The long arm of the IRS just got longer

Under FATCA, U.S.-source income (e.g., interest, dividends, rent) and the gross proceeds from most U.S. property sales received by foreign financial institutions (such as Canadian banks with U.S. operations), as well as non-financial foreign entities, would be subject to the withholding tax.

In order to avoid the withholding tax, an FFI must come to an agreement with the U.S. Treasury Department to provide the U.S. Internal Revenue Service with the name, address, U.S. tax identification number, account balance and other details of all U.S. accountholders who hold more than US$50,000 in deposits with that institution. The definition of U.S. accountholder includes U.S. citizens and green-card holders.

The two other ways that an FFI could avoid the withholding tax would be either to choose not to have any U.S. accountholders or not to have any U.S.-source income. For most Canadian financial services institutions, either option would be impractical, if not impossible.

First introduced in both houses of Congress in October 2009, FATCA was attached in a modified form to the larger Hiring Incentives to Restore Employment (HIRE) Act, a U.S. job-creation initiative signed into law by U.S. President Barack Obama on March 18. The withholding provisions of FATCA go into effect on January 1, 2013.

Although FATCA is now on the books, the U.S. Treasury department has been given wide latitude to draw up regulations as to how FATCA is to be implemented, and has sought commentary from interested parties. By all accounts, the Treasury has been inundated with submissions from financial services industry organizations and firms from around the globe asking for exemptions or other relief.

The Canadian Bankers Association, the Investment In-dustry Association of Canada, the Investment Funds Institute of Canada and the Canadian Life and Health Insurance Association all have made submissions.

A common concern among the various financial services sectors appears to be the expected administrative difficulties associated with becoming compliant. Introducing systems to capture newly needed client information will require time and involve significant costs.

The CBA, which has also made submissions to the Treasury in conjunction with international banking groups and which has been in communication with the Department of Finance in Canada regarding FATCA, says its members are concerned about matters such as privacy, account closures and customer identification.
@page_break@One of the CBA’s recommendations to the Treasury appears to be that the reporting requirements be limited to only new clients. Says Nancy Fung, vice president of operations for the CBA: “Since banks have not been required to [determine which clients are U.S. citizens] in the past, they may not have this information on existing clients and may not have systems set up to collect this information.”

Another concern is that FATCA requires an FFI to aggregate a customer’s holdings across all affiliates and subsidiaries in order to determine that client’s total balance, something industry groups say poses a significant administrative challenge.

Mutual fund and insurance firms are concerned that they, too, will be caught up in FATCA, the language of which seems to define “foreign financial institution” very broadly. Both groups argue that their reporting on U.S. citizens would yield little benefit to U.S. tax authorities while imposing a significant compliance burden on themselves.

“In the significant majority of cases, there would be no sense in an American holding a Canadian fund to try to escape U.S. taxation,” says Barbara Amsden, director of strategy and research at IFIC. “Tax rates are higher in Canada than in the U.S.”

For its part, the IIAC has asked for leniency or flexibility regarding the effective date of the legislation, penalties levied for not being compliant by that date and regulations around the identification of accounts, among other requests.

Indications are that the Treasury may publish FATCA regulations sometime in the coming weeks. Industry groups expect they will have an opportunity for another round of comments after the regulations are published, although no one is sure. Either way, financial services firms are anxious to get some idea of what will be required of them if they are to be ready for the Jan. 1, 2013, deadline.

Says Michael Bondy, lead banking tax partner in the financial services practice of PricewaterhouseCoopers LLP in Toronto: “Any administrative changes that are necessary will require a long lead time.”

Industry groups appear to be cautiously optimistic that the Treasury will give consideration to the recommendations given by colleagues around the globe.

“The Treasury was given some leeway to carve out exemptions,” says Andrea Taylor, assistant director with the IIAC, “so we’re hoping, through the regulations, that they’ll be able to put some reasonable exemptions in there.”

In August, the IRS announced that it had restructured its international tax program and added 875 staff members to the existing staff of 600. One of the reasons the IRS gave for the changes was the oversight and implementation of FATCA.

“The U.S. is pretty committed to bringing FATCA legislation in,” says Dennis Metzler, a partner in the U.S. tax services department of Deloitte & Touche LLP. “It’s in the statutes now — it’s not like you can ignore it.”

Any U.S. citizen or green-card holder in Canada who happens to be not in compliance with his or her U.S. tax obligations may find it more difficult to remain that way as a result of FATCA. It is likely that Canadian financial services institutions will be reporting directly to the IRS on the holdings of U.S.-citizen clients. As well, the HIRE Act introduces a new requirement for U.S. taxpayers to declare all foreign financial assets on their income tax returns each year, beginning after March 18, 2010, if the aggregate value of those assets is more than US$50,000, and there are significant penalties for non-compliance. IE