Plenty of tax exchange of information
Our November Private Client Briefing deals with the topic of how in times of increased transparency and global financial scrutiny, the exchange of tax information has become a critical process. To address these challenges, it's imperative to advocate for greater clarity, fairness, and streamlined procedures in the exchange of tax information, offering taxpayers a smoother path through this intricate landscape. Hope you enjoy the reading.
The story generally begins when the Portuguese tax authorities receive information on taxpayer X, concerning financial investments originating from DAC2/CRS from foreign tax authority in Country Y, through the OECD/EU Common Transmission System.
Until here no issue, as it is the international policies for the exchange of tax information between competent authorities that were developed at EU or OECD level working normally. 110 jurisdictions across the world apply the Common Reporting Standard (CRS) and the Foreign Account Tax Compliance Act (FATCA).
In 2022, information on over 123 million financial accounts, covering total assets of above EUR 12 trillion, was exchanged automatically according to the OECD.
There is limited information regarding the internal procedures used by the Portuguese tax authorities to cross-verify the information exchanged and the tax return information. "The 'black box' aspect becomes more evident in the following steps.
First step starts by taxpayers receiving a generic letter indicating that it was identified that foreign income was exchanged inviting the taxpayer to review their tax return on what regards foreign income. An invitation without detail or a warning that a potential problem may exist.
Second step starts by taxpayers being formally notified of a potential tax discrepancy indicating the amount and qualification of the income and requesting to the taxpayer to re-submit the tax return within a short deadline.
Third step starts by issuing a tax assessment on the value of the amount and qualification of the income (plus compensatory interests) mirroring the amounts resulting from the exchange of information and providing the taxpayer a short deadline to pay the outstanding tax.
Fourth step is expediting a tax enforcement process to ensure that the tax assessment is paid (if they have not paid under the prior step).
Between those steps many intermediate actions are generally taken by the taxpayer and advisors, but in many cases those actions are unsuccessful to stop the full force of the tax machine.
We also can provide some examples of technical issues arising from exchange of information mismatches:
joint accounts being reported for the full amount to both joint holders giving rise to discrepancies on tax returns;
information exchange on controlling persons that is deemed to be income made available or reporting jurisdiction as equating to source of the income;
gross proceeds of investment-linked life insurance contracts being considered income;
considering “other income” under CRS as equivalent to “other income” under tax treaties to disqualify the nature of the income as dividends or interest income; and
use of gross proceeds from sale or redemption under CRS without any recognition of corresponding acquisition cost.
To shed light on the tangible impact of the exchange of tax information, let's delve into a real-life scenario. Meet Taxpayer A, an individual inadvertently reported to the Portuguese tax authorities under CRS regulations for receiving a trust distribution. The report lacked critical details, causing substantial costs and distress. Taxpayer A embarked on a daunting journey to address the situation, clarifying the circumstances and resolving the ensuing tax assessments. Eventually, the situation was clarified, leading to tax assessments and, after a protracted process, a tax refund.
As legal counsels, we are noticing that the tax authorities use the data as indisputable proof of income being realized when the purposes of the exchange of information is to exchange some details of financial income and not to determine the exact amount of income to be taxed by the country of residency.
Numerous complex issues arise related to tax base, source determination, cross-border income qualification, and tax credits or exemptions.
There are also questions about what information is required to be reported, if this is correctly being reported by the foreign financial institution, but those unfortunately are not privy to the taxpayer.
The taxpayer is also in many instances confronted with a shift of the burden of proof and the “devil proof” or impossibility or extreme difficulty to produce information in short notice on foreign accounts, with foreign banks and documentation. Unfortunately it is not easy to navigate the system with confidence and minimal disruption.
One may also raise the issue of the burden of proof of facts that generally falls upon those who invoke them, being the tax authority or the taxpayer. Is it fair that the mere data stream under a XLS Schema communicated secretly between tax authorities without any notification to the taxpayer would be sufficient to invert the burden of proof automatically to the taxpayer?
In January 2026, we will have the addition to the exchange of information architecture (DAC Directives) of the information on certain revenues from crypto asset transactions and the provision of advance tax rulings for high-net-worth individuals.
Undoubtedly, the pendulum has shifted and the landscape of global finance has witnessed a paradigm move placing an emphasis on transparency.
Back in 2015, we were already talking about “Big Data, Tax Information and the New Oil – Paradox of Plenty?”
More than ever, taxpayers should beware of problems surrounding these issues are bound to increase in the coming years, because there will be a push towards automating the tax return submission process, because technology will be more used via data matching to compare with all connected information provided, and because artificial intelligence will be deployed to identify patterns and irregularities to pick up unreported income.
This means automatic exchange of information is here to stay and taxpayers will be evidencing that more frequently. That does not mean they should not remain vigilant and careful with the pendulum, as privacy and confidentiality play a major role in the financial industry. Recently, the Court of Justice of the European Union invalidated the public access feature of the Ultimate Beneficial Owner (UBO) register of the AML Directive. Stakeholders and institutions should continue to push for better information rules, better security governance to reduce cyber risks and privilege privacy concerns.
We live in an information-rich world, with plenty of tax-related data at the forefront.
© Kore Partners, 2023. This briefing provides for general information and is not intended to be an exhaustive statement of the law. Although we have taken care to provide accurate information, this should not replace legal advice tailored to your specific circumstances. This briefing is intended for the use of clients and selected recipients. Queries or comments regarding this, including joining our mailing list, can be directed to kore@korepartners.com