FATCA Intergovernmental Agreement Exposed as Bad Deal for ‘Partner’ Countries

Foreign Account Tax Compliance Act (FATCA) is a US law that attempts to force foreign financial institutions to report balances, receipts, and withdrawals in accounts that belong to Americans. If a bank or financial institution does not file such reports, the IRS will charge a 30% withholding tax on income from those investments.

The United States is the only country in the world which taxes based on citizenship rather than residency, on worldwide income of individuals, in the same manner as residents.

Darth Vader: I am altering the deal. Pray I don’t alter it any further.
Lando Calrissian: [to himself] This deal is getting worse all the time!

– from Star Wars: Episode V – The Empire Strikes Back (1980)

Two weeks after the release of purportedly final regulations on foreign financial institutions (FFIs) to implement the Foreign Account Tax Compliance Act (FATCA), the predictable (and predicted) chorus of hosannas from compliance vendors is in full swing. Faced with 544 pages of mind-numbing and confusing mandates (up from the draft of “only” 388 pages of last year), vendors literally banking on a FATCA compliance goldmine are renewing their call for FFIs to fall into line and pay up.

While the vendors are no doubt doing quite well for themselves at the expense of firms (some of which expect to spend $100 million each to comply with FATCA, and already have dozens of employees solely devoted to that task) – and of course of consumers, onto whom these expenses will be shifted – it isn’t clear that FATCA itself is doing as well.

Why? Because the U.S. Treasury Department’s ability to enforce FATCA directly, on each and every FFI on the planet is highly questionable. Instead, they need the active cooperation of foreign governments who have to be scared into signing intergovernmental agreements (IGAs), whereby the foreign “Partner” (as euphemistically termed in FATCA-talk) will enforce this American law against its own institutions and citizens.

So far, however, Treasury’s actual achievement in obtaining signed IGAs continues at a slow pace, as noted by Nigel Green, CEO of deVere Group. This is a particular problem with respect to major countries in Europe and elsewhere which require at least the appearance of even-handedness in the form of the so-called “Model 1” version of the IGA, which promises data exchange with the U.S. based on “reciprocity.”

Pretense of “reciprocity” exposed

No one who has read “Model 1” IGA (such as the agreement signed with the United Kingdom, unsurprisingly the first country to submit to Washington’s diktat) has any illusions that the supposedly “reciprocal” agreement is anything of the sort. While pursuant to Article 2(a) of the IGA the non-U.S. “Partner” governments must force their FFIs to provide what amounts to FATCA’s entire spectrum of invasive and expensive-to-collect financial data on “U.S. persons,” wherever they may be resident, the American side promises (pursuant to Article 2(b)) to provide only information on certain interest “Partner”-country residents derive from domestic U.S. institutions.

What is the reason for the mismatch on what is supposed to be a two-way street? The Treasury Department claims it is providing under Article 2(b) of the IGA only information pursuant to authority they already have under current law. (As will be further discussed below, even that claim is already subject to challenge from some in Congress.)

But that’s OK! Under Article 6(1) of the IGA, the Treasury Department solemnly promises the “Partner” government (here, the UK) that the asymmetry between U.S. and “Partner” obligations is only temporary:

Reciprocity. The Government of the United States acknowledges the need to achieve equivalent levels of reciprocal automatic information exchange with the United Kingdom. The Government of the United States is committed to further improve transparency and enhance the exchange relationship with the United Kingdom by pursuing the adoption of regulations and advocating and supporting relevant legislation to achieve such equivalent levels of reciprocal automatic exchange.

It would be hard to suggest with a straight face that the “Partner” country officials who negotiated this deal actually believe this commitment any more than the U.S. officials who made it. Chances of implementation and passage of such legislation are slim to none, and they all know it.

But at the same time, it’s important that the public façade of “reciprocity” be maintained that this is a genuine, mutually beneficial exchange. It’s one thing for the officials on both sides to acknowledge with a wink and a nod behind closed doors what’s really going on – the capitulation of the “Partner” to a unilateral U.S. demand, backed up with the threat of sanctions. But letting the whole wide world know that is another thing entirely. In particular, it’s important that citizens of the “Partner” country be kept in the dark that their government is not only compromising their sovereignty (par for the course) but is sticking them with a massive bill for higher consumer costs and for tax funds used to enforce FATCA domestically – and not even getting much of anything in return.

Recently, however, somebody blabbed:

Although the United States has committed to achieving reciprocity regarding the exchange of financial transaction information under the Foreign Account Tax Compliance Act, domestic banks are not subject to the same reporting requirements as are their foreign counterparts, an Internal Revenue Service official said Jan. 25.

According to Ted Setzer, manager of IRS’s Large Business & International Division, although existing requirements on U.S. banks will provide other governments with similar information required of foreign banks under FATCA, “clearly existing U.S. rules don’t require U.S. financial institutions to provide the exact same information that a foreign institution has to under FATCA.” [ . . . ]

Responding to a question about reciprocity, Setzer said the United States had committed to such a concept. However, U.S. reporting rules for domestic banks “are what they are,” and do not require identification procedures identical to those required under FATCA, he said.

