Originally published by Cayman Financial Review on April 26, 2017.
When the United States passed the Foreign Account Tax Compliance Act (FATCA) in 2010, it precipitated a shift in global tax enforcement. Enforcement efforts moved away from reactive investigations of suspected tax evaders, and toward a system of proactive, invasive information collection premised on the view that anyone who holds assets outside their country of origin is a tax cheat.
The U.S. adoption of FATCA was soon followed by similarly aggressive efforts by the OECD and the European Union. Now, however, there is growing reason to believe that the United States is realizing what a disaster FATCA has been for their citizens, the financial sector, and the global economy, and could soon reverse course. Just as when it was created, abandoning FATCA may have a significant impact on the direction of international tax policy.
The FATCA fallout
FATCA’s core provisions included new reporting requirements on both individual taxpayers and the foreign financial institutions that service them. Although the United States has no jurisdiction over the latter, it achieved effective control by threatening a 30 percent withholding tax on institutions that do not comply.
The negative consequences of FATCA, many of which were predicted by critics from the beginning, have proven to be extensive. The costs on financial institutions to comply with the law have far exceeded the revenues generated, and because the added burdens that come with them, many institutions have shut out American clients in response. Multinational businesses not wanting to get tangled up in the FATCA web have similarly removed or refused to hire Americans for positions with signing authority.
Onerous FATCA penalties have proven devastating for many Americans guilty of nothing more than simple oversights or minor errors in filling out complicated tax forms. In some cases, they can even exceed the value of the relevant assets. Citizens of other countries are also being penalized, as more so-called “accidental Americans” discover every day that their place of birth, or their parents’ citizenship, has made them U.S. taxpayers for life in the eyes of the IRS.
The list of problems introduced by FATCA could go on and on, and even the ‘taxpayer advocate’ at the IRS has faulted both the intent of FATCA and the agency’s implementation efforts. These problems have proven significant enough to draw widespread opposition both within the U.S. and internationally, though foreign institutions and government have operated under the erroneous assumption that there was nothing that could be done and so they might as well go along with it all.
Opposition renews under a new administration
Under President Obama, perhaps it is true that there was little that could have been done about FATCA, though we will never know since the affected parties did not make an effort. But even if that is the case, it is certainly no longer true. The 2016 Republican Party Platform decries FATCA’s “warrantless seizure of personal financial information without reasonable suspicion or probable cause,” while calling for its repeal. Under unified Republican government, FATCA is now clearly vulnerable.
Reacting to this opening, Nigel Green, founder and CEO of financial consulting firm deVere Group, teamed up with Jim Jatras, a former U.S. diplomat and leading authority on FATCA, to launch a DC-based lobbying and media campaign for FATCA repeal. Alongside the Center for Freedom and Prosperity, the Repeal FATCA campaign is putting pressure on Republicans to walk the walk and eliminate the Obama-era financial spying regime.
How repeal might happen
Senator Rand Paul and Congressman Mark Meadows both introduced repeal legislation in previous sessions of Congress, and they are expected to do so again during the current session if they have not already. Congress could certainly opt to advance these stand-alone bills and remove FATCA that way. However, it is much more likely that FATCA repeal will find its way into a comprehensive tax reform package currently being drafted.
Tax reform is a top agenda item of both the new administration and congressional Republicans, and is widely expected before the August congressional recess this year. A comprehensive tax reform package aimed at simplifying the tax code, particularly if it moves away from a worldwide tax system, would be the opportune time to unwind FATCA and reset U.S. policy toward the millions of Americans living overseas and the many more who choose to legally invest offshore.
Some are suggesting a compromise solution whereby a “same country exception” would exempt individuals using offshore accounts in the same country where they live or work. Pursuing this would be a mistake. For one, it does little to resolve most of the negatives associated with FATCA. To be sure, some individuals suffering under FATCA would get relief, but the industry costs would still be there, and the law’s complexity would arguably be worse. Institutions would still be incentivized to keep away from potential American clients or employees. And by “fixing” FATCA in only such a narrow fashion, it would effectively give the stamp of approval to the invasive global financial surveillance regime that would remain intact. This compromise, in other words, can only serve as a distraction for those who pursue it.
