Tax Planning

I Told Them So (And They Hated Me For It!)

In my mind, some things are so obvious I don’t understand how everyone doesn’t reach the same conclusions I do.

President George W. Bush’s campaign to oust Saddam Hussein from power is a great example. Shortly after Bush announced the invasion in 2003, I predicted that his action and the resulting war would accelerate the rise of Islamic fundamentalism in the Middle East. I also predicted Iraq’s neighbor Iran would benefit most from Saddam’s downfall.

And that’s precisely what happened.

Islamic fundamentalism has exploded, and the self-proclaimed “Islamic State” now controls a big chunk of the country. Even the areas “controlled” by the Iraqi government are held only with massive aid from Iran.

To me, this was the only possible outcome given the religious, political, and economic realities of the Middle East. A lot of people disagreed. Indeed, I received more hate emails after that essay was published than anything I’ve ever written. But it turns out I was right.

Fast-forward to 2010. At President Obama’s urging, Congress enacted a jobs bill called the Hiring Incentives to Restore Employment (HIRE) Act. How would Congress pay for these incentives? The answer lay tucked away in Title V, Subtitle A of the bill, the Foreign Account Tax Compliance Act, or FATCA.

In short, FATCA demands that every foreign financial institution (FFI) in the world sign an agreement and strictly comply with the IRS to turn over account information of its US clients. FFIs that fail to do so are subject to a 30% withholding tax on certain “withholdable payments” from US sources. They’ll likely also be subject to 30% withholding on payments from other participating FFIs anywhere in the world.

You might be wondering how the US could convince other countries to comply with these demands. For smaller countries, it’s easy: The IRS simply informed them that if they don’t, they’d risk being effectively cut off from the global US dollar clearing system. Since the US dollar accounts for nearly 90% of foreign exchange transactions and more than 80% of international trade finance, that’s not an idle threat.

It’s a bit like Little Red Riding Hood negotiating with the Big Bad Wolf over what’s for lunch.

For larger countries, though, the IRS offered a “carrot” as well as a “stick.” It promised them that information exchange under FATCA would be “reciprocal”; the IRS would provide account information on their residents’ investments in the US.

There was just one problem with this promise – the IRS had no legal authority to make it.

You read that right – there’s no legal mechanism to force US financial institutions to send account information on their non-US customers to the IRS or anyone else. The inter-governmental “sharing” agreements (IGAs) the IRS has signed with more than 100 countries to obtain the data FATCA requires are, in effect, a fraud.

And so, beginning in 2013, I predicted that the reciprocal information exchange the IRS promised would never come into effect without congressional authorization. And that Congress, as long as it was controlled by Republicans, would never consent to sending US account records to foreign tax authorities.

By then, the Obama Treasury Department had issued proposed regulations that would allow reciprocal exchange. But some in Congress feared – then and now – that these rules would discourage foreign investment in the US. That could simultaneously weaken bank balance sheets, reduce foreign purchases of US Treasury debt, and crush the US dollar.

Senator Rand Paul (R-KY) even promised to filibuster any information exchange agreements that call for the US to send account data to other countries.

Three years later, finance ministers in Germany, China, India, and other countries are starting to ask, “Where’s the data on our citizens investing in the US?” And there’s a deafening silence for the US response to that question.

The question of reciprocal data exchange took on new momentum earlier this year, with the release of the so-called “Panama Papers.” Journalists began pointing out that laws in most US states made it easier to hide money in the US than in any “offshore” jurisdiction. The EU Green Party even proposed blacklisting the US as a tax haven.

So, what happens next? Congress is no more likely to authorize information sharing now than it was in 2013. It might seem logical for America’s largest trading partners to simply say “good riddance” to FATCA and pull out of the IGAs they have signed. If the IRS begins withholding 30% of outbound transfers to these countries, as it’s threatened to do, they can retaliate by withholding 30% of outbound transfers to the US.

I don’t think that will happen. Most likely, the IRS will only impose FATCA sanctions against the weakest and most vulnerable countries – nations like Vanuatu or Nauru. If it did otherwise, the global economy could quickly grind to a halt as country after country imposed their own 30% withholding regime against outbound US dollar transfers.

The right thing to do, of course, would be for Congress to repeal FATCA. However, that won’t happen as long as Obama is in the White House.

But what happens in 2017, once Obama’s successor – be it Hillary, The Donald, or even Waka Flocka Flame – is inaugurated? Anything is possible… stay tuned!

Mark Nestmann

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