Surviving FATCA: A Roadmap for Delinquent U.S. Filers and their Advisors

 

 

In response to a formal treaty request made on July 16, 2008 by the U.S. Competent Authority to the Swiss government to provide records on 52,000 bank accounts maintained by tax cheats in the U.S. at UBS, the Swiss government handed over data on 12 accounts.Confronted with Swiss defiance in the face of a revised provision on information exchange which clearly embraced tax evasion by U.S. persons, in February 19^th, 2009 the United States took legal action to enforce a John Doe summons action commenced by the IRS in 2008.The legal action taken in February 2009 was to compel UBS to release documents on 52,000 secret accounts of U.S. clients holding about $14.8 billion in assets.Rather than risk criminal prosecution, in addition to a larger confrontation with the U.S. State Department and the U.S. Treasury Department, including the Federal Reserve, in August of 2009, Switzerland entered into an historic agreement to provide the names of 4,450 high value accounts to the U.S. government.Subsequently, the U.S. has used the threat of criminal sanctions to bring down Switzerland’s oldest bank, Wegelin & Co., which was indicted in New York, and sentenced to paying $58 million in fines and restitution.By Fall of 2013, a large number of Swiss banks were entering into a U.S. program for non-prosecution of Swiss banks, agreeing to pay billions in fines and penalties.The program has formally been made part of the exchange of information mechanism between the U.S. and Switzerland.The U.S. is currently investigating banks in Israel, the Caribbean, and India.In the Fall of 2013, the G-20 announced that information exchange would move to a system of automatic exchange from the current OECD standard based on exchange by request.The OECD’s Pascal Saint-Amans, director for the Center for Tax Policy attributed this change largely to FATCA.Since 2008, the United States has largely through its own initiatives, redrawn the rules on how governments may obtain information on taxpayers, through such unilateral measures as John Doe summonses, use of criminal prosecution, and FATCA. Any U.S. non-filer seeking to understand the potential danger of FATCA must come to grips with the sheer power that the U.S. is currently wielding around the globe to enforce its tax and reporting rules, and the dangers that exist through the possession of the IRS of data that will increasingly be transmitted to the U.S. under FATCA, enhanced automatic exchange of information as developed by the OECD’s Global Forum, and under TRACE, another OECD initiative aimed at facilitating withholding rules for financial institutions on investment income .There will be no where left to hide.Ten years ago, when I approached high net worth dual citizen families living in Toronto’s fashionable Rosedale, Bridle Path, and Forest Hill residential areas about coming into compliance, the universal response was always a chuckle, a smile, and the remark intended to end the conversation, “they will never know I’m here.” My, how times have changed.

 

In simple terms, FATCA is targeted at foreign financial institutions.It requires foreign financial institutions to identify to the IRS certain accounts owned by U.S. citizens or be subject to a 30 percent withholding on all of their U.S. source investment income.The IGA entered into by Canada provides an alternate framework such that financial institutions governed by the agreement in Canada will report the required information to the CRA, rather than to the IRS. FATCA represents a response by U.S. Congress to the gross abuses by foreign financial institutions and U.S. taxpayers of the U.S. qualified intermediary regime, withholding and foreign reporting rules including the criminal activities of Swiss banks to assist Americans evade U.S. income taxation. FATCA’s implementation (arguably the most draconian extraterritorial application of a single nation’s regulatory regime) and direction at an entire community of Canadian citizens and residents who are lawfully abiding by the tax laws of their country is grossly unfair. This injustice represents evidence of the failure of U.S. international tax policy.This policy calls upon Americans in Canada to comply with the costs (and penalties) of annually confronting some 7,000 pages of U.S. international tax reporting forms and instructions and to file all of the right forms on time.This task can turn what is a $200 return prepared by a tax preparer in Canada into a task costing many thousands of dollars in CPA preparation fees depending on the investments and assets held by the taxpayer—often with no U.S. taxes owing, not one cent.Canadians, many of whom have lived outside the U.S. most or all of their lives derive no benefit of any kind from the U.S. government to justify such an outlay. 

