Tuesday, May 18, 2010

FATCA: new automatic info exchange tool

The OECD has sought to persuade governments that its “on request” standard of information exchange – which is woefully inadequate, and an embarrassment for the OECD – is the “internationally agreed standard” for information exchange.

TJN, along with any expert in international tax who has a decent conscience, believes that there is a far better way to exchange information between jurisdictions, which is called Automatic Exchange of Information. We recently demonstrated, thanks to the expertise of Senior Adviser David Spencer, that Automatic Exchange of Information is, in fact, far more widespread than the OECD seems prepared to admit. It is, in fact, the emerging international standard, and it has proved workable in a number of areas.

Now we present another important piece of evidence about the ubiquity of Automatic Exchange of Information. This is the Foreign Account Tax Compliance Act (FATCA) which was enacted into U.S. law in March 2010 (with effective date of January 1, 2013.)

In effect, FATCA requires automatic exchange of information about U.S. persons with foreign financial accounts. It achieves this by subjecting each foreign financial institution (and other foreign entities) which invest their own funds or their clients’ funds in the U.S. to a 30 percent U.S. withholding tax on U.S.-sourced income – unless the foreign institution agrees to tell the U.S. Government information about foreign financial accounts of U.S. Persons.

FATCA builds on the existing (but deeply flawed) Qualified Intermediary (QI) Program, to create a stronger, though still flawed, piece of legislation.

This raises three main issues:
  • FATCA is a form of automatic exchange of information (not between jurisdictions, but between foreign financial institutions and the U.S. government.)

  • Although FATCA is an improvement on existing legislation, it still leaves the U.S. with double standards in its existing tax policy, by seeking to provide the U.S. authorities with information about its citizens, while still allowing the U.S. to provide de facto bank secrecy to foreigners who invest in the U.S.

  • While flawed, FATCA is nevertheless a step forwards, by making it harder for U.S. citizens to cheat on their U.S. taxes. Will other foreign governments follow the U.S. lead? It is potentially a powerful tool in tackling foreign tax evasion.
A bit of further background helps explain further.

The Qualified Intermediary (QI) Program
The QI Program was set up in 2001 to enable the U.S. government to collect tax owed to it by U.S. citizens, while preserving the U.S. as a secrecy jurisdiction for foreigners – thus continuing to thumb its nose at foreign jurisdictions, often in developing countries, who are trying to tax the income of their citizens. In short, it required foreign financial institutions to tell the U.S. authorities the identity of U.S. persons with funds invested in the U.S., but not to tell the U.S. authorities the identities of foreigners investing in the U.S. This is classic tax haven behaviour – and it is one of the main reasons why the United States was identified in first place as in TJN’s Financial Secrecy Index. Thousands of foreign financial institutions became so-called “Qualified Intermediaries.”

The devious line of thinking that led to the QI program went like this.

The U.S. wants to ferret out U.S. tax cheats. Yet the U.S. does not want to pass on information about foreign tax cheats to their home governments: if it did, then foreign tax evaders would take their money out of the U.S. and put it in another jurisdiction that would keep their information secret; among other things, this transparency would exacerbate U.S. balance of payments deficits. This is how secrecy jurisdictions work.

Yet if the U.S. had tried to ferret out information about U.S. tax cheats simply by getting foreign financial institutions to report on all income originating in the U.S., then it would have received a lot of information about potential U.S. tax cheats and foreign tax cheats. But the U.S. would not be able simply to take the information about U.S. citizens and then simply discard or ignore the information about foreigners. This is because the U.S. has a range of tax treaties and tax information exchange agreements (TIEAs) with other jurisdictions, which would formally require the U.S. to pass this information on to other foreign governments who are trying to identify tax their citizens’ overseas income. It would be obliged to be transparent.

What the U.S. did, instead, was to get someone else – the financial institutions -- to screen the information first, and then provide the U.S. with only the information about U.S. citizens. This way, the U.S. never receives any information about the identities of foreign tax evaders (and the financial institution is under no treaty obligation to inform the foreign government either). So the U.S. has no information available to submit under its treaties with foreign governments.

Problem solved. Foreign tax evaders will still invest in the U.S., knowing that their money will be protected by U.S. secrecy.

In fact, the original intent of the QI program was even more cynical, it seems. As a former U.S. tax official who was involved in the genesis of the QI program told TJN in a telephone interview in December 2009:

“It’s not clear to me that the QI program is well adapted to the objective of ferreting out Americans – that is not how it started at all. The program was not aimed at identifying Americans. The program was aimed at protecting the identity of foreigners while allowing them to invest in the US,” he said. “Making sure that Americans weren’t in the picture was part of it, but the real focus was on this competitive aspect abroad.”

