Facing up to Fatca
This article was first published in the 2nd quarter 2014 edition of Personal Finance magazine.
Most people accept that they have to pay taxes in their country of residence. But citizens of the United States and green card holders who live outside that country – even if they have never lived in the US or have no plans to return to it – also have to submit annual tax returns to the US Internal Revenue Service (IRS). Moreover, they have to report on their worldwide income. Although many can claim tax credits for tax paid in foreign countries, the credits do not always cover the US tax requirements, and double taxation is the result.
This has been the case for a long time, with US taxpayers subject to significant civil and criminal penalties for failure to comply with their extensive reporting, filing and taxpaying obligations. However, enforcement of the law where expatriate US citizens and residents are concerned (about 7.2 million of them) has not been an issue … until now.
The implementation of the Foreign Account Tax Compliance Act (Fatca) on July 1 is aimed at compelling the international financial services industry to report to the IRS on the financial accounts of US taxpayers, on trusts in which they have interests, and on companies and partnerships controlled, or deemed to be controlled, by US taxpayers.
It all started in 2009, when the IRS decided it needed annual reports from the worldwide financial services industry detailing, in respect of each and every account, the US taxpayer’s name, tax identification number and the associated account details, including account numbers, balances and movements. The IRS justifies this demand on the basis that it will significantly enhance compliance by US taxpayers, both voluntarily and through informed enforcement.
The big stick
Following the IRS’s decision, the US hit on the happy idea of compelling the global financial services industry to fall into line by using a big stick: the threat of withholding 30 percent of all payments derived from investments in the US. This is not the same as withholding 30 percent of interest and dividends, which has been in place for years. The new withholding tax applies to all payments, including entire capital returned on disinvestment.
The US is the largest recipient of inward investment in the world. It is very difficult for any international financial institution to operate without investing, directly or indirectly, in the US, or dealing with financial institutions that invest in the US. And so it became clear that the global financial industry would have to fall into line.
The US soon found there were snags – including a Republican Party campaign to have the law repealed (see “Fury over fatca(t) law”, below) and the suspicion that a sudden leap in the number of US citizens and residents renouncing their citizenship or giving up residency is at least partly due to the tax regime.
A greater problem is that many countries have strict rules about data protection, which actually prohibit compliance with Fatca. The threat of withholding tax for non-compliance was perceived as threatening the continued operation of non-US financial centres, including the very largest centres, such as London and Frankfurt.
Consequently, the governments of countries with international financial services industries intervened and have concluded, or are concluding, intergovernmental agreements with the US, that make Fatca compliance legally possible – and indeed compulsory – in those countries.
In return, the governments negotiating the agreements demanded concessions from the US. The result is that the financial sectors of countries that sign up to the agreements are exempt from Fatca’s withholding requirements. In theory, the countries with such agreements are also entitled to reciprocal disclosure of information about their taxpayers’ accounts in the US, but delivery on this particular aspect seems to have run into constitutional difficulties in the US.
The immediate task
To comply with Fatca, the banks, insurance companies, custodial institutions (for example, mutual funds, or unit trust funds, as they are known here) and investment entities (for example, hedge funds and private equity funds) of the world will have to check all their accounts as at June 30 to see if they have US taxpayers. This is a huge task, which will take years, and financial institutions will require many customers to fill in extra forms to make sure they are categorised correctly. Despite continuing pressure on the US to allow more time, so far there has been no indication of further delay.
Customers with US connections will be affected the most, but others will also be involved, even
some with no US connections at all. The finance industry will have to obtain additional declarations from new customers to ensure that they are categorised properly.
Based on the categorisation of old customers and additional information obtained from new customers, the financial industry will need to prepare reports destined for the IRS. All this is an additional cost to the international financial services industry, some of which will probably be passed on to clients, while some is absorbed by the industry.
No doubt, eventually, information technology solutions will be developed to automate data collection and reporting. Perhaps there will be industry cooperation in the process of absorbing these costs and developing the solutions.
Consequences for you
The consequences mentioned above are essentially administrative and will be regarded as relatively minor by the customers. But the real questions are:
* Fatca has already been extended to British taxpayers with US connections; will it extend to other taxpayers and if so, how quickly?
* What will be the consequences for all taxpayers of the “mining” of the data collected?
Tax authorities worldwide have seen that, once the machinery is in place, it is relatively easy to jump on the bandwagon and start scrutinising the offshore tax affairs of their citizens. Thus, the United Kingdom and the US are conspiring with the rest of the world to extend the reach of Fatca worldwide. Canada signed an agreement in early February, affecting about one million US citizens who pay very high Canadian taxes and do not consider themselves dual citizens. The announcement by the Canadian government recorded that 20 other countries had already signed agreements – Bermuda, the Cayman Islands, Costa Rica, Denmark, France, Germany, Guernsey, Ireland, the Isle of Man, Italy, Japan, Jersey, Malta, Mauritius, Mexico, Netherlands, Norway, Spain and Switzerland – while nine other countries had reached an agreement in substance, and a large number of countries were thought to be in negotiations with the US to sign agreements.
