On May 13, 2014, I was called to testify before the House of Commons Standing Committee on Finance regarding Canada's legislation that implements the Intergovernmental Agreement ("IGA") between the US and Canada concerning the Foreign Account Tax Compliance Act ("FATCA"). You may view the hearing by clicking here and my prepared remarks follow this article. I have come under considerable criticism for my support of the Department of Finance's decision to enter into the IGA. In short, I have said, and continue to believe, that the execution of the IGA is unquestionably a "good deal" for Canada. I would like to use this short article, however, to expand on this statement and offer that the analysis in reaching the answer is more interesting than the answer itself.
While the legislation currently before Parliament requires refinement, I do not address the changes we have highlighted in other submissions (you may find detailed discussion of these changes by clicking here).
FATCA generally
Before addressing whether the IGA is a good deal, a very brief background is helpful. FATCA is many things: it is extra-territorial, ham-fisted, unilateral, complex, and most importantly, validly enacted US law. Personally and professionally, I wish FATCA didn't exist in its current form, however as my dad (with the eloquence of a 35-year Navy veteran) used to say: "wish in one hand and spit on the other and see which one fills up faster." My old man was right: wishing things were different doesn't make them so.
FATCA's stated purpose is to catch Americans who use international capital markets to cheat on their taxes. Few would argue the validity of this goal. However, the manner in which FATCA sets out to achieve this goal is ambitious to say the least. FATCA basically turns non-US financial institutions into a conduit for the collection and disclosure of information on US depositors. It would be difficult to imagine the domestic law of any jurisdiction having more lofty ambitions.
Why would a non-US financial institution agree to collect information on US citizen customers? Well, because if they don't, any payments coming from US financial institutions would be subject to a 30% withholding tax. While banks, brokerages, life insurance companies, and other financial institutions frequently post healthy profits and profit margins, a 30% tax on US source earnings would, frankly, put them out of business. Hence, most non-US financial institutions must comply with FATCA or fold.
Enter the IGAs
Not-so-shortly after FATCA became law (18 months later, in fact) the US realized that non-US financial institutions may have a difficult time complying with its mandates. Pesky domestic banking, privacy and constitutional laws might have placed these institutions in the unenviable position of either: a) complying with FATCA and being in violation of domestic law; or b) complying with domestic law and being in violation of FATCA. Thus, the US Treasury offered cooperating countries a deal: if you enter into an agreement with the US, then that agreement (the IGA) will trump the really nasty bits of FATCA.
Is the IGA a "good deal?"
Are the IGAs a good deal for the countries that enter them? The answer is "yes," but the analysis of the question is much more interesting (and illustrative) than the answer.
Consider two examples:
First, when a mugger demands "your money or your life," I'm glad to exchange $35 and a Tim Hortons' coupon for the chance to wake up in the morning. Shame on the mugger for forcing this decision on me, but a rational person would conclude that the mugger has offered me a good deal.
Second, when a bank demands "complete this new account form or I won't open your new account" I'm glad to complete the new account form in order to open the account. The bank has offered me a good deal.
While the mugger and the bank have both offered me a good deal, the reasons the deals are good are considerably different. In the first instance, the mugger has no right to demand my money and certainly has no right to take my life. And while it is offensive to justice and equity to conflate the two, the fact of the matter is that my life is certainly worth more (at least to me) than the contents of my wallet. Those who paid attention in high school English class will recognize this decision as a dilemma or extortion, in that it is a choice between two bad alternatives.
In contrast to the mugger, the bank has offered me a different type of deal: either comply with its demand for information or receive nothing. The bank has the legal right (and obligation under Canadian banking law) to request this information. If I choose not to comply, I will not be able to open an account. The bank has offered me a good deal if I wish to open an account. Again, those who paid attention in English class will recognize this decision as a Hobson's choice, which is a choice between something or nothing.
Is the IGA more akin to the mugger's deal or the bank's deal?
I would submit that the IGA more closely resembles the bank's deal. First, the US has the sovereign right to regulate its capital markets and, therefore, has the ability (heavy-handed though it is) to impose the 30% tax on non-compliant financial institutions. Second, the US also has the sovereign right to tax its citizens as it deems appropriate (even if it stands nearly alone in citizenship-based taxation). Third, the information the financial institutions must collect under the IGA is already available to the US per various information exchange agreements found in both the OECD and US model tax treaties.
Some will argue that these examples are overly simplistic, and I would concede that they are, but they illustrate the point. Those who aced their high school English class might accuse me of posing these examples as a false dichotomy or false dilemma (which assumes that there are only two choices when there are others available). To those critics, I would note that the model IGAs were, for the most part, not negotiable. The IGA partners were able to insert pre-determined exemptions and exceptions, but the salient provisions were presented as a contract of adhesion; and in that sense, there truly were only two choices: take it or leave it.