It is worth noting that, if the Trump administration is so inclined, it can stop FATCA without Congress. The original law was hastily and poorly drafted, and as written would have been completely unenforceable due to its demands that foreign institutions violate the privacy laws of their host nations. To circumvent this problem, the Obama administration pursued so-called intergovernmental agreements, whereby the United States promised to share information ‒ an ultimately meaningless promise without Congressional action ‒ in return for foreign governments agreeing to eviscerate their privacy protections and help facilitate spying on financial accounts of U.S. persons for tax purposes. The foreign governments consider the agreements to be treaties and have acted accordingly, whereas the United States labels them only executive actions, meaning they have not gone to the Senate for confirmation and are not legally binding.
Simply put, the IGAs represent an extralegal expansion of executive power and were not authorized by FATCA. If the new administration were to pronounce them null and void for this reason, it would return FATCA to its original unenforceable status. FATCA would be effectively repealed until such time as Congress cleaned up its mess and removed it for good. It remains to be seen whether the Trump administration would consider this approach, but it is available to them should they so choose.
The industry needs a wake-up call
Foreign financial institutions have spent a lot of money complying with FATCA, in part because self-interested compliance industry consultants told them from the beginning that “FATCA is here to stay,” and are still repeating this nonsense today. Bad laws can be repealed the same as they can be adopted, and if institutions had spent a fraction of the resources fighting FATCA as they have complying then it would probably be gone already.
Nevertheless, that investment has left many of them complacent due to the sunk cost fallacy. They have already put significant funds into complying with FATCA, so why not just continue? Moreover, if FATCA is repealed, it will leave many decision makers left trying to explain why they could not be bothered to invest a tiny percent of the resources they spent on compliance into actually fighting FATCA.
That is an awfully expensive mistake to try and justify, but they should stop deluding themselves about the true cost of allowing FATCA to proceed.
FATCA itself is evidence that politicians are never satisfied. Neither know-your-customer rules, nor the Qualified Intermediary regime, or countless other burdensome regulatory efforts were enough, or else we would not have FATCA. What makes them think FATCA will be any different?
FATCA is certainly not going to move the tax compliance needle very far. So long as high tax rates give people incentive to evade, and tax code complexity provides ambiguity to help them do so, evasion will be a reality. If foreign financial institutions are going to let the U.S. walk all over them and force the expenditure of massive funds to help them collect a tiny fraction of that in revenue, then U.S. politicians are going to continue to treat them as willing participants in their hair-brained tax collection schemes. The only viable option is to say that enough is enough.
Where repeal leaves offshore
But whether all of FATCA’s victims support it or not, effort is finally being directed at repeal. Should it bear fruit, what happens next? For one, foreign institutions and governments are likely to be rather miffed at the United States for imposing such costs on the world for ultimately no reason. However, they should make sure to emphasize that they are upset that the United States unilaterally claimed jurisdiction over the entire globe in the first place, not that it finally came to its senses.
Second, several recent international initiatives, such as BEPS and the Common Reporting Standard, are premised on the FATCA-style idea that financial privacy is irrelevant and that financial institutions can and should be compelled to act as deputy tax collectors. These projects could only advance because nations that would otherwise object assumed the United States was on board. After all, why would the same U.S. that passed FATCA not support other nations pursuing similar policies? Never mind that the U.S. offers many of the same privacy protections to foreign investors that it condemns in other jurisdictions.
But if FATCA is abandoned, the political calculus changes. Smaller jurisdictions tired of having their tax policy dictated by the OECD could come together in opposition and even gain the support of the current U.S. administration. Whether or not they have the courage to finally stand up and fight remains to be seen, but if FATCA goes, it may well just be the first domino to fall.
