New policies in International Taxation

(The consequences of the FATCA and the BEPS)

Tax collection is one of the main goals for every state in the world. Neither states nor societies could ever survive without taxes. Public services – which include public education, public administration, judicial system, public health services, security, and military corps, among others- are funded with tax revenues.[1] In few words, taxes are vital for supporting the state. However, taxes are one of the issues that strains the relationship between the government and the taxpayer.

Over the years, taxpayers have been trying to implement sophisticated techniques and business schemes in order to hide their revenues from the tax authorities. There are cases in which these techniques are legal (looking for legal loopholes in the system) and some other cases, illegal (tax evasion). A good example of the latter are the Base Erosion and Profits Shifting (BEPS), which consists of different ways to avoid paying some taxes by shifting profits away from the location where the activities creating those profits take place. The U.S. Supreme Court has analyzed this issue in several precedents, prevaling the substance over the form.[2] On the other hand, fiscal planification has been ratified in several precedents.[3] And because of the increasing globalization, nowadays “it is becoming easier for all taxpayers to make, hold and manage investments through financial institutions outside of their country of residence”[4].

“Vast amounts of money are kept offshore and go untaxed to the extent that taxpayers fail to comply with tax obligations in their home jurisdiction”[5]. This means fewer resources for the states and consequently less money to spend on services and social programs provided by the states to the citizens. And since “countries have a shared interest in maintaining the integrity of their tax systems”[6], countries have been forced to exchange tax information. This is why new laws have been passed on this subject.

Tax systems have become more complex and new policies have been put into practice. “Over the past few years much progress has been made by the OECD, EU and the Global Forum on Transparency and Exchange of Information for Tax Purposes in improving transparency and exchange of information on request”. The aim of these new policies is to tackle the BEPS, carried out by taxpayers, mainly through Foreign Financial Institutions (FFIs), which include certain banks, common funds, and profitable assurance companies.[7]

The last innovation on this matter is the Foreign Account Tax Compliance Act, “which became law in the United States in 2010”. “The U.S. Congress and the “Obama Administration pressed for the Financial Account Tax Compliance Act (FATCA) in 2010 because they wanted to reduce the amount of tax evasion by Americans who had financial accounts outside the USA”[8].  Nonetheless, the implementation of said act is subject to the international states’ approval. USA has and will continue to propose the signing of Intergovernmental Agreements (IGAs) to the rest of the states in order to obtain the information needed to reduce the amount of tax evasion. There are two models of IGAs. The first one implies an indirect tax information exchange: the FFIs will give the information about the American citizens’ banks accounts to the tax authorities of their countries and these authorities will in turn inform the IRS about them. The second model implies a direct tax information exchange from the FFIs to the IRS. However, “the clock will stop ticking on July 1, 2014”[9], which is the deadline for these IGAs[10]. If a state decides not to sign the IGA, U.S. authorities will severely tax U.S. people investments in foreign countries.

The FATCA is the new policy on which I will be addressing in this essay. First, I will line out the characteristics of the FATCA and explain this new policy, its aim, and the conditions to implement it successfully. In second place, I will analyze the importance of the bank secrecy, how the FATCA can affect the right to the bank secrecy, and the states secrecy disclosure. Finally, I will focus on the implementation of the FATCA within the domestic law and its consequences.

 

1. FATCA

The FATCA is a new policy of international tax information exchange that consists of several obligations for foreign countries to abide by it. This new policy obliges FFIs to report to the IRS information of accounts held by American citizens in foreign countries. FFIs also have to identify the bank account holders and the amount of money in the accounts to then inform the IRS.[11] The procedure of this information exchange consists of several steps that must be followed by the FFIs: i) registration, ii) signing an Agreement with the IRS, iii) naming a representative who will be the connection between the IRS and the FFIs, iv) implementation of an internal procedure to detect “U.S. Persons”. “U.S. Persons” includes American citizens, residents in the US or not, American citizens with double nationality, American companies, foreign companies in which a U.S. person holds at least a 10% of the shares; and U.S. accounts, that includes any financial account (checks, savings, deposits, investments, custody accounts, commercial accounts) of more than USD 50,000 held by a “U.S. Person”. Whenever a US citizen withholder of an account is detected, the information must be provided to the IRS directly, if the countries sign IGAs model 2, or indirectly, if countries sign IGAs model 1.

