FATCA is Here - Now What?

The United States has given birth to FATCA and demands that the international financial industry legitimise its existence.

If FATCA is helpful to stabilising and enhancing the global economy, then continuing to implement the FATCA compliance regime may well be warranted. If it is determined to be a perilous threat to a financial institution’s or jurisdiction’s sustainability or viability, then a different decision may be justified.

The world’s income tax system dependent countries quickly adopted this latest tax enforcement creation almost as a knee-jerk reaction. It is bewildering that neither the US nor the other countries performed any significant detailed cost-benefit analysis. They jumped on board the train without fully knowing its destination. Every action, however, has consequences.

No one credibly doubts the necessity of the US government or any other government to raise money by way of taxation or borrowing to pay the enormous costs of providing services to its citizens and residents. However, history tells us that the need of government for tax revenues has always been a point of conflict between those who are in a position of political power to set the rules and demand payment, as opposed to those whose hard work and earnings are being taken. This is the stuff indeed that makes for political revolutions.

The FATCA regime was intended as a heavy-handed enforcement mechanism. Without that, getting everyone to comply would be impossible. This is true for the jurisdictions affected, the respective taxpayers, and the international financial industry caught in between. FATCA was enacted as part of a revenue enhancement mechanism to pay for the additional outlays incurred by passing the Hiring Incentives to Restore Employment Act (HIRE Act) of 2010.

It was projected to increase tax revenue by US$879 million a year for 10 years. Not much of a revenue goal considering the multitude of direct and indirect cost being incurred. For the US, that amount is chump change or a budget rounding error.

The avowed goal of the Hire Act was to put Americans back to work by providing tax breaks for small business. It hasn’t worked. The US labour participation rate is the lowest it has been in decades.

It makes one wonder, if it neither raises revenue nor helps provide an economic environment to create jobs in the private sector, then what good is FATCA?

The answer seems that not-withstanding the government’s own revenue projection of US$897 million annually, it is an article-of-faith there are hidden offshore accounts to be discovered that will yield vast amounts of new tax revenues. Not unlike an adventurer venturing into the unknown dreaming of finding the lost city of gold.

The IRS reports it has collected approximately US$6.5 billion in tax, interest, and penalties because of FATCA. Most of that is penalties and interest, so little more tax than projected has been collected. The FATCA believers say: “The gold is there it just takes more time to find it.” Given the number of delays already required, doubts about FATCA ever being feasible are not unreasonable.

The virtue and propriety of FATCA is a matter being hotly debated. As a political matter, FATCA’s continued existence is not assured.

Its most vocal supporters seem to be the service industry providers in the new FATCA compliance industry. FATCA promises to provide them an endless and increasing stream of fees. The tax justice crowd sees FATCA as enabling the fulfilment of their goal to redistribute money from the people who earned it to people who they feel are more deserving.

It is another way of making a good living while appearing to be socially relevant. Contrary to this, FATCA has its political opponents who are highly motivated to see its demise. Legislation for the repeal of FATCA has been introduced into congress.

While FATCA is safe from repeal for now, the Democratic senator who has been the primary and most vocal proponent behind the US anti-offshore tax policy will not be in the congress next term. While still speculation for the moment, after this coming election the senate itself may come under Republican control.

The Republican National Committee has promised to make FATCA repeal a reality if their party gets control of both the House of Representatives and the Senate in the upcoming election. This could be merely an election year ploy to get the American expat vote. FATCA is the number one hot button issue for some seven million potential voters who are US expats. They have been vociferous in their opposition to it.

Even now one Republican senator (under the Senate’s unique procedural rules) has placed a hold on all tax treaties to be approved by the Senate because of opposition to FATCA. A new tax treaty has not been approved since 2010.

Both Republican senators and Republican members of the House of Representatives assert that the Treasury had no authority to enter into any FATCA International Governmental Agreements (IGAs). They say that any purported IGA is actually a treaty. While the administration - the Treasury – can negotiate a treaty, the Constitution requires Senate approval to bring it into force.

The Treasury takes the opposite position claiming it has general authority and does not need specific statutory authority or Senate approval.

In point of fact, the FATCA legislation has no provision for IGAs. How this political power battle will turn out is a matter of speculation. Both sides of this debate agree that without IGAs, FATCA implementation fails.

What also should be understood is that on certain model IGAs with the US’s major trading partners and OECD members, those IGAs require reciprocity by the United States. FATCA for you and FATCA for me. Essentially, what is good for the goose is good for the gander.

However, there is no statutory authority for the Treasury to impose a FACTA type regime on the domestic US financial industry. While Treasury has issued a regulation requiring US banks to report on foreign depositor’s interest and dividends, the matter is being vigorously litigated by the Florida and Texas banking associations.

While the not the too-big-to-fail banks will go with anything the Treasury and Federal Reserve want, there are well over 10,000 other banks, credit unions, and other financial facilities, and all the thousands of businesses that depend on them, that have their Washington, DC lobbying organisations pressing congress in opposition. (One commentator pointed out this could involve 90 million voters.)They understand that imposing a FACTA regime domestically will drive them out of business.

