Global Financial Information Regime Looms

[The Independent Institute does not work to influence the legislative process, but we find the following information and analysis interesting and worth passing on.—Ed.]

Later this year Americans could wake up to some unpleasant surprises:

  • Higher fees and costs associated with banking, pensions, insurance, and investment;
  • Reduced foreign investment in the United States and, consequently, fewer American jobs; and
  • The virtual end of financial privacy, with Americans’ personal asset information collected wholesale by the IRS in order to provide it—with questionable security protections—to foreign governments and, in all likelihood, to an international financial authority.

Worst of all, these will be surprises of our own making.

Welcome to FATCA(T)

Few in America have heard of a pending U.S. mandate that has had much of the outside world sweating bullets for two years.  Whimsically named the “Foreign Account Tax Compliance Act (FATCA)”—missing only the final “T” to spell out the accusatorial jab at well-heeled tax cheats—the law was enacted in 2010 as an offset revenue provision in an unrelated jobs spending bill.   (According to the Congressional Joint Committee on Taxation, FATCA would yield annual revenues of about $1 billion, a paltry sum compared to the roughly $2 trillion in tax revenues collected each year.)

In a nutshell, FATCA requires every “foreign financial institution” (FFI) in the world to collect information on U.S. residents whose assets it holds, and provide them directly to the IRS.  Failure to do so will result in IRS’s withholding 30% of the recalcitrant FFI’s income derived from U.S. sources.  FATCA rules pertaining to partial U.S. ownership and revenues derived from third-party institutions (so-called “passthru” provisions) impose additional complex compliance mandates.

In one aspect FATCA largely duplicates existing directives under another law, “Report of Foreign Bank and Financial Accounts (FBAR),” which orders Americans to report to the IRS their assets held in foreign banks.  FATCA, however, not only covers a broad array of non-bank assets, like foreign stocks and private equity funds, it places the burden directly on the FFIs to identify the required information and hand it over to the U.S. Treasury, in many cases in violation of their own countries’ domestic laws.  Faced with costly compliance measures—which accounting, software, and law firms are happy to sell, expecting a FATCA bonanza courtesy of the IRS—some FFIs have been dropping their U.S. clients, or considering withdrawal of assets from the United States to avoid potential withholding.

Americans living abroad, who are estimated to number over five million and who pay billions in taxes to the U.S. Treasury every year, are treated as presumptive criminals under FATCA and increasingly are regarded as pariahs by their local FFIs in the countries where they live and work.   Reports are multiplying of institutions turning away new American clients and telling existing ones they need to choose: close your account or renounce your U.S. citizenship.

The incentive for FFIs to pull their money out of the U.S. potentially is even more devastating in light of the $21 trillion in foreign investment in the U.S., of which $10.5 trillion is invested in U.S. securities.   As reported by American Citizens Abroad, a survey by one major accounting firm estimates that almost two-thirds of FFIs will disinvest in the U.S. rather than risk FATCA penalties.  Comments ACA: “If even a fraction of those foreign investors divest, the loss to the U.S. would be in the trillions of dollars.  This at a time when the U.S. economy desperately needs more foreign investment, not less.”

But Wait, It Gets Worse . . .           

FATCA can only go into effect once final regulations are promulgated by IRS with an effective date.   By late 2011 the IRS had found itself faced with the daunting, perhaps impossible, task of extending extraterritorial enforcement to every non-U.S. financial institution worldwide, backed up with the draconian withholding penalty.  Amid rising protests from FFIs and foreign governments (which attracted little attention inside the United States) the IRS deferred an earlier year-end target date for issuance of draft regulations.

When draft FATCA regulations finally were released in February 2012 (more than two months late), the IRS had found a way to pull a rabbit out of its hat.   Simultaneously with 388 pages of draft regulations, the U.S. Treasury also announced jointly with five principal European Union governments that they have “agreed to explore a common approach to FATCA implementation through domestic reporting and reciprocal automatic exchange and based on existing bilateral tax treaties.”   While not much more than an agreement in principle, the U.S. + EU 5 announcement means that the U.S. and “FATCA partner” countries will each undertake to collect through domestic channels information it will then share with its “partners.”  For example, instead of German FFIs’ being required to report Americans’ assets directly to the IRS, Berlin will pass laws requiring German institutions to provide the same information to the relevant German government agency, which will then turn the information over to the IRS.

While FFIs’ initial reaction in the five EU countries was that the deal might substantially relieve them of the FATCA compliance burden (a mistaken notion, since the domestic laws and regulations now busily being drafted in Berlin, London, Madrid, Paris, and Rome effectively will recapitulate the IRS’s 388 pages), the real news is that FATCA will now hit domestic American financial institutions.  FATCA compliance costs, as legislated in 2010, were intended to fall solely on FFIs—by definition non-U.S. institutions.  But under the partnership agreement, IRS will have to issue new regulations of American banks, investment funds, etc., for FATCA-like reporting to the IRS for transmittal to “partner” foreign governments.  Moreover,  American institutions clearly would have reporting requirements at the outset for each and all of the EU five, a burden that could increase dramatically if, as seems intended, more countries are enticed or pressured into participation as “FATCA partners.”

If the “partnership” agreement holds, later this year IRS will have to replicate for domestic application the draft regulations on FFIs issued in February, minus the 30% withholding provision.  But whereas FFIs were already fretting over potentially tens of billions of dollars in aggregate costs to identify and report the assets of just one country’s citizens, the costs to U.S. institutions could be literally incalculable for reporting to multiple foreign countries, despite efforts to simplify compliance via existing Qualifying Intermediary (QI) and tax treaty provisions.  A classic case of a cure even worse than the disease, the FATCA “partnership” agreement-imposed enforcement costs on domestic institutions of course will be passed on to American consumers.

