Canada-US DTA: FATCA Provisions Added
By TreatyPro Editorial
18 February, 2014
On February 5, 2014, Canadian Finance Minister Jim Flaherty and National Revenue Minister Kerry-Lynne D. Findlay announced that, after lengthy negotiations, Canada and the United States had signed an intergovernmental agreement (IGA) under the longstanding Canada-US Tax Convention to implement enhanced information reporting between the two countries required by the US Foreign Account Tax Compliance Act (FATCA). Unlike the US Treasury's other IGA partners however, Canada drove a hard bargain.
FATCA, enacted by the US Congress in 2010 and which generally takes effect on July 1, 2014, is intended 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 to withhold 30 percent tax on payments of US-sourced income.
To address situations where foreign law would prevent an FFI from complying with the terms of an FFI agreement, Treasury has developed model IGAs.
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 US Internal Revenue Service (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 February 12, 2014, the US Treasury had Model 1 IGAs in effect with 19 jurisdictions, including Canada. Three Model 2 IGAs were effective as of the same date. The full list of effective FATCA IGAs can be viewed on the US Treasury's website.
The Canada-United States IGA
FATCA has raised a number of concerns in Canadaâamong both dual Canada-US citizens and Canadian financial institutions. One key concern was that the reporting obligations in respect of accounts in Canada would compel Canadian financial institutions to report information on account holders who are US residents and US citizens (including US citizens who are residents or citizens of Canada) directly to the IRS, thus potentially violating Canadian privacy laws.
Without an agreement in place, obligations to comply with FATCA would have been unilaterally and automatically imposed on Canadian financial institutions and their clients as of July 1, 2014. The Intergovernmental Agreement for the Enhanced Exchange of Tax Information under the Canada-US Tax Convention is therefore designed to address many of these concerns.
Under the agreement, financial institutions in Canada will not report any information directly to the IRS. Rather, relevant information on accounts held by US residents and US citizens (including US citizens who are residents or citizens of Canada) will be reported to the Canada Revenue Agency (CRA). The CRA will then exchange the information with the IRS through the existing provisions and safeguards of the Canada-US Tax Convention. This is consistent with Canada's privacy laws.
The agreement between Canada and the US is a Model 1 IGA and is reciprocal. This means that the IRS will provide the CRA with enhanced and increased information on certain accounts of Canadian residents held at US financial institutions. However, the Model 1 IGA with Canada differs from the US Treasury's other Model 1 IGAs by granting significant exemptions and relief to reduce Canadian financial institutions' reporting burdens. For instance, certain accounts are exempt from FATCA and will not be reportable. These include Registered Retirement Savings Plans, Registered Retirement Income Funds, Registered Disability Savings Plans, Tax-Free Savings Accounts, and others. In addition, smaller deposit-taking institutions, such as credit unions, with assets of less than CAD175m (USD160m) will be exempt. Additionally, the 30 percent FATCA withholding tax will not apply to clients of Canadian financial institutions, and can apply to a Canadian financial institution only if the financial institution is in significant and long-term non-compliance with its obligations under the agreement.
Commenting on the agreement, Flaherty said: "Canada engaged in lengthy negotiations with the US government to address our concerns and, as a result, significant exemptions and other relief were obtained."
Minister Findlay went on to explain that: "This is strictly a tax information-sharing agreement. This agreement will not impose any US taxes or penalties on US citizens or US residents holding accounts in Canada. The CRA does not collect the US tax liability of a Canadian citizen if the individual was a Canadian citizen at the time the liability arose. This includes dual Canada-US citizens. That will not change under this agreement."
It is proposed that the IGA will enter into force once Canada has notified the United States that the procedures required by Canadian law for the bringing into force of the IGA have been completed. It is proposed that the IGA have effect as of July 1, 2014.
The Canadian Federal Department of Finance has now published detailed draft legislative proposals and accompanying explanatory notes in respect of changes to the Income Tax Act to implement the IGA. The Department is inviting comments from the public on these proposals until March 10, 2014.
Reaction to the IGA
The Canadian Government has generally been congratulated for fighting the corner of the finance industry and taxpayers in extracting these substantial concessions from the US Treasury. For instance, Joanne De Laurentiis, President and CEO of the Investment Funds Institute of Canada (IFIC) said in a statement released shortly after the IGA was signed that:
"On behalf of Canadian investors, we want to recognize the government for its dedication in working to reduce the impact of FATCA on Canadian investors. The mutual funds industry is committed to a strong, stable investment sector where investors can realize their financial goals. The exemptions and relief secured by the Canadian government under the IGA will provide welcome relief to Canadian investors who may be subject to US tax rules as they save for retirement and other important life events."
