Reciprocity under a Model 1 Intergovernmental Agreement on FATCA
As is well known by now, the United States enacted a tax reform in 2010 known as the Foreign Account Tax Compliance Act, which seeks to end global tax evasion by Americans through the use of offshore bank accounts.1
Because by its terms the FATCA provisions do violence to other country’s laws (for example by requiring financial institutions to release personal and financial data to third parties in contravention of confidentiality laws), the US Treasury decided it would need to enter into intergovernmental agreements to overcome foreign legal obstacles to enforcement. Thus the FATCA “intergovernmental agreement,” or IGA was born.
In fact, two models of IGA sprang forth. The first, Model 1, enables foreign governments to act as intermediaries on behalf of their financial institutions, by having the institutions report to their own governments, followed by government-level automatic information exchange with the United States.
The second, Model 2, is a more simple agreement in which the non-US government agrees to require its financial institutions to deal directly with the US IRS notwithstanding any domestic regulatory regime that would otherwise prevent transmission of personal financial data to third parties. Most countries that have initialed or signed IGAs have opted for the Model 1 approach, and it appears that this is the model that the Cayman Islands has recently decided to pursue.2
But the Model 1 Agreement itself comes in two flavours: non-reciprocal and reciprocal, so the Model 1 choice is an opportunity for additional decision-making. The non-reciprocal model is just that: in such an agreement, the US undertakes to do little more than refrain from immediately imposing FATCA penalties in the case of noncompliance.
The primary purpose of a Model 1-based agreement is therefore to bypass domestic confidentiality laws by interposing foreign governments as information conduits between foreign institutions and the IRS, and perhaps to make some administrative concessions with respect to the reach of FATCA.
In contrast, under the Reciprocal Model 1, the US undertakes a few more obligations. The term “reciprocal” nevertheless belongs in quotes, because if there is one characteristic that defines the Reciprocal Model 1 IGA, it is that agreements drafted on this model will most certainly not be reciprocal for some time, if ever.
Instead, the IGA is almost comically ill-named, by its own admission: in Article 6, it states that:
The United States acknowledges the need to achieve equivalent levels of reciprocal automatic information exchange with [FATCA Partner]. The United States is committed to further improve transparency and enhance the exchange relationship with [FATCA Partner] by pursuing the adoption of regulations and advocating and supporting relevant legislation to achieve such equivalent levels of reciprocal automatic exchange.
Anyone who pays attention to tax reform (or indeed any legal reform) in the United States will not feel very optimistic for the cause of reciprocity upon reading this language. People living in jurisdictions looking to become FATCA partners might therefore wonder: when my government signs an IGA, what will it give and what will it get in return?
A careful reading of the text of any negotiated IGA will be necessary to answer that question with certainty. Yet the Model IGAs exist for a reason: they are meant to create uniformity, thus employing a series of bilateral agreements to in effect achieve a multilateral information exchange regime.
This is confirmed by the inclusion of a “most favoured nation” clause—something rare in double tax agreements, since it prevents differential treatment across nations, the sine qua non of such agreements. The pertinent language is found in Article 7 of the Model IGA, and it reads virtually identically in the IGAs signed to date:
Consistency in the Application of FATCA to Partner Jurisdictions
[FATCA Partner] shall be granted the benefit of any more favorable terms under Article 4 or Annex I of this Agreement relating to the application of FATCA to [FATCA Partner] Financial Institutions afforded to another Partner Jurisdiction ….
The United States shall notify [FATCA Partner] of any such more favorable terms and shall apply such more favorable terms automatically under this Agreement as if they were specified in this Agreement and effective as of the date of the entry into force of the agreement incorporating the more favorable terms.
As a result, the Model language is a good place to begin an inquiry into what the respective parties will do under a finalised arrangement. The following table outlines the various tasks that each party will undertake either directly or on behalf of its institutions, to demonstrate the ways in which the Model IGA is and is not reciprocal in its terms.
It demonstrates in simplified terms what countries get and what they give, under a Model 1 “Reciprocal” Agreement. Of course, in the name of simplifying for the sake of clarity, many technical details have been left out and it will obviously be critical to look at the text of actual agreements in order to assess what is specifically undertaken by the signatory countries. The goal here is not to provide an encyclopedic resource but rather a general overview, to illustrate what the quid pro quo looks like in a Reciprocal IGA. Thus, according to the text of the Table 1 Model 1 Agreement governments can expect to give and what they can expect to get in return.
