The Foreign Account Tax Compliance Act (FATCA) is a portion of the 2010 Hiring Incentives to Restore Employment (HIRE) Act that requires individuals to report their financial accounts held outside of the United States and foreign financial institutions to report to the Internal Revenue Service (IRS) about their American clients. FATCA was designed primarily to combat offshore tax evasion and recoup federal tax revenues.
Under U.S. tax law, U.S. persons are generally required to report and pay taxes on income from all sources. "U.S. persons," in this case, include U.S. citizens and U.S. permanent residents residing outside of the United States.Taxpayer identification numbers and source withholding are used to enforce foreign tax compliance. For example, mandatory withholding is often required when a U.S. payor cannot confirm the U.S. status of a foreign payee. The IRS previously instituted a Qualified Intermediary (QI) program under IRC §1441 which required participating foreign financial institutions to maintain records of the U.S. or foreign status of its account holders and to report income and withhold taxes. One report found that participation in the QI program was too low to have a substantive impact as an enforcement measure and was prone to abuse. An illustration of the weakness in the QI program was that UBS, a Swiss bank, had registered as a QI with the IRS in 2001 and was later forced to settle with the U.S. Government for $780 million in 2009 over claims that it fraudulently concealed information on its American account holders. Self-reporting of foreign financial assets was also found to be relatively ineffective.
It has been estimated that the U.S. Treasury loses as much as $100 billion annually to offshore tax non-compliance. Therefore, supplementing the reporting regimes already in place was deemed to be an effective means of increasing compliance and raising government revenue. After committee deliberation, Sen. Max Baucus and Rep. Charles Rangel introduced the Foreign Account Tax Compliance Act of 2009 to Congress on October 27, 2009. It was later added to an appropriations bill as an amendment, sponsored by Sen. Harry Reid, which also renamed the bill the HIRE Act. The bill was signed into law on March 18, 2010.
FATCA has three main provisions:
It requires foreign financial institutions, such as banks, to enter into an agreement with the IRS to identify their U.S. account holders and to disclose the account holders' names, TINs, addresses, and the accounts' balances, receipts, and withdrawals. U.S. payors making payments to non-compliant foreign financial institutions are required to withhold 30% of the gross payments. Foreign financial institutions which are themselves the beneficial owners of such payments are not permitted a credit or refund on withheld taxes absent a treaty override.
U.S. persons owning these foreign accounts or other specified financial assets must report them on a new Form 8938 which is filed with the person's U.S. tax returns if they are generally worth more than US$50,000; a higher reporting threshold applies to overseas residents and others. Account holders would be subject to a 40% penalty on understatements of income in an undisclosed foreign financial asset. Understatements of greater than 25% of gross income are subject to an extended statute of limitations period of 6 years. It also requires taxpayers to report financial assets that are not held in a custodial account, i.e. physical stock or bond certificates.
It closes a tax loophole that foreign investors had used to avoid paying taxes on U.S. dividends by converting them into "dividend equivalents" through the use of swap contracts.
Certain aspects of FATCA have been a source of controversy in the financial and general press. The controversy primarily relates to five central issues:
Cost. Although numbers are still somewhat speculative, estimates of the additional revenue raised seem to be heavily outweighed by the cost of implementing the legislation. The Association of Certified Financial Crime Specialists (ACFCS) claims FATCA is expected to raise revenues of approximately US$800 million per year for the US Treasury; however, the costs of implementation are more difficult to estimate, and estimates between hundreds of millions and over US$10 billion have been published. ACFCS also claims it is extremely likely that the cost of implementing FATCA (which will be borne by the foreign financial institutions) will far outweigh the revenues raised by the US Treasury, even excluding the additional costs to the US Internal Revenue Service for the staffing and resources needed to process the data produced. Unusually, FATCA was not subject to a cost/benefit analysis by the Committee on Ways and Means.
Capital flight. The primary mechanism for enforcing the compliance of foreign financial institutions is a punitive withholding levy on US assets. This may create a strong incentive for foreign financial institutions to divest (or not invest) in US assets, resulting in capital flight.
Foreign relations. Forcing foreign financial institutions and foreign governments to collect data on US citizens at their own expense and transmit it to the IRS has been called divisive. Canada's Finance Minister Jim Flaherty has raised an issue with this "far reaching and extraterritorial implications" which would require Canadian banks to become extensions of the IRS and would jeopardize Canadians' privacy rights. There are also reports of many foreign banks refusing to open accounts for Americans, making it harder for Americans to live and work abroad.
Extraterritoriality. The legislation enables US authorities to impose regulatory costs, and potentially penalties, on foreign financial institutions who otherwise have few if any dealings with the United States. The U.S. has sought to ameliorate that criticism by offering reciprocity to potential countries who sign Intergovernmental Agreements, but the idea of the US Government providing information on its citizens to foreign governments has also proved controversial. The law's interference in the relationship between individual Americans or dual nationals and non-American banks led Georges Ugeux to term it "bullying and selfish."
Citizenship renunciations. Time magazine has reported a sevenfold increase in Americans renouncing US citizenship between 2008 and 2011 and has attributed this at least in part to FATCA. Another surge in renunciations in 2013 to record levels has been reported in the news media, with FATCA cited as a factor in the decision of many of the renunciants.
