By Lowtax Editorial
10 July, 2014
Described by the US Government as a "major milestone" on the path to eradicating offshore tax evasion, but branded by its critics as "the worst law that most Americans have never heard of", the Foreign Account Tax Compliance Act (FATCA) went into force on July 1, 2014 after a long period of preparation by the Internal Revenue Service (IRS), foreign revenue agencies and foreign financial institutions (FFIs). The law's main provisions are described in this special feature.
What is FATCA?
Signed by President Barack Obama in March 2010 as a revenue provision to the Hiring Incentives to Restore Employment Act, FATCA is designed to tackle the non-disclosure by US citizens of taxable income and assets held in foreign accounts. The law is intended to ensure that the US obtains information on accounts held abroad at 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.
To address situations where foreign law would prevent an FFI from complying with the terms of an FFI agreement, the United States Treasury Department has developed three model intergovernmental agreements (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 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 July 7, 2014, 34 jurisdictions had signed Model 1 IGAs with the US Treasury. An additional five countries have signed Model 2 IGAs. A further 54 jurisdictions have reached agreements in substance with the US over Model 1 IGAs in addition to eight countries which have reached agreements in substance on Model 2 IGAs.
In practical terms, FATCA adds yet another reporting burden on those with interests in foreign accounts. So US citizens, US individual residents, and what the IRS describes as "a very limited number of non-resident individuals" who own certain foreign financial accounts or other offshore assets (specified foreign financial assets) must report those assets on new Form 8938 'Statement of Specified Foreign Financial Assets', which must be attached to the annual US income tax return (Form 1040).
Individuals who do not have to file an income tax return for the tax year do not need to file Form 8938, even if the value of their specified foreign assets is more than the appropriate reporting threshold (specified below). Those required to file Form 8938 do not have to report financial accounts maintained by: a US payer (such as a US domestic financial institution); the foreign branch of a US financial institution, or; the US branch of a foreign financial institution.
For individuals who are resident in the United States, if the total value of the specified foreign assets is at or below USD50,000 at the end of the tax year, there is no reporting requirement for the year, unless the total value was more than USD75,000 at any time during the tax year.
Higher asset thresholds apply to US taxpayers who file a joint tax return or who reside abroad. Married taxpayers filing a joint income tax return and living in the US must report if the total value of their specified foreign financial assets is more than USD100,000 on the last day of the tax year or more than USD150,000 at any time during the tax year. Married taxpayers filing separate income tax returns and living in the US must report if the total value of their specified foreign financial assets is more than USD50,000 on the last day of the tax year or more than USD75,000 at any time during the tax year.
US taxpayers living abroad must file Form 8938 if they file a return other than a joint return and the total value of specified foreign assets in the foreign account is more than USD200,000 on the last day of the tax year or more than USD300,000 at any time during the year. Non-resident taxpayers filing a joint return and with specified foreign assets of more than USD400,000 on the last day of the tax year or more than USD600,000 at any time during the year must also file Form 8938.
The IRS currently defines a taxpayer living abroad as: a US citizen whose tax home is in a foreign country and who is either a bona fide resident of a foreign country or countries for an uninterrupted period that includes the entire tax year; or a US citizen or resident, who during a period of 12 consecutive months ending in the tax year is physically present in a foreign country or countries at least 330 days.
The following types of foreign assets must be reported on Form 8938:
- Financial (deposit and custodial) accounts held at foreign financial institutions
- Foreign stock or securities not held in a financial account
- Foreign partnership interests
- Foreign mutual funds
- Foreign accounts and foreign non-account investment assets held by foreign or domestic grantor trust
- Foreign-issued life insurance or annuity contract with a cash-value
- Foreign hedge funds and foreign private equity funds
In addition to accounts held at foreign branches of US financial institutions and US branches of foreign institutions, the following assets are not reportable under FATCA:
- Domestic mutual fund investing in foreign stocks and securities
- Indirect interests in foreign financial assets through an entity
- Foreign real estate held directly
- Foreign real estate held through a foreign entity (although the foreign entity itself is a specified foreign financial asset and its maximum value includes the value of the real estate)
- Foreign currency held directly
- Precious Metals held directly
- Personal property, held directly, such as art, antiques, jewellery, cars and other collectibles
- Social Security-type program benefits provided by a foreign government
Penalties for failure to report foreign financial assets on Form 8938 when required under the legislation are harsh. Non-disclosure may result in a penalty of USD10,000, and an additional fine of up to USD50,000 for continued failure after IRS notification. Furthermore, underpayments of tax attributable to non-disclosed foreign financial assets will be subject to an additional substantial understatement penalty of 40 percent.
The FATCA Timetable
Final regulations for the implementation of FATCA were issued by the US Treasury and IRS on January 1, 2013. From August 2013, FFIs have been permitted to use an on-line portal for FATCA registration. Under current timelines, FFIs must have fulfilled their due diligence and withholding requirements to comply with FATCA by July 1, 2014 (extended from the original January 1, 2014 deadline) ready for the first reports to reach the IRS by March 31, 2015, regarding accounts maintained during 2014.
