FATCA and extra-territorial taxation
Generally the question of whether one is a “U.S. person” (citizen, Green Card Holder, resident, substantial presence test) is determined under U.S. law. FATCA has the effect of enforcing the taxation of “U.S. persons” who reside outside the U.S. By changing the definition of “U.S. person”, the U.S. can increase the number of “U.S. persons” residing in other countries. FATCA – by identifying “U.S. persons” – is the enforcer of extra-territorial taxation. The combined effect of “U.S. person” taxation and FATCA is that the U.S. can increase or decrease its tax base in other countries. If more people are deemed to be U.S. persons the tax base will increase. The FATCA rules make clear that the U.S. and only the U.S. will define what is a “U.S. account” (held by a “U.S. person”).
Interestingly the IRS has offices outside the U.S. (London, Frankfurt, Paris and Beijing). As FATCA becomes fully operational, one wonders whether the IRS will establish more “Local Office(s) Internationally”. FATCA is likely to make the IRS a “U.S. export”.
The U.S. is gradually expanding the number and kinds of people that it deems to be taxable “U.S. persons”. Leaving aside the question of “citizens”, it’s important to realize that U.S. “residents” (which can include people who do NOT reside in the U.S.) are taxable “U.S. persons”.
FATCA and U.S. Citizens
The ebb and flow of U.S. citizenship law is complicated. There are two aspects that are of immediate relevance to this discussion.
1. Citizenship for Immigration and Nationality Purposes:
For many years, it was possible under certain circumstances to be born in the U.S., move to another country, and automatically lose U.S. citizenship. Those sections of the U.S. Immigration and Nationality Act that mandated this loss of citizenship have been repealed. (See for example the recent post and comments at the Isaac Brock Society about the old S. 350 of the Immigration and Nationality Act). In other words, many who would have lost U.S. citizenship under S. 350 still have U.S. citizenship. In fact, I have talked to numerous Canadians who believed that they had lost their U.S. citizenship under S. 350 (which was repealed in 1978.) In addition U.S. Supreme Court decisions, beginning with Afroyim v. Rusk, have made it more difficult to lose U.S. citizenship. This has resulted in a situation where large numbers of Canadians (who have not believed they are U.S. citizens) are deemed by the U.S. to be U.S. citizens.
2. Citizenship for Tax Purposes
Since 2004, U.S. law has separated U.S. citizenship for tax purposes from U.S. citizenship for Immigration and Nationality purposes. One is now still considered to be “U.S. citizen” for tax purposes even when one ceased to be a U.S. citizen for Immigration purposes. To put it another way: You can lose all the benefits of U.S. citizenship and still be considered to be a U.S. citizen for tax purposes. (See for example S. 877A(g)(4) of the Internal Revenue Code.)
To put it simply over the last 35 years (or so):
The pool of “citizens” for “U.S. tax purposes” has been increasing because of changes in BOTH U.S. tax law and Nationality law.
FATCA and U.S. Residents
FATCA applies to those that the U.S. defines as U.S. “residents”. It’s easier for the definition of “residency” to be expanded than for the the definition of “citizenship” to be expanded. For example as one comment on the Isaac Brock Society points out, all the U.S. need do, is change the number of days required to qualify under the “substantial presence” test. Note that Green Card holders are considered to be U.S. “residents” until they affirmatively break the “residential tie” with an I-407. (Note how much of the focus of the “Streamlined compliance Rules” is on “residence”.)
To put it another way: by changing the definition of “residence”, the U.S. will be able to expand its tax base. In the case of Green Card holders and some Canadian Snowbirds, the effect of defining them as U.S. residents is to legitimately (from a U.S. perspective) claim the right to tax resident citizens of Canada. The theory is that they have a sufficiently close “connection” to the U.S. to be treated as actual residents.
For FATCA purposes “residency is defined under U.S. law
The definition of “residence” is difficult and can be counter intuitive. Here is a link to the Canada Revenue Agency site advising Canadian residents with Green Cards on the FATCA IGA:
I hold a U.S. green card. How does this affect my tax residency?
If you are a green card holder (that is, a lawful permanent resident of the U.S.), the U.S. considers you to be a U.S. resident.
However, if you are a resident of Canada for tax purposes and do not hold U.S. citizenship, you should not identify yourself as a U.S. person to your Canadian financial institution.
I suggest that this answer is incomplete. I suggest that for this statement to be true that the “Green Card” holder would need to make the appropriate treaty election to NOT be treated as a U.S. resident. (I am willing to be corrected if I am wrong on this).
My point is that to allow the U.S. to define “residence” and to define “citizenship” in a FATCA world (to define who is a “U.S. person” for tax purposes), is to allow the U.S. to determine which Canadian citizens it wants to claim as its taxpayers. This point was illustrated in a recent Rick Mercer video:
“Have you or anybody in your family ever been an American? It’s time to double check!”
