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FATCA - A Status Report

Many people doubted whether the United States Foreign Account Tax Compliance Act – commonly referred to by its acronym FATCA – was a viable piece of the legislation when approved by Congress six years ago, given its wide extra-territoriality. Yet, six years later, and most of the world's nations have signed up to FATCA in one way or another. This special feature provides a status report on FATCA, and looks at how far the legislation's tentacles have spread.

What Is FATCA?

FATCA was signed by President Barack Obama in March 2010 as a revenue provision to the Hiring Incentives to Restore Employment Act. It is designed to tackle the non-disclosure by US citizens of taxable income and assets held in foreign accounts.

The law is framed to ensure that the US obtains information on accounts held abroad at foreign financial institutions (FFIs) by US persons. Failure by an FFI to disclose information on their US clients, including account ownership, balances, and amounts moving in and out of the accounts, will result in a requirement on US financial institutions to withhold 30 percent tax on US-source income.

FATCA's History

Final regulations for the implementation of FATCA were issued by the US Treasury and Internal Revenue Service (IRS) in January, 2013. Since August 2013, FFIs have been permitted to use an on-line portal for FATCA registration (see below). The final text of the agreement to be entered into by FFIs and guidance for participating FFIs was released in December 2013. FFIs had to complete due diligence and withholding requirements by July 1, 2014 (a deadline pushed back from January 1, 2014) ready for the first reports to reach the IRS by March 31, 2015, regarding accounts maintained during 2014.

However, in recognition of the difficulties that FFIs were experiencing in having the necessary reporting systems in place on time, on May 19, 2014, the IRS announced that calendar years 2014 and 2015 would be regarded as an enforcement and administration "transitional period" with respect to the implementation and enforcement of FATCA. This meant that while FATCA was still considered effective from July 1, 2014, the IRS would refrain from "rigorously enforcing" many of its requirements in the two years in question so as to "facilitate an orderly transition," as long as FFIs were making a "good-faith" effort to achieve compliance.

Inter-Governmental Agreements

When FATCA was enacted, its critics saw its extra-territoriality as its major flaw. Because for the legislation to work as intended, foreign governments would somehow have to be persuaded to break their own data protection and privacy laws in order for the IRS to get its hands on confidential financial account information of America clients of foreign banks and other FFIs. 

The US Treasury addressed this situation by developing three model inter-governmental agreements (IGAs) allowing data exchanges to take place between foreign jurisdictions and the IRS. And crucially, it dangled the carrot of "reciprocity" in front of foreign governments in order to expedite the creation of an IGA network – in other words, the IRS is sharing information about foreign persons with US bank accounts with their country of residence. The three model IGAs are as follows:

  • The Model 1 IGA requires FFIs in the foreign jurisdiction to report tax information about US account holders directly to the government, which will in turn relay that information to the IRS.
  • The Model 1A IGA is essentially the same, except that the IRS will reciprocate with similar information about account holders from the signatory country with the partner government.
  • The Model 2 IGA requires FFIs to report specified information about their US accounts directly to the IRS, to the extent that the account holder consents or such reporting is otherwise legally permitted, and such direct reporting is supplemented by information exchange between governments with respect to non-consenting accounts. FFIs also report to the IRS aggregate information with respect to holders of pre-existing accounts who do not consent to have their account information reported, on the basis of which the IRS may make a "group request" to the partner jurisdiction for more specific information.

As of September 8, 2016, a total of 113 IGAs were in force, had been signed, or had been agreed "in substance."

However, on January 1, 2017, the Treasury will begin updating its IGA list to provide that certain jurisdictions that have not brought their IGA into force will no longer be treated as if they have an IGA in effect.

FATCA Registration System

The FATCA Online Registration System is a secure, web-based system that FFIs and other entities can use to register for FATCA purposes. Launched in 2013, the system allows the IRS to identify FFIs with FATCA obligations. These entities generally report on foreign financial accounts held by US taxpayers under the terms of FATCA or pursuant to the provisions of IGAs.

In November 2015, the IRS upgraded the FATCA Online Registration System, to allow the registration of sponsored entities, and to make the platform easier to use. In addition, since November 16, 2015, the upgraded registration system has allowed users to update their information, download registration tables, and change their financial institution type.

At the time, the IRS reported that more than 170,000 FFIs, located in more than 200 jurisdictions, had registered with the agency. 

FATCA Exchanges

In October 2015, the IRS confirmed it succeeded in exchanging financial account information with certain foreign tax administrations by the September 30, 2015 deadline.