The aim of the FATCA is to tackle and reduce the BEPS in order to repatriate untaxed money. The US Treasury implemented this policy so that Americans file reports of their offshore bank accounts and overseas profits.[12] The US has a legal and legitimate interest in taxing US citizen incomes. Incomes can be legally taxed no matter if they are obtained in the territory of the USA or overseas.

This legitimate interest is not only applicable to the USA but to many other countries around the world: Argentina, for instance. Its authorities are also able to tax Argentinean citizens’ incomes. Argentine Income Tax Law establishes a tax on incomes obtained by Argentine citizens, provided that article 1 of said law states that Argentine citizens will pay taxes for local income sources as well as World Wide income sources[13].

The consequences of the FATCA has been analyzed by the Congressional Joint Committee on Taxation that projected that the U.S. government will collect about $8.7 billion during the first 10 years that the FATCA law is in effect, reported Executive magazine[14]. Now, we can imagine the importance of the FATCA for the US government.[15]

As regards the conditions set to implement this new policy, the US has adopted a strict position. The US proposes foreign states to sign the IGAs that enable tax information exchange. At first sight, this new scheme of information exchange seems to be positive for the IRS and for the foreign state. However, not everything that shines is gold. In first place, the US Treasury announced that certain clauses on specific entities and bank accounts will not be negotiated.[16] Secondly, IGAs model 1 gives the US the opportunity to make the tax information exchange reciprocal.[17] And finally, “FATCA penalizes Americans and FFIs, such as banks that do not comply with the law (…) while foreign banks that don-t disclose their American account holders are subject to a 30 percent withholding tax on the Americans income.”[18]

IGAs must not be seen as compulsory for foreign states. Foreign states have the opportunity to review the IGAs models and decide to sign them or not, facing the consequences. Nonetheless, there are pros and cons on signing the IGAs. Foreign states can also benefit from the two way tax information exchange.

 

2. Bank Secrecy

One additional issue that the states must take into account is the bank secrecy. Bank secrecy can be seen from many different points of view. It has its pros and cons. Bank secrecy is a right of every citizen and is a basic principle for the development of the economy. While bank secrecy is a tool that gives confidence to people, it can be an obstacle for the states to prevent illegal activities like money laundry.

Privacy and bank secrecy have been protected by laws in most of the countries, if not all. Privacy is a right that has been recognized by the U.S. Supreme Court of Justice in Grisworld v. Connecticut when the Court stated that several amendments “imply zones of privacy that form the basis of the general privacy right affirmed in this case”.[19] It is true that bank secrecy is a right that is granted by laws in the world –in Argentina, Financial Entities Law article 39 grants the banking secrecy-. However, rights are not absolute. Rights can be regulated by the laws. Laws can state exceptions to the rights of the citizens. As “Justice Thurgood Marshall put it in his Smith v. Maryland (1979) dissent, that privacy is not a discrete commodity, possessed absolutely or not at all”.[20]

People could never expect progress and development in the economy if the right to privacy or the bank secrecy did not exist. People do not want to have their financial information disclosed.  Important transactions, purchases and investments need to be performed with absolute discretion, in privacy. A breach in the privacy right or the bank secrecy could severely damage the development of an economy in a country. For instance, important and well- known real estate investors perform their transactions through a third party who will never reveal the name of the investor to the seller. If this third party were obliged to reveal the investor behind the operation, the seller would probably raise the price of its property since someone has seen an added value that the owner could never see, and nobody would want to perform operations in such atmosphere. Moreover, secrecy is vital in many professional careers, such as psychologists, medics, lawyers, even priests cannot unveil the professional secrecy. Secrecy is what gives confidence into the people.