There have also been doubts expressed as to workability of FATCA due to its complexity, and the legislative timetable for implementation has already been pushed back twice.
American Citizens Abroad, a Geneva-based organization representing the interests of six million Americans residing outside the U.S., opposes the legislation and has launched a campaign to repeal FATCA. The group argues that "FATCA legislation is predicated on the faulty assumption that foreigners throughout the world with no predisposition to favor the U.S. will react positively to its attempts to convert them into unpaid IRS agents", and in addition to the issues above stresses the increased risk of identity theft, and the risk of a two-tier banking system developing to the partial exclusion of the U.S.
There are wildly varying estimates of the likely cost of implementing the legislation. FATCA is expected to produce approximately $8.7 billion in additional tax revenue over 10 years, which is small relative to the estimated $40 billion per year cost of international tax evasion.:36 The United States Congress Joint Committee on Taxation estimated that the FATCA bill would raise $792 million of additional taxes a year in the next ten years.
Estimate of the costs to the private sector, the IRS and foreign revenue authorities are less precise. Compliance cost to financial institutions alone has been roughly estimated at US$8 billion a year, approximately ten times the amount of estimated revenue raised. The United Kingdom government has estimated that the cost to British businesses alone will be £1.1 billion - £2 billion for the first five years (approximately two thirds of the estimate total additional global tax revenue expected). There are few reliable estimates for the additional cost burden to the IRS, although it seems certain that the majority of the cost seems likely to fall on the relevant financial institutions and (to a lesser degree) foreign tax authorities who have signed intergovernmental agreements.
FATCA added Internal Revenue Code § 6038D (26 U.S.C.§ 6038D) which requires the reporting of any interest in assets over $50,000 after 18 March 2010, and § 1298(f) (26 U.S.C.§ 1298(f)) requiring shareholders of a passive foreign investment company (PFIC) to report certain information. It also added §§ 1471–1474 (26 U.S.C.§ 1471 et seq.) requiring U.S. payors to withhold taxes on payments to foreign financial institutions (FFI) and nonfinancial foreign entities (NFFE) that have not agreed to provide the IRS with information on U.S. accounts.
The IRS issued temporary regulations (TD 9567) on 14 December 2011 requiring the filing of Form 8938 with individual income tax returns, and proposed regulations (REG-130302-10) for domestic entities. Treasury and the IRS issued final regulations and guidance (TD 9584) on reporting interest paid to nonresident aliens on 17 April 2012. Treasury and the IRS issued proposed regulations (REG-121647-10) regarding information reporting by, and withholding of payments to, foreign financial institutions on 8 February 2012, and final regulations (TD 9610) on 28 January 2013.
FATCA implementation faces legal hurdles because it may be illegal in foreign jurisdictions for financial institutions to disclose the required account information. There is a controversy about the appropriatenesss of intergovernmental agreements (IGAs) to solve any of these problems.
The United States Department of Treasury has published model IGAs which follow two approaches. Under Model 1, financial institutions in the partner country report information about U.S. accounts to the tax authority of the partner country. That tax authority then provides the information to the United States. Model 1 comes in a reciprocal version (Model 1A), under which the United States will also share information about the partner country's taxpayers with the partner country, and a nonreciprocal version (Model 1B). Under Model 2, partner country financial institutions report directly the U.S. Internal Revenue Service, and the partner country agrees to lower any legal barriers to that reporting. Model 2 is available in two versions: 2A with no Tax Information Exchange Agreement (TIEA) or Double Tax Convention (DTC) required, and 2B for countries with a pre-existing TIEA or DTC. Hence an IGA can be concluded without either a TIEA or DTC in place, as a tax professor has corrected an assertion by Rand Paul.
All of the IGAs so far have been reciprocal Model 1 agreements, with the exception of Switzerland's, which is a Model 2 agreement. The IGA with Mexico is the only one that has entered into force.
Russia, while not ruling out an agreement, requires full reciprocity and abandonment of US extra-territoriality before signing an IGA..
^111 Cong. Rec. S1635-36 (daily ed. Mar. 17, 2010) (statement of Sen. Levin) ("Right now, thousands of U.S. tax dodgers conceal billions of dollars in assets within secrecy-shrouded foreign banks, dodging taxes and penalizing those of us who pay the taxes we owe. The Permanent Subcommittee on Investigations... estimated that these tax-dodging schemes cost the Federal Treasury $100 billion a year.") [hereinafter "Levin statement"], http://www.gpo.gov/fdsys/pkg/CREC-2010-03-17/pdf/CREC-2010-03-17-pt1-PgS1633-8.pdf#page=4
^U.S. Government Accountability Office (GAO), Offshore Financial Activity Creates Enforcement Issues for IRS: Testimony Before the Committee on Finance, U.S. Senate, March 17, 2009 (statement of Michael Brostek, Director, Strategic Issues Team) at 10, [hereinafter "GAO Report"], http://www.finance.senate.gov/imo/media/doc/031709mbtest1.pdf
^26 U.S.C. §871(m); dividends such as those paid by a U.S. corporation are U.S. source and therefore subject to the 30% withholding tax for foreign payees. 26 U.S.C. §§871(1)(A), 861(a)(2). The loophole was based on reclassifying the payment as income derived from the residence of the foreign payee and therefore exempting the payment from U.S. taxation.