These are local businesses not the big money centre publicly held banks. For elections, it is accepted that politics is predominantly a local matter. A curiosity of the parochial nature of US politics. Most US politicians probably would not support legislation, which would endanger their re-election chance. Certainly not over a few measly billions of dollars of tax. Even if FATCA survives politically there are doubts as to whether the IRS has the capacity to administer FATCA.

The Government Accountability Office (GAO), the National Taxpayer Advocate Service (NTAS), and the Treasury Inspector General for Tax Administration (TIGTA), among other governmental oversight bodies, all say that the IRS is already overburdened, undermanned, and underfunded. The IRS has been described as an agency in crisis even before being charged with administering FATCA.

For years, decades really, the utter complexity of the US tax law has teetered over the cliff of being both unadministratable by the government and uncompliable by the taxpayers. In this, the IRS and the taxpayers are victims of tax politics. IRS may get the blame, but the fault lies with congress.

The IRS and the administration are under a microscope both in congress and in the courts. There are at least five congressional investigations and numerous lawsuits against the IRS accusing it, and indirectly the President, of engaging in many despicable and nefarious actions. Against this backdrop, it is conceivable that the IRS will not be given the additional resources by congress it needs to fulfill its duties and responsibilities.

FATCA depends on the IRS getting a significant increase in its budget to modernise its computer systems to meet the difficult job of administering a FATCA regime. FATCA depends on there being a cutting edge computer system in place to handle the volume and complexity required in its operations. Onboarding 600,000 foreign financial institutions into a computer system is a daunting challenge even if a bureaucracy had virtually unlimited resources.

Reports by the GAO, NTAS, TIGTA and others have repeatedly pointed out the existing systemic failures of all the governmental computer systems including the IRS. Even the simple task of keeping track of emails is a problem.

This computer failure came under focus in the current congressional investigations and court cases, when the Commissioner of the IRS explained why there were problems in producing emails as required. Besides having the hard-drives in 20 out of 82 computers in question crash, the Commissioner also explained that the IRS is hampered by an ‘archaic’ information technology system that averages 15 years old.

The IRS not only does not have the requisite computer technology neither does it have the personnel. Under its current budget, it can hire only one new employee for every five it loses. It is projected that some 40 per cent of the management will retire in the next five years. Competing with private industry for trained IT personnel will take money. The Republicans in the House of Representatives, where all spending bills originate, plan to cut the IRS budget

This calamitous situation is made even graver since Congress and the President imposed on the IRS the burden of implementing simultaneously two enormously complex tax regimes—The Patient Protection and Affordable Care Act a/k/a Obamacare (the controversial health care law) and FATCA. The readily recognisable consequences being that the real world ability of the IRS, or any bureaucracy, to implement and administer FATCA and Obamacare may be little more than an aspirational dream.

Concerns over the cybersecurity compound the dilemma. Security of private financial information is a dominate issue for everyone in government and the global financial industry. Considering the computer security breaches already a daily occurrence, it is prudent to assume that no computer system is secure. The government’s own reports back that up. Whatever information is loaded on a computer system connected to the internet can be hacked. Even if not internet connected, if it is on a computer it can be stolen by someone on the IFC inside. It is not a question of if; it is only a question of when.

FATCA compliance demands that substantial and intimate private financial information must be obtained by a financial institution to determine if an account holder, customer, or investor is a US person or company - or isn’t. Essentially, this puts all that valuable financial information on a silver platter.

US financial institutions attempting to comply with FATCA’s requirements are experiencing extreme difficulties. US financial institutions play an important role in the collection of withholding taxes for the government and education of global investors in US markets. Letters sent to the IRS Commissioner by some of the major US banks explicitly make this point.

They explain that while their “advisors and software vendors continue to work diligently...to establish the processes and procedure necessary to implement FATCA ...We need more time to fully understand the guidance provided to date and its interaction with local IGA requirements, provide comments to the government, change our internal processes and systems, train our employees, and educate clients.”

“FATCA is unparalleled in its complexity, size, and global reach, and there is simply not enough time left to ensure a successful launch by July 1, 2014 [Which IRS has now delayed until next year and allowed transition patch]. The open questions are too numerous and the time needed to implement all the rules that we do not understand is too short.”

Any decision by an institution, which involves both the expenditure of precious capital and its continued existence as a viable entity, is not made in a vacuum. Context becomes everything. Whether FATCA compliance is in the best interest of any player in the global financial industry or jurisdiction is a decision that each must make on their own.

FATCA is here. What needs to be determined by all who are affected is what are they going to do now?

Denis Kleinfeld
Denis Kleinfeld is highly regarded as a lawyer, teacher and author. His private legal practice, Kleinfeld Legal Advisors, is located in North Miami Beach Florida. He is an Adjunct Professor at the LLM Wealth and Risk Management Program, Texas A & M School of Law. His private practice focuses on strategy planning of domestic and international tax, legal, financial, matters involving the wealth and risk management for private clients and private businesses. He is co-author of the two-volume treatise, “Practical International Tax Planning,” 4th Ed. published by Practicing Law Institute. He is the contributing author on Foreign Trusts published in “Administration of Trusts in Florida” by The Florida Bar and authored chapters for the American Bar Association’s in “Asset Protection Strategies: Wealth Preservation Planning with Domestic and Offshore Entities Vols. I and II.” He is a contributing author to the “LexisNexis Guide to FATCA”.