I’ll go even further: The OECD has gone mad when it comes to Protectors. Stark raving mad. The real question now is whether countries implementing CRS will follow the OECD into the insane asylum. Some might. None ought to.
What on earth am I on about?
Earlier this month, the OECD posted updated CRS FAQs on its website. They are available here. If you scroll down to page 15, Question 5, you will see the following new Q&A:
This FAQ does not pass the laugh test. The OECD’s own definition in the Common Reporting Standard (CRS) of an Account Holder in a trust that is a Financial Institution is a person who holds a so-called “equity or debt interest” in the trust. A “debt interest” Account Holder is not defined, and debt interests are in any event not relevant to this blog. But “equity interest” Account Holders are defined in the CRS. Specifically, they are held by “a settlor or beneficiary of all or a portion of the trust, or any other natural person exercising ultimate effective control over the trust.” Since the word “Protector” is not mentioned in that definition, the only way a Protector could—even arguably—be an equity interest Account Holder in a trust is if it satisfied the language at the end of the definition, i.e., if it were a natural person “exercising ultimate effective control over the trust.” But look back at the FAQ—it says a Protector must be treated as an Account Holder “irrespective of whether it has effective control over the trust.” This is truly nuts and directly contrary to the OECD’s own definition of an equity interest Account Holder in a trust.
Now let’s dig a little deeper.
Under both FATCA and CRS, the whole universe of entities is divided into two groups: “Financial Institutions” (FIs) and “Non-Financial Entities” (NFEs).
NFEs are further divided into two groups: “Active” NFEs and “Passive” NFEs.
As relevant to this blog, FIs report two things:
- their “Account Holders”, and
- if their Account Holders are Passive NFEs, the Controlling Persons of those Passive NFEs
(The Controlling Persons of Active NFEs are irrelevant.)
Therefore, what’s relevant for FIs is Account Holders, and what’s relevant for Passive NFEs is Controlling Persons:
|Account Holders||Controlling Persons|
Now, the FATCA Inter-Governmental Agreements (IGAs) and CRS both define (i) the “Account Holders” of a trust that is an FI, and (ii) the “Controlling Persons” of a trust that is a Passive NFE. Those definitions are different when it comes to Protectors. As we shall see, that difference is fundamental.
For reasons I’ll explain later, my firm view is that a Protector should never be an Account Holder of a trust that is an FI if that trust is properly administered. Some practitioners take a different view, arguing that a Protector can be an Account Holder of an FI trust if the Protector has certain powers especially the right to change the trustee. One thing is indisputable, though: As demonstrated above, it is absolutely nonsensical to argue that all Protectors are Account Holders in FI trusts. And yet this is the very position the OECD takes in the above FAQ!
To understand even further why the FAQ’s position makes no sense, you need to understand the history of the definition of an Account Holder in an FI trust. More specifically, you need to know not just what that definition says but how it relates to the definition of a Controlling Person of a Passive NFE trust. Let’s start with the latter.
CRS defines a Controlling Person of a Passive NFE trust as “the settlor(s), the trustee(s), the protector(s) (if any), the beneficiary(ies) or class(es) of beneficiaries, and any other natural person(s) exercising ultimate effective control over the trust.”
The FATCA IGAs’ definition is identical in all materials respects. As you can see, Protectors are expressly included. There is no question, then, that at least some Protectors are Controlling Persons of Passive NFE trusts.
One can quibble about whether the language at the end of the definition (“other natural person(s) exercising ultimate effective control over the trust”) modifies all the categories that come before it, i.e., whether Controlling Persons include all settlors, trustees, Protectors and beneficiaries or only those exercising ultimate effective control over a trust. The CRS Commentary takes the position that all Protectors are included even if they are not “exercising ultimate effective control over the trust.” I don’t necessarily agree with that interpretation. However, the definition is ambiguous enough that the OECD’s interpretation is certainly plausible.
Thus, under CRS, if you’re a Protector of a trust that is a Passive NFE you’re automatically a Controlling Person. Full stop. And if the Passive NFE trust is an Account Holder of an FI, e.g., it has an account at a bank, the FI (bank) will report the Protector as a Controlling Person. That much is clear. Open issues include how one treats Protector committees, corporate Protectors, and persons with Protector-like powers who are not called Protectors, e.g., “Appointors”. I’ll leave those issues for another day. To keep things simple for this blog, we’ll assume we’re dealing with a Protector who is called by that name, who is an individual, who is not also a settlor or beneficiary, and who is not a member of a Protector committee.
Now, the above definition of a Controlling Person of a Passive NFE trust was not created by the OECD or even by the U.S. when it wrote the FATCA IGAs. No, the definition was copied from the definition of a “beneficial owner” of a trust in the 2012 version of the so-called Financial Action Task Force (FATF) Recommendations, which are anti-money-laundering (AML) rules. Indeed, both CRS and the FATCA IGAs expressly require the definition of Controlling Persons of Passive NFE trusts to be interpreted consistently with the FATF Recommendations.
With that background, let’s turn away from the definition of a Controlling Person in a Passive NFE trust back to what’s directly involved in the OECD’s new FAQ on Protectors, i.e., the definition of an an Account Holder in an FI trust.
Under both CRS and the FATCA IGAs, the definition of an Account Holder of an FI trust uses the definition of a Controlling Person of a Passive NFE Trust as its starting point. But it makes hugely significant changes especially when it comes to Protectors. Take a look at the following table comparing the two definitions and you’ll see what I mean.
