FATCA a big leap in tax enforcement

FATCA a big leap in tax enforcement

The US pushes to strengthen tax enforcement with an act set to come into force this July. The benefits are clear, but it remains to be seen how the costs of the new measure will impact the markets.

Tax evasion and so-called tax havens can cause major national and international problems. When governments receive less tax revenue, they have less money to invest in innovation and development, and thus find it more difficult to pursue economic recovery or guarantee long-term economic performance. One side of the problem is that there has been very limited international cooperation to combat the issue, despite having been prominent on the G20 agenda for years.

However, the US has initiated a strong response to this dilemma in the form of FATCA. FATCA – The Foreign Account Tax Compliance Act – is a statute that requires all US persons to disclose their financial accounts held outside of the United States. Considering US citizens are taxed based on nationality, not residence, this means Americans living abroad will find it harder to avoid paying taxes.

On top of this, the act requires foreign financial institutions such as banks to keep the US Internal Revenue Service (IRS) up to date about their own American clients. Depending on whether the host country signs a Model 1 or Model 2 intergovernmental agreement, the financial institution will be in contact either directly with the IRS or via the host country’s tax authorities.

This statute is particularly ambitious in the way it crosses borders on tax enforcement. Normally it would be safe to assume that countries such as Switzerland would not take part in such an act and opt to maintain their reputation for banking discretion. But the United States has created some strong incentives to comply with FACTA, including a 30% withholding levy on all US assets that pass through non-FATCA financial institutions. As such it is not surprising that Switzerland signed the act already in February.

While the IRS has previously attempted to implement similar international tax enforcement in the form of the Qualified Intermediary program, FATCA will be tighter and have stiffer penalties. For instance, it closes a loophole whereby foreign investors used to avoid paying taxes by converting US dividends into “dividend equivalents.”

After having been passed as part of the HIRE Act in 2010, FATCA is now set to come into force in July of this year. Estimates claim that the US Treasury loses up to $100 billion annually to tax evasion. According to the Association of Certified Financial Crime Specialists (ACFCS), FATCA is expected to raise about $800 million per year for the US Treasury. That does not account for quite the full outstanding sum, but it is a good start.

However, not everyone is pleased by FATCA. Many have concerns that the costs of implementing FATCA will outweigh the benefits it brings, especially for the foreign financial institutions that will bear a large part of the burden. The UK has estimated that implementing FACTA will come with costs of up to £2 billion in the first five years. Even US-based financial institutions will be subject to FATCA if they have clients in foreign jurisdictions.

Furthermore, FATCA may make it more difficult for Americans to live and find work abroad if they need to fill out additional paperwork. It can also have an effect on the willingness of financial institutions to invest in US assets (considering they may be withheld if FATCA is violated), which would essentially result in capital flight from the US. Indeed, the Republican National Committee, worried the act is too risky, passed a resolution calling for the repeal of FATCA on January 24.

Nevertheless, 45 countries have completed intergovernmental agreements to implement FATCA, and many more agreements will probably be finalized before the deadline in July. With the strong incentives to join FATCA, both financial institutions and governments have been surprisingly eager to join, and places such as the Cayman Islands and Jersey have signed on to observe the act. Even China is expected to comply.

In fact, the threat of being left out of FATCA is already being used as a diplomatic tool. The US suspended FATCA talks with Russia in late March as a reaction to Russia’s behavior on the Crimean peninsula. Essentially this adds another element to US sanctions.

In any case, FATCA will cause difficulties for foreign banks and the IRS alike, as do all new adjustments. But FATCA is a great leap with regard to changing international tax information sharing and enforcement. Secretive banking and tax evasion will be significantly harder to accomplish if FATCA is successful. And organizations such as the OECD are also seeking to strengthen the international tax enforcement agenda. As such, we are moving step by step towards a more positive system of increased transparency and richer national treasuries.

Categories: Finance, North America

About Author

Karl Sorri

Karl has gained global experience working at the Transparency International Secretariat in Berlin, the Political/Economic Section of the U.S. Embassy in Helsinki, and as a freelance journalist. Karl holds an MA in Politics from the University of Glasgow and an MSc in International Relations from the London School of Economics.