“How we get to full reciprocity and how long it takes is something we’ll have to be working on,” Setzer said.

[“Full Reciprocity Under FATCA Is a Work in Progress, IRS Official Says,” Bloomberg Law, 1/28/13]

Some have been critical of Mr. Setzer for having the bad manners to speak something like the truth out where it could be reported to those not familiar with the imbalance codified in the IGAs. But putting aside questions of indiscretion and the vague characterization of a timeframe for “full reciprocity” – something that clearly isn’t going to happen anytime soon, and probably not ever – it’s nice to have confirmed officially what most people familiar with the details prefer to obscure.

Take the best deal on offer – until we change the deal . . .

Even with this built-in imbalance of obligations, many countries may still regard an IGA as the best protection against direct, extraterritorial FATCA enforcement by the IRS. Indeed, the more burdensome and onerous the regulations, the more terrified FFIs will clamor for their governments to sign an IGA (and push their own citizens and consumers under the bus) to avoid them. This threat was bluntly set out in an unpublished comment by one professional who admits FATCA is “ill-conceived” but still applauds Treasury’s strong-arm tactics, wielding their scary 544 pages as a club:

In retrospect: the parallel track of IGA’s and individual FFI agreements for banks in countries where there is no IGA, really represent a tremendous PR coup for the US Department of the Treasury! On the one hand, the FATCA Regs. which have no substantive applicability to the new procedures under the IGA’s, are a good reminder of how truly miserable the IRS can make your life if you are one of the unfortunate banks in countries where the IGA process has yet to begin. Five hundred and forty four boring detailed pages of what the IRS expects you to do if you indeed have the misfortune of being a bank in a non-IGA jurisdiction which has to enroll and register individually with the IRS to be a withholding agent for the United States government. It is as if the Treasury were saying to the whole international financial community: “just wait and see how tough we can get if you have sign up as a withholding agent. You would be best advised to get after your respective governments to step up and be a player so you can self-certify your compliance with the AML and KYC rules AND NOT have to deal directly with us.”

Surely, Treasury officials themselves use more diplomatic language when talking with their foreign counterparts. But as with Mr. Setzer, openness is a virtue – in this comment, about the unvarnished threat impelling countries to sign IGAs that are all cost, no benefit.

Indeed, about the only real benefit a “FATCA Partner” country can hope to secure in signing an IGA is the prospect of having certain categories of industry or financial products of particular importance declared as a “deemed-compliant FFI or as an exempt beneficial owner” under FATCA, and therefore listed on Annex II of the IGA and relieved of FATCA compliance requirements. This is a significant draw for signing an IGA for a number of countries who want their pension plans exempted from FATCA.

. . . which we can do any time we want

The trouble is, exemption of favored industries of products under an IGA actually is no protection at all.

First, in issuing the final regulations, the Treasury Department already has exempted “certain retirement funds, life insurance and other ‘low-risk’ financial products held abroad, which are not considered havens for dodging taxes, are exempted from reporting their U.S. account holders’ information to the IRS.” So one might think that the incentive to sign an IGA to protect key industries may be reduced. On the other hand, for some jurisdictions, even the final regulations “confuse rather than clarify” on that point, so some industry is still pushing for an IGA “to provide further clarity” and specifically include “in the annex to the IGA . . . a list of exempt institutions/products.” Or to put it another way, even after issuance of the “final” regulations, vagueness and fear remain Treasury’s key tools for pushing countries into IGAs.

Moreover, an IGA provides no protection at all for one additional, simple reason: they are written on sand. The U.S. unilaterally can cancel the IGA at any time with one year’s notice, for no reason whatsoever, and leave the “FATCA Partner” and its FFIs faced with ‘original FATCA’ and the full 544 pages of regulations! Under Article 10(2):

Either Party may terminate the Agreement by giving notice of termination in writing to the other Party. Such termination shall become effective on the first day of the month following the expiration of a period of 12 months after the date of the notice of termination.

But surely the American side wouldn’t do this . . . would they? After all, some governments believe an IGA binds the U.S. in a manner comparable to a treaty obligation (here, from an unpublished response to a constituent from a working group in an aspiring IGA “Partner” government):

Any intergovernmental agreement would be an extension of the existing double tax agreement and would build on its information exchange mechanism. Once any tax treaty has been signed and is in force, it cannot be changed unilaterally – all changes must be made by mutual agreement or by renegotiation. This rule would also apply to the intergovernmental agreement.

Such assurance is entirely illusory, for at least two reasons:

First, from the U.S. side, an IGA is considered an “Executive Agreement,” which emphatically is not a treaty or binding on the U.S. in the same way a treaty is. Treasury deftly has come up with IGAs – which are not even provided for in the FATCA statute – as a way to cajole other countries into enforcing FATCA on themselves while bypassing Congress entirely. By contrast, for many “Partner” countries, especially those with parliamentary systems (unlike the U.S.), the IGA must be put through treaty ratification procedures and then legislatively codified in domestic law. In a nutshell, the “Partner” would lock its obligations into stone, while the U.S. “obligations” amount to the whim of the U.S. Treasury Secretary.

