U.S. and China Team Up to Launch Global Tax System

In the world of offshore asset protection and personal finance, you regularly come across the claim that there are only two countries that actively tax their residents’ worldwide income: the United States and Eritrea. All other countries only tax income earned at home.

That’s apparently no longer true.

It turns out that in the early 1990s, Chinese tax officials went on a series of fact-finding missions around the world. One team enjoyed what The The New York Times Company (NYSE:NYT) describes as a “long visit” with the IRS, and came away with “a two-volume bound copy of the U.S. tax code and a five-volume copy of I.R.S. regulations.”

After reviewing the materials, the Chinese government decided to write a tax code that would allow them to tax their residents’ worldwide income … only problem is, they had no idea way to enforce it.

But with steps the United States has taken in recent years to globalize its taxation system, suddenly China has exactly the resource it needs to do the same.

Taking Inspiration from Uncle Sam
The Chinese actually adopted their worldwide definition of taxable income in 1993. But until now they had no idea how to get information about their residents’ offshore income, so they didn’t enforce the rule.

Enter the U.S. Foreign Account Tax Compliance Act. FATCA has created for the United States what amounts to a global tax information-gathering and enforcement system. Notionally designed to enforce U.S. tax obligations on Americans with foreign financial accounts, FATCA’s global reach has inspired many other countries — including China — to adopt similar rules.

After all, the exchange of tax information is a two-way street. The same communications channels created to tax Americans’ offshore income and assets can be used by other countries to tax their own offshore residents.

This helps to explain the otherwise odd fact that the Chinese government has been exceptionally cooperative in implementing FATCA. Indeed, Michael DeSombre, a partner with Sullivan & Cromwell in Hong Kong, claims that “China decided to agree to FATCA to get the reciprocal information on its citizens.”

But here’s perhaps the question we should be asking: With countries conspiring together to ensure that their citizens’ tax information be made accessible to their respective nations, how long before others recognize the advantage of this and start doing the same?

A One-World Tax System?
Slate recently observed that in a 1986 law, Congress clarified that any income earned by U.S. residents while in space — such as colonists on Mars — would be subject to U.S. taxes. When there is a pan-galactic tax system in place one day, it will surely be modelled on the systems emerging here on Earth, starting with FATCA.

Just look at where we’re headed. China’s decision to tax its offshore residents will almost certainly increase pressure for similar action by countries with sizable budget deficits and large numbers of affluent expatriates, like Australia, Britain, France and Ireland. The hunt for money, combined with the rapidly evolving technologies of surveillance, will prove too tempting to bloated governments in the end.

As in a crime drama, those deficits are the motive. FATCA and its associated global information web are the opportunity. The means will be the willingness of each government to force foreigners to pay taxes to their government of origin. China’s decision to join the crowd in this regard suggests that the “one-world government” so feared by some is in fact emerging … albeit not from the United Nations, but from the IRS and its foreign brethren.

Covering Your Assets
At the Sovereign Society, we’ve always held that it’s important to honor one’s legal tax obligations, but also that it’s perfectly appropriate to try to minimize them. Our concerns about the emerging global tax system aren’t rooted in a desire to avoid taxes.

But experience has shown that when it comes to taxes, governments shoot first and ask questions later. The U.S. government, for example, is perfectly happy to order U.S. banks to deduct funds from the bank accounts of people the IRS claim owe taxes. They do this even before the people in question have been informed that there’s a problem. They just check their account one day to find their money gone. It’s up to them to challenge the IRS.

This says to me that offshore asset protection planning, such as an offshore asset protection trust, is more important now than ever. The day is coming when the IRS can order a foreign bank to hand over your money just as easily as it can inside the U.S. itself.

The only way to avoid having to claim your money back — as opposed to fighting the IRS up front in court — will be to have some of your assets in a secure offshore jurisdiction that doesn’t just roll over when the U.S. government comes knocking.