What's wrong with the US Fatca tax law

Business Times - 23 Aug 2011


What's wrong with the US Fatca tax law

Apart from violating financial privacy laws, the new rules will prove costly for FFIs

By LEON HADAR
WASHINGTON CORRESPONDENT

IN RESPONSE to protests from American businesses, the federal government decided to repeal earlier this year a complex and intrusive tax scheme aka '1090' that would have required companies to collect tax identification numbers for any of their suppliers whenever they did more than US$600 of business - that included, for example, out-of-town hotels the company's salesman were staying in - and then send the required paperwork to the Income Revenue Service (IRS).

Demonstrating some common sense, officials and lawmakers in Washington decided to eliminate the '1090' after arriving at the conclusion that the tax rule amounted to the kind of bureaucratic and financial nightmare that would impose unnecessary burdens on American businesses at a time when the government's main goal was to help revive an ailing economy.

But Washington has not exhibited the same kind of refreshing common sense when it came another new component of the US tax law known as the Foreign Account Tax Compliance Act (Fatca), that would require non-American financial institutions to scrutinise billions of dollars of deposits to find US citizens who might be hiding money. Not unlike the '1090', the Fatca is basically trying to force private companies to join the IRS in searching for tax evaders.

The reason why the Fatca is getting less attention in Congress and the US media than the '1090' provision is clear. The '1090' could have had an adverse effect on big and small American businesses that continue to exert political power on Capitol Hill and whose anti-tax plight could ignite some sympathy among many Americans who detest the federal government's intrusion into their lives and are critical with what they regard as the IRS's abusive methods.

American 'imperial overreach'

The Fatca rules, on the other hand, would target institutions that most Americans love to hate these days - banks. And if these banks are foreign and are being suspected of sheltering the billions of dollars that are supposedly hidden by those reviled American 'fat cats', what is there not to like in the Fatca?

On one level, it makes a lot of sense in our age of globalisation and the free-flow of capital worldwide for the US to ensure that American citizens would not avoid paying their personal income taxes on foreign dividends and interest by hiding their funds in overseas bank accounts.

Until recently, the government required US taxpayers to report overseas bank accounts on their personal returns but lacked the means to force them to do that.

The new Fatca provisions not only require Americans with more than US$50,000 in foreign assets to report them and the income they earn. They also place the burden of policing the law on foreign financial institutions (FFIs) that are now compelled by law to report the IRS each year all the available information on the accounts of American citizens. A 30 per cent withholding tax penalty on all US payments of dividends, interest, and security proceeds would be imposed on any FFI failing to provide this kind of report on its American client.

'Imagine the US reaction if a foreign power - say China, Japan, or Russia - enacted legislation requiring US financial firms to report similar information on their citizens, and imposed a stiff penalty on US firms that failed to comply,' American economist Gary Hufbauer wrote in a report issued last month by Peterson Institute for International Economics.

'One hopes that Congress and the Administration would scream to the roof-tops,' Mr Hufbauer, a senior fellow with the Washington-based think tanks who describes the Fatca as a form of American 'imperial overreach'.

In addition to raising concerns about violating existing laws with regard to financial privacy (in Switzerland, for example), the new Fatca rules are going to burden FFIs with enormous bureaucratic and financial costs, including by making millions of dollars in investment in new software and staff to deal with the added tasks.

Moreover, it is not even clear that the huge regulatory system that would affect American individuals and companies engaged in cross-border economic activity is going to produce major economic benefits for Americans. In particular, it could affect thousands of Americans who work abroad and/or are married to non-American spouses - as well as foreigners who legally reside in the US and are required to pay taxes according to American tax law - who may not be allowed now to open accounts in FFIs.

The Peterson Institute's Mr Hufbauer has called on Congress to delay the implementation of Fatca for five years. 'During that time, the Treasury Department should be instructed to negotiate cooperative, two-way, reporting agreements that would require financial institutions in both countries to report the holdings of foreign taxpayers who are citizens of the other country,' he wrote.

Mr Hufbauer believes that such reporting requirements should not target all Americans and their foreign counterparts but only high-net-worth households, with households with fewer holdings being targeted on a random basis. Then after five years, the Treasury 'should dispassionately evaluate' the reporting burdens and the additional revenue raised. At that point, a sensible decision can be made on whether Fatca should be allowed to take effect, Mr Hufbauer concluded in his report.

Contrary to vision

That is certainly a proposal that makes a lot of sense. Or Washington should go even beyond that and like in the case of the '1090' tax provision, eliminate the Fatca from the law books. After all, the rules run so much contrary to the vision promoted by President Barack Obama of a United States that is committed to a diplomatic and economic engagement with the rest of the world.

If anything, Washington should be celebrating the role of American multinationals and entrepreneurs, including members of the Asian diasporas that are operating abroad and are helping to spread American economic and political ideas, serving as the unofficial ambassadors of American capitalism in countries like China and India. Washington should certainly not be punishing them.

Copyright © 2010 Singapore Press Holdings Ltd. All rights reserved.