New U.S. tax rule fuels frustration

By Vikram Barhat | June 5, 2012 | Last updated on September 15, 2023
3 min read

Canadian financial institutions: comply with new U.S. tax rules or face the consequences.

The Foreign Account Tax Compliance Act (FATCA) will be a new filter over the current U.S. withholding tax regime to which financial institutions must apply to all their clients, or risk facing an additional withholding tax.

FATCA, which resulted from a major revamp of the U.S. withholding tax code, proposes a 30% withholding tax on certain payments made to foreign financial institutions (FFIs) and non-financial foreign entities (NFFEs) that refuse to identify U.S. account holders and investors.

U.S. tax law is applied based on citizenship, which differs from most countries which apply a residency test. This unique policy impacts about seven million American expatriates worldwide, and nearly a million in Canada.

“It’s all about financial institutions trying to locate whether they have U.S. accounts, U.S. direct account holders or U.S.-owned entities,” Washington DC-based John Staples, partner at law firm Burt, Staples and Maner LLP told a Canadian Institute conference, in Toronto. “A lot of that regulation [focuses on] how you go about trying to ensure you’ve done all you can to figure out whether or not you’re dealing with a U.S. account holder.”

What gives FATCA real bite is a withholding provisions, which can be enacted against non-participating FFIs, those who opt out of the regime. It can also be applied to recalcitrant account holders who refuse to supply information. Both are classified under the act as “withholding agents.”

Problem is, many of these withholding agents are unaware that FATCA also applies to specific transactions. “In the regime, [those] making different kinds of payments that are FATCA relevant, are also withholding agents,” said Staples. “You may be transacting with institutions the [U.S.] government wants to force under the regime.”

FFIs that participate will be busy, and must first identify U.S. accounts to the IRS. This extra-jurisdictional reach puts foreign institutions in a tight spot, and many are reluctant to enter into agreements that are at odds with local privacy laws.

“There’s an annual reporting obligation [under which] the information FFIs find after due diligence is going to go to the IRS,” he said. “[Uncooperative clients] will put [Canadian] financial institutions in a hard position because; on the one hand, U.S. government is [demanding] client information, on the other, institutions are wondering if they’re going to get sued under the Canadian law.”

The conflict has prompted IFIC to ask the U.S. Department of Treasury for changes to avoid unintended consequences.

Further, FATCA will require institutions to adopt new technologies to ensure everyone’s fully complaint. The cost and time this may take will create additional barriers.

“It’s down to how you deal with the cost of this project,” said Ann Noges, director, tax advisory group, RBC. “The overall cost to an enterprise is huge. And then how do you decide how the different businesses bare the cost of the overall project?”

Participating institutions will find timely implementation of new account opening procedures and related upgrades an uphill task.

The issue of reciprocity, raised by several countries, further amplifies the furor. Those opposed to the unidirectional flow of information from FFIs worldwide to U.S. tax authorities, are demanding the U.S. share similar information about their nationals.

This has led to an agreement to on automatic exchange of information between the U.S. and its FATCA partners – France, Germany, Spain, Italy and the UK – based on existing bilateral treaties.

Details of what information will be exchanged aren’t specified in the treaties, nor has the U.S., according to a PwC newsletter, “signaled an intention to expand on the information currently shared with the FATCA partners.”

Vikram Barhat