In other words, it was the Tax Haven USA aspect that was the main objective of the QI program. The objective of ferreting out U.S. tax cheats was secondary.

How FATCA expands the scope of the QI program.
FATCA does not displace QI but builds on it. It preserves the essential Tax Haven USA approach – preventing the US having to provide information to foreign governments about their own fatcats using the USA as a secrecy jurisdiction. What it does is to beef up the ability of the U.S. to find out about its own tax cheats, by expanding the scope of QI.

QI is a voluntary program – foreign financial institutions agree to be bound by its rules, and pass on information. However, many of the foreign financial institutions that hold U.S. accounts are outside the reach of U.S. law, because they have decided not to become Qualified Intermediaries.

FATCA tackles this by expanding the scope of the requirements. Specifically, it expands:

- the type of U.S. Persons about whom automatic exchange of information is required;
- the type of foreign financial institution which must provide information automatically to the U.S. Government
- the type of income about which automatic exchange of information with the U.S. Government is required.

A PWC analysis suggests that the scope of FATCA is broad. As it says:

“FATCA requirements could extend to every type of foreign investment entity used in an alternative fund structure, including foreign master trading entities, offshore feeder fund vehicles, foreign private equity investment funds, SPVs and securitization vehicles, if they invest in securities generating U.S. source income.”

This detailed TJN Briefing Paper provides more specific details about the provisions of FATCA. Our Information Exchange page provides a range of links on this broad subject.

6 Comments:

Anonymous Keef said...

Opportunities for reciprocity toward foreign governments in this matter are relatively few, since no countries apart from the US and, I have heard, Albania, tax the foreign earnings of expatriates. Hence, other countries don't care about their citizens evading taxes while overseas because they don't owe any (not being subject, as Americans are, to a tax on their very citizenship).

10:40 pm  
Blogger DavidWelles said...

With the FATCA the U.S. is leading by example. No other country has a similar law, but they could adopt one.
Do other countries need a similar law? Many countries have different but quite effective means to catch tax evaders. For example, Germany pays whistle blowers for lists of German residents with unreported accounts abroad.
The FATCA is a wake up call to foreign financial institutions that have U.S. depositors. The cost of failure to report is one they cannot afford, a 30% withholding tax on the their U.S. source income, whether belonging to Americans, others or themselves. Their accountants will force them to comply.

11:20 pm  
Blogger DavidWelles said...

Beginning 2013, the US sub custodian will be the enforcer. All registered US securities are held by US sub custodians, like Bank of New York, State Street, Northern Trust, BBH . .They are clients of The Depository Trust, the custodian of all US registered securities. . . Over $30 trillion dollars worth. If a foreign financial institution trades in US securities, it must do so with a US Sub Custodian The US Sub Custodian will require evidence, maybe a certificate from the IRS, that the foreign financial institution is in compliance with FATCA. If it does not, the US Sub Custodian is required to withhold 30% of all Us source income, including dividends, interest AND GROSS SALES PROCEEDS!

3:11 am  
Anonymous Anonymous said...

I believe that this new law will be very bad for US economy. Can you imagine if all foreign money that is now invested on US deposits&bonds go to other exchange currencies or foreign company bonds ? This could be the end of the US dollar as a trade reference. Many company headquarters will move out. In first moment the dollar devaluation will help but in the second moment there will be no value for government long-term bonds. Also the economy is no longer industrial, it has became "services". Hope all the odds are well thought before this starts.

10:19 am  
Blogger DavidWelles said...

Keef has a point, but I suspect a significant portion of the tax revenue collected from FATCA will come from American Citizens and Green card holders living in the U.S. with investments in offshore entities. In this respect, other countries should have an interest in FATCA type laws. I heard that in the late 1990s the largest investors in several Latin American country were residents of these countries bring their money home again.

7:26 am  
Anonymous Anonymous said...

The US will be at risk of becoming "subsidaries" of US companies. Move your company headquarters out of the US to avoid FATCA, pay all your customers, and suppliers from there. Construct your business so money only goes into the US, not out. The complete opposite of FATCA. Job done - FATCA and its administration avoided. Canada would be a good choice.

US Treasury whinges about lost of tax revenue - tough luck.

4:25 pm  

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