BY ANDREW TARPEY
An American man in his twenties working at a law office in Chicago has decided that he wants to take a year off from work and backpack through Australia, desiring to see a part of the world geographically distant from his but that has always fascinated him. During his travels, he meets an Australian woman, and the two hit it off. They get married and decide to settle in Australia. All of a sudden the man’s yearlong expedition down under has turned into a permanent settlement in the country. Having chosen to move all of his assets to his new adopted country, some may think that the man’s financial ties to the United States and days of filing U.S. tax returns are over. However, unbeknownst to some, he is required to file and pay taxes to the U.S. government on what he earns in Australia. What’s more, his bank in Australia is required to report to the United States Treasury Department that he has an Australian bank account and what his assets are. Though this may seem unfair and intrusive since the man no longer lives or works in the United States, this is a reality under the law known as FATCA.
In a world of increasing globalization and cross-border financial transactions, it has become commonplace for individuals to establish trusts and other financial arrangements in foreign countries. There are many reasons for this, including fear of litigation in their home country, a desire for financial security and confidentiality, and inheritance and estate planning. With more people establishing financial arrangements overseas, nations have become concerned about the lost tax revenue that may result. This concern that countries have over their citizens moving money to what some governments see as “tax havens” has compelled the United States to take a legislative approach to try to keep tabs on the accounts its citizens hold in other countries. In 2010 the United States federal government passed the Foreign Account Tax Compliance Act, more commonly known by its acronym FATCA. This law requires non-U.S. financial institutions to search their records for individuals who are deemed to be U.S. persons for tax purposes and to report the assets and identities of these persons to the U.S. federal government.
Financial institutions which do not report this information are subject to a 30% withholding tax on all U.S. transactions, a penalty strong enough to force most foreign banks to comply. Taking notice of the U.S. government’s desire to know the whereabouts of its citizens’ financial dealings overseas, other nations decided to establish a multilateral program of cooperation requiring the exchange of financial information of account holders who are tax residents of other countries. This reciprocal exchange of information is known as the Common Reporting Standard (CRS).
The United States is one of the few nations which requires its citizens and those considered to be U.S. tax residents (such as green card holders) to report and pay U.S. taxes on income from countries outside the U.S. As a result, the reporting requirements of FATCA have large implications for U.S. citizens and tax residents living abroad. Without the reporting requirements instituted by FATCA, the U.S. government would have practically no way to identify the non-U.S. assets of citizens and tax residents living overseas. FATCA allows the U.S. government to identify the assets of these individuals to ensure they are reporting as required. However, the reporting requirements of FATCA are not without controversy.
Many would argue the FATCA law is the catalyst behind an ever increasing number of Americans living abroad who are renouncing their citizenship. This increase in renunciations has coincided with the passing of FATCA. In early 2017 the U.S. Treasury Department released a list of individuals who had chosen to either renounce their citizenship or give up their rights to permanent residence in 2016. There were 5,411 such individuals who did so that year, which is a 26% increase over 2015 (4,279) and a 58% increase over 2014 (3,415). The requirement for U.S. citizens to file taxes when living abroad is not new. However, it’s not hard to see that FATCA has played a role in the renunciation of citizenship for Americans, as in the past a U.S. citizen abroad may have been able to get away with not filing and paying taxes on their non-U.S. income.
In addition to the thousands of Americans inclined to renounce their citizenship at least partly due to FATCA’s effects, there is also the issue of how those countries who are forced to comply with FATCA and their financial institutions will deal with what is described by many as a massive bureaucratic headache. Former Canadian Finance Minister Jim Flaherty bemoaned the fact that the law has in effect used foreign banks as an enforcement arm of the Internal Revenue Service and described it as having “far reaching and extraterritorial implications”. Foreign financial institutions may also run into problems in identifying which of their clients are American, as many do not record the nationality of their account customers.
In instances where foreign banks do not have digitized records, the task of sifting through large numbers of records to identify which of its clients are U.S. persons for tax purposes can be a huge expense, and this doesn’t take into account the cost of educating personnel on FATCA compliance and implementing new company procedures and software. Finally, there is the issue of capital flight, as some foreign financial institutions may divest or choose not to invest in U.S. assets when they otherwise might have. As the 30% withholding penalty on U.S. financial transactions is the main leverage the U.S. government has in forcing compliance with FATCA reporting, some foreign financial institutions may find compliance with FATCA to be too expensive, complicated and cumbersome and may choose not to do business with the U.S. financial system when there are alternatives which they see as less burdensome and heavy-handed.
Following the basic model of FATCA, the Common Reporting Standard was developed in 2014 by the Organization for Economic and Cooperative Development (OECD), an intergovernmental economic organization. Prior to 2014, countries which engaged in treaties for sharing account and tax information with other governments did so upon request, whereas under CRS the exchange of information happens automatically. The OECD followed the initiative of finance ministers and central banks of the G20 member states in developing this automatic exchange, and in February 2014, the G20 members endorsed the exchange of information through the Common Reporting Standard. In May 2014, 47 countries signed on to the agreement, and by October of that year, around 60 nations had committed to implement CRS in their domestic legislation. The automatic exchanges under the CRS agreement began in 2017, and the number of countries which participate has grown to over 100. The number of countries participating in the CRS agreement is expected to grow larger in the future.
Although CRS was to a large extent modelled on FATCA, it also differs from it in important ways. For starters, with over 100 countries participating, the scope of CRS is much broader than FATCA. In addition, there is the reciprocal nature of CRS which stands in contrast to the one-sided reporting nature of FATCA (the U.S. doesn’t provide information to other countries about the American bank accounts of their citizens). Also, as stated previously, the U.S. issues a 30% withholding tax on financial institutions which are not compliant with FATCA. CRS issues no such levy for non-compliance; each member state may impose financial penalties for non-compliance, but withholding taxes do not exist within CRS.
So what does the future hold for FATCA and CRS?
Are such cross-border reporting standards here for the long term? With regard to CRS, it appears so, judging by the number of countries who have chosen to participate in this exchange since its inception. Countries take tax evasion very seriously, and see CRS as a way to avoid having more money leave their coffers. Although there have been calls from some politicians in the U.S. to repeal FATCA due what some see as an invasion of privacy and unfairness towards Americans living overseas (their bank accounts and assets get reported to the Internal Revenue Service, while Americans living in the U.S. don’t have such information about them reported), there have been no serious legislative measures proposed to do away with FATCA. For those with hopes of getting rid of the law, their best chance may have been to do so in the tax reform law passed by Congress and signed into law by President Donald Trump in December 2017, but that piece of legislation didn’t address FATCA, so it appears that it will remain in place for the foreseeable future.