange of information (AEOI).(1)

Together, the CRS and the US intergovernmental agreement comprise the AEOI agreements.

As Cayman Islands entities are not directly subject to the AEOI agreements, the Cayman Islands has introduced legislation to implement these under the Tax Information Authority Law.(2) The Department of International Tax Cooperation (DITC) has issued guidance notes on the AEOI legislation,(3) providing details of the notification, reporting and ongoing obligations that apply, as well as a useful reminder of the differences between the Foreign Account Tax Compliance Act and the CRS.

The DITC is the government department responsible for tax affairs and the Tax Information Authority (TIA), created by the Tax Information Authority Law, is the competent authority for tax cooperation, housed in the DITC.

This update sets out the main obligations and action points under the AEOI legislation for Cayman Islands investment funds (for further information please see "Automatic exchange of information – further update").

How are investment funds classified for AEOI purposes?

In practice, most Cayman Islands investment funds fall within the definition of an 'investment entity' (one type of financial institution under the AEOI legislation) and will be classified as Cayman reporting financial institutions. There are differences between the definitions provided in the Foreign Account Tax Compliance Act Regulations and the CRS Regulations, with the term 'foreign financial institution' being used in the former. This update discusses financial institutions only.

Notification obligations

Register with US Internal Revenue Service

A reporting financial institution must obtain a global intermediary identification number (GIIN) – even if it has no US reportable accounts – through either the US Internal Revenue Service (IRS) Foreign Account Tax Compliance Act portal or a paper submission.(4)

Under the Foreign Account Tax Compliance Act Regulations, a Cayman Islands investment fund which is a reporting financial institution must register with the IRS within 30 days of starting business. While a fund is not technically operating until it starts to accept subscription payments from investors (for the purposes, at least, of the Mutual Funds Law), in reality, all funds must provide their GIIN numbers to banking and other counterparties at an early stage of their creation in order to open accounts. Therefore, this registration should be done as soon as possible after the vehicle has been formed.

When registering for a GIIN, the IRS portal requires the name of a natural person to be listed as the financial institution's responsible officer. The responsible officer of a reporting financial institution must:

  • deal with the IRS online registration;
  • certify that certain information entered as part of the online registration is accurate; and
  • certify that the reporting financial institution will comply with its Foreign Account Tax Compliance Act obligations.

The portal does not invoke the US Treasury concept of a responsible officer and those obligations are not imported into the Cayman Islands legal framework. The responsible officer is often the compliance officer of the investment manager or one of the directors of the fund if it is a corporate vehicle.

Register with TIA through AEOI portal

All Cayman financial institutions (both reporting and non-reporting) must register with the TIA on its AEOI portal and provide the required information, including details of their principal point of contact and authorising person. This information must be submitted by a PDF authorisation letter, signed by a director, trustee or general partner of the institution, and is intended to provide the DITC with details of all Cayman financial institutions. Where an institution has reporting obligations under the Foreign Account Tax Compliance Act Regulations, it must also enter its GIIN when it registers on the AEOI portal. The authorising person will be the only person from whom the TIA will take instructions that the principal point of contact has changed. The same person cannot be appointed as both the authorising person and the principal point of contact, and the TIA must be notified of any changes to these roles within 10 business days. For financial institutions which are already registered on the AEOI portal for Foreign Account Tax Compliance Act or UK Crown Dependency and Overseas Territories International Tax Compliance Regulations (UK CDOT) purposes, the principal point of contact must file:

  • a variation in reporting obligations on the portal to register the institution for CRS purposes; and
  • an updated authorisation letter giving details of the institution's authorising person.

Due diligence, reporting and ongoing obligations and penalties

Written policies and procedures

Every reporting financial institution must establish and maintain written policies and procedures in respect of their obligations under the AEOI legislation and related guidance notes, and implement and comply with those policies and procedures. Investment funds which have delegated this role to their administrator or another third-party service provider must have written policies and procedures in place, which describe:

  • the functions delegated;
  • the oversight of the delegation; and
  • the performance of any obligations that have not been delegated.

For reporting financial institutions which have not delegated these obligations, more comprehensive written policies and procedures must describe the performance of those obligations in a way that is reasonable for the business.

Identify reportable accounts

The directors, general partner, manager (for a limited liability company established in the Cayman Islands under the Limited Liability Law) or trustees (each an operator) of a reporting financial institution must ensure that they have a compliance and diligence programme in place to identify and report reportable accounts(5) in accordance with the due diligence requirements set out in the Foreign Account Tax Compliance Act Regulations, the CRS Regulations and related guidance notes. In the funds context, a 'financial account' is "any equity or debt interest in the investment entity other than interests which are regularly traded on established securities markets". As most funds do not issue debt or have their equity interests listed on an exchange, the classification of financial accounts is relatively straightforward. For example, for a standard Cayman Islands corporate hedge fund, the financial account will be the shares held by the investor and the value will be the net asset value as reported from time to time.