Meanwhile, Canada's banks, represented by the Canadian Bankers Association (CBA), say they have been very clear on FATCA from the beginning: "while we understand that the US government is attempting to address tax evasion, we have opposed how they are going about it with FATCA. Canada is not a tax haven and Americans do not move here to evade taxation."
Nonetheless, despite international opposition, including from Canada, the FATCA implementation deadline remains unchanged, so the CBA has conceded that entering into an IGA "is the best approach under the circumstances."
"We recognize and support the efforts that the Canadian government has made," the CBA stated. "The alternative would potentially expose Canadians to punitive US withholding taxes on income from their investments, including retirement income, of 30 percent. The IGA should avoid that and ensure that the domestic rights of Canadians are respected while still sharing relevant taxpayer information bilaterally."
With the G20 having stated publicly that the best method of addressing tax evasion internationally is through the expanded use of tax information sharing, the CBA concluded that "FATCA is simply one part of the new global reality."
Banks and investment funds in Canada are now studying the detail of the implementing legislation to determine how the IGA will be implemented and how the agreement will affect them in practice. The likely impact on individual and corporate investor, as envisaged by the CRA, is outlined below.
Under IGA, Canadian financial institutions will have to take new steps to verify whether an account holder is a US person for US tax purposes. In general, an individual is a US person for US tax purposes if they are a US resident or a US citizen. As a result, individuals may be asked to certify or clarify to their financial institution their US tax status, produce documents (such as a driver's licence) or both for any representation they make. Canadian financial institutions need this information from account holders to satisfy their obligations under Canadian law for enhanced tax reporting to the CRA.
If a financial institution applying the due diligence rules of the agreement determines that any of its account holders are US persons, such as US residents and/or US citizens (including US citizens who are residents or citizens of Canada) the financial institution will be required to collect and report information on the account to the CRA in respect of that account holder. This information will be transmitted by the CRA to the US IRS under the existing provisions of the Canada-US tax treaty relating to exchange of information. The information that will be collected and shared with the IRS will include information about the account holder such as name, address, and in most circumstances the individual's US taxpayer identification number, and certain financial information pertaining to the account.
Under some circumstances, financial institutions may need to request more information from certain account holders where they already have information in their records indicating that an account holder may be a US person. However, financial institutions will be required to send to the CRA information on account holders who fail to cooperate with requests for information (the information will be similar to the information reported on US account holders), which the CRA will transmit to the IRS.
The CRA has not developed a prescribed form for Canadian financial institutions to use to collect the information they are required to collect under the agreement. Instead, financial institutions have been given the freedom to design solutions that are tailored to their particular businesses as long as they collect the required information.
Under the agreement, Canadian financial institutions will have to take steps to identify and report on certain account holders that are US entities and certain entity account holders that have substantive owners that are US residents or US citizens. For example, a corporation may be asked to indicate where it is incorporated, the nature of its activities, and whether it is controlled by US citizens or US resident individuals. These requirements are in addition to obligations that may exist under other regulatory regimes (such as for anti-money laundering purposes).
Under some circumstances, financial institutions may rely on information already in their records or that is publicly available indicating that the entity or one or more of its controlling persons may be a US person. Financial institutions may also ask their clients to provide a certification to declare whether they are a US person.
Generally speaking, an entity will be a US person if it is:
- a corporation or partnership organized in the US or a US state;
- a trust subject to US law that is controlled by one or more US citizens or US residents for tax purposes; or
- a testamentary trust of a decedent that was a US citizen or a US resident for tax purposes at the time of death.
A corporation incorporated in Canada, or organized in any other place outside of the US, is not generally a US person.
In addition to US persons, a financial institution applying the due diligence rules of the agreement, as they apply to entity account holders, is required to determine whether the account holder is:
- a financial institution and, if so, whether it is of a particular type;
- or a non-financial foreign entity (or NFFE), and if so, whether it is a passive NFFE (see below).
To be a financial institution, an entity must be a custodial institution, a depository institution, an investment entity, or an insurance company that offers insurance contracts with an investment component or annuity contracts. Further guidance on what entities are financial institutions will be issued in the future.
All entities are NFFEs except financial institutions and US persons. Therefore, all Canadian and other non-US entities that are not financial institutions are NFFEs.
An NFFE can be either a passive NFFE or an active NFFE. Canadian corporations (that are not financial institutions) that carry on an active trade or business are generally active NFFEs. Entities that do not engage in substantive business activities to produce a good or service will generally be passive NFFEs.
If an entity account holder is a passive NFFE, any individual that is a US person that is a controlling person of the account holder must be identified.
As with individual account holders, the CRA has not developed a prescribed form for Canadian financial institutions to use to collect information on US entities. Financial institutions will instead design their own ways to gather the required information. But financial institutions will be required to send to the CRA information on account holders who fail to cooperate with requests for information, which the CRA will transmit to the IRS.
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