IRS Commissioner John Koskinen said of this achievement that: "This groundbreaking effort has fundamentally altered our relationship with tax authorities around the world, giving us all a much stronger hand in fighting illegal tax avoidance and leveling the playing field."

"Meeting the Sept. 30 deadline is a major milestone in IRS efforts to combat offshore tax evasion through FATCA and the intergovernmental agreements," said Koskinen. "FATCA is an important tool against offshore tax evasion, and this is a significant step in the process. The IRS appreciates the assistance of our counterparts in other jurisdictions who have helped to make this possible."

IRS FATCA Efforts Praised…

The IRS is normally used to receiving criticism rather than praise. However, the agency was generally applauded by the Treasury watchdog TIGTA for its implementation of the Foreign Account Tax Compliance Act.

The 2015 TIGTA investigation found that the agency "has taken steps to provide information to affected stakeholders that explains the FATCA requirements and expectations." It pointed out that the IRS has a website solely dedicated to providing a variety of FATCA-related information for individuals, financial institutions, and foreign governments.

The audit decided that, "overall, the FATCA Compliance Roadmap is fairly comprehensive," and "the IRS has made a reasonable effort to keep external stakeholders informed on the status and events related to the implementation of the FATCA."

It found, however, that the IRS has experienced "some delays in implementing its compliance strategy and anticipates that some of the estimated implementation dates may change due to the availability and accessibility of FATCA data and budget limitations (e.g., information technology and human resources funding)."

TIGTA also suggested some improvements. In particular, it recommended, and the IRS agreed, that the IRS "needs to update the FATCA Compliance Roadmap to include more information on how the IRS will specifically ensure that FFIs comply with FATCA (such as when, what, and how the data related to FFI compliance will be reviewed and what outcomes are expected)."

…But The Finance Industry Laments

The impact of FATCA in financial terms can only be guessed at. However, it has been estimated that financial institutions and other reporting entities around the world are spending about USD8bn a year to ensure they are compliance with FATCA.

But is the industry really ready to be the eyes and ears of the world's tax authorities? Recent research suggests that financial institutions are generally confident about meeting existing and incoming automatic exchange of information obligations. However, the study also found that a significant proportion of the industry is facing higher costs and risking fines by being under-prepared for new compliance requirements.

The research by Aberdeen Group for Sovos Compliance, the tax compliance and reporting software firm, shows that there is "a large gap in preparedness" for reporting requirements under the OECD Common Reporting Standard (CRS), FATCA, and the United Kingdom's equivalent regime, commonly referred to as CDOT. Worryingly, many institutions, Sovos said, related high rates of inaccurate filings and excessive compliance costs, and expressed fears of significant business impacts, including reputational damage and falling customer numbers.

In a survey of 100 leaders of financial institutions subject to the CRS that is being rolled out globally through the end of 2018, 64 percent of respondents said their organization is "significantly prepared" to cope with the demands of automatic EoI. However, the report showed that less than half of filings under FATCA, which has been effective for more than two years and upon which the CRS is substantially based, are accurate and complete.

FATCA's Impact On US Expats

While the finance industry is doubtless making every effort to comply local FATCA requirements, for some financial institutions this is a regulatory measure too far. Therefore, rather than risking the legal and reputational consequences of failing to meet these requirements, many financial service providers have decided that dealing with US clients is simply more trouble than it's worth. And the upshot of this is that many Americans, having had their existing bank accounts closed, and applications for new accounts refused, are struggling to obtain even the most basic financial services while residing abroad.

American Citizens Abroad (ACA) has no doubt that a financial services "lockout" effect exists against American customers from FFIs in foreign jurisdictions, and is advocating the inclusion of a "Same Country Exemption" (SCE) in the final FATCA regulations, soon to be issued by the Treasury Department.

In a letter to Robert B. Stack, Deputy Assistant Secretary for International Tax Affairs, ACA urged Treasury to exempt Americans residing in a foreign country from the rules requiring foreign financial institutions (FFIs) to report on US account holders' accounts.

Where a US person truly resides in a foreign country and has a normal financial account at a bank or similar institution in the same country, ACA is recommending the FFI should treat it as if it belonged to someone who is not a US taxpayer, and the latter would not have to list the account when returning Form 8938, Statement of Specified Foreign Financial Assets.

It remains to be seen whether the US Government has listened to the concerns of the vast constituency of US expats.

FATCA Versus Privacy – An Unloved Law

The IRS assures us that it has developed information system infrastructure, procedures, and data use and confidentiality safeguards to protect taxpayer data. The IRS has also stressed that it will only engage in reciprocal exchange with foreign jurisdictions that, among other requirements, meet its stringent safeguard, privacy, and technical standards. Indeed, before exchanging with a particular jurisdiction, the United States conducted detailed reviews of that jurisdiction's laws and infrastructure concerning the use and protection of taxpayer data, cyber-security capabilities, as well as security practices and procedures.