Of course “double checking” means checking according to U.S. law.
Increasing and decreasing the “U.S. person” tax base – The question becomes:
Are there other connections that the U.S. might use to define residents of other nations as “U.S. residents” or “citizens” for tax purposes?
U.S. residence is an “elastic” concept. It can be defined and redefined at the stroke of a pen. To what extent does it or can it include people who consider themselves to be residents of other countries?
Interestingly Michael Kirsch in his article justifying citizenship-based taxation, did note that by using Skype (and other methods of communication) it was easy to stay in touch and stay connected to the U.S. Might the U.S. definition of residency evolve to include digital connections to the U.S.? Might the definition of U.S. residency evolve to include potential ways to stay in contact with the U.S.? Might the definition of U.S. residency expand to include the use of “U.S. products or services”?
We don’t know. Why not? Because under the FATCA rules, the U.S. and only the U.S. defines who is a “U.S. person”.
In 2012, an article appeared in the New York Times which describes how the U.S. claimed extra-territorial jurisdiction over somebody based on the use of a .net domain name. In this case the use of the “.net” name was used as a sufficient connection to the U.S. to justify extradition. (Although this was NOT a case of defining someone as a “resident for tax purposes” one can imagine how this claim of jurisdiction could be expanded).
Because the domain name was registered in the United States, it fell under the ambit of American law.
The assumption (justifying the claim of jurisdiction) must be that the use of the “.net” domain is evidence of a sufficient tie to the U.S. to justify claiming jurisdiction for the purposes of criminal law.
Could certain other digital ties be used to deem people “residents” for tax purposes?
No doubt, some will regard even the suggestion of this as absurd. The issue is NOT what is happening today. The issue is where this might logically (not reasonably) evolve.
I suggest that the following would have been considered “absurd” at the time:
1. The use of the 1970 FBAR law to wage war on Americans abroad beginning in 2011. Imagine suggesting in 1970, that FBAR would be used to confiscate the retirement savings of Americans abroad.
2. The 1986 PFIC Rules to deem all Canadian mutual funds to be instruments of tax deferral for which the gains should be confiscated in a punitive way.
3. If in 2010, if somebody had said that the real effect of FATCA would be on Americans abroad and that it would result in their renouncing citizenship, that would have been considered absurd.
These are three simple examples of the “unintended consequences” of laws that were (at least initially for a different purpose) and are now enthusiastically enforced in a manner never contemplated ON THE RESIDENTS AND CITIZENS OF OTHER COUNTRIES.
And let’s not forget that …
Although the U.S. has always “officially” had citizenship-based taxation, until 2009, the U.S. “unofficially” had residence based taxation.
In 2001 would you have imagined that the IRS would have embarked on an unexpected, unannounced retroactive tax enforcement campaign against Americans abroad (the vast majority of them who didn’t even know they were required to file U.S. taxes)?
In 2008 would you have imagined that the IRS would have “generously allowed” those who did NOT know they were U.S. citizens to “come clean” by paying only 5% of their net worth to the IRS under the Offshore Voluntary Disclosure programs?
We are speculating about the future of FATCA and where it could/may go.
At a minimum, FATCA:
A. Allows the U.S. to define who is a U.S. taxable person residing outside the U.S. (which includes but is not limited to U.S. citizens meaning it includes residents and more) ; and
B. Tax those people (and therefore their countries) because – We the United States of America have made the decision to claim them as our own. As Calgary411 points out, those with a U.S. birthplace residing in Canada are now considered to be primarily (even though they may be Canadian) U.S. citizens.
But FATCA is NOT tax legislation (You say) – It’s “ONLY” information sharing legislation (of course its sole purpose is to facilitate taxation)
It is presumed that the U.S. has the right to define its taxpayers. Once “U.S. persons” are defined under U.S. law, FATCA (via the cooperation of the Canadian banks) will identify those persons to the U.S. Without protection, they will be subject to unfair taxes and possible penalties. This is because of a U.S. tax system that forces all U.S. citizens to obey the rules applied to U.S. residents. The U.S. Internal Revenue Code provides “limited tax credits” on specific types of Canadian income and almost no recognition for the “Canadian tax exempt status” of retirement planning vehicles in Canada. As more and more people are identified by FATCA, it will become more and more clear how many Canadians owe U.S. tax. The problems are exacerbated when both Canada and the U.S. claim a person as tax resident of their respective countries.
An appropriate Canada/U.S. Tax Treaty must be used to protect Canadian residents from being taxed as U.S. Persons in ALL relevant respects
Obviously the FATCA IGA and enabling legislation should have included a provision that:
“Under no circumstances can a Canadian citizen who is a resident in Canada be considered to be a “U.S. person” for FATCA.”
