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Offshore Tax Crackdown Opens With 30% Penalties for Banks

By Richard Rubin
June 30, 2014 12:17 PM EDT 137 Comments
In 2013, 2,999 Americans renounced citizenship, the highest number on record. The four highest totals have all occurred since Fatca became law, though the exact reasons for renunciations aren’t reported.
Photographer: Jason Hawkes
In 2013, 2,999 Americans renounced citizenship, the highest number on record. The four highest totals have all occurred since Fatca became law, though the exact reasons for renunciations aren’t reported.

The Internal Revenue Service is about to get an unprecedented look at bank accounts and investments U.S. citizens hold abroad, through a law that is making it harder to hide assets from the tax collector.

Tomorrow, the U.S. government will start imposing 30 percent taxes on many overseas payments to financial institutions that don’t share information with the IRS.

That new burden has frustrated overseas banks and U.S. expatriates. It’s also created a new standard of global bank-to-government information sharing designed to throw light on often difficult-to-trace accounts.

No one knows yet how successful the law will be in combating tax evasion. Still, it allows the U.S. to scoop up data from more than 77,000 financial institutions and 80 governments about its citizens’ overseas financial activities.

“I don’t think anything on this scale has ever been tried before,” said John Harrington, a former international tax counsel at the Treasury Department who is now a partner at Dentons in Washington. “The idea that it would go off without a hitch is sort of hard to imagine.”

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What led to the 2010 Foreign Account Tax Compliance Act, or Fatca, was the inability of federal tax authorities to obtain clear information about financial accounts that U.S. citizens have outside the country. That’s especially important for the U.S., because unlike many other countries, it taxes citizens on their worldwide income regardless of where they actually live.

‘Honor’ System

“If you had an account outside of the U.S., you were pretty much on your honor to disclose that information,” said Denise Hintzke, the global tax leader for Deloitte Tax LLP’s Fatca practice.

In establishing the law, Congress and President Barack Obama in effect threatened to cut off banks and other companies from easy access to the U.S. market if they didn’t pass along such information. The U.S. was able to leverage its status as a financial center to demand action from governments and banks in other countries.

The proposal was barely debated when Congress in 2010 passed it as a budgetary offset to a tax credit for hiring. It was projected to raise $8.7 billion in revenue over a decade.

Congress hasn’t addressed it since then, although the Republican National Committee voted earlier this year in favor of repeal.

Withholding Tax

Under Fatca, U.S. banks and other companies making certain cross-border payments -- such as interest and dividends -- to foreign financial institutions must withhold a 30 percent tax if the recipient isn’t providing information about its U.S. account holders.

Later phases of the law will apply to a broader set of cross-border payments, such as gross proceeds from stock sales. Many non-financial companies will be affected, too.

The law has been accompanied by a new set of regulations and definitions, creating a cottage industry of advisers and interpreters. It was supposed to start Jan. 1, 2013, which was put off until tomorrow to give taxpayers more time to comply.

Fatca prompted more than 77,000 financial institutions to register for the program to avoid the withholding tax. As a result of that compliance, the government doesn’t expect to collect much direct revenue from the 30 percent levy, said a senior Treasury official who spoke on condition of anonymity to discuss planning for Fatca.

Direct Disclosure

In most cases, the law isn’t being implemented as written, because foreign banks said direct disclosure to the IRS would violate local laws. The prospect of withholding spurred negotiations between the U.S. and foreign governments, and other countries saw the potential benefits of reciprocal information exchange.

“This will become a sharing, automatically, between the various countries,” Hintzke said.

So far, the U.S. has reached final or provisional agreements with more than 80 jurisdictions, allowing for government-to-government information exchange or streamlined business-to-government exchanges.

The list includes jurisdictions that often are labeled as tax havens, such as the British Virgin Islands, the Cayman Islands and Guernsey. It also includes most of the world’s major economies, such as Germany, Japan, Canada and the U.K.

China Agreement

Last week, the U.S. announced an agreement in principle with China, allowing payments between the two countries to avoid withholding taxes. The official said negotiations with countries such as China often take more time because they ask for more during the talks.

The development of a global information exchange happened quickly, said Manal Corwin, who helped come up with the new rules at Treasury before moving to KPMG LLP, where she is national leader of the international tax practice in Washington.

“You’ve got countries and businesses applauding Fatca not so much because they like its existence,” she said. “It has become a way to prevent additional burdens that might have come into existence.”

Some expatriates renounced their U.S. citizenship rather than tolerate the requirements under Fatca and the lack of access to local banks that are refusing American customers or placing additional restrictions on them. The broad reach of the law means that it is affecting taxpayers who have been complying with the tax code.

Renouncing Citizenship

In 2013, 2,999 Americans renounced citizenship, the highest number on record, according to Treasury data compiled by Andrew Mitchel, an international tax lawyer. The four highest totals have all occurred since Fatca became law, though the exact reasons for renunciations aren’t reported.

“Fatca has been a pretty difficult blow for our U.S. expatriates,” said Martin Karges, senior director in international tax at BDO USA LLP in New York. “They may be shifting money to noncompliant jurisdictions.”

As the account information comes into the U.S. starting in 2015, the focus shifts to the IRS, which will use the data to guide its investigations into offshore tax evasion.

Even without Fatca in place, the U.S. has used prosecutions against Credit Suisse AG (CSGN) and UBS AG (UBSN) to glean information on Americans hiding overseas accounts.

Bankers, Lawyers

Prosecutors have charged more than 70 U.S. taxpayers and three dozen bankers, lawyers and advisers in their crackdown on offshore tax evasion. Those charged include H. Ty Warner, the billionaire creator of Beanie Babies plush toys; Igor Olenicoff, a billionaire real estate developer; and Brad Birkenfeld, a former UBS AG banker who blew the whistle on the bank.

The IRS has sponsored offshore voluntary disclosure programs since 2009 that have brought in about $6.5 billion in interest, taxes and penalties and prompted more than 45,000 Americans to reveal offshore holdings.

The tax agency has said it’ll have a relatively light enforcement touch for the first two years of Fatca for financial institutions that are trying to comply.

The resource-constrained IRS is making Fatca a priority without spending too much time on “small-scale” compliance matters, Commissioner John Koskinen said in a speech at a Washington tax conference earlier this month.

In ‘Shadows’

“The IRS and other enforcement agencies around the world will be able to focus on the structures and arrangements that, unfortunately but inevitably, will be devised to stay in the shadows in a new world of tax transparency,” he said. “And in that new world, governments will need to work closely together to shine light into those shadowy spaces until they no longer exist.”

Almost right up to the deadline, the IRS has been issuing forms and instructions and Treasury has been signing international agreements.

“We can question whether the cost is worth the benefits,” Harrington said. “But there’s no question there’s a cost, a big one. And it’s going to be ongoing too.”

To contact the reporter on this story: Richard Rubin in Washington at rrubin12@bloomberg.net

To contact the editors responsible for this story: Jodi Schneider at jschneider50@bloomberg.net Laurie Asseo

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