FATCA Update: As Additional Countries Agree to Share International Tax Information, Hiding Assets Abroad becomes Increasingly Difficult

May 20, 2014   
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In recent years the United States has increasingly amplified the pressure on United States persons to disclose assets they hold and income they earn abroad, especially relating to offshore financial accounts.  Two prominent examples of these efforts are the United States’ increased focus on imposing penalties and prosecuting entities and individuals for failing to file Foreign Bank Account Reports (FBARs), and the passage and forthcoming implementation of the Foreign Account Tax Compliance Act (FATCA), Internal Revenue Code §§ 1471-1474.  Many of our previous blog entries have focused on FBAR and FATCA enforcement and compliance, such as those entries found here, here, and here.

Now, the United States’ focus on reining in offshore tax evasion has spurred other countries to cooperate and agree to share financial information on a global scale, greatly reducing the effectiveness of well-established bank secrecy laws in the process.

Recent Efforts to Compel Account Information: FATCA

Generally, FATCA imposes a regime under which Foreign Financial Institutions (FFIs), such as foreign banks, foreign mutual funds, and foreign private equity funds, as well other foreign, non-financial entities are subject to a 30 percent withholding tax on income that would not otherwise be taxable by the United States, unless they enter into agreements with the IRS to identify and provide information regarding their US account holders or, in the case of a foreign entity, their US owners.  For instance, if a Foreign Financial Institution is due to be paid an interest payment from a US obligor that would otherwise qualify as tax-exempt portfolio interest, and that FFI has not entered into an agreement under FATCA with the IRS, the US business making the interest payment is obligated to withhold 30 percent of the otherwise non-taxable interest payment.

After passing FATCA, the United States found that in some cases conflicts existed between the mandates of FATCA and the domestic law of the FFIs that were subjected to FATCA.  In particular, certain nations’ domestic bank secrecy laws prevented the disclosure of much of the information required by FATCA.  In order to overcome these conflicts, the United States has entered Inter Governmental Agreements (IGAs) specifically intended to facilitate the implementation of FATCA.  There are two models of IGAs, Model 1 and Model 2.  Model 1 requires foreign financial institutions to report information regarding US account holder to their domestic government, with the domestic government to then provide the information to the United States.  Under Model 2, the foreign financial institution provides the US account holder information directly to the United States.  Most nations have entered into a Model 1 agreement.  A complete list of countries that have entered into IGAs with the United States is here.

The United States has entered into IGAs with a number of prominent banking nations, including Switzerland and the Cayman Islands.  Additionally, the United States has just agreed to an IGA with Israel and Singapore in substance (i.e. it has been agreed to but not yet signed) at the end of April and the beginning of May respectively.  On account of the IGAs, banks in the corresponding countries will generally not be able to rely on domestic bank secrecy laws to avoid meeting their obligations under FATCA.

As described above, a key part of FATCA is the withholding obligation imposed on payors with obligations to FFIs.  If the FFI does not comply with FATCA and reach an agreement with the IRS to disclose information regarding its account holders, income that is otherwise not taxable will be taxed at a flat 30 percent and is collected by requiring payors to withhold the tax.  This regime creates an extremely strong incentive for foreign banks to comply with FATCA.  In the end, most banks will protect their own bottom line rather than the keeping secret the identity of their account holders.  As a result, US persons holding offshore accounts should expect disclosure of their identity and account information as FATCA begins to be implemented.

Withholding under FATCA was initially set to begin January 1, 2014.  That date was moved back to July 1, 2014.  While the July 1, 2014 date is still effective, the IRS recently announced that 2014 and 2015 would be viewed as transitional years, and that foreign banks and withholding agents subject to FATCA that make good faith efforts to comply with FATCA may be relieved from its withholding regime.  Absent good faith compliance efforts, however, the IRS will not provide relief.

Exchange of Information among OECD Nations: Applying the Principles of FATCA on a Global Scale

FATCA requires FFIs and other foreign entities to disclose information regarding their account holders or owners only to the United States.  However, international cooperation in the sharing of tax information on a much wider scale took a big step forward earlier this month when two of the world’s most prominent hosts of offshore bank accounts, Switzerland and Singapore (along with a number of other countries) agreed to participate in the Organization of Economic Cooperation and Development’s (OCED) Automatic Exchange of Information in Tax MattersSome have speculated that the pending implementation of FATCA accelerated the sharing of tax information across a wider international scale.