Nonetheless, a strict bank secrecy right can also have a negative effect on the state. States will have a difficulty on preventing crimes. Crime prevention can be seriously jeopardized by an strict bank secrecy. A strict bank secrecy facilitates money laundering. It allows people that obtain money from coming from illegal sources – such as drug dealing, terrorism, tax evasion, among others – to be safe from the tax authorities. Authorities will find it very hard to discover tax evaders without a tax information exchange that would unveil the bank secrecy.

States have a legal and legitimate right to identify offshore bank accounts from their citizens and repatriate untaxed amounts of money.

The unveiling of the bank secrecy by the states will have negative effects. Said effects could be, for example, a quick loss of capitals from the states to accounts in other territories, such as tax heavens. The question we must ask ourselves now is whether the states are willing to abandon bank secrecy and suffer face the consequences.

 

3. Implementing the FATCA worldwide.

FATCA is a US domestic law. The US wants this domestic law to have international effect through the signing of the IGAs. However, the signing of the IGAs by the states will not necessarily produce an automatic effect in their internal law systems. The countries’ constitutions determine the proceeding needed to follow in order to enter into international agreements and to determine their hierarchy. This could be higher, equal or below of the law’s hierarchy. For instance, the Argentine constitution states that the executive power withholds the treaty-making power[21]. The treaty-making power means that the president can sign international agreements. However, we have two problems to take into account regarding this issue. The first one is that the Congress is in charge of approving or rejecting these international agreements.[22] In case of rejection, the IGAs will remain as soft law. In words of Barberis soft law can have many definitions such as laws in process of creation and that do not have legal effect or legal hierarchy yet, intergovernmental agreements, international conferences directives, etc.[23] And the second problem is that the FATCA and the IGAs are regulations on tax matters. Tax matters, in many or most of the states, can only be legislated by the Congress or the Parliament, that is, the representatives of the population.  Article 75.2 of the Argentine constitution gives the Congress the power to tax. Therefore, we can understand that if the Congress do not ratifies the IGAs signed by the executive power, these will not have any effect on the internal law system.

Limitation of powers to the executive power can be traced back to the year 1215 when the Magna Carta was enforced. The Magna Carta was the first document that limited the power of the executive power, in those years, the King. In words of Justice Marshall in McCulloch v. Maryland (1819): “the power to tax involves the power to destroy”. Such power must remain in the hands of the population, through their representatives.

 

4. Conclusion.

FATCA was enacted in 2010 in the U.S. This notwithstanding, the U.S. Treasury and the IRS have been extending the deadline for the signing of the IGAs until the ultimatum in July 1, 2014.

FATCA is a strong tool for reducing BEPS, which are continuously increasing in these times of globalization. The aim of the FATCA is to repatriate untaxed amounts of money. This aim will be achieved through the signing of the IGAs. However, it is not clear yet whether the states will abide to the IGAs, since the U.S. has settled down in a strict position and will not negotiate the terms and conditions.

The U.S. is putting a great pressure on the states, since the rejection of the IGAs is not free of consequences for the states. States are in the difficult position of abiding to the IGAs and unveil the bank secrecy –that can turn into a massive loss of capitals that will go overseas –, or reject them and expect a 30% tax withholding from the U.S. government to the FFIs.

FATCA is a challenge for the states sovereignty. The states, if signing the IGAs, will be obliged to enforce a U.S. domestic law. This U.S. domestic law will necessarily enter into conflict with the states internal law system, since most of them grants the right to the bank secrecy.

From my point of view, there is not an only solution to this problem. Besides, no person can find the right one. It is to the states to decide. States will have to put the pros and cons in the balance.

Any of the choices taken by the states will have an effect in the taxpayers. These could be whether the breach in their right to the bank secrecy, or the payment of an additional 30% tax.