The DITC has confirmed that the Cayman Islands is taking a wider approach to due diligence under the CRS. Under the standard, there is still a distinction between a 'participating' jurisdiction, which has indicated that it will sign up to and implement the CRS, and a 'reportable' jurisdiction, for which reporting is required. Reporting financial institutions should ensure that they identify the tax residency of all account holders and relevant controlling persons (in the context of investment funds, this means investors), not just the tax residency of those in reportable jurisdictions. The 2017 CRS reportable jurisdictions are set out as an appendix to the guidance notes, which also includes a provisional list of 2018 reportable jurisdictions to enable reporting financial institutions to start planning for 2018.

Report specified information annually to DITC

Separate XML files must be submitted for each CRS reportable jurisdiction for which a Cayman reporting financial institution has reportable accounts and for US reportable accounts. Reporting obligations under the Foreign Account Tax Compliance Act Regulations and the CRS can also be satisfied by submitting a manual entry return. The first reporting year for the CRS for Cayman financial institutions was 2016, with certain information due to be submitted to the DITC on or before August 31 2017 for accounts opened since January 1 2016.(6) The information which must be provided will eventually include the name, address, taxpayer identification number, date of birth (where applicable), account number and account balance or value as at the period end. If the account holder is a passive non-financial entity(7) whose controlling persons are specified persons (with regard to the Foreign Account Tax Compliance Act) or reportable persons (with regard to the CRS), then the name, address and tax identification number of such persons must be provided.

Nil returns

Cayman reporting financial institutions must file nil returns for all CRS reportable jurisdictions for which they have no reportable accounts. This is done by submitting a CRS filing declaration and should be the final step after the Cayman reporting financial institution submits any necessary XML files for CRS reportable jurisdictions where the reporting institution has reportable accounts. Although not mandatory, reporting institutions should also file nil returns for Foreign Account Tax Compliance Act purposes if they have no US reportable accounts.

Liquidation reporting obligations

The CRS Guidance Notes require that financial institutions which are in liquidation or being wound up must fulfil their CRS notification and reporting obligations as normal. Liquidators must also ensure that the financial institution notifies the TIA of its final dissolution or winding up, and reporting institutions must comply with their reporting obligations for the previous and present calendar years. Under the CRS, a Cayman investment entity – like an investment fund – remains classified as such, even if it is closed (ie, has no remaining participating investors or is not open to further investors) or is in liquidation.

Offences and penalties

The CRS Regulations introduce various offences – including providing materially inaccurate information, tampering with information and hindering the TIA in its functions – with substantial fines or penalties applying on breach. The offences include potential criminal liability for directors and certain officers where their financial institution has committed an offence, unless they exercised reasonable diligence to prevent the breach. Any defendant has a defence if it has a reasonable excuse; however, insufficient funds and reliance on an agent are not classed as reasonable excuses. A breach of policies and procedures will also be deemed if a reporting financial institution relies on a self-certification or documentary evidence which it knows or has reason to believe is materially inaccurate. In addition, it is now an offence for any person to provide a false self-certification to a financial institution. Therefore, financial institutions and any party which has been engaged to assist with the CRS due diligence process should be aware that if they receive a false self-certification and they are aware of that fact, it may give rise to a requirement to make a suspicious activity report under the Proceeds of Crime Law.

Key dates

During 2017, certain transitional arrangements apply for financial institutions, with the key dates as follows:

  • Mid-May 2017 – the CRS and Foreign Account Tax Compliance Act notification and registration function became available on the AEOI portal, including variation in reporting obligations, with US Foreign Account Tax Compliance Act XML reporting available in June 2017.
  • Mid-June 2017 – the updated AEOI portal user guide for the CRS and the Foreign Account Tax Compliance Act became available with detailed CRS user guidance. The CRS reporting function also became available on the AEOI portal.
  • July 31 2017 – the CRS and Foreign Account Tax Compliance Act notification and registration deadline for Cayman financial institutions.
  • August 31 2017 – the CRS and Foreign Account Tax Compliance Act reporting deadline for Cayman reporting financial institutions, for the 2016 reporting year.
  • December 31 2017 – the review of pre-existing lower-value individual accounts and pre-existing entity accounts for CRS purposes must be completed.