This table highlights what can reasonably be expected from the United States pursuant to the terms of an agreement modeled after the Reciprocal Model 1 IGA, at least under current US law. At present, the best a foreign country can hope for in terms of equivalent information from the US is its addition to a list of countries with which the US will exchange portfolio interest-related information on an automatic basis.7
There is only one country currently on that list—Canada—and that country was already in a reciprocal information sharing relationship with the United States with respect to such payments.8 As the table above shows, there remain important gaps in what the US is undertaking to provide by way of cooperative mutual behaviour.
While Article 7 provides some hope that more checkmarks will appear in the “USA” column in the above table, the case for pessimism appears high because the United States is the source of mixed messages with respect to the role and virtue of tax havens and inconsistency in the approach to information exchange. The mixed message emanates from some prominent US lawmakers, who suggest that the United States ought to behave more like a tax haven even while sometimes simultaneously arguing against Americans’ use of offshore tax shelters.
For example, recently Congressman Devin Nunes said that the US should abandon corporate income tax in order to “make the US the largest tax haven in human history.”9 Congressman Nunes may not be well known internationally, but he is the co-chair of one of 11 tax reform working groups convened by Ways & Means Committee members Sandy Levin and Dave Camp, which are collectively tasked with preparing a report on the best way forward for the US tax system.10
Nunes’ comments echo sentiments by his more well-known fellow Ways & Means Committee member and 2012 vice-presidential candidate Paul Ryan, who in 2010 said:
We need to have a tax system that makes America a haven for capital formation. Let’s make this country a tax shelter for other countries instead of having other countries be a tax shelter for America. This would ultimately raise revenues and promote economic growth. 11
Rep. Ryan at the same time expressed his belief that “there must be a decrease in the amount of tax shelters for people to park their income overseas.” If there is a coherent message here, it is that the United States should try to gain a competitive advantage by becoming a tax haven while preventing foreign countries from doing the same. That suggests that despite the language in Article 7, America’s FATCA partners should probably not count on receiving “equivalent levels of reciprocal automatic information exchange” any time soon.
Statements by other American legislators suggest additional reason for pessimism. Legislators have long opposed changing rules that would have US financial institutions report on portfolio interest payments made to foreign account holders—which are just one aspect of information that will be exchanged under the IGAs. These payments are not taxed in the United States and, other than in the case of Canada, have not traditionally been reported to the IRS.12
As a result, there is virtually no way for the home governments of such account holders to ensure that their taxpayers report and pay tax where it is due.
This is the essential problem FATCA seeks to solve. Yet, in opposition to a proposed expansion of the reporting rules in 2003, Senator Gordon Smith expressed his failure to understand “why we put the enforcement of other nations’ tax laws as a priority at Treasury,” and urged the Treasury not to “drive the savings of foreigners out of bank accounts in the United States and into bank accounts in other nations.”13
Private sector advocates similarly argue that interest reporting would “hinder tax competition between nations” and “help oppressive governments track down flight capital.”14
These long-held sentiments have been repeated in response to the Treasury’s decision to revise the interest reporting rules to make it possible to reciprocate under IGAs with respect to interest payments. Thus Florida’s Congress members wrote a letter to the President to oppose the revision on the grounds that reporting interest earned by foreign account holders to their home countries would cause serious harm to the US economy by chasing hundreds of billions of dollars out of US financial institutions, and would moreover violate the intent of Congress in exempting such payments from interest and reporting for over 90 years.15 Florida Senator Marco Rubio joined in these dire warnings, stating that:
- Forcing banks to report interest paid to nonresident aliens would encourage the flight of capital overseas to jurisdictions without onerous reporting requirements, place unnecessary burdens on the American economy, put our financial system at a fundamental competitive disadvantage, and would restrict access to capital when our economy can least afford it.16
- The head of the American Bankers Association warned against expanding the information reporting rules and later condemned the Treasury for ostensibly agreeing to automatic exchange with Mexico “in secret” and without notice or consultation with relevant stakeholders.17
The message is clear that while preventing Americans from sheltering their taxes abroad might be a worthy goal for the state, it is not so clear that a preferred strategy would include eliminating those services at home in order to attract foreigners. This is further evidenced by the initial tepid contribution and later outright rejection by the United States of an OECD initiative that addressed tax evasion through the use of offshore bank accounts.18
This may be because the US has much at stake in the global competition for foreign capital. Indeed, a report from Global Financial Integrity in 2010 found that “the three jurisdictions holding the largest amount of non-resident deposits are the United States, the United Kingdom, and the Cayman Islands,” with the US leading with over $2 trillion in private, non-resident deposits.19
Moreover, the United States ranks No. 1 on the Financial Secrecy Index, which “identifies the jurisdictions that are most aggressive in providing secrecy in international finance and which most actively shun co-operation with other jurisdictions.”20
This puts the United States in “the role of Switzerland” for other countries,21 and particularly has allowed the state of Delaware to become “the best place to hide wealth”:22
One of the smallest states in the US, it offers the best protection for anyone who does not want to disclose their identity as a beneficial owner of a company. That is one very good reason why the East Coast state hosts 50 per cent of the US’s quoted firms and 650,000 companies – almost equivalent to one company per Delaware resident.
