08:08 27.04.2020


Forcing Private Capital Out of the Shadows: (Not) New Trends

6 min read
Forcing Private Capital Out of the Shadows: (Not) New Trends

Ihor Olekhov, partner, CMS Cameron McKenna Nabarro Olswang

On 28 April 2020, a new Law comes into force “On the Prevention and Combating the Legalisation (Laundering) of the Proceeds of Crime, Terrorist Financing and Financing of the Proliferation of Weapons of Mass Destruction” (the “AML Law”). The key objective of the AML Law is the consolidation of efforts and the enhancement of the coordination and quality of work done by entities responsible for financial monitoring in combating money laundering, offshore structures and tax evasion. The mechanisms introduced by the AML Law include in particular extending the broad tax powers provided for in draft law No. 1210 (the “Tax Law”) voted by the Verkhovna Rada of Ukraine in January 2020, although still unsigned by the President.

Having analysed the AML Law and the Tax Law through the prism of their impact on private persons and their capital, we have identified similar trends and anticipate that they will also be reflected in other legislation. Below we make observations and recommendations to help the business community and other capital owners prepare for today’s and future changes.

  1. Comprehensive Client Due Diligence

The AML Law provides for numerous measures aimed at an enhanced due diligence of the client, its structure, commercial activity and financial transactions.

From among these key changes, we highlight the following:

  • a wider range of primary financial monitoring entities (“PFME”) which are obliged to detect suspicious transactions in clients’ activities and report such instances. As a reminder, at present the list of the PFME includes banks, financial institutions, accountants, legal advisors, tax advisors, persons providing the services of the formation and management of legal entities, notaries, estate agents, cryptocurrency exchanges, etc;
  • the introduction and application of a risk-oriented approach in the work of the PFMEs with clients. The new approach requires several criteria to be considered, including the identity of the client, the country of the company’s registration, the type of activity, the scale of financial transactions, the business model, the beneficial owners, etc.; in other words, PFMEs will pay considerable attention to owners of non-transparent business structures, complex business models and high-value transactions, and will apply a complex approach to analysing the related information;
  • stricter requirements regarding the identification and disclosure of ultimate beneficial owners. From now on, PFMEs will be obliged not only to identify but to verify the reliability of the information about the ultimate beneficial owner of their clients;
  • detailed disclosure of relations with politically exposed persons and their related persons that have been established to carry a high degree of risk. Note that the law includes business partners among related persons, therefore private capital owners should take account of potential risks associated with any family and business relations with politically exposed persons;
  • a significant increase in the fines that can be imposed for failing to comply with the AML Law. For example, PFMEs can now be fined as much as UAH 27 million and for those PFMEs that are financial institutions, UAH 135 million. Stricter sanctions are expected to act as a stimulus for taking the financial monitoring obligations more seriously.

However, the developments introduced by the Tax Law also provide new requirements for extensive disclosure Ukrainian residents are to make reports to the tax authorities. In particular, the Tax Law introduces a controlled foreign companies (CFC) tax regime that will require Ukrainian beneficial owners to report to the tax authorities any companies they control abroad. As part of this reporting, information about the ownership structure/control inside business groups will have to be disclosed.

Thus, Ukraine is moving towards comprehensive financial and tax disclosures that have practically become a reality in many jurisdictions around the globe. Accordingly, we expect progress in external audits of clients and analytical activity aimed at enabling PFMEs to confirm the information that a client provides on its business, structure, beneficiaries, tax payments, etc.

  1. Consolidation of Efforts and Exchange of Information

Another trend is the introduction of the exchange of information mechanisms concerning clients at national and international levels. The exchange of information will operate for both the measures aimed at combating money laundering and tax purposes.

At the national level, the AML Law enables PFMEs to exchange information they have obtained as part of the know-you-customer (KYC) procedure. In addition, the possibility of exchange is provided for regarding information on a refusal to the client to establish a business relationship, open an account or perform a financial transaction. This means that a single instance of being listed as a “violator” may considerably affect the client’s reputation among PFMEs in the future.

At the international level, the AML Law makes international cooperation possible on a case-by-case basis, which, in practical terms, is not always an efficient measure of combating financial crime. An obligation is placed on PFMEs to monitor whether clients and their capitals have any connections with terrorism and terrorist financing. The key evidence that may prove such a connection exists is the UN Security Council’s resolutions, decisions of foreign states and courts.

On the other hand, an example of an efficient international exchange of information is the cooperation under common reporting standards, known as CRS, that provide for the automatic exchange of information between jurisdictions on clients’ accounts with financial institutions for the purpose of using such information in tax inspections. At present, Ukraine is not yet a fully-fledged participant of this cooperation; however, the accession process has already started with the adoption of the Tax Law which makes the necessary changes to the national legislation regarding financial institutions’ reporting on client accounts. Subsequent steps envisage Ukraine’s accession to international instruments that will give the green light to the exchange of collected information.

Thus, the world and Ukraine are demonstrating a noticeable trend with PFMEs and, in particular, financial institutions becoming all but key agents in fighting for the transparency of doing business and taxation. Not only are financial institutions authorised to collect an extensive slice of the information about their clients, they are able to analyse it, make conclusions, report it to the state authorities and exchange it between each other.

Financial institutions today possess an enormous amount of information. The establishment of national and international exchanges will enable states and their tax authorities to access this information and use it, in particular, for law-enforcement and fiscal purposes. In such settings, the opportunities to hide behind the shield of banking secrecy are becoming fewer and fewer.

To minimise potential risks and the adverse impact on the business community, we recommend that private capital owners prepare for the new realities. In particular, private capital owners should make the corporate structures as simple as possible, work on the business models, prepare for audits on the part of the PFMEs and be ready to provide explanations and, in some instances, supporting documents to the extent of both the sources of capital and compliance with the requirements for its taxation.