Conclusion
Those who study this area of the law will conclude that the Department of Finance did the right thing when it executed the IGA with the US. If it had not, then Canadian financial institutions would have been subject to the harsh and thorny provisions of FATCA. Instead, these entities are now subject to the much more sane provisions of the IGA and Canadian domestic legislation. The IGAs represent a good deal for the countries that enter into them and, more importantly, the US has the right the collect the information on its citizens, and also the right to impose a sanction for non-compliance. The IGAs are not a "your money or your life" choice. The legislation requires refinement and I am confident that Parliament will work out the issues we have identified in our various submissions.
Appendix: Prepared remarks
May 13, 2014
Mr. James Rajotte, M.P.
Chair, Standing Committee on Finance
Sixth Floor, 131 Queen Street
House of Commons
Ottawa, ON K1A 0A6
Re: Speaking Notes for Roy Berg
Heard before the Standing Committee on Finance May 15,
2014
Bill C-31 the Economic Action Plan 2014 Act, No. 1
Good afternoon Mr. Chairman and members of the Committee,
My name is Roy Berg, I am a U.S. tax lawyer with Moodys Gartner Tax Law in Calgary, Alberta. I was born, raised, educated, and practiced tax law in the U.S. for 17 years before immigrating to Canada 3 years ago. As such there are few who are more personally and professionally vested in this issue than I am.
On March 9, 2014 our office submitted extensive analysis and commentary to Finance regarding our concerns about the draft legislation, and on April 10, 2014 we submitted a brief on these concerns to the Committee. I would be happy to elaborate on any of the materials we have submitted as they are rather detailed.
Before I summarize our comments I would like to emphasize that we agree with the Minister of Finance that entering into the IGA with the U.S. was beneficial to Canada. Had it not entered into the IGA, Canadian financial institutions would have faced the unenviable dilemma of either complying with Canadian law and risking FATCA's 30% withholding tax; or complying with FATCA and risk violating Canadian law. Unfortunately, as FATCA and the IGAs are designed, there is no middle ground.
Those are simply the facts, and as U.S. Senator Patrick Moynihan said: "Everyone is entitled to his own opinion, but not to his own facts."
The Committee is likely aware of jingoistic rhetoric admonishing Finance for ceding Canada's sovereignty or encouraging Parliament to "stand up" to FATCA. If the Committee hears testimony of this type we encourage it to remember that FATCA is U.S. law and it is enforced by the markets and not the IRS. In short there is nothing to stand up to.
While the IGA is unquestioningly beneficial to Canadians the legislation before you requires refinement. Specifically the manner in which the term "financial institution" is defined under the legislation is more narrow than the Treasury regulations, the IGA, and the OECD's common reporting standard.
The Department of Finance disagrees that the definition of financial institution found in the legislation is more narrow than found in the IGA. In our brief we provide the legal analysis to support our position.
The Department of Finance does not disagree, however, that the definition of financial institution found in the legislation is more narrow than the Treasury regulations and the guidance notes and domestic legislation of every other jurisdiction that has executed an IGA, especially that of the U.K. The Department of Finance's position appears to be that every other country is simply taking a broader approach than is required by the IGA.
Admittedly, all Model 1 IGAs require domestic legislation to be brought into effect. However several Treasury officials have stated publically that such domestic legislation should be consistent with the Treasury regulations and the bill before you deviates substantially from them.
If the definition of financial institution is not amended in the legislation, the result may be that the U.S. may conclude that the IGA has not been brought into force and thus subject all Canadian financial institutions to the full weight and force of FATCA.
The financial industry also appears to concur with the Department of Finance position on the definition of financial institution. We respectfully submit that the financial industry stake in the administration of private Canadian trusts is limited and their stakeholders will not be affected by the limited definition of financial institution.
If the legislation is not amended and the IGA is brought into force, the result will be unnecessary withholding on Canadian private trusts that have U.S. affairs.
Consider the following example:
Assume Husband dies and leaves his assets to his widow in a spousal trust. Further assume neither the Husband, widow, beneficiaries, or trustee of the trust is a U.S. person. The only connection with the U.S. is an investment in an interest bearing account in the U.S. Before the U.S. bank will make a distribution to the trust, it will require the trust to disclose its entity classification on the U.S. form W-8BEN-E. The trust will indicate that it is a non-financial foreign enterprise under Canadian domestic law. The U.S. bank however, will know that the trust should be classified as a financial institution under the Treasury regulations. Because there is a conflict in classifications the U.S. bank will withhold 30%.
Thus, if left unchanged, the legislation will draw in Canadian trusts to FATCA withholding when they would not otherwise be subject.
Moodys Gartner Tax Law LLP
Roy Berg JD, LLM (US TAX)1
Managing Director
Footnotes
1. Admitted to practice in California and Washington and a Student-at-Law in Canada
Moodys Gartner Tax Law is only about tax. It is not an add-on service, it is our singular focus. Our Canadian and US lawyers and Chartered Accountants work together to develop effective tax strategies that get results, for individuals and corporate clients with interests in Canada, the US or both. Our strengths lie in Canadian and US cross-border tax advisory services, estateplanning, and tax litigation/dispute resolution. We identify areas of risk and opportunity, and create plans that yield the right balance of protection, optimization and compliance for each of our clients' special circumstances.
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