Are FATCA’s Dissenters Tilting at Windmills?
In the Cervantes novel of the same name, Don Quixote hopes to bring justice to the world by reviving the old ways of chivalry*. Believing a series of windmills on the horizon to be marauding Giants, Quixote launches an ill-fated attack on these imaginary enemies. Like the aforementioned hero, FATCA’s dissenters may have misidentified their enemy.
FATCA’s raison d’etre is to discover the hidden assets of American citizens living outside of the US. This is made necessary by a quirky facet of US law that demands that taxation is applied to citizens of the US, rather than residents. Only the US and Eritrea (two nations with little else in common) organise their tax legislation in this way. FATCA forces foreign banks that have US persons as clients to disclose information about these people and their assets to the US government. This has proven to be rather unpopular with both American persons living abroad and financial institutions.
The problem with FATCA
FATCA itself has several issues. A significant number of Financial Institutions, averse to increased regulatory burden and leery of financial penalties, have denied access to banking facilities to Americans. Indeed, many small banks feel that the cost of accepting American clients far outweighs the benefits. For the nine million US Persons living and working abroad, this is quite obviously problematic.
The anti-FATCA movement also highlights privacy issues inherent with FATCA, and in particular, infringement on rights guaranteed to Americans by the 4th Amendment. The privacy concerns relate to the mechanism used by banks to transmit data about their US clients to the IRS. As data protection laws may prevent a bank outside the US from transmitting financial information to a foreign government institution (i.e. the IRS), FATCA uses a mechanism whereby banks report their data to a local government authority. That local authority can then legally transmit the data about Americans to the IRS. The privacy concerns here are real and should not be lightly dismissed, but these issues are not unique to FATCA. The 4th Amendment argument is more spurious in my opinion. For those unfamiliar, the 4th Amendment to the US Constitution provides Americans security of their persons, possessions, houses, papers etc. and protects against unreasonable searches and seizure (bold for emphasis). Courts in the US have dismissed numerous tax-related 4th Amendment claims over the years, and there appears to be little new that the FATCA situation brings to the table in this regard. I make no comment on this specific issue as I am neither a lawyer, nor American.
For Americans outside the US, FATCA means additional tax scrutiny. Many American citizens abroad are required by law to complete a report of Foreign Bank and Financial Accounts (FBAR) annually, which provides details of assets held in foreign accounts. Prior to FATCA, the IRS had no way of knowing whether these reports were being filed or if they were accurate. The problem for a number of US persons living overseas is that FATCA has torn back the veil of secrecy. Ultimately, there are fewer places to hide for US persons living abroad that do not wish to pay taxes to the IRS.
I should make it clear at this stage that I do sympathise with the nine million American citizens living abroad that have been impacted by the implementation of FATCA. However, FATCA is very much Quixote’s imaginary giant. The enemy of US persons abroad is in fact citizenship based taxation, not FATCA. In fact, many Americans are now renouncing their citizenship in order to avoid this issue entirely. In 2016, 5,411 people took just this action and the number is rising year on year.
The anti-FATCA movement
Opposition to FATCA has been strong from the outset from both American citizens living abroad and the financial industry. While the latter has largely accepted FATCA, made the necessary changes to their operations and infrastructure and moved on to the next new regulatory challenge, the former continue to pose stiff opposition.
There are numerous grass-roots advocacy groups fighting tooth and nail to see FATCA repealed. They are organised and highly vocal, particularly on social media. In fact, the mere mention of FATCA on twitter will likely trigger a deluge of tweets that summarise the contempt that has grown in that community towards FATCA. Furthermore, they have a champion in the form of Senator Rand Paul (R-KY) who has introduced a FATCA repeal bill whilst also single-handedly preventing all pending US tax treaties from being ratified.
The Repeal of FATCA was part of the Republican party platform for the 2016 election, however it is unclear how harmonised the President and the party are on any number of issues, including FATCA. With that in mind, I am not inclined to impersonate Nostradamus and speculate what may happen in this area. What is clear however, is that the Republicans control the White House, Senate, House of Representatives and the Supreme Court, and their position is to repeal FATCA rather than alter citizenship based taxation.
What if the US started taxing residents instead of citizens?
Let us propose for a minute that the US did abandon citizenship based taxation, what purpose would FATCA hold then? As taxation would be based on residency, Americans living and working abroad would no longer be liable for US taxes and assuming FATCA was modified accordingly (which it would have to be), the banks would have no problem offering them accounts. The only people that would be impacted by FATCA under this scenario would be US residents trying to hide their assets off-shore, or as they are more commonly known, criminals.
This leads me neatly to my next point. The purpose of FATCA is to catch tax-evaders. However, due to America’s almost unique insistence on taxing citizens it also captures honest, hardworking people in its net. FATCA itself has significant upsides. In fact, such is the attractiveness of reporting tax evaders off-shore, over 100 countries have signed up to the OECDs Automatic Exchange of Information (AEoI) project, which is modelled on FATCA. Thankfully, the citizens of these countries will not be subjected to the problems, in part due to almost total world-wide adoption of residency based taxation principles.
What if FATCA does get repealed?
I have looked at the potential benefits of moving to a residency based taxation system, but what would happen if the US does repeal FATCA? In such a scenario, the banks that turned their backs on American customers would welcome them back with open arms overnight. However, the need to report foreign earnings is part of the US Code, and is unrelated to FATCA. This means that US persons abroad will still have to report their offshore income and accounts to the IRS. Honest Americans will do so honestly, and pay their taxes, whereas dishonest Americans will not.
The political pressures that had a role to play in the creation of FATCA are perhaps even stronger now than when it was conceived. Offshore tax evasion is still a hot topic and public interest in seeing such practices ended shows no sign of slowing down. If FATCA were repealed, it would only be a question of time before the US implemented new measures to crack down on US citizens hiding assets abroad. The obvious option would be to opt in to the OECD AEoI project, thereby harmonising tax rules across all the G20 nations and more. As a regulatory compliance specialist, this situation seems the most practical from the perspective of the industry.
It is hard to tell how effective FATCA has been at tackling tax evasion. Sadly, the IRS isn’t really in the business of making that sort of information public. What is clear however is that there is a global will to crack down on these practices. Whether the mechanism is FATCA, AEoI or something else entirely, US persons living overseas will continue to face increased scrutiny of their tax practices for the foreseeable future.
It is undeniable that FATCA has caused some pretty significant collateral damage. And, perhaps if it were repealed and replaced with a more global framework (like AEoI) fewer banks would elect a “no Americans” policy. But, no matter what the tax framework looks like, the underlying issue is still present. As long as the US continues to tax its citizens, rather than residents, cross border tax issues will remain.
*A pet peeve of mine is the modern use of the word chivalry. While today the word is synonymous with good manners, its roots lie in the medieval code of combat and ethical conduct. Next time a friend decries the death of chivalry, challenge them to a joust, or offer to flay one of their enemies in the name of valour!
Subject Matter Expert
Chris is a subject matter expert in US Internal Revenue Code Chapter 3 (QI) and Chapter 4 (FATCA), OECD Common Reporting Standard & Automatic Exchange of Information (CRS/AEoI) and MiFID II. Chris’ responsibilities include consultation and research, alongside the delivery of TConsult’s Interim Periodic Review (IPR) product and production of content for TConsult's marketing channels.