Under the OECD Agreement, taxpayers’ financial information, including bank balances, dividend income, interest income, and information regarding asset sales, will be automatically shared among the member countries on an annual basis.  In addition, financial companies will be required to identify and disclose the ultimate beneficiaries of shell corporations, foreign trusts, and other foreign entities that can potentially be used to disguise beneficial recipients of taxable income.  With this information, signatories to the OECD Agreement will be able to largely determine their citizens’ offshore income without reliance on the citizens fulfilling their reporting obligations.

Particularly relevant is the inclusion of Switzerland and Singapore in the agreement.  Switzerland has long been a destination for those seeking to hide assets abroad, primarily due to the country’s strict bank secrecy laws.  Singapore has recently grown in prominence as a host of offshore bank accounts.  Switzerland’s and Singapore’s decision to agree to the automatic sharing of financial information is a clear indication that the United States’ efforts to combat offshore tax evasion are working.

The United States has made tremendous efforts to compel Swiss banks in particular to identify their US account holders notwithstanding Swiss bank secrecy laws.  For example, in the second half of 2013 the United States Department of Justice partnered with the Swiss Federal Department of Finance and established a program allowing Swiss banks not currently under criminal investigation by the Department of Justice to come forward and disclose potential past violations, pay penalties, close accounts of recalcitrant account holders, and establish programs to comply with FATCA going forward in exchange for an agreement by the Department of Justice to not prosecute the bank. We have previously written about these cooperative efforts between the United States and Switzerland here.

In addition, the United States has been investigating 14 prominent Swiss banks, including UBS and Credit Suisse, for potential criminal violations.  Through these criminal investigations, the United States has prosecuted banks, taxpayers, and individual bankers that evaded tax or aided or abetted US taxpayers in the evasion of income tax through undisclosed Swiss accounts.  Switzerland’s decision to sign onto the OECD Agreement represents a major shift in Switzerland’s historical approach to bank secrecy and appears to be, at least in part, a consequence of the United States’ efforts to compel information from Swiss banks.

The Fallout for US Taxpayers

The signatories to the OECD Agreement did not set a specific deadline to begin automatic sharing of information, but reports indicate that sharing will begin in 2017 and will involve tax information collected through 2015.  While the United States has entered into IGAs with a number of the countries that are parties to the OECD Agreement, there are a number of countries included in the OECD Agreement that do not yet have executed IGAs with the United States.  Therefore, to the extent local law still prohibits compliance with aspects of FATCA, the OECD Agreement should have the effect of breaking down those impediments and permitting the US to acquire information it would not otherwise be able to acquire relying on FATCA and IGAs alone.

More fundamentally, the wide range of countries that signed on to the OECD Agreement marks a significant indication that hiding assets in foreign jurisdictions for the purpose of avoiding tax on the income produced by those assets is becoming increasingly difficult.  Moreover, there is no indication that the United States’ interest in rooting out offshore tax evasion will wane anytime soon.  Taxpayers with offshore assets related to tax non-compliance need to seriously contemplate disclosing their assets and past non-compliance under the 2012 Offshore Voluntary Disclosure Program (OVDP).  As described in previous blog entries, the OVDP permits taxpayers with offshore assets and a history of non-compliance to come clean with the IRS for generally reduced penalties and a commitment from the IRS to not recommend criminal prosecution.  It is important to keep in mind that entry into the OVDP is generally unavailable to taxpayers whose identity and history of non-compliance has already been made known to the IRS or other federal authorities.

The attorneys at Fuerst, Ittleman, David & Joseph have extensive experience working with taxpayers who have undisclosed foreign bank accounts and who have availed themselves of the IRSs voluntary disclosure program. We will continue to monitor the development of these issues, and we will update this blog with relevant information as often as possible. You can reach an attorney by calling us at 305-350-5690 or emailing us at  contact@fidjlaw.com.