January 17, 2011 - Phil Hodgen

Foreign banks, FATCA, and unintended consequences

Our Federal government gave the world a little gift in 2010.  It is a law designed to enforce U.S. tax payment by its citizens.  It threatens to make Americans into financial pariahs outside the United States.

There is a Business Week article about this, showing the early pushing and shoving from foreign banks who, to put it bluntly, do not like this new law.  [Thanks, D. E., for the email about this article.]

The new law

The new law is called FATCA.  From the article:

The Foreign Account Tax Compliance Act, known as FATCA, was incorporated into jobs legislation enacted in March [of 2010]. The law requires overseas financial companies for the first time to identify their American customers to the Internal Revenue Service and withhold 30 percent of U.S. interest and dividend payments from account holders who provide inadequate information to determine their U.S. status.

The Obama administration pushed for the measure in the wake of the political firestorm arising from the case again UBS AG, which in 2009 settled U.S. government claims that they helped thousands of rich Americans hide their money offshore.

[Aside:  when will Congress stop behaving like college sophomores with these silly acronyms for the laws they pass?]

Current tax enforcement policy doesn’t work

The Treasury Department, Department of Justice, and Internal Revenue Service have been awe-inspiring in the way they have pursued “tax evaders” in the past couple of years.  [Tax evasion is somewhat equivalent to pornography, in that the IRS knows one when they see one, and in the case of the ongoing Offshore Voluntary Disclosure Program, grandmothers and ordinary Americans living abroad are tax evaders and quasi-felons.  But I digress. . . .]

The mindset in Washington DC has been to require more paperwork to be filed, with even higher penalties if the paperwork is late, incomplete, or missing.  Those of us on the outside aren’t privy to the statistics for success.  But we can see what the IRS cannot see and never will see.  A reasonable consensus among tax practitioners would be that the international tax enforcement efforts show a very mixed bag of results.

Let me translate this for you.  The penalties are so high that they are counterproductive.  Far from encouraging people to come forward and clean up their tax messes, the staggeringly high penalties are causing people to seriously consider not filing the paperwork required and risk the penalties.

It’s the Inquisition all over again, but this time without the assurance that if the taxpayer comes to Jesus all sins will be forgiven.  So to speak.

I missed the high-jump bar this time, so let’s raise the bar and try again

Keep doing what you’re doing and you’ll keep getting what you’re getting.

The IRS perspective seems to be “If it isn’t working well, then we should do MORE of it.  Then it will work better.”  Higher penalties.  More forms to fill out.  Higher penalties if you screw things up.

It’s like the high jumper.  He sets the bar, takes a run, and jumps.  Not high enough.  The bar falls to the ground.  The intrepid high jumper thereafter raises the bar by 5 cm and tries again.

That’s the government thinking in a nutshell.

Foreign banks leading innocent Americans into a life of vice

Now our Congress has a new plan.  If bludgeoning taxpayers into submission doesn’t work — and clearly it hasn’t worked, because this new law I’m about to describe is proof of prior strategic failures at the government, let’s try a different tactic.

The problem isn’t evil American taxpayers.  (Well it is, actually.  According to the IRS, if you’re living abroad you must be a felon and a tax cheat.  If you’re a U.S. company doing business abroad you must be a money launderer and must be skimming profits and hiding them.  There is no other explanation! If you’re guilty, why were you arrested, etc.?)

The problem is evil foreign banks.  Foreign bankers are, metaphorically speaking, waiting on the dock, and huskily saying “Hello, sailor!” to Americans abroad.  Those bankers are enticing, encouraging, and forcing Americans to cheat on their U.S. taxes.

We’ll punish those foreign banks!

Here’s the solution as cooked up by Congress.  What do we have that foreign banks want?  Answer:  the New York Stock Exchange.

So here’s the deal, foreign banks.  You can invest your own money in the U.S. capital markets.  You can do investment management for your clients and put their money into the U.S. capital markets.  But when you want to take your money home, the IRS is going to take 30% off the top.

Oh.  You don’t want to give away 30% of your money to the U.S. government?  Simple.  Tell us the names of your American customers.

Possible consequences of the new law

The new law has a number of possible outcomes.  I think all of these outcomes will be seen in the real world in the next few years:

  • Create systems to identify their U.S. citizen customers and report all of this information to the U.S. government.  Then they can make investments in the U.S. capital markets without any withholding tax.  This is what the IRS evidently predicts.  Problem:  MASSIVE overhead.  Other privacy issues according to their home country laws.  But bankers care mostly about overhead.  More overhead = less profit.
  • Kick all of their U.S. customers out of the bank.  Have only foreign customers.  Then they can invest in the U.S. stock markets with impunity.  Problem:  U.S. citizens and businesses become pariahs and are unable to conduct normal financial activity abroad.  This is an acceptable result to the IRS as well–U.S. citizens cannot hide money from the U.S. government.
  • Tell the U.S. government “No.” Problem:  they can’t invest in the U.S. stock markets anymore because they lose 30% of the money they take out of market and send home.  That makes their customers unhappy.  But the foreign bank can continue to service U.S. citizen customers.  Problem:  this makes the New York Stock Exchange unhappy and the foreign bourses extremely happy.  I think over the long haul this will be seen quite a lot.  Contrary to the view in Washington DC, it’s a big world out there, and there are a lot of investment opportunities outside the United States.  Foreign banks who choose this strategy are essentially declaring the U.S. capital markets irrelevant.

Action advisory

If you are a U.S. citizen with money outside the United States, your “Come to Jesus” deadline is January 1, 2013.  Plan on the possibility of being kicked out of your bank sometime between then and now.  If your account is undisclosed at the moment, take that factor into account.  Don’t be blindsided as many of our clients were — standing on the street in Zurich with a massive bank check in their hands, wondering what to do next.