Tax evasion

Dropping the bomb

America’s fierce campaign against tax cheats is doing more
harm than good

Jun 29th 2014

GENEVA AND NEW YORK

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AT A recent conference for offshore wealth managers in Geneva, Basil Zirinis of Sullivan &
Cromwell, a law firm, began his presentation with a discussion of events in Iraq, where Islamist
fighters were advancing on Baghdad. Barack Obama, he claimed, was drawing a red line around
the city and, if necessary, would “drop FATCA on them”. Worse, they would get no deadline
extension. The nuclear option, he added, was to treat them as if they were Swiss.

The analogy was tasteless, but also telling. FATCA stands for Foreign Account Tax Compliance
Act, an American law passed in 2010 to crack down on the use of offshore banks, particularly in
Zurich and Geneva, to hide taxable assets. The law, part of which takes effect on July 1st, is the
most important and controversial development in decades in the international fight against tax
evasion. It is feared and loathed by moneymen because of its complexity, its global reach and the
high cost of compliance. One senior banker denounces it as “breathtakingly extraterritorial”.

Transparency campaigners love it because it threatens to blow apart the old way of exchanging
tax information between countries “on request”, which they view as unwieldy and soft on cheats.
FATCA, they hope, will usher in “automatic” exchange of data, leaving the tax-shy with
nowhere to hide.

In essence, FATCA turns foreign banks and other financial institutions into enforcement arms of
America’s Internal Revenue Service (IRS). They must choose between turning over information
on clients who are “US persons” or handing 30% of all payments they receive from America to
Uncle Sam. The threat appears to be working. More than 77,000 financial firms have signed up.
About 80 countries have struck agreements with America to allow their banks to hand over data.

The financial industry is struggling to work out which funds, trusts and other non-bank entities
count as “financial institutions” under the law. There is also confusion over who is a “US
person”. The definition is broad and includes not only citizens but current and former green-card
holders and non-Americans with various personal and economic ties to the United States. Some
Canadian “snowbirds” who travel to America for part of each year could be caught in the net,
says Allison Christians, a tax professor at McGill University. As the complexities of
implementation have grown apparent, the American authorities have had to extend several
deadlines. Banks, for instance, will get a two-year moratorium on enforcement as long as they
are striving to comply.

FATCA has already sent a chill through the 7m Americans who live abroad. Thousands have
been told by their local banks and investment advisers that they no longer want their custom
because it is too much hassle. Many others will now have to spend thousands of dollars to
straighten out their paperwork with the IRS, even if they owe no tax (and most do not, since they
will have paid a greater amount abroad, which counts as a credit against tax owed in America).

A record 2,999 of these exasperated expats renounced their citizenship or green cards in 2013.
More than 1,000 did so in the first quarter of 2014. (Before FATCA the number was a few
hundred a year.) Others have remained American and fought back against unfriendly banks.
Using anti-discrimination laws, a Dutch-American sued a Dutch lender that had pre-emptively
shut his account and 149 others; he won the case in April. To its credit, the IRS acknowledges
the problem and is trying to soften the blow. It recently introduced a streamlined compliance
programme for expats who inadvertently failed to fill out the right forms, for example—although
this still requires refiling three years of returns.

FATCA also places a burden on the IRS, by generating an unwieldy amount of information. The
agency is being given far more to do with far fewer people (thanks to budget cuts), leaving it “on
the verge of collapse”, according to a former senior official.

It is not clear that the law will ensnare its quarry. Seasoned tax dodgers are not so naive as to
hold money in their own names. FATCA will penetrate some of the shell companies and other
structures they hide behind, but Senate investigators and other experts say loopholes remain.
Related to that is the question of whether FATCA will pay for itself. Counting only the expense
for American financial firms, the answer is maybe, if it brings in at least the $800m a year
estimated by Congress. (The law was passed without any formal cost-benefit analysis.) However,
the overall costs of complying, borne mostly by non-American banks, are likely to far exceed the
extra tax receipts.

FATCA is about “putting private-sector assets on a bonfire so that government can collect the
ashes,” complains Richard Hay of Stikeman Elliott, a law firm. Mark Matthews, a former deputy
commissioner of the IRS now with Caplin & Drysdale, another law firm, argues that the effort
put into hunting offshore tax evaders is disproportionate: the sums they rob from the public purse
“look like a pinprick” compared with other types of tax dodging, such as the under-declaration of
income by small businesses.

Another question is whether FATCA might be subsumed into a scheme being promoted by the
OECD, a club of mostly rich countries, whereby signatories would share data on financial
accounts annually. It has won backing from around 50 countries, including big European nations,
India, China and Brazil (and from big banks, which assume compliance costs will be lower under
a single global standard). It differs from FATCA in an important respect: information-sharing
will be based on residence, not citizenship.

As more countries are pushed to share tax information systematically, the focus will turn to
America’s willingness (or lack of it) to reciprocate. Latin Americans, for instance, are big users
of banks in Florida, but America remains choosy about which governments it will share data
with, and how much. It also has only limited information to give on the owners of shell
companies because it does not collect their names itself. In some respects, America is less
upright than the tax havens it deplores.

This article appeared in the Finance & economics section of the print edition under the headline
"Dropping the bomb"

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