If “FATCA” were a person and decided to enter a beauty pageant, it would be booed off the stage for being unsightly. If “FATCA” were a writer and decided to write a nonfiction book, it sure as heck wouldn’t be, “How to Win Friends and Influence People.”
What is it about this petulant law that that makes it one of the most vilified among the expat community? In this blog, I discuss the basics of FATCA. Let’s begin with its purpose. And that provides a glimpse into why it has caused a mass uprising. The purpose of FATCA is to combat noncompliance by U.S. taxpayers who are allegedly “hiding” income or assets in offshore accounts.
Under FATCA, foreign financial institutions must perform due diligence to identify U.S. account holders and report their account information to the Internal Revenue Service (IRS). Account information includes not only the account balance but interest as well.
In certain jurisdictions, laws of the foreign country where the financial institution is located have strict bank secrecy laws that would prevent the institution from complying with FATCA’s requirements. To overcome this obstacle, FATCA implements a collaborative approach that enables banks in foreign countries with these restrictions to provide the required information – without any risk of violating the laws in their home jurisdiction. In order to achieve FATCA’s information reporting objectives, the United States worked hand-in-hand with France, Germany, Italy, Spain, and the United Kingdom to develop a model intergovernmental agreement. That agreement is referred to as a “Model 1 IGA.” Model 1 IGA was released in July 2012 and lays the foundation for bilateral agreements to implement FATCA. These agreements are based on traditional government-to-government tools for exchanging information – namely, income tax treaties or tax information exchange agreements.
Under Model 1 IGA, a foreign government makes a major concession. It allows certain financial institutions located in its jurisdiction to disclose information required under FATCA through a two-step process. First, these financial institutions are expected to identify U.S. accounts and report the information required under FATCA to the foreign government. The foreign government, in turn, reports the information to the IRS. Because a partner government agrees to establish rules to ensure that the United States will receive all of the FATCA information pertaining to U.S. accounts in that jurisdiction, all of the financial institutions in that jurisdiction are treated as compliant with FATCA.
The United States also developed a Model 2 IGA. Under Model 2 IGA, foreign banks disclose information required under FATCA directly to the IRS. Obviously, this requires a coordinated effort. At the center of this effort is the foreign government. It directs and enables all relevant financial institutions located in its jurisdiction to identify and report information about their consenting U.S. accounts directly to the IRS. Model 1 IGA has two versions: a reciprocal version and a non-reciprocal version. This answers the age-old question, what motivation does the foreign government have to cooperate in the first place? In other words, what does it get out of this?
Under the reciprocal version, the United States agrees to provide the foreign government with information that U.S. financial institutions currently report for accounts held by residents of the partner jurisdiction. This includes information collected under the bank deposit interest regulations.
The rub that many countries have is that current U.S. Treasury regulations do not require U.S. financial institutions to report the same information about their non-U.S. clients to foreign governments as foreign financial institutions are required to report about their U.S. clients to the U.S. government under FATCA. For example, FATCA requires foreign financial institutions to report the account balance or value of all financial accounts, including bank deposits and custodial accounts. Current Treasury regulations, on the other hand, merely require U.S. financial institutions to collect information on the U.S.-source income paid to those accounts. Thus, the argument is that there is a double-standard and that Uncle Sam is being a hypocrite.
Not surprisingly, many countries expressed strong reservations about requiring another country’s financial institutions to turn over significantly more information to the United States than U.S. financial institutions were required to turn over to that foreign jurisdiction. That all changed when the United States agreed to report bank deposit interest information. In so doing, the U.S. has taken a step — albeit small — in the direction of implementing rules and supporting legislation that would provide for equivalent levels of information exchange. In fact, that stipulation was critical to securing agreement from numerous jurisdictions to follow the Model 1 IGA approach.
The U.S. government is quick to point out what it believes is an “overwhelmingly positive reaction” to these agreements. It relies on the following statistics to support this belief: as of June 2014, the government has either signed or has reached agreements on IGAs with nearly 80 jurisdictions, and it is in active negotiations with many others. Time is a crucial factor in these negotiations, especially since FATCA withholding on U.S.-source payments made to non-participating foreign financial institutions began on July 1, 2014. According to the government, suspending further negotiation of IGAs would be nothing shore of devastating.
First, it would negatively impact the United States’ ability to enforce the provisions of FATCA without imposing substantial withholding tax.
Second, for countries with legal impediments to implementing FATCA, the IGAs are the chief means by which the United States can obtain FATCA information from financial institutions in those jurisdictions. If a moratorium were placed on IGA negotiations, it would be the modern-day equivalent of a financial Armageddon.
Why? Because financial institutions in those jurisdictions would be legally unable to comply with the FATCA reporting regime. As a result, they would be subject to a withholding tax of 30 percent on payments arising from their U.S. investments. And if there was ever a tax that would lead to a mass exodus of divestment from U.S. investments by an affected class of financial institutions, this would be it. For precisely this reason, the government believes that this fallout would cause irreparable harm to the country’s financial interests.
According to the government, suspending enforcement of FATCA and further negotiation of IGAs would also harm the United States’ efforts to enforce its own tax laws. For example, if countries decide not to pursue IGAs for the reasons stated above, foreign financial institutions in those jurisdictions may be legally unable to report information on their U.S. account holders. In that case, the United States would not be able to obtain the information that it needs to ensure that its citizens are in compliance with U.S. tax laws.