OPINION: FATCA at 10: Teenager-in-waiting

As of today, FATCA is 10 years old. If any of my readers have grown up children, do you remember what they were like when they were ten? Well, I do. And to me, FATCA is pretty much the same.

Which is to say it's confusing; most adults ignore it, even when it's got something useful to say; and other kids copy its homework with enthusiasm (the OECD, for example, embraced FATCA, with its own Automatic Exchange of Information (AEoI regime, as well as with its Common Reporting Standard (CRS), sometimes nick-named the "Global FATCA", or GATCA"). 

Of course, FATCA at 10 doesn’t actually exist. I said it ten years ago, and I’ve been saying it ever since. By this I mean that there is no such "Act" on the U.S. statute books.

Even the HIRE Act, which is where the text of what we now all call FATCA actually resides, went through several other formulations, all of which were rejected, before finally making it into law.

In this respect, FATCA is, from a foreigner's viewpoint (and I speak here as a Brit), like most of the U.S. tax system – a miasma.

Not only does FATCA not exist, in the technical sense, none of the U.S. tax treaties with other countries have been ratified, nor have any of the bilateral FATCA Intergovernmental Agreements (IGAs).

So, looking at it one way, this whole thing could be viewed as a massive smoke and mirrors construct. In other words, the U.S. has managed to get the rest of the world dancing around like a puppet, without actually having a legal leg to stand on.

The other irony of FATCA (or rather the HIRE Act, in which it was embedded) is that Title V is actually a standard mechanism in most U.S. statutes, to make sure that if there is a cost of implementation of a given law, that the law itself specifies where the money is going to come from to fund it, or where any offset might be found.

In the case of the HIRE Act – the Hiring Incentives to Restore [U.S.] Employment Act, to give it its full name – which had been conceived and introduced in order to give U.S. corporations tax breaks over a short period of time, in order to encourage them to hire more workers, this was the given reason for including FATCA, that is, to provide the necessary funding.

The HIRE Act's corporate tax breaks expired several years ago. But FATCA, this world-girdling, extra-territorial oversight and reporting system that was designed to make  foreign banks do due diligence on ALL their account holders, so that the repatriated tax of their American clients, was actually conceived as a means of seeing to it that U.S. corporations could hire more people than they would do otherwise. Think about that for a while.

It's also interesting to take a look at the history of FATCA from a practical viewpoint.

After the HIRE Act was implemented, and the IRS began rolling out the rules to make it work, the IGAs started to get signed. A big swathe of countries signed up at the beginning, then the numbers quickly tailed off. 

That said, those countries that signed up first were the biggest: and even today, if you look at the number of GIINs (Global Intermediary Identification Numbers) issued, more than 50% come from just five jurisdictions.

But that’s not even the most curious part. You’d expect that such a massive endeavour, requiring as it did the imposition of extra-territorial powers by the U.S. directly or indirectly on every non-U.S. financial institution (of which I estimate there are at least a million, even though the number of GIINs is still less than half that), would have been very thoroughly thought through and role-played-out.

And yet, if you take a look at the IRS website within a year or two of the roll-out, there were more than forty memorandums of understanding (also now discredited by the Executive), corrections, clarifications, updates and partner letters.

One might call that nothing more than the "bedding in" of a piece of new legislation, but for multi-national financial institutions, it was nevertheless a seemingly unending series of operational headaches that they had no choice but to put up with.

This may all sound rather negative, but, unless you are a tax evader reading this, most people want the tax system to work properly, and no one can doubt that having  extra revenue to spend on good causes would be useful. (That, of course, is underpinned by the presumption that governments are generally able to spend the extra money they receive wisely, a view that I will leave to the reader to take a view on.)

Is FATCA perfect?

FATCA is of course, not perfect. I am in fact on record on many occasions as saying that this regulation has so many gaping holes in it that you could drive a truck through them without once touching the sides.

A couple of examples.