However, in recognition of the administrative difficulties faced by FFIs to ready for FATCA reporting, the IRS announced in May 2014 that it is regarding calendar years 2014 and 2015 as an enforcement and administration "transitional period" with respect to implementation and enforcement. In practice, this means that the IRS will refrain from "rigorously enforcing" many of FATCA's requirements this year and next, as long as FFIs are making "a good-faith effort" to achieve compliance.
Report of Foreign Bank and Financial Accounts (FBAR)
US citizens are already required to report certain information to the IRS about foreign bank accounts by filing the Report of Foreign Bank and Financial Accounts, or FBAR, every year.
US persons are required to file FBARs annually if they have a financial interest in or signature authority over financial accounts, including bank, securities or other types of financial accounts, in a foreign country, if the aggregate value of these financial accounts exceeds USD10,000 at any time during the calendar year.
Unfortunately, FATCA merely supplements, rather than replaces, FBAR reporting, so that those affected by FATCA reporting will usually have to file under both regimes.
The US Treasury Department views the coming into force of FATCA as a "major milestone" in the Obama Administration's effort to crack down on tax evasion and reduce the tax gap. And surprisingly, given its extra-territorial nature, FATCA has gained broad international support. This is evidenced by the lengthening list of countries which have either signed FATCA IGAs, or have reached an agreement with the US Treasury in substance. Indeed, FATCA is being used as a template for other information-sharing regimes, including by the United Kingdom with its offshore territories, and a pilot automatic exchange of information system launched by a core group of EU member states.
Deputy Assistant Secretary for International Tax Affairs Robert B. Stack said on July 1, 2014, that: "Over the past several years, FATCA has become the global standard in combatting international tax evasion and promoting transparency, and today this important initiative goes into effect. With FATCA agreements treated as in effect with nearly 100 jurisdictions and more than 80,000 financial institutions already registered to comply with the IRS, the international support for FATCA is without question. We will continue to work with our international partners in our efforts to crack down on international tax evasion and create a fairer and more transparent global tax system."
However, while Treasury officials are predictably hailing FATCA as good for Governments in their quest to uncover hidden tax revenue, others say it is bad for individuals.
One unintended consequence of FATCA's spread throughout the world for US citizens is that banks and financial institutions are simply refusing to accept American clients because of the compliance burden involved (it has been said that complying with FATCA has cost the financial sector upwards of USD7bn). According to a Heritage Foundation report published in June 2014, FATCA is burdening Americans living overseas with "enormous financial and legal burdens" through increased compliance costs and denials of service from foreign banks that do not want to have to deal with the law.
"FATCA's costly IRS reporting requirements and its significant legal and financial risks make it unprofitable and arduous for foreign financial companies to serve Americans," said the Foundation "Some institutions have already closed the pre-existing accounts of their American clients, (and) lack of access to financial services has made it extremely difficult for Americans living and working abroad."
One bank that has disclosed its intention to stop accepting business from Americans is Russia's second-largest bank, VTB, which has around 2,000 US clients.
There are of course accusations that FATCA represents another nail in the coffin of individual privacy and another step on the road to Big Brother-dom. As the Heritage Foundation pointed out: "FATCA granted the Internal Revenue Service a new level of intrusiveness into the lives of Americans. Under the legislation, the IRS is granted enhanced regulatory power in determining, based on its judgment, whether Americans with these accounts have wrongfully evaded US taxes."
It has also been suggested that FATCA is responsible for a sharp rise in the number of Americans renouncing their citizenship, which is probably about the only way to escape the US' all-encompassing tax net. According to Treasury Department statistics published in the Federal Register in May 2014, just over 1,000 United States taxpayers gave up their passports or their green cards in the first quarter of 2014, an increase of 47.4 percent over the 679 individuals that did so in the first quarter of last year. This figure was only surpassed by the 1,130 passports given up in the third quarter of 2013.
With millions of Americans residing abroad these numbers are quite small, and giving up a US passport is not a decision to be taken lightly. There could in fact be several reasons for the sudden spike in citizenship renunciations, including mere coincidence. However, campaigners against FATCA say that it is no accident that more and more Americans are handing back their passports as FATCA becomes grim reality.
Moreover, if projected revenue figures turn out to be correct, FATCA's opponents say that the law will represent very poor value for money for taxpayers, yielding somewhat under USD1bn for an outlay by national revenue authorities and FFIs of several times this amount.
There is a small but growing movement in Washington for the repeal of the law. At the winter meeting of the Republican Party's National Committee in January 2014, a resolution was adopted calling for FATCA's repeal, and last year, Senator Rand Paul, a Kentucky Republican, introduced a bill that would repeal FATCA's anti-privacy provisions, thereby rendering the law effectively redundant. Bill Posey, another Republican Congressman, has also taken issue with the Treasury's legal authority to conclude IGAs as under the US Constitution only the Senate has the right to authorize foreign treaties.
The Republicans are not currently in a strong enough position to overturn FATCA. Indeed, given the general lack of public awareness about the law, there are few votes in it for them anyway. So for the foreseeable future at least, the continued existence of FATCA looks assured.
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