National Treasury and the South African Revenue Service (SARS) announced around the same time that they had “opened negotiations with the US Department of the Treasury with a view to concluding an intergovernmental agreement with respect to Fatca. An agreement of this nature would significantly reduce South African financial institutions’ compliance costs with respect to Fatca. This would be achieved through the exchange of information between South Africa and the US on a reciprocal basis in terms of the existing double taxation agreement between the two countries.”
The announcement went on to say: “South Africa joins a growing number of jurisdictions that have either concluded or opened a dialogue with the US, with a view to concluding an intergovernmental agreement. The emerging prospect of further co-operation between these jurisdictions for the automatic exchange of information between them is an exciting development, which South Africa will be exploring.”
Levels of non-compliance in different countries will vary, as will the level of sophistication of local tax authorities, but how long will it be before further countries join in? Will the programme be attractive to the rest of Europe, South America, other African countries, the Middle and Far East, and others?
The G20 has asked the Organisation for Economic Co-operation and Development (OECD) to spearhead a programme to ensure that tax transparency between jurisdictions is the new norm. A conference of the OECD Global Forum on Transparency and Exchange of Information for Tax Purposes, which involves 122 countries, was held in Jakarta, Indonesia, in November last year and established a new group to monitor and review the “automatic exchange of information” consistent with the G20 call.
A rush to comply?
With intergovernmental agreements in place and data sharing legitimised, taxpayers with or without US connections will no longer be able to rely on a lack of scrutiny of their tax affairs in certain jurisdictions.
Suppose you have an offshore trust with a legitimate history; it is your safety net and you have never needed to touch it or report on it. In future, your local tax authorities will have a new window on your international affairs and an opportunity to discuss them with you.
The information the tax authorities receive thanks to Fatca, or the common reporting standard that is agreed, will be current information at the time of the data exchange. But what about historical lines of questioning? If the information suggests that such a line of questioning might be appropriate, what is to stop the tax authorities from asking questions about the past?
Suppose you are a US citizen by accident of birth, you have never lived in the US, and you have ignored or misunderstood the IRS requirement that you file an annual “foreign account balance report” on your UK bank account. The IRS will know. The penalty could be a percentage of the account balance.
Perhaps you are a dual UK and South African resident who still has a bank account in the Cayman Islands, a long-established trust in the Turks and Caicos Islands and/or a company in the British Virgin Islands that you are reluctant to disclose. Her Majesty’s Revenue & Customs in the UK will have it on file and, once South Africa has implemented the common reporting standard, so will SARS.
As a resident of South Africa – one of the countries that have started negotiations but not yet rolled out their own “tax transparency” programmes – you have a little more time. But the automatic exchange-of-information initiative seems unlikely to falter and the negotiators suggest it may take as little as an extra six months.
The global financial industry will, reluctantly but unavoidably, become a policeman for tax authorities, reporting automatically to those authorities in a tax-collector friendly manner. It is likely that every institution will ask for your place of tax residence and tax number, and, as countries join the programme, so reports will start to be filed carrying your number, which will be returned to your country of tax residence, and no doubt the report will be linked with your tax return.
As a result, a large amount of additional data about the international affairs of taxpayers will be available to fiscal authorities throughout the world. The opportunities for data mining are manifest.
End of ‘offshore’?
In this new era, the multi-million-dollar question is whether privacy in the so-called tax havens is still a significant “unique selling point” of the offshore world. And if it is, privacy from whom? These jurisdictions claim to be properly regulated, flexible, tax-neutral offshore platforms, but to what extent are they still sheltering aggressive tax avoidance, which has survived solely or partly because of lack of scrutiny? Perhaps a tide of shady international funding will go out and we will see who is wearing the bathing suit.
FURY OVER FATCA(T) LAW
The Foreign Account Tax Compliance Act (Fatca) has been dubbed “the worst law most Americans have never heard of” by the Repeal Fatca campaign (repealFatca.com), which has been adopted by the Republican Party.
Campaigners claim the legislation was pushed through by the Democrats without proper scrutiny and that, far from simply catching “fat cat” tax cheats, it would, among other things:
* Violate Americans’ constitutional protections;
* Disregard the mutual respect of sovereignty among nations;
* Punish Americans who work abroad bringing business to the United States;
* Set up a global financial fishbowl, with personal financial information “shared” among governments worldwide;
* Lead to higher taxes, and ultimately international taxation; and
* Harm the US’s global competitiveness.
US tax law expert Andrew Wood, who writes for Forbes magazine, reported at the end of January that “Americans abroad complain that they face serious employment problems from Fatca, including discrimination by foreign company employers. An American signature on corporate accounts triggers a reporting obligation to the Internal Revenue Service. In effect, they say, American competitiveness is being hurt. Job opportunities and promotions for Americans in multi-national corporations are at risk.”
He said there were other serious implications: “One of the most obvious is the inability to open new financial accounts or the forced closure of existing ones. Americans abroad can be pariahs shunned by banks for daily banking activities. There can be scrutiny of non-US spouses, making the decision to file a joint tax return often a mistake. For all but the very sophisticated, compliance isn’t simple, and the penalties for transgressions can be exorbitant.”
Uproar or not, there seems to be no going back, now that governments have seen the future and like the idea of the global policing of taxpayers.
* Anthony Markham is a partner at the Maitland Group, which provides administrative, legal and tax advice to individuals and corporate clients.