…Delaware – the political power-base of the US vice-president, Joe Biden – offers high levels of banking secrecy and does not make details of trusts, company accounts and beneficial ownership a matter of public record. Delaware also allows companies to re-domicile within its borders with minimal disclosure, and allows the existence of privacy-enhancing “protected cell” or “segregated portfolio” companies, among many other stratagems useful for protecting the identity of those who do business there.
FATCA arose directly in response to publicity surrounding well known foreign institutions, most especially in Switzerland, that helped US customers hide income and assets from the IRS.23 The publicity continues, reinforcing the need for the protection of the US tax base against erosion through criminal activity.24
Thus FATCA is cast by its proponents in a defensive role against criminal behaviour. But in the absence of reciprocity from US institutions, the reverse proposition remains possible and the United States perversely positions itself to gain from the very behaviour it seeks to eliminate in other jurisdictions.
This brief look at what countries give and what they get under an IGA with the US signals the vital role of reciprocity in making sure countries use international agreements to gain mutual advantage through cooperation rather than a unilateral edge through coercion and competition.
- FATCA came into force as part of the Hiring Incentives to Restore Employment Act (HIRE Act), which was signed into law by President Obama on March 18, 2010. Public Law 111–147: Hiring Incentives to Restore Employment Act, (18 March 2010), 124 STAT. 71 Title V, Subtitle A, online: <http://www.gpo.gov/fdsys/pkg/PLAW-111publ147/pdf/PLAW-111publ147.pdf>.
- If CFR has prior coverage, can cite here.
- In the US, this includes physical residence in the US or citizenship or possession of a US green-card regardless of physical residence, and relevant indicia include place of birth, mailing address, telephone numbers, standing transfer orders, powers of attorney, and signatory authority. For virtually all other countries, residence refers to physical residence.
- Beginning in 2017. The TIN refers to that of the residence-country, and this applies only to new accounts; for existing accounts, or in cases where the FATCA partner jurisdiction does not issue TINs, institutions will collect and exchange date of birth; for the US, this is qualified as “where available.”
- Although contemplated by the IGA, this assumes that Treasury will authorize exchange with respect to information it has recently begun to require from US FIs under revisions to the IRC § 6049 regulations; see Treas. Reg. § 1.6049-4(b)(5).
- Beginning in 2015; 2016 for gross sales proceeds.
- Treas. Reg. §§ 1.6049-4(b)(5), 1.6049-8. According to the Treasury, the IRS will exchange information only to “foreign governments with which the United States has an agreement providing for the exchange and when certain additional requirements are satisfied. Even when such an agreement exists, the IRS is not compelled to exchange information… if there is concern regarding the use of the information or other factors exist that would make exchange inappropriate.”
- Reg 1.6049-8. This is the case even though the US-Mexico IGA is currently in force and the US has begun requiring reporting from US financial institutions with respect to Mexican account holders.
- Ramesh Ponnuru, How to Make America a Global Tax Haven, at <http://www.bloomberg.com/news/2013-03-25/how-to-make-america-a-global-tax-haven.html>.