 

To its credit FATCA has resulted in being the driving force behind the G-20 and OECD’s recent shifting of gears to implement automatic exchange of information as the global standard to combat the use of offshore accounts for tax evasion.That is actually a good result, and it benefits not only the U.S., but also other countries like Canada.One 2011 estimate put the number of offshore bank assets held by Canadian residents at over $100 billion.A primary tool in the fight against tax evasion by Canada our Tax Information Exchange Agreements, or TIEAS.Canada has been minting these agreements with tax haven jurisdictions (as of March 2013 there were 16), to allow CRA access to foreign bank account information in connection with an audit or exam.A key flaw in TIEAS is that CRA must already know about the tax evasion, whereas under automatic exchange, information is transmitted annually allowing CRA to identify all kinds of tax avoidance and tax evasion activities in real time, and to counter them.

 

 For Canadians of U.S. heritage, FATCA appears to be contrary to a key purpose of international tax policy, which is to bolster concepts of equity and fairness in a nation’s tax system.Almost all Canadian residents with U.S. roots hold their financial assets in Canadian banks and report and pay income taxes to Canada, and so there is no fraudulent intent to willfully hide income or assets on their part.Tax policy is driven in part by the goal of horizontal and vertical equity—that a taxpayer in Detroit and a taxpayer in Miami, should be subject to the same tax rules and rates on their worldwide income (domestic and foreign), and the fact that the taxpayer in Miami holds unreported investments in the Cayman Islands should not confer an advantage in calculating that person’s tax liability.The problem with this policy is that taxpayers in Toronto, Vancouver, and any point in the U.S. are not similarly situated in any respect. Canadians are integrated into a country which has its own identity, laws, and history and which comprise unique constitutional, political, educational, historical, cultural, and economic institutions, systems, and values. The so-called benefits rule which the Supreme Court used to support the U.S. taxation of a expatriate in Mexico in Cook v. Tait in the 1920s is a long way off, and there are little if any U.S. direct benefits taxpayers living in Canada derive from the U.S. government under that test today to justify the cost of spending many tens of thousands of dollars in professional fees to enter into a voluntary disclosure process to produce numerous returns with an ultimate U.S. tax liability of not one cent (arising in large part due to the rules on foreign earned income exclusions and foreign tax credits). In October 2011, Ambassador Jacobsen spoke to the Canadian Club in Ottawa and assured his listeners that the IRS is not out to get honest grandmas who don’t owe anything to the IRS. But this is simply not what has happened. The IRS and the U.S. Treasury are throwing grandma and grandpa—all over Canada from the train, and running right over them. Regretfully, some, but not all IRS agents are treating Canadians in the same light as Americans with unlawful Swiss bank accounts.What FATCA did is on the negative side, is let the proverbial fox into the hen house, sadly with Minister Flaherty opening the door.What should have happened, is an agreement on FATCA (so Canada can move in step with the world towards automatic exchange), with a concurrent global agreement between Canada and the U.S. Treasury bringing a just and immediate conclusion to the delinquency situation of an estimated 1 million Canadians of U.S. heritage.But that is not what happened, and the U.S. tax and reporting laws as unfair as they may be, must be understood and navigated to ensure that a family can truly protect and preserve its financial wealth, and avoid being decimated by the IRS.

 

 

As the philosopher Goethe once observed, “we are never deceived, we deceive ourselves.”FATCA does not grant immunity against the IRS’s ability to obtain information from your sacred RRSP accounts, as many Canadian journalists or the Canadian government would have you believe. It merely exempts those accounts (and some others) from the penalty regime under FATCA and the related obligation to report those accounts. FATCA does not throw out the door Article XXVII (Exchange of Information) of the Treaty, calls upon CRA to use its regulations for accessing taxpayer information to obtain information requested by the IRS. So, once the IRS knows you exist from other account information, it can then request CRA to furnish all relevant returns and information required to complete returns on your behalf and subject you to civil penalties, including failure to file and pay penalties and civil fraud penalties.Moreover, the IRS can utilize summons powers under Code Section 7602 issued directly to the taxpayer living in Canada to comply with information requests or be subject to criminal and civil sanctions. Constitutional due process is automatically granted to the IRS for this process, even though the Canadian taxpayer does not live in the U.S. What does this mean? How about being barred for life on entering the U.S., or flying over U.S. airspace. Perhaps the food at hotels in Cuba will improve. Perhaps mother or father can visit you in Canada. What we do not yet know, is whether or not the dreaded powers of the John Doe Summonses, which have brought banks the world over to their knees, and empower the U.S. to obtain bank account information from Canadian banks with agents in the U.S. (remember U.S. vs. Bank of Nova Scotia where the U.S. compelled a Canadian bank to provide account information on its Caribbean branch after it was subject to a penalty of $1.8 million) will be brought into play, but who can say never in this world. The U.S. has also used its summons and enforcement powers to freeze foreign accounts where banks had sufficient constitutional ties to the U.S., as well as special grand jury subpoena powers.Perhaps at present FBAR penalties may not be enforceable in Canada, but, the IRS has other means to as Nina Olson, the US Taxpayer Advocate has said “terrorize Canadians” (which she urged the IRS to stop doing). 

