U.S. tax hunt overseas causes global headaches

There is little that can be done about FATCA and the change has to come from within the U.S.

Death and taxes, life’s two certainties according to Keynes, sometimes have a causal relationship.

One dies and some taxes are often associated with that event. Alternatively, one encounters so much regulation from multiple tax jurisdictions that it can cause death by paperwork, figuratively speaking of course.

Such is the case of the United States Foreign Account Tax Compliance Act or FATCA, which has caused a lot of anxiety for banks, funds and individuals in India.

Signed into law in the U.S. in 2010, FATCA affects not just financial institutions in the U.S. and ‘U.S. persons’, i.e., citizens and residents of the U.S. and companies, trusts and other entities controlled by them, but also what the U.S. defines as ‘Foreign Financial Institutions’ or FFIs (‘foreign’ is with regard to the U.S.).

These institutions, which include banks, mutual funds, PE and hedge funds, among others, are required to collect information on U.S. persons who are depositors or investors. Failure to do so would entail a 30 per cent withholding tax on the FFI’s U.S. source income.

This is where the bite is — in today’s integrated global economy, it is likely that a financial institution outside the U.S. pays money to or gets money from a U.S. source and not complying with FATCA will automatically mean being subject to a withholding tax.

Sharing information

To overcome any country specific hindrances to sharing information on investors and depositors, the U.S. has entered into Inter Governmental Agreements (IGAs) with partner countries. An IGA was signed with India in 2015.

FATCA is part of the U.S.’s answer to tracking money hidden in offshore accounts so it can be brought into the tax net.

This is part of a larger global trend to fix loopholes in international taxation in order to make evasion harder. But the picture is a bit messier with FATCA owing to the fundamentally different nature of U.S. taxes.

The U.S. is the only developed country in the world that imposes citizenship based taxes — so American entities everywhere are normally required to file U.S. tax returns regardless of their residence or the source country of income.

Global initiative

Country by country reporting of income, a global initiative whose objective is to plug gaps when multinational corporations file returns in different countries and income slips through, already has the backing of the OECD and several other countries, said Shreya Rao, founder of the Rao Law Chambers, a Bengaluru-based tax law firm.

However, all these non-American systems and treaties have similar data needs.

The Common Reporting System (CRS) on the Automatic Exchange of Information (AEOI) was developed by the OECD and G20 together and, “requires the financial institutions of the ‘source’ jurisdiction to collect and report information to their tax authorities about account holders ‘resident’ in other countries … ,” according to a Central Board of Direct Taxes guidance note from December 2015.

Some 98 countries, including India, have signed up for this and reporting starts in phases from 2017 onwards.

Complex exercise

“[The U.S.] can’t really cooperate with other countries if they want to enforce a system that is only theirs… this means that the U.S. has to collect its information itself. That’s really what is making the whole exercise very complex,” Ms. Rao said.

India hoped that it would get full data reciprocity by signing an IGA, i.e., equivalent information on Indian assets and income in the U.S., and while the U.S. has said it is committed to the idea, this is yet to be achieved. Yet an IGA has been signed by India and compliance deadlines have begun. Media reports of more than Rs.1 trillion ( Rs.1 lakh crore) of mutual funds’ assets being frozen by SEBI after August 31 for non-compliance with FATCA created enough of a stir for the Association of Mutual Funds in India (AMFI) to issue a press release last month to allay concerns.

The frozen accounts would continue to earn but simply become unavailable for transactions until FATCA declarations were made, AMFI said in the press release.

The association went on to assure investors that the FATCA related self-certification process was simple and streamlined.

Banking lock-outs

Disquiet over FATCA and the citizenship-based taxation policy of the U.S. is not limited to India. For U.S. citizens and residents living abroad and paying taxes in their countries of residence, holding bank accounts and investing in funds in their host countries is not an offshore activity. There have been reports in the media, especially from European countries, on banking lock-outs for American citizens and residents.

Onerous FATCA requirements have been driving these. All this has meant living outside the United States with a U.S. passport has become a very expensive if not an entirely impractical proposition for many middle-class Americans.

The number of Americans giving up their passports has increased from 231 in 2008 to 3,415 and 4,279 in 2014 and 2015 respectively, according to the U.S. Federal Register.

Repeal unlikely

A repeal of FATCA is unlikely as long as the U.S. retains its citizenship based taxation.

However, a modification through a ‘same country exemption’ is more realistic and this is an area advocacy groups such as American Citizens Abroad (ACA), are working on. A same country exemption seeks a FATCA reporting exemption for everyday bank accounts used by expatriate Americans in their host countries.

“ACA has been speaking extensively with Treasury’s Assistant Secretary for International Affairs and recently sent him documentation on his request for further information on Same Country Exemption,” Marylouise Serrato, Executive Director at ACA told The Hindu.

Until the U.S. changes its tax laws and moves to residence and source-based taxation, FATCA-type situations are unlikely to go away. Increased data sharing between governments on income sources and tax payers is an effective way to track hidden funds and track evaders and bring them into the tax net.

However, for this to be done in a truly multilateral, reciprocal and efficient manner, the U.S. needs to align itself much more with the rest of the world’s taxation principles and tools.