This article appeared in Cayman Financial Review, Third Quarter 2014, Issue 36.
Since its passage in 2010, financial institutions and their governments have scrambled to comply with the costly impositions of the Foreign Account Tax Compliance Act (FATCA). To entice foreign governments to assist in administration of the law and bypass certain legal obstacles, the U.S. Treasury Department has promised reciprocal information sharing. Now, however, they are admitting to having promised more than they can deliver.
The U.S. government’s assertion of authority over the global financial sector has redirected tens of billions of dollars away from productive pursuits and towards compliance efforts. So complex are the demands imposed by FATCA that the law, as originally passed, was almost assured to fail. There was simply little chance that thousands of individual financial institutions would be able to both comply with FATCA’s demands and continue to operate within the legal requirements of their host nations, particularly when it comes to protection of privacy rights.
To circumvent the issue of conflicting local laws, the U.S. Treasury Department conjured for itself powers and responsibilities not part of the actual legislation. Namely, they developed intergovernmental agreements (IGAs) to allow foreign governments to first collect information on American taxpayers before sending it to the IRS. Because institutions are sharing the information with their own governments rather than directly with U.S. authorities, and those governments are updating their laws accordingly, the IGAs allow for compliance with local privacy laws as well as FATCA.
As would be imagined, not every government has been thrilled by the prospect of upending their laws to placate U.S. fiscal imperialism. To entice skeptical foreign governments to sign the IGAs – without which the law would fail – Treasury promised to share similar information on any of their citizens investing in U.S. markets. Now, however, it’s becoming increasingly clear such reciprocation may never occur, throwing FATCA’s viability back into question.
Making sense of US obligations
Members of the U.S. Congress, one chamber of which having changed party control since FATCA’s passage, have expressed skepticism and concern about Treasury’s handling of the law. Not only has Senator Rand Paul introduced legislation to repeal most of FATCA outright, a policy recently endorsed as well by the Republican National Committee, but several other members have authored letters challenging various aspects of Treasury’s implementation, and in particular the handling of IGAs.
Rep. Bill Posey, a member of the House Financial Services Committee, authored a critical letter to the Treasury Department characterizing the IGAs as “not authorized, or even mentioned, in FATCA,” and concluded that “flaws evident in the IGAs being negotiated to implement FATCA reflect flaws in the Act itself.” Of greater significance for the law’s future, he also suggested that “it is difficult to conceive of any circumstance that would justify imposing such an expensive and counterproductive domestic mandate [as reciprocal information sharing].”
Foreign governments might be excused for finding this all very confusing. After all, many were promised by the Treasury Department that the U.S. would give what it receives. In reality, the obligations specified under the IGAs only commit the U.S. to “pursuing the adoption of regulations and advocating and supporting relevant legislation to achieve such equivalent levels of reciprocal automatic information exchange.” This is a convoluted way of saying that the Treasury Department really, really wants to provide reciprocal information, and it’ll even ask nicely for actual Congressional authority to do so.
That’s right, the Treasury Department – the only U.S. body involved in authorizing, negotiating or signing IGAs – has no authority to provide reciprocal information. And since the agreements are not being submitted to the Senate for its advice and consent as constitutionally required for ratification of treaties, they haven’t true force of law within the United States. Although Treasury prefers not to advertise its need for additional authority, it’s been implicitly acknowledged by inclusions of provisions asking such authority in the administration’s budget requests, as well as by officials speaking behind closed doors.
Real reciprocity unlikely
A comparatively simple rule requiring U.S. banks to collect and report interest payments to non-resident accounts took over a decade for Treasury to push through and successfully implement. That rule met significant Congressional opposition, but ultimately lacked the significance to spur direct legislative challenge. Treasury cannot pull the same trick with FATCA, where the costs to U.S. banks would compel a real response. They have no choice but to rely on Congress for reciprocal authority, which for both political and economic reasons is unlikely to be forthcoming.
As indicated by the Posey letter, there is no domestic appetite for imposing the kind of reporting on American banks as has been placed on the rest of the world. A large reason Treasury has been able to act beyond its authority thus far is because those most afflicted by FATCA lack political power in the U.S. system. The same cannot be said of American banks, which hold considerable influence but thus far have sat on the sidelines of the FATCA debate.
A clear ideological divide between branches also makes reciprocation unlikely.
FATCA’s champions are in the executive branch and come from the political left, where an ideological desire to grow government fuels the never-ending hunt for tax revenue. Congressional Republicans, on the other hand, largely believe that overseas Americans shouldn’t even be paying tax on foreign earnings, preferring the international norm of territorial taxation to the current uniquely American worldwide approach.
In all likelihood, the upcoming midterm elections will strengthen the hand of Republicans and further weaken what is soon to be a lame-duck administration. The Senate may even change hands from Democrats to Republicans, increasing the likelihood of the nascent FATCA repeal movement bringing legislation to the fore. Regardless of whether repeal efforts succeed, Congress is disposed against further FATCA authority, and will likely only become even more hostile after the election.
Not every country that has signed a FATCA IGA cares about reciprocal information. Many, particularly smaller nations with favorable tax policies designed to attract investment, have no interest in pursuing tax dollars earned overseas. These nations signed IGAs simply to extricate themselves and their financial institutions from an IRS-imposed quagmire.
But there are large nations that do care about reciprocation, and their cooperation is essential for FATCA to work. Should they tire of broken promises and hypocrisy from the U.S., they may demand renegotiation and once again throw viability of the entire system into question. The question remaining will be whether any soul searching about American fiscal imperialism is sparked should the entire enterprise blow up in their collective faces.