The Foreign Account Tax Compliance Act – What’s Wrong America?

It’s hard to recall the introduction of a US federal law inviting such a backlash from US citizens – and Canadians – as FATCA. Despite undoubted and ongoing issues surrounding human rights, healthcare, gun control, homosexuality, drugs and abortion laws, it is the requirement for every US citizen – regardless of whether they live inside the US or not – to report all their foreign-based financial accounts to the IRS, which consumes internet forums and opinion givers like nothing else. The usually steady financial blogs and forums have exploded with apparent FATCA experts all too keen to express their distaste at the newly launched legislation, but how come?

On the face of it, a law which was apparently introduced to put an end to the long list of US individuals concealing assets in foreign bank accounts thus avoiding federal tax, may not seem like anything remotely out of order.

In Britain, avoidance and evasion has cost the Government billions, and is something which many high-profile figures have been publicly held accountable for. Sheltering earnings from tax in offshore bank accounts is not a particularly popular arrangement among the general public, and most would welcome a ruling which requires those who are liable to pay tax, to pay it. So why the outcry and “gross injustice” being attributed to America’s tax requirement law? We must first dig a little deeper…..

What is FATCA?

FATCA legislation was swiftly drafted and added to the HIRE bill which President Obama signed into law in 2010. At that time, Congress and the Administration saw the tax law as being nothing other than beneficial for the majority, after all, the US loses over $100 billion in swerved tax each year according to Federal Reserve estimations.

Key Requirements of FATCA

Foreign Financial Institutions (FFI’s) which include stock brokers, banks, all manner of funds, insurers and trusts must directly report to the IRS relating to all assets owned by US citizens under their umbrella. This extends to both US citizens and Green Card holders.

These FFI’s will have to submit annual reports to the IRS which gives the name, address, largest account balance, and the cumulative credits and debits of all accounts owned by an American.

Failure to comply from am FFI perspective will mean sanctions being imposed on their US activities. A 30% withholding tax will be immediately imposed on all of its US transactions. This has essentially guaranteed that all major FFI’s comply with the legislation, despite many taking the privacy of their clients very seriously, there is really nowhere else for them to go.

The IRS has now signed up over 95,000 institutions to FATCA in 220 countries worldwide. Unsurprisingly, it is the tax-avoidance haven of the Cayman Islands which boasts the most FFI’s now under agreement to provide information on their US customers. A staggering 18,408 FFI’s on the Cayman Islands (or at least virtually operating from the Cayman Islands) are on the latest IRS-published FATCA list.

Those from the US who have their assets within these FFI’s must pay attention to the following: FATCA rules also state that any Green Card holder or US citizen with over $50,000 (more for expats) in financial assets overseas must file a new, and rather complex 8938 form with their annual tax return. An inconvenience at the very least one would imagine. If one were to understate, and the FFI subsequently reported a somewhat different figure to the IRS, the US account holder would be subject to a 40% penalty for non-disclosure. The loophole that was formerly used to keen avoiders was to convert dividends into “dividend equivalents”, thus paying no tax, has now been closed as all physical stock and any bonds must also be reported.

And finally, any foreign company which is not listed, but which has a minimum 10% US ownership must also immediately hand over the name and tax ID number of the US owner.

FATCA Affects Everyone

Those directly and indirectly affected by FATCA are more or less every single American living anywhere in the world. The reasons we will go into, however those with more pressing and immediate concerns over the legislation are:

• All US-based financial institutions
• US stock markets
• US businesses operating overseas
• US expatriates
• US citizens with foreign investments

FATCA has created what many based in the US see as a stunningly imposing and threatening piece of legislation creating direct financial problems – not to mention legal issues – for the world’s financial institutions and for US citizens, and while many commentator’s views are thoroughly ostentatious and a touch neurotic, they are, for all intents and purposes, pretty much on the money.

Complaints Unheard

The demands placed on every foreign corporation, partnership and financial institution by FATCA has led many to question exactly to what extent they must adhere to this ruling. Most jurisdictions across the globe have in place privacy laws of their own which would be contravened by any such notion of private information sharing with the IRS. As well as this, the burden on time for any FFI required to provide detailed information upon a specific individual would be considerable, not to mention the cost implications of implementing a system to cope with this reporting requirement.

After a large backlash from FFI’s, the Teasury Department has created what is known as an IGA “Intergovernmental Agreement.” What this essentially does, is relieve the requirement of any FFI to directly supply information to the IRS – thus exposing themselves to legality issues within their own jurisdiction. Instead, the information is supplied from government to government. An FFI is however still required to sign up to register with FATCA or face the 30% withholding tax, regardless of whether their government agrees to the IGA.

Despite an anti-discriminatory clause being added into these agreements – in the hope that US residents in foreign jurisdictions will not be penalised for the over-zealous reporting requirements of taking them on as a customer – many US expatriates have been faced with rejection letters for simple bank account applications, existing accounts closed, restricted access to funds…. The list goes on. The simple reason given is “Banking Policy”, the simple reason is FATCA.

US Unattractive to Foreign Investment

Because of the threat of a 30% withholding tax, and the necessity to provide private information, many foreign entities are choosing to rid themselves of existing US securities and investments, and many high-profile banks have expressed their clear intention to sever ties with US finance.

The Institute of International Bankers, along with the European Banking Federation and the Japanese Bankers Association have all warned that FATCA could result in divestment – especially among smaller institutions due to the reporting and compliance burdens place upon them. In essence, many may just take their investment clout elsewhere.

Foreign Investment in the US is in excess of $21 trillion, and as such FFI’s have significant weight when it comes to any attempt to be dictated to. If the US becomes unattractive as an investment proposition due to the severity of the reporting requirements, and the privacy evaporation, you can be certain that big-time corporations would not give a second thought to placing their interest elsewhere.

