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Debunking 5 Myths About FATCA

The Foreign Accounts Tax Compliance Act of 2010 (FATCA) requires foreign banks and other financial institutions automatically report the accounts held or controlled by U.S persons to the IRS on an annual basis. The goal of the automatic exchange of financial information in tax matters is increased offshore transparency, reduction of the tax gap and elimination of taxpayer noncompliance. The FATCA provisions are instituted trough:

  • Intergovernmental Agreements (IGA) signed between the United States and a foreign country. When the IGA enters into force, FATCA becomes the law of the foreign country and the financial institutions located there have no option but compliance. The Department of the Treasury reports that as of 2017th, 113 foreign jurisdictions signed FATCA IGA with the States.
  • Foreign financial institutions located in a country with no IGA have a choice. They can gain FATCA compliant status after registration and approval by the IRS. Or they might remain non-compliant facing potential penalties on certain payments originating in the United States. A complete list of all FATCA compliant institutions on a country-by-country basis is available at the FATCA website.

The automatic exchange of financial information is so controversial that some embrace it as a cure, while others consider it doomed. To help you take a side, we have presented the five most persistent and widely cited FATCA myths.

Myth #1 – FATCA forced foreign banks close accounts held by U.S. persons

The most avid argument set forth by taxpayers, institutions, and organizations opposing the exchange of financial information. Obviously, the originators of this myth have no clue how FATCA works at all.

The FATCA requires a foreign financial intuition to implement adequate internal controls and follow due diligence procedures aiming to identify accounts held or controlled by U.S. taxpayers. The bank makes a disclosure of all U.S. taxpayer accounts to a local authority or the IRS on an annual basis. If no reportable accounts were identified, the bank certifies no such were found.

Of course, an exception applies. The IRS recognizes that some foreign banks are so small that the costs of implementing FATCA would be unjustified. These banks are granted an exemption from FATCA if they close all accounts held or controlled by international taxpayers. Yes, you got it right! Not just the accounts held by Americans, but all international accounts! Thus, the exemption applies only to small-size local banks that certify they have and will never have any international clients at all.

Foreign banks with at least one international client, regardless of nationality, do not qualify for an exemption. Depending on the scale of operations, they face thousands or even millions of dollars in FATCA compliance costs per year. Even worse, because of the due diligence requirements, the banks bear the costs of maintaining FATCA compliant status, even when there are no U.S. clients at all!

Now when you know how FATCA operates, ask yourself a rhetoric question. If banks face millions of dollars in fixed costs to maintain FATCA compliance even when no U.S. clients on record and the variable costs are a fraction of a dollar per client, does it make economic sense to close the accounts owned by a U.S. persons?

Myth # 2– FATCA targets U.S. citizens, residents, and expats

The increase in individual offshore disclosures and awareness are the consequence not the cause of FATCA. The automatic exchange doesn't call for an imposition of any tax on any U.S. person holding an offshore financial account. Nada! Instead, a 30% "penalty" is imposed on overseas financial institutions that refuse to comply with FATCA. How come and why so?

In 2007-2010, the IRS investigated several foreign banks under allegations they assisted U.S. taxpayers to hide billions of income abroad. The Swiss flagship UBS settled with the IRS for $780 million for helping U.S. taxpayers to evade tax on $20 billion of assets. The bank disclosed over 4400 affected taxpayers to the IRS. The fate of the German’s Deutsche Bank was identical. It settled for $580 million and handed over 2000 bank clients to the IRS. The HSBC in India, Fist Caribbean International Bank, and others followed.

The IRS just figured it out! It is more cost-effective and productive forcing a foreign bank to pay the penalty and denunciate 4000 U.S. taxpayers, than separately testing, probing and indicting 4000 taxpayers. Hence, the FATCA was implemented to target international financial institutions not the U.S. taxpayers with offshore accounts.

Myth #3 – FATCA increased the tax compliance burden on U.S. taxpayers

The FATCA added Sections 1471-1474 to the Internal Revenue Code (IRC) and modified certain other reporting requirements already in place. All in all, less than 20 pages of tax law. So what is the fuss about it?

