The life insurance companies’ challenges and best practices in the fight against tax fraud (2023)

Indeed, since the 1st of September 2019, life insurance companies have to consider the CAA questionnaire composed of questions providing a risk scoring depending on the answer for new life insurance contracts and new operations of existing contracts. Life insurance companies have to establish an action plan to perform within a reasonable time a manual review of the contracts and at the latest before the end of 2024 for the risky contracts and before the end of 2027 for the remaining ones (section 3.5 of the CAA Circular letter 18/9).

The Regulation of the CAA N.20/03 of 30 July 2020 relating to the fight against money laundering and terrorist financing specifies some elements notably with respect to the risk-based approach and the scope of the internal audit. The control of the AML/CFT policy and procedures is under the responsibility of the internal audit department and also part of the external audit performed by the “réviseur d’entreprise agréé”.

Following the Law of 23 December 2016 implementing the 2017 tax reform, the money laundering offense has been extended to aggravated tax fraud (fraude fiscale aggravée) and tax evasion (escroquerie fiscale). Thus, life insurance companies have to take into consideration the new predicate tax crimes within the scope of their professional AML/CFT obligations, notably customer due diligence and cooperation with authorities.

In this respect, we are currently seeing more and more controls and questions raised by the local and foreign regulators and tax authorities which should be put in perspective with the upcoming visit from the Financial Action Task Force (FATF). The CAA has just published a new version of its qualitative questionnaire in its Circular letter 22/3 dated 3 March 2022. The purpose is to collect structured and updated information to assess the compliance and efficiency of the AML/CFT process by the actors of the life insurance industry, including both insurance companies and intermediaries. This questionnaire has to be completed by 18 March 2022 and includes tax related questions as well. For example, life insurance companies have to confirm whether they ask systematically for additional documentation (incl. a tax memo or a proof a regularization) in case of high-risk clients from a tax perspective.

In the following section, we will detail the tax transparency regulations and challenges that life insurance companies are facing in the fight against tax fraud closely linked to AML/KYC and suggest some appropriate actions to ensure good governance as well as minimizing the operational impacts.

The challenges of the life insurance industry in the context of the fight against tax fraud

Like many other actors of the Financial Sector, life insurance companies have been facing additional challenges coming from the tax transparency regulations in Luxembourg over the last years. Various tax transparency regulations came into force (incl. FATCA, CRS and DAC6) to set-up automatic exchange of information between tax authorities that aims to strengthen the fight against tax fraud at a worldwide scale.

Further to the 2017 tax reform mentioned in the introduction, the Commission de Surveillance du Secteur Financier (CSSF) co-signed with the Financial Intelligence Unit (FIU) Circulars 17/650 and 20/744, containing indicators that the actors of the professional sector should consider to identify any risk of tax fraud. It has been confirmed by the FIU by its Circular dated 31 March 2017 that the Circular 17/650 would be applicable to all professionals subject to AML/CFT obligations. Life insurance companies are thus concerned by this CRF circular.

In addition, the Association des Compagnies d’Assurance et de Réassurance (ACA) has been inspired by the indicators of the CSSF Circular 17/650 and has adopted a list of new indicators on 2 April 2020 taking into account the specificities of the life insurance industry. The ACA specified that this list is not exhaustive. Even the existence of one or more indicators would not automatically trigger a reporting obligation, but would result in a deeper review to assess whether the doubt is justified.

The list includes several indicators that are linked to the tax residence and the FATCA/CRS status of the clients (e.g. the use of a legal entity without economic substance located in a jurisdiction not subject to the automatic exchange of information and whose ultimate beneficial owner is resident in another country). In addition, the definitions of financial account and account holder for FATCA and CRS purposes are more complex in the life insurance context. A deeper analysis of all contracts, the involved parties and their rights is necessary to be able to assess which contracts and parties are in scope.

When reviewing the stock, the “fictitious” change of a tax residence during a “suspicious period”, i.e. before the entry into force of the automatic exchange of information under CRS (1st of January 2016), may constitute an indicator of tax fraud as well, because the change of the tax residence could result in the circumvention of CRS reporting to the tax authorities of the jurisdiction of its actual residence.