- Levin and Camp Announce Ways and Means Tax Reform Working Groups, Feb. 13, 2013, at http://levin.house.gov/press-release/levin-and-camp-announce-ways-and-means-tax-reform-working-groups
- Geoffrey Gabor, “Inside The Budget Battle With Congressman Paul Ryan”, TJE American Business Magazine, online: <http://www.americanbusinessmag.com/2011/08/inside-the-budget-battle-with-congressman-paul-ryan/>.
- The rule is found in IRC § 6049(b), defining interest, and Reg. 1.6049-4, 1.6049-8.
- Letter from Sen. Gordon Smith to Treasury Secretary John Snow, reprinted in BLOOMBERG’S DAILY TAX REPORT, (20 February 2003) (concerning proposed non-resident alien interest reporting rules (REG-133254-02)).
- Katherine M. Stimmel “Free Market Interest Groups Urge Treasury to Withdraw Alien Interest Reporting Rules” (27 January 2004) Bloomberg BNA, 16 S G-2.
- Letter from Florida Congresspersons to the President, March 2, 2011, at http://posey.house.gov/uploadedfiles/irs-delegationletter-march3-2011.pdf
- Letter from Marco Rubio to the President, April 4, 2011, http://www.floridabankersassociation.com/docs/links/IRS_NRA_Rubio.pdf
- Letter from Frank Keating to Timothy Geithner et al, Dec 12, 2012, a http://www.aba.com/Solutions/Acct/Documents/ABANRALetter%28USMexicoIGA%29121212.pdf
- See, e.g., Robert Kudrle, The OECD’s Harmful Tax Competition Initiative and the Tax Havens: From Bombshell to Damp Squib, 8 GLOBAL ECON. J. (2008) (describing shifts in OECD approach and US reaction to the harmful tax practices project as it evolved).
- Ann Hollingshead, Privately Held, Non-Resident Deposits in Secrecy Jurisdictions, at http://www.gfintegrity.org/storage/gfip/documents/reports/gfi_privatelyheld_web.pdf
- Id at 10.
- Kevin Stier, Foreign Tax Cheats Find U.S. Banks a Safe Haven, Oct. 29, 2009, at http://www.time.com/time/business/article/0,8599,1933288,00.html.
- Nick Mathiason, Delaware – a black hole in the heart of America, The Guardian, Nov. 1, 2009, at http://www.guardian.co.uk/business/2009/nov/01/delaware-leading-tax-haven.
- See William McGurn, “Obama’s IRS Snoops Abroad” (16 July 2012) The Wall Street Journal, online: <http://online.wsj.com/article/SB10001424052702303933704577531280097324446.html> (“David Axelrod invoked the holy grail behind the FATCA led, global IRS expansion. ‘We lose $100 billion a year to offshore tax shelters,’ Mr. Axelrod told CNN”.). For background information on base erosion via offshore holdings, see David Voreacos, “Offshore Tax Scorecard: UBS, Credit Suisse, HSBC, Julius Baer” (12 October 2011), Bloomberg News, online: <http://www.businessweek.com/news/2011-10-12/offshore-tax-scorecard-ubs-credit-suisse-hsbc-julius-baer.html>; Kim Dixon, “Nearly 15,000 Americans Admit Offshore Tax Cheating” (17 November 2009), Reuters, online: <http://www.reuters.com/article/idUSTRE5AG3IU20091117>; Martin Sullivan, U.S. Citizens Hide Hundreds of Billions in the Caymans, TAX NOTES, May 24, 2004, p. 96; John DiCicco, Acting Attorney Gen., U.S. Dep’t of Justice Tax Div., Dep’t of Justice Asks Court to Serve Summons for Offshore Records (15 April 2009), online: <http://www.justice.gov/ opa/pr/2009/April/09-tax-349.html> (“Some United States taxpayers are evading billions of dollars per year in United States taxes through the use of offshore accounts”).
- See, e.g., Department of Justice: Office of Public Affairs, “South Florida Woman Pleads Guilty to Failing to Disclose Income from Swiss Bank Accounts and Agrees to $21 Million Penalty (8 January 2013) online: <http://www.justice.gov/opa/pr/2013/January/13-tax-030.html> (“‘The Justice Department continues to pursue those who hide income and assets from the IRS through the use of nominee businesses and offshore bank accounts,’ said Assistant Attorney General Keneally. ‘U.S. taxpayers who fail to come forward in the voluntary disclosure program risk prosecution and substantial fines, as this case demonstrates.’”).