As you can see, neither trustees nor Protectors are mentioned in the definition of an Account Holder in an FI Trust. This is not a mistake. It was an intentional omission.
Remember, the definition of a Controlling Person of a Passive NFE was copied from the FATF Recommendations. But the FATF Recommendations don’t define “Account Holders” in trusts. This is because trusts don’t actually have “Account Holders”. Settlors, yes. Beneficiaries, yes. Trustees, yes. Protectors, maybe. But “Account Holders”? No. Except that both CRS and FATCA say FI trusts have “Account Holders” (I am not making this up!) so they obviously had to define that term. What did the drafters do? As mentioned earlier, they defined an “Account Holder” in an FI trust to be anyone with a “equity or debt” interest in the trust. So what is an “equity” interest”?
As anyone with a passing knowledge of trust law knows, beneficiaries have equitable title to trust assets and trustees have legal title. Protectors, of course, have neither equitable nor legal title. So it made sense to include beneficiaries as “equity interest” Account Holders in trusts, but not to include trustees or Protectors. As for settlors, well, unless they are also beneficiaries, they don’t have equitable title. However, settlors at least come a lot closer to having equity interests in trusts than do trustees and Protectors—after all, settlors are the people who actually create trusts and transfer their assets to those trusts. So, rightly or wrongly, settlors were included in the definition of “equity interest” Account Holders. But, rightly, trustees and Protectors were deleted from the definition, which took as its starting point the definition of Controlling Persons of Passive NFE trusts.
Thus, as pointed out above, given that Protectors (and trustees) are not expressly listed as Account Holders in FI Trusts, the only possible way they could be included is if they fell within the language at the very end of the definition, i.e., if they were natural persons “exercising ultimate effective control over the trust.” There is no other possibility: Unless a Protector is also a beneficiary or settlor (which is not the sort of Protector we’re discussing in this blog), there can be no way a Protector can fall within the definition of an Account Holder in an FI trust.
As mentioned earlier, I don’t believe any Protectors of trusts that are properly administered are Account Holders in FI trusts. In other words, I don’t believe any Protectors exercise “ultimate effective control” over properly administered trusts. The definition doesn’t say “some control”, “much control”, or even “significant leverage”. It says “ultimate effective” control. That’s pretty powerful wording. That describes someone who’s running the show and calling the shots—someone in the driver’s seat.
Now, some practitioners argue that if a Protector has the right to change the trustee, the Protector does run the show and call the shots and is therefore exercising “ultimate effective control” over the trust. I beg to differ. Sure, a Protector with the right to hire and fire the trustee has a good deal of leverage over the trustee. But “ultimate effective control”? To reach that conclusion, you have to assume the trustee is, in effect, the Protector’s puppet—that the trustee is so afraid of being fired that it does whatever the Protector says. If the trustee truly cowers in this fashion, then the trustee is not doing its job. A trustee has fiduciary obligations. If it ignores those obligations and simply bows to the Protector’s every wish to save its job, it is in breach of trust. So, I maintain that a Protector of a trust that is properly administered should never meet the definition of an Account Holder in a FI trust, i.e., should never be treated as exercising “ultimate effective” control over the trust.
Let’s say, though, that you have a trust that’s not properly administered, i.e., where the trustee really does do the Protector’s bidding and cedes “ultimate effective” control over the trust to the Protector. We can all agree that in that case—a case where the trustee is in clear violation of its fiduciary duties—the Protector should be treated as an Account Holder of the trust. However, all sane people can also agree that—provided you apply the actual definition of an Account Holder, not some made-up definition—that a Protector who does not exercise “ultimate effective” control cannot be an Account Holder.
Now let’s go back to the FAQ. It says a Protector “must be treated as an Account Holder irrespective of whether it has effective control over the trust”. That is patent nonsense. Again, an Account Holder is (i) a settlor, (ii) certain beneficiaries, and (iii) any other natural person “exercising ultimate effective control over the trust.” So on what rational basis can anyone—even the OECD—argue that a Protector is an Account holder “irrespective” of whether it has effective control over the trust? Not possible. Except that’s just what the OECD has done in this FAQ. By sheer fiat, it has re-written its own definition of an Account Holder in an FI trust—a definition that appears in its own CRS and Commentary—and reinserted the word Protector. Think about it—the definition of an Account Holder in an FI trust deliberately excludes the word “Protector”. And now the OECD says “oops”, we’re sticking it back in. Not by amending the definition, mind you, but by adopting an FAQ that directly contradicts the definition.
You may well think all of the above is academic—that the OECD makes the rules, and if it wants to change them mid-stream by playing fast and loose with its own definitions, so be it. CRS countries and the trustees in those countries have to follow these rules, even if they’re nonsensical, right? Wrong!
In my next blog, I will address head on whether this new FAQ, indeed whether any OECD FAQ or even the the so-called “CRS Implementation Handbook”, should be followed if they contradict the CRS and its Commentary. For reasons I will explain in that blog, I will show that, unless CRS countries roll over and play dead and require their fiduciaries to do the likewise, anything the OECD says that contradicts the plain language of the CRS and Commentaries themselves should be ignored. I’ll go further: Anything the OECD says, whether in FAQ or the Implementation Handbook, that contradicts the plain language of the CRS and Commentaries must be ignored unless expressly required to be followed by an implementing jurisdiction. Stay tuned.