FATCA: Blowback is a Bitch
By Mark Nestmann • February 26, 2013
Blowback- an unforeseen and unwanted effect, result, or set of repercussions
--Merriam-Webster Online Dictionary
FATCA, otherwise known as the Foreign Account Tax Compliance Act, is probably the worst law that most Americans don't know about.
I've written about this monstrous law repeatedly, most recently here. But now, it looks as if the prospects for FATCA's implementation are caught behind a rock and a hard place. And it's all because of blowback.
In a nutshell, FATCA demands that virtually every foreign financial institution (FFI) sign and strictly comply with a reporting and withholding agreement with the IRS with respect to US account holders. The IRS refers to an FFI that signs such an agreement as a “participating FFI.” So-called “non-participating FFIs” will be subject to a 30% withholding tax on certain “withholdable payments” from U.S. sources. They'll also likely be subject to 30% withholding on payments from participating FFIs as well, anywhere in the world.
Understandably, most FFIs aren't anxious to go it alone with the IRS. That's especially true because the IRS hasn't yet released a draft agreement for them to sign. Many FFIs have therefore approached their respective governments and asked for help.
Along these lines, last February, the United States signed a joint declaration with five EU nations (France, Germany, Italy, Spain, and the United Kingdom) to initiate an “intergovernmental approach to FATCA implementation.” The U.S. Treasury agreed to “collect and exchange on an automatic basis information on accounts held in U.S financial institutions” by residents of these countries.
Unfortunately for the IRS, there's a problem with this approach. Under current U.S. law, information exchange only goes one way—from the foreign bank (or government) to the IRS. There's no mechanism in place for the Treasury to collect and exchange data on U.S. accounts held by residents of most foreign countries with those countries' governments.
And now, for the blowback. Germany—one of the original signers of the joint declaration—has yet to actually sign its inter-governmental agreement. One possible reason is the lack of reciprocity in the agreement. Other countries said to have serious issues with the lack of reciprocity are China, Russia, India, Brazil… even Canada.
The problem for the IRS is that under its new model of inter-governmental cooperation, FATCA will be effective only if foreign governments force their financial institutions to become compliant. And many powerful foreign governments don't seem to be in a rush to do so.
Earlier this month, the Obama administration began preparing new legislation to force U.S. banks to disclose more information on foreign investors to those investors' home governments. Could this because the IRS has only an empty hand to offer when it comes to reciprocity?
However, the Obama administration has an uphill battle in convincing Congress to enact such coercive legislation. Many in Congress fear that foreign investors could pull trillions of dollars out of U.S. banks if the proposal becomes law. That could dramatically reduce foreign purchases of U.S. Treasury debt and crush the U.S. dollar. More blowback.
Without that legislation, though, the IRS will need to go back to negotiating with individual FFIs in countries unwilling to sign an inter-governmental agreement. And that poses considerable risks to FFIs. It's a little like Little Red Riding Hood negotiating with the Big Bad Wolf over what's for lunch.
For instance, numerous FFIs have decided to "opt-out" of FATCA by firing all their U.S. customers. However, even these FFIs still have to sign a one-sided agreement with IRS that promises draconian consequences to the FFI if breached.
One of the many land mines in the agreements is simply identifying —and firing—U.S. customers. Unlike all other major countries, the United States taxes its non-resident citizens as if they never left. That means a non-resident U.S. citizen is a "U.S. person" for tax—and FATCA— purposes.
At the same time, hundreds of thousands of non-resident U.S. citizens hold a second passport, and use that passport to operate non-U.S. accounts. If an FFI doesn't know—that their apparently non-U.S. client actually is a U.S. citizen, and the IRS finds out, the FFI is in breach of their agreement. It could then find itself subject to 30% withholding on many outbound transfers from the United States or participating FFIs.
Every non-U.S. bank in the world, even those with no known U.S. customers, must conduct a comprehensive examination of every client to make certain it didn't overlook even a single U.S. citizen.
Most non-U.S. banks don't wish to take on this burden. And so they're petitioning their governments to assist them…taking us full circle back to where we started at the beginning of this post. Isn't blowback a bitch? Perhaps a better use of the FATCA acronym would be the "Fear and Total Confusion Act."
What's next? I hope that the Obama administration does the honorable thing and ask Congress to repeal FATCA. Repeal won't cost the U.S. Treasury much (if anything). Yes, it's true that politicians like Sen. Carl Levin (D-Mich.) claim that U.S. taxpayers evade more than $100 billion in tax annually by hiding the money offshore. That's a preposterous estimate for reasons I wrote about here. A more accurate total might be 1% of that amount.
Repeal would also allow the United States to keep its coveted title as the world's largest tax haven. Well, at least for non-U.S. citizens. U.S. banks wouldn't be forced to disclose more information to foreign governments.
Unfortunately, I don't think repeal is politically tenable, at least for the moment. So, in the meantime, I'm advising our clients to deal only with offshore banks and financial advisors that are making a good-faith effort to comply with FATCA. I'll keep you posted of new developments as they occur.
Copyright © 2013 by Mark Nestmann