The world recently took another step towards a unified personal tax-collection regime when France signed an agreement to co-operate with the US Foreign Account Tax Compliance Act. Under such agreements, which were to come into effect in January 2014 but have been delayed for six months beyond it, each non-exempt financial institution in the co-operating country and the United States will tell its home tax authority about the financial accounts of customers who are citizens of the other. The home tax authority will then share the information with its overseas counterpart in a standardized way. Chris Hamblin of Compliance Matters investigates.

 The world recently took another step towards a unified personal tax-collection regime when France signed an agreement to co-operate with the US Foreign Account Tax Compliance Act. Under such agreements, which were to come into effect in January 2014 but have been delayed for six months beyond it, each non-exempt financial institution in the co-operating country and the United States will tell its home tax authority about the financial accounts of customers who are citizens of the other. The home tax authority will then share the information with its overseas counterpart in a standardized way. Chris Hamblin of Compliance Matters investigates.

High-net-worth individuals (HNWs) are going to be a favourite target for the Internal Revenue Service as, it believes, they are more likely to cheat the taxman than anyone else. This is because a great deal of their income is self-certified and a great many of them are entrepreneurial “chancers”. The IRS estimates that Americans underpay their taxes by about $345 billion every year, according to Barron’s, the popular financial news website and magazine. The IRS collected about $65 billion of enforcement revenue in the fiscal year of 2011 – nearly 13 per cent up on the previous year’s figure of $57.6 billion, which itself was 18 per cent up on the $48.9 billion of 2009. This process required the employment of thousands of revenue officers, agents and special agents. The IRS says that its staff in “key enforcement occupations” rose in number from 20,203 to 22,184 between 2001 and 2011.

Nine countries have so far signed intergovernmental agreements in respect of FATCA with the US. These are the United Kingdom (which signed first on 12 September 2012); Denmark and Mexico (November); Ireland (January); Switzerland (February); Norway (April); Germany and Spain (May); and France (July) with Singapore to follow soon and another 80 governments being pressurised to do the same. All existing agreements follow the text of a pre-existing US model agreement almost word-for-word. The carve-outs or exemptions that the US has allowed in each case are sparse to say the most. 

ANATOMY OF AN INTERGOVERNMENTAL AGREEMENT 

Spain’s carve-outs are to be found in Annex II of the document. The exempt beneficial owners are the big governmental entities such as the Banco de Espana and the regulators and retirement funds. These, which HNWs often use along with the less affluent, comprise any fund regulated under the amended text of the Law on Pension Funds and Pension Schemes of 2002; and any entity defined under Article 64 of the Amended Text of the Law on the Regulation and Monitoring of Private Insurance of 2004. This second exemption applies to mutual funds as well but only if all the participants are employees, if the promoters and sponsoring partners are their employing firms and benefits are exclusively derived from the social welfare agreements (a Spanish phenomenon) between both parties. This will tend to exclude HNWs. 

There are, at least potentially, some carve-outs for private banks as well. Small banks can be classified as “deemed-compliant financial institutions” but only if they pass a battery of stringent tests. 

These are as follows: 

• the bank must be regulated in Spain; 
• it must have no fixed place of business abroad; 
• it must not solicit account-holders outside Spain; 
• the tax laws of Spain must require it to report information or withhold tax on its accounts; 
• at least 98 per cent of its accounts must belong to citizens of the European Union; 
• it does not provide accounts to (I) any specified US person who is not resident in Spain, (ii) a non-participating financial institution, or (iii) any “passive NFFE” (a type of non-US entity defined in US Treasury regulations) with controlling persons who are US citizens or residents; 
• it has systems in place on or before 1 January (now 1 July) to make sure of this and to close any accounts that do not comply; 
• it reviews the existing accounts of people who do not live in Spain for compliance with FATCA; 
• it ensures that all its related entities are incorporated in Spain and are themselves compliant with FATCA; and 
• it must not discriminate in its business policies against opening accounts for American residents in Spain. 

This last, and some might say rather sneaky, requirement seems to be designed to keep such an entity in constant fear of transgression against FATCA. It does not say whether the IRS would interpret a policy of keeping a bank’s foreign customer base lower than two per cent – and therefore turning away all Americans whose enrolment would tip the balance over that figure – as “discrimination”. Any Spanish institution that answers to this detailed description – if such an institution exists at all – is likely to suffer from constant insecurity as far as FATCA is concerned. This is probably the first time in the modern era when one sovereign state has treated others in this way. 

WHAT HAPPENS IF THERE IS NO INTERGOVERNMENTAL AGREEMENT? 

The Hire Act of 2010, of which FATCA is a part, allows the US Treasury, acting in tandem with the IRS, to waive certain requirements and this discretion forms the basis for intergovernmental agreements. The US authorities prosper from these agreements by receiving the active co-operation of foreign governments in their tax-collecting drive; the partner-countries benefit by obtaining a few meagre exemptions. In the case of non-signatory nations, however, foreign financial institutions are expected to co-operate directly with the IRS. If they have a presence or any resources in the US, dire consequences will follow if they fail in this regard. 

Withholding taxes are common in the tax world. One example of them is the money that an employer automatically takes out of an employee’s monthly wage and gives to the tax authority without any permission from – or involvement by – the employee in the process. Under the new regime, if a non-compliant foreign bank has an American customer who wishes to make a transfer from the US to it, the sending bank in the US will deduct the 30 per cent and the IRS will keep it for itself. 

Things do not necessarily improve if the foreign bank dismisses all its American customers. If it receives a payment from a firm in its own country that is owned by Americans, or has a substantial American ownership, any holdings it may have in the US will be subject to the 30% withholding tax. FATCA is designed to make it unprofitable for such a bank to hold any assets in the US. 

If the non-participating foreign financial institution or private bank has an American affiliate or subsidiary, the tax will have an even more drastic effect. In all cases, 30 per cent of monies coming into its coffers from American or other participating institutions will be deducted before it reaches it. If the institution’s turnover is of any size, it will lose its assets quickly. If it tries to repatriate all its assets home, it will lose 30 per cent of everything it sells even before it can do so because the assets’ buyers will pay through accounts at their own banks, which will deduct automatically. No bank or other business can prosper under such circumstances. 

Lastly, withholding taxes traditionally attempt to capture money for underlying taxes. The Hire Act does not do this; the 30 per cent, with a few possible exceptions, is totally punitive in this case. The IRS might be about to replace the Office of Foreign Assets Control as the US regulator that banks around the world fear the most.