 

 

The first step that a taxpayer should take is to hire US counsel to establish a privileged and confidential environment where all pertinent tax and legal history can be obtained and analyzed.Just yesterday I was consulted on the case of a taxpayer who was advised, erroneously by her tax advisor that due to an inherited account in Italy from her mother, she would only be subject to the 5 percent penalty in OVDI (she did not qualify for a more favorable pathway). But the tax advisor did not look carefully at her facts or the rules, and she was in fact subject to the 27.5 percent penalty.Taxpayers are often put into one program or another without a careful analysis being performed only to find out that they did not qualify for streamlined procedures, and are not unable to go into OVDI, and must absorb the full price of the FBAR penalty regime and all foreign reporting penalties. Sometimes, taxpayers have classic legal grounds under the juridical concept of reasonable cause but that too is missed and not developed to the taxpayer’s advantage.Once a careful analysis and strategic explanation is provided, a taxpayer can then formulate a plan of action with his or her advisors and execute it. While it is beyond the scope of this article to explain the relevant legal obligations and rights a taxpayer has in the field of voluntary disclosure before the IRS, the message is that much will ride on the careful selection of an experienced advisor in tax controversy and US international tax law. This is not the time to go to the dollar store.Once before an IRS agent, skill is also very important to avoid being drawn into traps set often by the lack of knowledge of the examining agent around the very laws he or she is seeking to test the reasonableness of your returns against.

 

 

The flight response of many Americans is to book an appointment at the US consulate to expatriate and to end the horror. Without expert US legal tax and immigration planning and counsel, the expatriation process can result in imposing an exit tax on a taxpayer’s worldwide appreciated assets; subject the taxpayer to continued obligations under the U.S. tax and reporting rules, including income and estate and gift tax rules; and possibly worst of all—a permanent bar from entry into the U.S.There are a number of related fields of expatriation law which need to be carefully considered on the tax and immigration side relating to advising a taxpayer of the process, including how to avoid the mines in exiting the U.S. tax door. Critically, green card holders (even a green card that expired 20 years ago) are very much fully liable for U.S. tax and reporting obligations and specialized planning is needed to evaluate a strategy customized for the unique facts of the card holder in order for that individual to safely return the card—and bring about an end of these obligations. 

 

 

Notwithstanding FATCA, or the IRS summons power, tax and financial advisors must understand that many of the U.S. tax and reporting liabilities, especially those relating to foreign bank accounts will transfer on a personal basis to the executor of a decedent’s estate. So much emphasis is placed in the gleaming towers of Bay street financial wizards on investment strategies, so little effort is allocated to dealing with the dilemma of the clients U.S. compliance status, which FATCA has now shined a light upon. The same can be said of wills and estates planning for delinquent families. To what avail? To be sure, this situation is not the fault of these Canadians, nor their advisors, nor their bankers, nor their politicians, nor those men and women in the U.S. Treasury or the IRS. It is simply a very large problem crying out for an immediate and powerful solution and re-alignment of U.S. international tax policy to recognize the unique facts of history and present reality. While we await action by the Canadian government to bring about a just solution towards the economic and emotional plight of one million Canadians who must now alone square off against the IRS, families should get the best cover they can. You don’t get angry at a storm, you get out of the way.

 

 

^[1]David Kerzner, Ph.D. (Law) is a U.S. and Canadian tax attorney who represents clients before the IRS and the CRA from offices in Toronto and Buffalo. His work, International Tax Evasion in the Global Information Age, is published in Canada and globally by: Irwin Law, U of T Press, Palgrave Macmillan, and Springer Nature.