But Wait – It Gets Even Worse . . .

It doesn’t take a great stretch of the imagination to see that what was touted as a net to catch rich Americans hiding assets in foreign accounts is likely to end up as the practical abolition of banking privacy in general, for which an intergovernmental FATCA partnership can be seen as the camel’s nose under the tent.  After all, what in principle is the difference between a French or British bank’s or pension fund’s reporting on an American citizen’s assets and transactions to Paris or London for transfer to the IRS (and a parallel process on the American side and in every other participatory country) and collecting such information about a government’s own citizens from domestic institutions?  In light of the data the IRS and its sister services will retrieve under the proposed partnership, any limitation on governments’ oversight of, literally, everyone’s private financial data increasingly will seem quaint and incongruous.   To start with, gathering of domestic data on deposits by foreign account holders will already include information on dual nationals, that is, people who are also citizens of the country in question.  If, for example, the IRS can demand detailed information about the deposits in an American bank of a U.S. citizen who also happens to be a citizen of Mexico for the purpose of informing the Mexican authorities, why shouldn’t IRS have unrestricted access to the same information about an American who happens not to be a citizen of somewhere else?

For citizens of countries with very restrictive currency controls, pervasive corruption, or poor human rights protections, disclosure of such data could have devastating consequences for the account owners in their home country.  This will intensify existing concerns about transmitting data from both American and foreign depositors in U.S. institutions.  For example, for reasons unrelated to FATCA, legislation already has been introduced in Congress (S. 1506, H.R. 2568) to prevent the Treasury Department from expanding United States bank reporting requirements with respect to interest on deposits paid to nonresident aliens.  These concerns will increase dramatically—perhaps explosively—upon release of IRS draft FATCA partnership regulations requiring American institutions to go on a “fishing expedition” in order to provide private financial information on millions of depositors, a significant proportion of whom would be U.S. citizens (i.e., dual nationals) for transmittal to foreign governments or (as eventually would be likely if the partnership expands membership significantly) to a central international repository.

Toward a Global Financial Fishbowl

Among the commitments in the U.S. + EU 5 agreement is that of “working with other FATCA partners, the OECD, and where appropriate the EU, on adapting FATCA in the medium term to a common model for automatic data exchange of information, including the development of reporting and due diligence standards.”  While the future role of the EU remains unclear—it is significant that Washington chose to bypass the European Commission in Brussels and first deal directly with EU member governments—the reference to the OECD (Organization for Economic Co-operation and Development) is further grounds for concern.  A 34-country organization whose stated mission is “to promote policies that will improve the economic and social well-being of people around the world”—well, who could object to that?—OECD has been in the forefront of efforts for combatting “tax havens” to eliminate “harmful tax competition” from low-tax jurisdictions in favor of “tax harmony.”  As some have characterized it, OECD aims “to create a global high-tax cartel” based on comprehensive intergovernmental financial information sharing or (in the words of the U.S. + EU 5 agreement) “a common model for automatic data exchange,” a natural way-station to a central global data clearinghouse—perhaps managed by the OECD itself.  Not only would this entail unacceptable risks for the security of personal financial data, it would be a powerful tool for pushing “harmonized” tax rates at higher levels and, ultimately, a threat to all countries’ financial sovereignty.  Even more ominously, comprehensive global collection of financial data and transactions could facilitate final realization of an idea that has been kicking around for a number of years in different forms: a supranational financial transaction tax (FTT).

Partly because they have little understanding of how American law and regulation work, reinforced by advice from those helpfully offering to sell them expensive compliance services, the prevailing view among FFIs—especially those in the five initial EU “partner” countries—is that FATCA is a done deal and nothing can be done about it.    This is of course incorrect.  While prudence indeed suggests that all potentially impacted parties prepare to comply, unless and until IRS issues final regulations with an effective date, financial institutions are not legally obligated to do anything.   (Beginning this year, some non-withholding tax compliance aspects of FATCA are already in effect. Certain U.S. taxpayers with interests in foreign financial accounts have had to file Form 8938 to report such interests.)  As things stand now under the draft regulations, FATCA compliance mandates for institutions would begin to be phased in in January 2013 and would not take full effect until 2017.   Meanwhile IRS needs to issue draft regulations impacting domestic American firms—which if they are self-interested will take notice of the danger beforehand—while a presumably growing list of “partner” countries craft their own domestic FATCA-oid regimes.

. . . or towards FATCA Repeal?

Many who oppose this problematic legislation see a window of time to defeat it. As the havoc FATCA and its global extrapolation would wreak becomes increasingly evident, compared to the meager benefit to the U.S. government’s coffers, a clearer picture is emerging of the long list of oxen who will be gored: American expatriates, dual nationals, American consumers of financial and investment services of any sort, workers in foreign investment-dependent industries, and anyone who doesn’t want their private financial data shared with who-knows-who—not to mention American and foreign firms (notably FFIs in countries inclined to resist signing on to the so-called “partnership”) saddled with costs completely out of balance with FATCA’s supposed revenue purpose.

FATCA is replete with vulnerabilities that could help sink it. Enacted without a cost/benefit analysis of its modest revenue recovery versus its far-reaching, destructive consequences—much less the kind of extensive public debate devoted, for example, to the so-called “Buffett Tax” on very high incomes—FATCA could have trouble passing Congress today.  It remains to be seen whether it will be a significant campaign issue in this election year.

James George Jatras is a Washington-based attorney with Squire Sanders, a global law firm. Focusing primarily on international affairs, he previously served as a policy analyst for the U.S. Senate Republican leadership and as an American Foreign Service Officer. He can be reached at [email protected].
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