The source of funds has also to be considered from a tax perspective. Especially with respect to old subscriptions made in cash or bearer shares, life insurance companies are facing difficulties to identify if those funds were tax compliant at the time they were injected into a life insurance policy. In addition, funds coming from high-risk countries from a tax standpoint or bank accounts which are not held by the policyholder would typically increase the risk of being exposed to tax fraud. Life insurance companies should have sufficient documentation on file to prove that it does not include funds that may not have been declared to the relevant tax authorities in the past, even if reported today in the context of the automatic exchange of information.

In order to comply with their various obligations, life insurers have to interact with intermediaries in order to receive the appropriate documentation to ensure that their clients are tax compliant and to assess any potential risk of tax fraud.

In this context, they might rely on them to a certain extent as well. However, the ultimate responsibility still remains with the life insurance companies which have to obtain information/documentation from the policyholders and the beneficiaries. They may be reluctant to provide some information/documentation or have some material difficulty to provide some specific documentation, notably to evidence the origin of wealth that may have been generated some decades ago.

Further to the documentation received, life insurance companies must perform a detailed review via their different lines of defense that should include some basic and key principles of the tax transparency regulations. A lack of critical controls of the consistency and the rationale of the documentation received can trigger a breach with respect to the tax transparency regulations, e.g. incorrect or missing reporting under CRS based on false tax residence. Any conflict in a client file or increasing complexity should be subject to a deeper review that may include additional information and documentation requests to evidence the tax compliance of the clients.

Unfortunately, there are no clear-cut guidelines to find the right balance between monitoring of the regulatory risk and the pragmatism to ensure a smooth relationship with the various intermediaries. This challenge may increase in case of complex cases that can take the form of partial documentation with respect to the source of wealth, tax regularization that occurred years ago or the set-up of a corporate structure as policyholder or beneficiary of the life insurance contracts.

Roadmap to have an efficient onboarding and due diligence process from a tax transparency perspective

In order to be able to deal with the challenges identified above and the various obligations under the different tax transparency regulations (incl. the detection of tax fraud indicators), it is important for life insurance companies to have updated internal procedures and processes in place considering the interaction between the different regulations. As a concrete example, if a life insurance company identifies the use of a fake tax residency by a policyholder, this finding has an impact on the CRS reporting which is performed based on the tax residence. A fake tax residence is also an indicator of tax fraud listed under the CSSF Circular 17/650 and has to be reported to the FIU, and it may constitute a cross-border reportable arrangement under DAC6 under hallmark D1.

Given the volume of life insurance contracts and operations to be reviewed, it is crucial for life insurance companies to have an efficient operating model with a clear risk-based approach in place to prioritize the review of client files. In this respect, it might be helpful to leverage on the data encoded in the system and extract some key elements of the contracts (e.g. date of the subscription, source of funds, tax residence, etc.).

The following elements can constitute key drivers in terms of risk of tax fraud: the origin of wealth, the source of funds and the tax residence of the policyholder and beneficiary. As an example in case of a succession, the policyholder should be in a position to provide the life insurance company with some documentation evidencing the declaration of the succession and explanation how the de cujus built his wealth. The lack of documentation or inconsistent explanations about the inherited funds could raise a doubt and, if not cleared, trigger a suspicion of tax fraud. In case the funds are coming from another jurisdiction than the jurisdiction of tax residence of the involved persons (especially from high-risk countries) without any reasonable explanation, further investigations would be required as well to assess whether the doubt is justified.

Given the complexity, practical guidance and the use of checklists might facilitate the review and could be used for audit trail purposes. The practical guidance could consider regulatory provisions of the life insurance company's main markets and basic tax knowledge about those distribution markets (e.g. obligation of declaration of donation/inheritance within their main markets of distributions). In addition, checklists and the consistency of the methodology used might guide less-experienced employees through the review and identify those cases that would need to be escalated or for which additional documentation would need to be obtained. In this respect, it is of utmost importance that employees are familiar with the operational processes and trained accordingly. In addition, roles and responsibilities within the organization should be clearly defined to have a common understanding of the process to be followed and to avoid certain tasks being forgotten or done twice.

To conclude, life insurance companies should be able to answer detailed questions they might receive from the regulator or foreign tax authorities with respect to AML Tax aspects. In case of audits performed by the CAA, they have to be able to explain their risk assessment and to demonstrate the actions performed during the lifecycle of the contract. A complete and consistent client file including the tax aspects is the prerequisite to be compliant with their professional AML/CFT obligations.

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