Second, as noted above, the right of the U.S. to terminate the IGA under Article 10(2) amounts to an effective ability to change its terms at will. (Of course the “FATCA Partner” has the right to terminate as well, but as the party seeking protection from the threats of the other party, that’s unlikely.) Once an IGA is signed, the Treasury Department easily can come back in a year or two and say, “Alright Partner, we want to cut back on our over-generosity on Annex II and require compliance of your precious pension plans and some other FFIs we earlier agreed to exempt. Oh, and we want to lower the reporting amount from $50,000 to $10,000. If (now that you’ve capitulated anyway and recognize who’s in charge around here) you balk at changing the rules or at our revocation of some temporary concessions, you can just go back to Square One and comply directly with the 544 pages of regulations. It’s your choice – Partner.”

Any guess which way the “Partner” will jump?

Congressional action could be fatal to IGAs – and to FATCA too

With Treasury’s choosing the Executive Agreement ploy for the IGAs, in large measure to deal Congress out of the equation, it might be supposed there’s no danger from that quarter. That may not be the case, however.

It must be remembered that for several years Treasury already has been engaged in a running gun battle with some key members of the House Committee on Ways and Means, notably Oversight Committee Chairman Charles W. Boustany Jr., M.D. (Republican, Louisiana) and Congressman David G. Reichert (Republican, Washington) over requiring U.S. banks to report interest on accounts of non-resident aliens (NRA). The argument over the authority and impact of NRA interest reporting precedes Treasury’s efforts to pressure other countries into FATCA IGAs. But the two issues dovetailed last year, notably with publication of an IRS bulletin citing as “authority” for faux-reciprocal reporting to “FATCA Partner” governments under the IGA the same disputed regulatory and statutory application claimed by the IRS to justify NRA interest reporting. In a significant push-back from industry, in December 2012 the American Bankers Association (ABA) wrote to the Treasury Department, stating that that powerful industry group –

. . . strongly objects to the NRA reporting automatic exchange provision included in the U.S.-Mexico IGA. Moreover, since there is no indication or evidence suggesting that the Treasury conducted the required due diligence for entering into such an automatic exchange relationship, we strongly recommend that Treasury reconsider this automatic exchange relationship with Mexico.

Of course the likelihood that the Treasury Department will reconsider information exchange with Mexico or any other country dragooned into signing an IGA is about as great as chances for Congress to enact legislation providing for fully reciprocal information exchange: virtually zero. However, that doesn’t mean that Congress can’t or won’t consider measures to block even the limited data promised to “Partner” countries under the “Model 1” IGA.

These concerns about NRA interest reporting and mandates on U.S. domestic industry under the IGAs are still short of moving toward FATCA repeal – so far. But they do show how out of touch with political realities in Washington are Treasury’s purported commitments to prospective “Partner” governments. Simply put, as bad a deal for “Partner” countries the “Model 1” IGA already is on its face, Treasury cannot be sure of keeping its promise of even the meager “reciprocity” spelled out in it as Congress increasingly focuses on FATCA costs boomeranging back towards the US.

What needs to be done next

As accurately stated in the ABA letter, “there is no indication or evidence suggesting that the Treasury conducted the required due diligence for entering into such an automatic exchange relationship” with Mexico. Indeed, there is no indication or evidence any such due diligence was performed at any step along the way for FATCA at all, either before its enactment in 2010, or for the impact of the 544 pages of regulations on the U.S. and global economy, or on the costs and effects of the IGAs. Instead, there is every indication and evidence of the exact opposite: That FATCA will not succeed in policing “tax cheats” or raising significant revenues but will trigger a host of deleterious consequences. If that’s not “the worst law most Americans have never heard of,” what is?

As a bad deal for all concerned, the IGAs should also be seen as a “weak link” for undermining FATCA and working for its repeal before its worst features go into effect. For that to happen, as Center for Freedom and Prosperity President Andrew Quinlan has written, “it’s time for more Americans to hear about FATCA and the damage it is preparing to do – if not already doing – to the world economy.”

This means that foreign governments need to stop helping to save FATCA from its own fatal flaws by signing IGAs that cannot provide promised protection for cherished institutions. Instead, they should tell Treasury in clear and principled terms that they will not allow their domestic firms to comply with FATCA, and that they’re prepared to respond with WTO and other remedies if IRS tries to apply sanctions (notably FATCA’s 30 percent withholding threat for “recalcitrance”). Finally, firms faced with wasting untold millions of dollars to comply with FATCA need to stop pressing their governments to sign IGAs and instead help get rid of it by supporting the repeal campaign in the United States.

Originally published on Repeal FATCA.