However, critics of FATCA – particularly in the United States – say that the law is not only massively extra-territorial in scope, but also tramples all over an individual's right to privacy and could lead to falling foreign investment in the US. What's more, the US Government has been accused of using FATCA as a sledgehammer to crack a nut, for the Treasury Department estimates that only USD800m per year in extra tax will be collected under the law – a figure which pales into insignificance compared with the money spent by financial institutions and tax authorities to introduce FATCA.

FATCA has been challenged on a number of fronts, both legislatively in the United States, and via the courts in the US and other countries. One of the most vocal critics is Senator Rand Paul, a Kentucky Republican, who has called FATCA "a textbook case of a bad law." In March 2015, Paul introduced a bill in the Senate to repeal FATCA's "anti-privacy provisions," thereby rendering the law redundant.

A similar bill was introduced in the House of Representatives on September 7, 2016, by fellow Republican Mark Meadows (R - North Carolina). Meadows believes that FATCA violates privacy rights guaranteed by the Fourth Amendment of the US Constitution, and his bill would therefore repeal all of FATCA's information reporting and tax withholding requirements. "Ultimately, it is clear that FATCA goes well beyond what is appropriate and requires a level of disclosing information to the IRS that violates Americans' Fourth Amendment rights and places unnecessary burdens on taxpayers," he said.

Paul's bill is a carbon copy of proposed legislation he introduced in the previous session of Congress. However, that failed to come up for a vote, and with just a few weeks of the current session remaining, his and Meadow's bill are likely to suffer the same fate.

Senator Paul has been equally as unsuccessful in using the courts to overturn FATCA. In April 2016, the US District Court for the Southern District of Ohio dismissed a case brought by Paul and a group of individuals, who attempted to make several challenges to FATCA and the Report of Foreign Bank and Financial Accounts (FBAR).

In their introduction to the case, the plaintiffs stated that the FATCA and FBAR "laws and agreements impose unique and discriminatory burdens on US citizens living and working abroad," and that "the challenged provisions are unconstitutional and the defendants [Treasury, IRS and FinCEN] should be enjoined from enforcing them."

The plaintiffs called IGAs unconstitutional, as they had not been submitted to the US Senate for its advice, consent or approval, while they also "nullify the right of individuals to refuse to waive foreign privacy laws that would otherwise prohibit their banks from disclosing their account information to the IRS."

Furthermore, it was noted that the FATCA and FBAR reporting requirements "require US citizens living abroad to report more detailed information about their local bank accounts than US citizens living in the United States."

Finally, it was claimed that the 30 percent "tax" imposed by FATCA on payments to foreign FIs when they "choose not to help the IRS pry into the bank accounts of their US customers … is not a tax at all but rather a penalty designed to accomplish indirectly through financial coercion what the US government cannot mandate directly through regulation."

However, the court decided that all of the plaintiffs lacked standing to sue in various ways. In particular, they had failed to establish that they had suffered an injury caused directly by the Treasury, IRS or FinCEN.

Court challenges on foreign soil have also fallen short, including in Canada, where in September 2015, the Federal Court denied a request for an injunction to prevent the collection and disclosure of FATCA information to the United States regarding American citizens living in Canada.

While an attempt to block FATCA exchanges by the state of Israel was initially more successful, a later hearing overturned the injunction. Ominously, the judge in the second hearing appeared to suggest that the age of individual privacy was over.

The Israeli lawsuit was initiated by an organization called Republicans Overseas Israel. And it is probably fair to say that, in the US, critics of FATCA have a more sympathetic ear on the Republican side of Congress than the Democratic. Indeed, the Republican Party's election platform, agreed at its National Convention in July 2016, says FATCA and FBAR results in "Government's warrantless seizure of personal financial information without reasonable suspicion or probable cause" and is of the opinion that "FATCA not only allows 'unreasonable search and seizures' but also threatens the ability of overseas Americans to lead normal lives."

However, the platform stopped short of pledging to repeal these laws, and Republican presidential candidate Donald Trump has not expressed a wish to do so.

Thus, while opponents will probably continue in their attempts to repeal or nullify FATCA, their chances of success would seem remote. A Trump presidency, allied with a Congress controlled by Republicans, would improve these chances considerably. However, with FATCA having effectively gone global under the guise of OECD the Common Reporting Standard, automatic exchange of information seems to be becoming the norm, rather than something exceptional.

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