US-based Banks May Also Suffer

As well as the potential long-term threat to the investment sector, the United States banking sector could also become less attractive. The aforementioned IGA will be reciprocated by the US, ie; every time information is required by a foreign government relating to one of their nationals residing in the UAS, the US bank will have to oblige. Now, the US is certainly no tax haven, but it is a safe haven for those opting to store their money here and away from the prying eyes of the corruption-laden government in their home country. This is particularly true of those residing in Latin America. If anonymity is lost, there would be no point in banking with anyone based in the US. The foreign capital held in banks in the States is estimated to amount to $1 trillion. Not to be sniffed at.

Potential Damage Could be Irreparable

If just a fraction of foreign entities holding investments, bank accounts and securities within the US decide to take what they have and search for a better option, the repercussions could be disastrous. The US economy is already in a precarious state, and reduced foreign investment could mean the markets, the banks and the growth of the US economy in general will both deteriorate and suffer.

The idea that investors and FFI’s will withdraw from business with the States is mere conjecture at this point, but it is a very real possibility. And if it does happen, the FATCA bill and its extra $792 million per annum raised in additional taxes, would pale into nothing more than a contribution of little significance when set against the losses it encouraged.

There has never been a study commissioned on the costs and benefits of FATCA, but you can be sure that the administration costs will be extreme for the IRS, let alone the financial institutions both in the USA and abroad that must radically amend their current procedures in order to comply.

US Expats Bearing the Brunt

As FATCA requires what any organization would deem excessive reporting requirements, FFI’s globally are point blank refusing American clients for account, insurance, and pension schemes. This is only currently a relatively rare occurrence, however if it is a trend that continues, US citizens will either be stranded overseas with no insurance and no accounts, or they will simply renounce their US passport.

Furthermore, the requirements of employment – both for foreign companies and those based in the US looking to develop its activities overseas – mean that the provisions of insurance policies and pension funds for employees are mandatory. If they are unable to source these financial products for US citizens, the likely outcome is that they will be generally deemed as unemployable. Again, this is an extreme scenario, and is by no means the case just now, but the potential disruption for US expatriates is disturbingly extensive.

Those residing overseas are subject to reporting requirements not necessitated by those that choose to remain in the US, yet have foreign accounts and investments. This is because American residents are only required by law to report income for tax purposes, and not assets. US expatriates are – some would argue – done a massive disservice by wishing to spread their wings and represent their nation internationally.

There are over 7 million US expats abroad, and the IRS tax levy on them brings in very little as it is, since many reside in high tax countries such as the UK, Germany, Canada and France, and once local tax has been weighed in, the residual amount due to the IRS is minimal after foreign tax credit deductions.

10% Ownership Woe

When it comes to foreign entrepreneurship, many Americans who attempt to partner with associates and begin an enterprise have found themselves closed out of the deal due to the excessive nature of the reporting requirements and the hefty expenditure involved with compliance. The 10% ownership rule requires any business with an American stake holder with a 10% interest in the company, to report annually and comprehensively upon every detail of their financial activities. This affects literally millions of companies worldwide, and it could provide a real barrier to furthering American business interests, as potential partners may just see the burden as a step too far.

Cost

Numbers are certainly not set in stone in relation to the cost of FATCA in terms of implementation, but according to most estimates, this cost will far outweigh the levies raised by it. Although the IRS are predicted to increase their revenue annually by $800 million, the cost of implementation is far harder to measure, and in all likelihood the cost will be met by the FFI’s needing to comply.

As with many of its policies, America has perhaps gone a step too far with FATCA. While nobody could possibly begrudge the requirement to catch tax cheats, the complicated and expensive – as well as the all-encompassing – nature of this tax legislation seems to alienate and victimize innocent Americans, and even those who are not US citizens in their own minds.

Foreign Government Opinions

Britain certainly appears to be a fan, as does Australia. Both economies also lose billions to tax cheats, and both are beginning consultations on the implementation of their own “FATCA-style” legislation. But in Asia, it would seem that many are looking at alternatives to the US. The Chinese in particular are rubbing their hands with anticipation at the level of investment which may have been pushed their way as a result of FATCA.

Here to Stay

However, the law has happened. Repeal attempts have been made – and have been unsuccessful. It would appear that FATCA is here, and here to stay. Rather than attempting to overturn the entire legislation, certain aspects may be more likely to be open to amendment. Of course there are so many aspects to it that affect such a wide range of people – many with no ties to the US whatsoever – that it will perhaps be a case of whoever shouts the loudest and gets the largest numbers behind their case for amendment.

Canadians recently filed a suit to try and block FATCA, claiming that the IGA – which Canada held back on for as long as they could – is illegal and contravenes privacy laws within Canada. It probably does, but if the US withholds 30% tax for non-compliance, how many Canadian FFI’s are going to think twice about handing over details, and how many Canadians with dual-nationality or American parents are going to risk 40% penalties for non-disclosure. The sensible guess would be not many.

FATCA certainly raises huge issues, not least the fact that the IRS are essentially dealing in threats in order to get their legislation adhered to, but what realistically can be done other than to swallow the legislation and accept it?

You could ignore it and hope that by the time the IRS catches up with you, the act will have changed or been abolished. This is not a wise move though.

Unfortunately for most, there is no clear way around this. FATCA is viewed globally by foreign entities as disruptive, and with a strong-arming method of compliance, it has not been welcomed by anyone. Many large corporation swill look to growing markets in Asia as a way of cutting out the US once the severity of the regulations and reporting requirements really hit home. It’s good that tax evaders are no longer able to get away with it, there’s no argument there, however at what cost? It’s too early to say how this will work. Give it a year and the predictions for the consequential fallout of FATCA will begin to either be disproven, or confirmed.