For many, the complexity arises because of Section 6038D. It created a brand new report on Form 8938 "Statement of Specified Foreign Financial Assets." U.S. taxpayers with foreign financial assets over a de minimis threshold must make an annual report to the IRS by attaching Form 8938 to a duly filed income tax return. Indeed a complication, no arguments against it. However, is the brand new Form 8938, a lightning out of a clear sky?

Not even close! Form 8938 is nothing more than a summary statement, a duplicate filing for many other disclosures that have been in existence for decades. Let's examine the form in detail. It requires reporting of foreign bank and securities accounts, pension funds and trusts, company interests, equity funds, and the like.

Sounds familiar? Consider the Foreign Bank Account Report (FBAR) provisions under the Bank Secrecy Act of 1970, the Controlled Foreign Company (CFC) reporting requirements enacted back in 1962, the reports related to offshore transfers in force as of 1997 and the foreign trust disclosure provisions dating back to 1982.

In reality, FATCA did not add significant complexity to the already overly complex and cumbersome tax code. The FATCA naturally surfaced longstanding tax law provisions taxpayers did not care about by making them difficult to bypass and disregard!

Myth #4 – FATCA calls for a reciprocal exchange of financial information

A useful model for automatic exchange of financial information requires a universal standard on information being subject to the exchange, aligned to the interests of the countries involved. The FATCA is the forerunner of the OECD’s Common Reporting Standard (CRS) for a bi-lateral exchange of financial information in tax matters. However, a word about two-way exchange appears only in a reciprocal Model 1A IGA. Out of the 113 IGAs to date, only 57 are reciprocal agreements!

Furthermore, the Model 1A agreement creates no universal standard of exchange. The expensive and time-assuming due diligence provisions applicable to foreign banks do not apply to their U.S. counterparts. The financial information provided by the IRS is based solely on tax data remitted by the U.S. banks under other provisions of the tax code. FATCA has been written with the USA in mind.

For example, bank account interest, dividends and capital gains paid to non-resident aliens and foreign companies are otherwise required to be reported on Form 1042-S. The unchanged and unverified 1042-S information will be made available by the IRS to a Model 1A country. No further inquiries will be made by the IRS or the financial institutions involved.

So where is the bi-lateral exchange? There is a long way of legislative changes before the Government is first willing and then capable of collecting and providing full-scale financial information to foreign partner jurisdictions. Until that day, the FATCA will be a one-way road only.

Myth #5 – Residency determined under a tax treaty overrides FATCA

The Canadian Revenue Agency (CRA) made a stunning discovery. As per information posted on the CRA’s website, Green Card holders who are residing in Canada can apply the tie-breaker rule in Article IV(2) of the US-Canada Income Tax Treaty to override the definition of a U.S. person in Article 1(1)(ee) of the Model 1 IGA.

The CRA came to that conclusion by skimming a paragraph on page 6 of IRS Publication 519 "U.S. Tax Guide for Aliens." The text reads that a dual-resident taxpayer, who is a resident of both the United States and another country under each country's tax laws, can determine residency under the tie-breaker rule of a tax treaty. Thus, a Green Card holder with stronger social and economic ties to Canada can purportedly inform a Canadian financial institution that under the provisions of the tie-breaker rule of the U.S.-Canada income tax treaty, the person is not a resident of the United States.

Excellent reasoning! However, CRA failed to stipulate the paragraph in IRS Publication 519 is taken out of the context of Treas. Reg. 301.7701(b)-7. The Regulation exemplifies that the tax treaty definition of residency applies only to statutes levying taxes. There is no tax levied on any person when the automatic exchange of financial information takes place. The tax treaty definition of residency does not apply.

The tax is levied when a person files a U.S. income tax return. At that point, the tax treaty comes into play. A Green Card may submit Form 1040-NR claiming non-resident alien status under the tie-breaker rule of the US-Canada Income Tax Treaty. Of course, doing so could trigger the expatriation tax provisions of Sections 877 and 877A so better thing twice.