From 2018, financial institutions will have to register on the TIA AEOI portal by the next April 30 after the first calendar year in which they become a Cayman financial institution and must thereby comply with the AEOI legislation. Reporting financial institutions will have to submit their reports to the TIA by May 31 each year.

Non-participating financial institutions and withholding tax

Reporting financial institutions are not subject to withholding tax for Foreign Account Tax Compliance Act purposes unless they are designated as non-participating financial institutions. The IRS may classify a Cayman Islands reporting financial institution as non-participating following the conclusion of procedures set out in the US intergovernmental agreement. The IRS may determine that a reporting financial institution is in significant non-compliance with the Foreign Account Tax Compliance Act obligations. It may then notify the TIA and require it to compel the reporting financial institution to obtain and report the required information. Failure to do so within 18 months of first notification permits the IRS to deem the reporting financial institution to be a non-participating financial institution and the Cayman Islands entity will be subject to withholding tax.

There are no withholding tax provisions under the CRS.

What steps should Cayman Islands funds have taken so far?

To address the issues arising under the AEOI legislation, investment managers and operators of existing Cayman Islands investment funds should have reviewed their existing documentation to ensure that:

  • there is sufficient disclosure regarding the various AEOI regimes;
  • the fund can obtain self-certification documentation at subscription or where a change of circumstances indicates that the self-certification is not reliable on a regular basis – examples being a change of address, telephone number or standing instructions to a bank maintained in a jurisdiction other than the tax residency of the investor;
  • the fund has the power to take broad steps to deal with investors which do not provide information or updated information and to allocate costs to those investors; and
  • there are exculpation provisions for the operators of the fund from liability arising from AEOI compliance.

In particular, Cayman financial institutions should review their CRS compliance policies and update these to ensure that they:

  • have suitable written policies and procedures in place;
  • are correctly registered with the DITC, including having provided details of their authorised person on the AEOI portal; and
  • can file any nil returns needed.

Subscription documents require special attention and should include:

  • an obligation on the investor to provide information and comply with due diligence requests which may require the provision of nationality, permanent residency information and tax residency representations; this can be in the form of a self-certification;(8)
  • an acknowledgement that the fund will disclose information to the TIA, which in turn will provide that information to tax authorities globally;
  • a general waiver of any legal restrictions which might otherwise prevent disclosure of information by the fund – although it should be noted that the AEOI legislation makes it clear that compliance with the disclosure obligations under the legislation will not amount to a breach of other Cayman Islands laws;
  • an acknowledgment of the effect of non-compliance and lack of disclosure by an investor and an acknowledgement that the fund may take any of the broad selection of powers that are reserved to the fund in its constitutional documents; and
  • an agreement that the investor will have no claims against the fund for any damages or liability arising as a result of actions taken or remedies pursued by the fund in order to comply with existing or future obligations imposed by the AEOI agreements or any enabling legislation enacted in the Cayman Islands.

This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.

For further information on this topic please contact Jonathan Culshaw at Harneys' Hong Kong office by telephone (+852 3195 7200) or email (jonathan.culshaw@harneys.com). Alternatively, contact Ian Gobin at Harneys' Cayman office by telephone (+1 345 949 8599) or email (ian.gobin@harneys.com). The Harneys website can be accessed at www.harneys.com.

Endnotes

(1) The government is also a signatory to an intergovernmental agreement with the United Kingdom which is being phased out in 2017 and superseded by the obligations contained in the CRS.

(2) The Tax Information Authority (International Tax Compliance) (United States) Regulations and the Tax Information Authority (International Tax Compliance) (Common Reporting Standard) Regulations, as amended, comprise the AEOI legislation. Definitions used here are as set out in the AEOI legislation unless otherwise indicated.

(3) The guidance notes can be found here and here.

(4) Registered deemed compliant financial institutions are also obliged to register with the IRS.

(5) US reportable accounts under the Foreign Account Tax Compliance Act Regulations and reportable accounts under the CRS Regulations.

(6) The TIA has confirmed that Cayman financial institutions which have reporting obligations under the UK Crown Dependency and Overseas Territories International Tax Compliance Regulations (UK CDOT) should not file a separate report in 2017; but rather, must include in their single CRS file for the United Kingdom all information that would be reportable under UK CDOT and, if it has reporting obligations under the CRS, any information that is reportable for the United Kingdom as a reportable jurisdiction which is not already reported above. From 2018, reporting on UK persons will be under the CRS obligations, as UK CDOT is phased out.

(7) The full definitions of a 'passive non-financial foreign entity' or 'passive non-financial entity' can be found in the guidance notes and the self-certification forms listed below.

(8) Links to the entity and individual self-certification forms issued by the DITC can be found here.