The recent "COPA" exercise, for one, was perhaps the most classic case of head-in-the-sand futility I have ever seen.

For those who aren't familiar with COPAs, or “Certification Of completion of due diligence on Pre-existing Accounts” (as they are properly called), these were required by the IRS to be filed by financial institutions in certain, but not all, overseas jurisdictions, to confirm that they had reviewed the financial accounts of all their clients that pre-dated the coming into force of FATCA, and that they had assigned these accounts so-called Chapter 4 status, the purpose of which was to identify the Americans in their client databases. In practice, though, this was done in some cases but not in others.

The recognition by the U.S. that, on a given date, financial institutions would have legacy clients and add new clients to this, was in itself sensible enough, and providing a limited time over which those "pre-existing accounts" should be documented for FATCA purposes was equally logical, as was the presumption that subsequent procedural changes would ensure that new accounts would be automatically documented at onboarding.

However, the transition period was repeatedly extended, until at a certain point firms were obliged to certify that they had completed the exercise.

Now, though, the problem is that the U.S. no doubt assumes, reasonably, that all pre-existing accounts have been assigned Chapter 4 status, and that the issue is done and dusted.

As a result, all new updates to the regulation have not addressed the issue, because the U.S. thinks it no longer exists. The problem, though, is that some firms haven't even started to do their due diligence on pre-existing accounts, let alone completed it. 

That's because new tax regulations are complex, and even ten years on – as I've no doubt many others in my field will confirm – one still comes across "foreign financial institutions" that even now haven't got a clue about what they are by now supposed to have already done, with respect to COPAs, let alone completed it.

My second example of the gaping holes that remain with FATCA, 10 years on, exemplifies the adage that regulations are only ever as good as the teeth that the enforcement entity in question has – and uses. It is not enough just to have teeth, in other words, someone must be seen to be willing to put them to use.

With respect to enforcement of FATCA, it is done in two parts. The first, which is mostly overlooked by everyone outside the U.S., mandates that Americans with bank accounts and assets overseas must report these accounts to the IRS, subject to domestic penalties if they fail to do so.

The second, more-well-known element of FATCA enforcement is that which obliges foreign financial institutions to identify all of their U.S. account holders, through regular due diligence, and report them to the U.S.

Leaving the domestic piece alone for the moment, the teeth for the second part of FATCA has mainly been left to the "Competent Authorities" of each party to determine whether the regulations have been breached – and if so, whether the breach was minor or not.

At this point, we need to understand two things. First, the IRS (the U.S. Competent Authority) has suffered budget cuts for the last ten years, and is a severely-stretched resource, focusing mainly on its domestic taxpayers.

Second, foreign Competent Authorities are also more focused on deriving income from their own residents than they are on helping the U.S. with its tax-evading citizens.

The bottom line, then, is that FATCA’s teeth are really very small. And it wasn't until other U.S. agencies began to lend their support to the IRS, in the form of sting operations, that anyone outside the U.S. took any real notice.

'FATCA's older brother, Chapter 3'

At this point I'd like to say a few words about FATCA’s older brother, Chapter 3 – or the "Qualified Intermediary" regulations, as they are more commonly (and equally inaccurately) referred to.

A Qualified Intermediary is a non-U.S. financial institution that is obliged, under the QI rules, to formally identify to the IRS those of its clients that invest in U.S. securities. These procedures are subject to verification (two times in a six-year period) by an external auditor. If a firm is not a QI then, by definition, they are an NQI [Non-Qualified Intermediary] and, as then-U.S. President Obama said in 2009, "…any foreign firm that does not sign a [QI] Agreement with the U.S. will be deemed to be facilitating tax evasion…"

The QI Agreement and the overall Chapter 3 regulations that apply to QIs and NQIs rules pre-date FATCA by around a decade. 

Under FATCA, financial institutions were and are being asked to share the personal data of their American clients  across national borders, in the interests of the detection and prevention of tax evasion. This raised natural data protection issues from the outset, and it was these that led to the use of IGAs with the governments of the countries in which the various respective financial institutions in question operate, so that these financial institutions wouldn't have to break domestic data-protection laws in order to comply with this U.S. law.

