Following the introduction of the Criminal Finance Act 2017 in the UK and EU Council's revisions of its "blacklist" of non-cooperative jurisdictions for tax purposes (last updated June 2019) and numerous intergovernmental bodies' efforts to clamp down on tax avoidance in the EU, firms are expected to introduce enhanced defensive measures to ensure tax and money laundering compliance when transacting with blacklisted jurisdictions. Here we explore five core areas, which financial institutions must consider to ensure they meet anti-money laundering (AML) and tax regulatory requirements.
High-profile data leaks such as the Panama Papers and Paradise Papers have put tax management matters firmly on the international radar. Intergovernmental bodies such as the G20, Organization for Economic Cooperation and Development (OECD) and Financial Action Task Force (FATF) have established that fighting tax evasion and tax avoidance requires an international response. The EU Council has also been focusing heavily on clamping down on tax avoidance, evasion and fraud. As part of its work in 2019, the EU updated its list of non-cooperative EU tax jurisdictions, which continue to fall short of acceptable international standards for transparency, fair tax competition and the OECD's Base Erosion and Profit Shifting (BEPS). The 11 remaining countries on this "blacklist" continue to be subject to increased monitoring and audits, withholding taxes and/or additional documentation when they transact with financial institutions within the EU.
Managing Money Laundering Risks Associated with "Blacklist" Countries
As a result of the Criminal Finance Act 2017, managing tax integrity risk is now an integral part of AML compliance. We have seen an increased number of EU financial institutions starting to assess the risk of money laundering through tax evasion when undertaking due diligence or transaction monitoring. These firms are also taking active measures to ensure preventative AML systems and controls are implemented efficiently. However, a number of firms are falling behind emerging market practices and regulatory requirements.
To assist EU firms with managing tax integrity risks and meeting regulatory expectations, we set out below five key areas of good practice:
- Risk appetite should clearly articulate the firm's appetite in relation to customers' tax motives and tax optimization strategies. Firms should ensure this risk appetite is reflected in management information reported to senior management. This will support firms in demonstrating effective oversight of the performance of the business against its risk appetite and identify potential customers outside risk tolerance levels.
- Business risk assessment should incorporate an impact analysis including a heat map of business lines, sectors and countries of operation and registration. Firms should also consider how the EU blacklist affects their operations. If a Firm identifies tax integrity risks upon conducting the analysis, it should formulate new policies and procedures as well as strengthen internal controls to address these new risks. This will provide the robust framework from which compliance and senior management can demonstrate effective understanding, oversight and management of tax-related financial crime risks.
- Training should be provided to all employees to enable them to sufficiently identify tax integrity red flags. Employees across the business should know how to pinpoint unusual transactions or suspicious behavior. Understanding risks and early detection can materially mitigate tax-related financial crime risks firms may be exposed to.
- Due diligence/customer risk assessment should consider the complexity of organizational structures such as layers of the customer's ownership structure, presence of special purpose vehicles, foreign legal entities, presence of trusts or amendments to customer's ownership, nature and purpose of business relationship and financial flows. Examples of high-risk indicators include overly complex organizational structure across multiple jurisdictions, presence of nominee shareholders or bearer shares in a structure or overly complex transaction layers which includes multiple jurisdictions. Firms should also ensure that customers who present higher tax-related risks, continue to be compliant with applicable tax legislation and seek comfort where needed through requesting confirmation from a reputable tax adviser.
- Transaction monitoring controls should be in place to monitor account activity, including cross-border transactions. Where unusual account activity is detected, good practice includes requesting customers to provide evidence supporting the transaction to fully understand the commercial rationale of the account activity.
How Duff & Phelps can help?
Our AML and tax experts across our European offices can help you navigate these complexities and assist your firm in meeting regulatory requirements.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.