The number of signing states is increasing dramatically. There are 27 Jurisdictions that have signed agreements, Model 1 IGA – 27: Australia, Belgium, Canada, Cayman Islands, Costa Rica, Denmark, Estonia, Finland, France, Germany, Gibraltar, Guernsey, Hungary, Honduras, Ireland, Isle of Man, Italy, Jamaica, Jersey, Luxembourg, Malta, Mauritius, Mexico, Netherlands, Norway, Spain and United Kingdom. There are 5 Jurisdictions that have signed agreements, Model 2 IGA: Austria, Bermuda, Chile, Japan and Switzerland. Finally there are 30 jurisdictions that have reached agreements in substance and have consented to being included on this list (beginning on the date indicated in parenthesis), Model 1 IGA:  Bahamas, Brazil, British Virgin Islands, Bulgaria, Colombia, Croatia, Curaçao, Czech Republic, Cyprus, India, Indonesia, Israel, Kosovo, Kuwait, Latvia, Liechtenstein, Lithuania, New Zealand, Panama, Peru, Poland, Portugal, Qatar, Romania, Singapore, Slovak Republic, Slovenia, South Africa, South Korea and Sweden.[24]

 

[1] Holmes, Stephen, Sunstein, Cass R. The Cost of Rights: why liberty depends on taxes, Norton, New York, 1999.

[2] Knetsch v. United States”, 1960, 364, US 361; “Bugler v. Johnson”, 1969, 394 US 741; “Commissioner vs. Newman”, 159 F. 2d 848, 851 (2d Cir. 1947); “U.S. v. Phellis”, 257 U.S. 156, 168 (1921); “Weinert’s Est. v. CIR”, 294 F. 2d 750, 755 (5th Cir. 1961); “Towne vs. Eisner” 245 U.S. 418, 425 (1918).

[3] “Helvering v. Gregory, 69 F. 2d 809, 810 (2nd Cir, 1934), aff’d 293 U.S. 465 (1935). “[A] transaction, otherwise within an exception of the tax law, does not lose its immunity, because it is actuated by a desire to avoid, or, if one choose, to evade, taxation. Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; here is not even a patriotic duty to increase one’s taxes”.

[4] See http://www.oecd.org/ctp/exchange-of-tax-information/Automatic-Exchange-Financial-Account-Information-Common-Reporting-Standard.pdf

[5] See http://www.oecd.org/ctp/exchange-of-tax-information/Automatic-Exchange-Financial-Account-Information-Common-Reporting-Standard.pdf

[6] See http://www.oecd.org/ctp/exchange-of-tax-information/Automatic-Exchange-Financial-Account-Information-Common-Reporting-Standard.pdf

[7] Malherbe, Jacques, Tello, Carol P., “Le Foreign Account Tax compliance Act (FATCA) américain: un tournant juridique dans la cooperation sur l’echange d’informations fiscales”, Revue de Droit Fiscale nº 3, Janvier 2014, LexisNexis, p. 6

[8] De Blis, Michael, “FATCA Law is Striking Fear into Foreign Banks”. See http://taxconnections.com/taxblog/fatca-law-is.striking-fear-into-foreign-banks/

[9] De Blis, Michael, Op. Cit.

[10] See http://www.irs.gov/Businesses/Corporations/FATCA-Governments

[11] Malherbe, Jacques, Tello, Carol P., Op. Cit. p. 5

[12] Malherbe, Jacques, Tello, Carol P., Op. Cit., p.5

[13] See http://www.infoleg.gob.ar/infolegInternet/anexos/40000-44999/44911/texact.htm

[14] De Blis, Michael, Op. Cit.

[15] listado paises signatarios

[16] Malherbe, Jacques, Tello, Carol P., Op. Cit., p. 8

[17] Malherbe, Jacques, Tello, Carol P., Op. Cit., p. 8

[18] De Blis, Michael, Op. Cit.

[19] Hall, Kermit L., Ely Jr., James W., United States Supreme Court Decisions, Second Edition. Oxford University Press, New York, 2009, p. 136.

[20] Hall, Kermit L., Ely Jr., James W. Op. Cit., p. 173.

[21] Argentine Constitution article 99 par. 11

[22] Argentine Constitution article 75 par. 22

[23] Barberis, Julio., Formación del derecho internacional. Abaco, Buenos Aires, 1994, p. 282-288.

[24] Marini, Ronald, “10 More FATCA Agreements… Brings the Total to 62!”, May 14, 2014. See http://taxconnections.com/taxblog/10-more-fatca-agreements-brings-the-total-to-62/