Two very important international tax battles are taking place in Washington, largely behind closed doors. The lack of attention is surprising since the outcome of these fights will have an enormous impact on the future of tax competition, fiscal sovereignty, and financial privacy.
The first fight revolves around the Protocol amending the Convention on Mutual Administrative Assistance in Tax Matters. By way of background, the Convention is a multilateral agreement from the Organization for Economic Cooperation and Development that commits states to engage in sharing of information about the cross-border investments of each other’s citizens. This is so governments can enforce national tax laws designed to impose counterproductive tax burdens of tax on dividends, interest, capital gains, and other forms of capital and business income.
The United States is a participant in the original Convention, which was limited to nations that belong to either the OECD or the Council of Europe. And the United States is a signatory to the Protocol to the Convention, which obliges nations to share even more information, including sensitive personal information such as birthplace (which is, to most countries, irrelevant for tax purposes) on an automatic basis, with any and all participating governments, including Russia, China, and many nations from the developing world. But signing the Protocol is largely irrelevant if the United States Senate fails to give its advice and consent to ratification.
That has not happened, in part because Senators Rand Paul of Kentucky and Mike Lee of Utah have placed a “hold” on the treaty. This does not necessarily kill the Protocol, but it does mean that it cannot be brought before the Senate for a quick vote. To break the hold and approve the pact, the Senate would have to devote several days to the issue, and that is very unlikely since other legislation has higher priority, particularly since there is no organized lobbying campaign for the Protocol.
However, there is a wrinkle in this story. The two senators also have a hold on seven bilateral tax treaties. These agreements are generally benign, with a primary goal of protecting multinational corporations from double taxation, compared with the Protocol, which is designed to enable punitive taxation of individual capital income. And since bilateral tax treaties are supported by the business community, there is some pressure to overcome the hold on these tax treaties, which raises the possibility that other senators may decide to break the hold on the OECD Protocol at the same time.
For what it is worth, Senators Paul and Lee have a legitimate gripe about the seven bilateral treaties. These pacts have provisions designed to facilitate heavy taxation of individual capital income by sharing information about cross-border investments. And since that information is supposed to be collected and shared without any due process legal protections, Paul and Lee would like them to be modified. At the risk of understatement, that is an uphill battle.
As of now, there is a stalemate. The two senators are confident about the merits of their position and have shown no willingness to capitulate. But the other side is increasing the pressure. Paul and Lee have been attacked by President Barack Obama, who says their concerns about privacy and due process are “quirky.” And some GOP senators are getting anxious to approve at least some of the bilateral tax treaties. At some point, this becomes an irresistible-force-vs-immovable-object battle.
Regardless of what happens to the OECD Protocol, there is another fight that is similarly important for the future of tax competition, fiscal sovereignty, and financial privacy. As of now, the United States is the world’s largest tax haven, despite the pressure on the United States to cooperate with other countries in eliminating tax competition regardless of the consequences for the American economy. There are two reasons for America’s status as a tax haven. First, many states have very attractive incorporation laws. Setting up companies is very simple and in many cases there is no need to share information that could be collected or shared with foreign tax authorities.
Second, the national government has very attractive tax laws for nonresident aliens, i.e., foreigners who do not reside in the United States. With a few exceptions, these people are untaxed on the interest and capital gains they earn on their American investments. And since there is generally no reporting to the IRS on these payments, there is no information to share with foreign governments. Only with the express assistance of the IRS can foreign governments step in to collect a residual tax on U.S. investments. It is not clear why enabling foreign countries to tax U.S.-based investment returns is beneficial to U.S. economic interests. In years past, all proposals introduced to gather more information on foreign investors for purposes of sharing with other countries have been soundly defeated in Congress.
And these policies are extremely beneficial to the United States. Foreigners have invested more than $30 trillion in the United States according to Commerce Department data, and more than $16 trillion of that amount is portfolio investment, much of which presumably is protected from tax by foreign governments.
This leaves the U.S. very vulnerable to the charge of hypocrisy. American politicians enacted the Foreign Account Tax Compliance Act (FATCA), which coerces foreigners into sharing information with the United States, yet there is no reciprocity in the legislation. When other countries objected to what they rightly viewed as FATCA’s extraordinarily extra-territorial reach over their financial institutions, Treasury took it upon itself to enter into international agreements to smooth things over. In so doing, Treasury made promises that it would seek the necessary rule changes in the U.S. to enable the IRS to impose FATCA on U.S financial institutions as a quid pro quo. Treasury now argues that lending assistance to other countries is necessary to fulfill those unauthorized promises.
Ironically, the OECD has decreed that the U.S. should not be considered a tax haven merely because Treasury has entered into all of those unauthorized agreements. They did so solely to create the appearance of progress and a level playing field, “deeming” the U.S. to be in compliance with the bureaucracy’s self-anointed standard for global information gathering and exchange. This is nonsense, as several targeted “tax havens” have pointed out to the Paris-based bureaucracy.
The Obama Administration now seeks to change American policy so that the IRS can automatically collect and share information with foreign governments. If you peruse the Treasury Department’s General Explanations of the Administration’s Fiscal Year 2017 Revenue Proposals, starting on page 202, you will see that the White House wants to massively expand data reporting on the income and assets of nonresident aliens: “Provide for reciprocal reporting of information in connection with the implementation of the Foreign Account Tax Compliance Act.”
Here’s the main part of the proposal: The proposal would require certain financial institutions to report the account balance (including, in the case of a cash value insurance contract or annuity contract, the cash value or surrender value) for all financial accounts maintained at a U.S. office and held by foreign persons. The proposal also would expand the current reporting required with respect to U.S. source income paid to accounts held by foreign persons to include similar non-U.S. source payments. Finally, the Secretary would be granted authority to issue regulations to require financial institutions to report the gross proceeds from the sale or redemption of property held in, or with respect to, a financial account, information with respect to financial accounts held by certain passive entities with substantial foreign owners, and such other information that the Secretary or his delegate determines is necessary to carry out the purposes of the proposal.
The good news, from the perspective of U.S. financial institution and nonresident aliens, is that Congress so far has shown very little interest in adopting such a change. As far as most politicians on Capitol Hill are concerned, the U.S. gets what it wants from overseas, so what is the incentive to adopt the White House’s proposal. Especially since groups such as the Center for Freedom and Prosperity have spent years raising awareness about the risks to the American economy of undermining America’s tax haven status just to please a bunch of international bureaucrats at the OECD.
The bad news is that congressional opposition may not be enough to permanently kill the scheme. It may just be a matter of time before the White House tries to unilaterally change the law by issuing regulations that would require this massive data reporting. To some degree, that sounds unlikely. After all, how could the administration justify trying to change existing law via regulatory edict? Such an effort unambiguously would seem like an abuse of executive power, particularly since the White House has asked over and over again for Congress to change the law to allow for the collection and sharing of information on the U.S.-source investments and income of nonresident aliens.
Yet that is exactly what the White House already did in pushing through a regulation forcing American banks to report bank account interest paid to nonresident aliens. That regulation is being challenged, but the courts so far have ruled that the administration has the power to force American banks to help enforce foreign tax law even though the clear legislative intent of American tax law was the opposite.
To conclude, here’s how the two issues of the OECD Protocol and FATCA reciprocity are connected. If the White House ever convinces the Senate to give its advice and consent to the ratification of the Protocol to the OECD’s Convention, the Treasury Department would probably cite that treaty as a justification for a set of regulations that would force American financial institutions to report all the U.S. income and assets of nonresident aliens.
If that happened, America’s status as a tax haven would be seriously undermined and the OECD would finally be accurate in claiming that a level playing field existed.