Arguably a  sound approach, although it's debatable whether a bank’s customers would see it as anything other than governments trying to side-step their own data privacy laws. In fact, the data privacy issues raised by FATCA have in fact been mentioned, and are currently the subject of an ongoing legal case here in the UK, which is being brought by a U.S.-born British citizen with the help of London's Mishcon de Reya law firm, and funded by donations. 

Those with concerns would appear to have a case, as there have been some major data breaches, including one last year that saw the names, addresses, incomes and social security information of as many as 5 million Bulgarians and foreign residents stolen after a hack of Bulgaria's national tax agency. 

What I’ve always found curious about this whole issue of IGAs, and data privacy concerns, is that no one seems to remember that the Chapter 3 regulations have required even more detailed personal data to be shared with the U.S. for the past 20 years, in the form of 1042-S information returns – and yet no one seems to have ever mentioned a possible need for Inter-Governmental Agreements here.

Given that most of the world’s financial institutions are non-qualified intermediaries (NQIs), this means that all of their clients who receive U.S.-source income must be reported individually to the U.S. government. (Their U.S. clients are of course also reported, on 1099 returns.) 

Each 1042-S from an NQI contains such information as the individual in question's name, address, tax identification number (TIN), date of birth, U.S. income, amount of tax withheld and so on – and that data goes directly to the U.S.

What I struggle to see is why, if the end-of-year balances of Americans with non-U.S. accounts are so sensitive that they need IGAs, all of this Chapter 3 data doesn't also warrant a comparable degree of care.

This, of course speaks to the fact that FATCA, like all regulation, does not exist in a vacuum.

When we say that FATCA penalties are obscure at best, and there is no perception of the sword of Damocles hanging over anyone’s head, this is mirrored in the way Chapter 3 transgressions have been handled.

By my own estimation, the U.S. is missing out on around US$87bn a year in unapplied fines on NQIs that simply choose not to report at all, and the IRS chooses not to pursue.

Lack of data 

This brings me to my final point, which is that although both the Chapter 3 regulations and FATCA were introduced at least in part to increase tax revenues, neither seems to be achieving this goal.  

This was one of the points raised by a U.S. Government Accountability Office report on FATCA  last year.

What's more, the focus by most commentators on FATCA is on the penalty numbers rather than the tax revenues being generated – not that this data is, for the most part, readily provided – so we have not much in the way of proof as to whether FATCA is actually successful in the time-honored way of evaluating a tax's success.   

In other words, if we are to evaluate how well our 10-year-old is doing, we need good reliable data – the equivalent of a school report. 

But unfortunately, the HIRE Act didn't call for the gathering and publication of data in connection with its revenue-raising provisions. 

In conclusion...

Summing up, it's fair to say that FATCA has had an interesting first decade. It was mis-named at birth; it is being implemented around the world through the use of international agreements and treaties that have never been ratified by the U.S. government; and despite all this, the OECD saw fit to essentially cut and paste most of its basic provisions into its own AEoI/CRS framework, which the rest of the world has been implementing the last few years.

While FATCA may be riddled with operational holes, and compliance is not well or consistently implemented or enforced, the principle behind FATCA remains, for most people, a sensible objective – even though we do not really have any idea about how well it has performed to that objective. 

Also, FATCA's unintended consequences, as a result of the U.S.'s citizenship-based tax regime, on "accidental Americans" and others need fixing, most would agree. 

Finally, the rise of COVID-19 will undoubtedly cause operational problems for both reporting firms and the various competent authorities in question – a bad first case of the flu, shall we say, for our 10-year-old.

The yet-to-be answered question remains, of course, what kind of teenager our young master FATCA will turn out to be...

 To read more commentary by TConsult Ltd founder and chairman Ross McGill, on the TConsult website, click here.