Several witnesses before the House of Commons Finance Committee made this point. The Government of Canada very specifically and very unwisely rejected this.
It is essential that this issue be reconsidered.
To put it simply:
A. The U.S. cannot be allowed to claim Canadian citizens who are resident in Canada as “U.S. Persons”; and
B. If the U.S. claims the right to define residents of Canada (and other nations) as “U.S. persons” in general, then all tax treaties with the U.S. must aggressively protect Canadian citizens and residents of Canada from the effects of being part of the “FATCA Roundup”. The existing treaty is laughingly inadequate.
A comparison of FATCA and the OECD Model Tax Treaty
Accepting that FATCA is an “information exchange agreement”, it’s interesting to compare FATCA to Article 26 of the OECD Model Tax Treaty on Income and on Capital.
Article 26 is the “information sharing section”.
Article 4 is the section that both defines residence and determines what happens where both countries claim the person as a “taxpayer”.
Although both FATCA and Article 26 are about “information sharing”, the OECD includes a specific mechanism in the agreement itself to determine what happens if the person is a tax “resident” of both countries. (Of course the rest of the world uses residence-based taxation.) Under FATCA the U.S. (which uses “citizenship-based taxation”) and only the U.S. determines who is a “U.S. person” for tax purposes. This is an intolerable situation which the international community cannot permit.
October 29, 2014 – OECD Automatic Information Exchange Agreement
The governments of Western democracies have convinced themselves that their “fiscal problems” are the result of untaxed income and capital and NOT the results of their incompetent management and overspending. In addition, the world has progressed to a point where a greater percentage of total income comes from capital. As a result what is dubbed “The War On Tax Evasion” is really a search for “Capital Identification”. In any event, the days of financial (or any other kind) of privacy are over. The October 29, 2014 “Berlin Agreement” is an expression of this principle.
On October 29, 2014 approximately 50 members of the OECD agreed to a a “Common Standard For An Automatic Exchange of Financial Account Information In Tax Matters.”
This is definitely worth reading. The combination of this and FATCA guarantees that financial privacy has ceased to exist.
The U.S. did NOT sign this agreement.
I suspect that the agreement was unattractive to the U.S. for the following reasons:
1. The OECD agreement requires reciprocity with respect to the disclosure of account information. Every FATCA IGA has clarified that the U.S. is NOT required to reciprocate in the disclosure of financial information;
2. The OECD agreement assumes that the jurisdictional basis to tax is residency and not citizenship.
In February of 2014, McGill law professor Allison Christians explained the rationale for this result.
Going forward …
The issue is NOT who is right and who is wrong in this discussion. The point is that under the regime and framework established by FATCA, the U.S. has claimed the right to deem residents of other nations, to be taxable U.S. persons. This is obviously an absurd situation and completely unjustifiable in a global world. On June 27, 2012 Professor Richard Harvey, in a debate in Geneva, Switzerland defended FATCA on the basis that it was necessary to defend the tax base of the United States of America*. By taxing the residents of other nations, FATCA is a U.S. assault on the “tax base” of all sovereign nations.
In addition, to be taxable as a “U.S. person” means to be taxable according to U.S. tax laws. There are many U.S. citizens abroad who DO owe U.S. tax. This is because U.S. tax laws are not compatible with the tax laws (particularly the retirement plans) of other nations. Furthermore, (there has been much written about this) to be taxable according to U.S. laws, means that Americans abroad, will have great difficulty engaging in meaningful retirement planning, employment and business opportunities. This is clearly harmful to the citizens and residents of other nations (which the U.S. is claiming as its own) and those other nations specifically.
The “bottom line” is very clear:
1. Canada’s complicity in FATCA must be stopped.
2. Since one of the clear purposes of FATCA is to enforce U.S. taxation of residents of other nations, all attempts must be made to stop “U.S. Person taxation which includes: “place of birth taxation” and “residence based taxation defined by inappropriate criteria.”.
These issues are not restricted to Canada. They affect all nations. To date, the Alliance for the Defence of Canadian Sovereignty is the only group that is highlighting these issues in the courts. We hope that our lawsuit will assist in the identification and clarification of how FATCA has the potential to allow the U.S. to inappropriately impose “extra-territorial” taxation on the world.
For the record, this is NOT a theoretical issue. Yesterday I received a call from a man in his 80s who was just told that he has 6 weeks to transfer his investment account out of a Canadian based investment management company. Why? The reason given was two-fold:
(1) We have identified you as a “U.S. person” and (2) we are not equipped to meet the requirements of FATCA.
As the following article makes clear, this is NOT happening just in Canada!
We thank you for your continued support and confidence.
*The June 27, 2012 FATCA debate in Switzerland (predating the IGAs) which also features Jackie Bugnion is well worth watching.
Here you go: