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FATCA and America’s Foreign Tax Problem

October 31, 2014

The Foreign Account Tax Compliance Act (FATCA)is currently causing a huge amount of problems for those Americans who live abroad. In many caess, “Live abroad” is better defined as: America considers you American because one of your parents was American and the IRS is damned well going to get its money.

Listing all the problems with FATCA would take a fair amount of page count, but the Economist, which is the epitome of dry British understatement, describes it as a piece of legislation that include “extraterritoriality stunning even by Washington’s standards.” FATCA isn’t going after rich Americans who enjoy living in New York while they keep their assets in tax free havens— those individuals have a myriad of ways to avoid paying taxes, many of them legal, thanks to years of determined lobbying. No, it’s largely going after middle-class individuals who do not live in the US have no interaction with the US and in some cases did not even know they were American Citizens! This isn’t just antagonizing the populations of tax havens like the Cayman Islands, but is angering many Canadians, voting citizens of one of America’s close allies and a nation that never comes up in the same sentence as “tax haven.”

But the problem of the FATCA isn’t bound up with the legislation itself— as bad and overarching as it is, FATCA is merely a symptom. It is bound up in the very concept of citizen-based taxation, as opposed to resident based taxation.

To put it simply, the overwhelming majority of nations (everyone except America and Eritrea) do not tax non-resident citizens. Beyond the somewhat snarky comment that if every other civilized nation (and for that matter, the uncivilized nations)feels that taxing non-resident citizens is a bad idea, maybe you’re doing it wrong, this shows that America is basing it’s taxation scheme on old and fairly completely discredited concepts of extraterritorial jurisdiction.

Will the tax deal be altered?  Maybe not, but like Lando, foreign banks may not have much of a choice if the US does alter the deal.

Extraterritoriality is a fairly rare practice today, mostly related to diplomats, foreign deployed military units and, oh yes, every American citizen on the planet, at least when it comes to taxes. The problem with this is two-fold.

Firstly, why should an American pay taxes when he or she is a long-term resident of another nation? What about when he or she didn’t even know they were an American citizen, which has happened more than a few times and is now finding proud citizens of Canada being informed that they owe Uncle Sam a great deal of money. A resident of another nation who enjoys dual-citizenship is not making use of American resources. He or she is not bound by other forms of American law— commit assault in Britain and you’ll be talking to the British court system, not the American.

Most nations extend this principle to taxation— if you’re living in New York, even if you are a British citizen, the British government assumes that you should be paying your taxes to the United States, not Great Britain, unless of course some of your income is derived from interests in Great Britain. This is different, mind you from the argument that you shouldn’t pay taxes because you’ve never used the state’s services. If you live in a modern state, you are using their services, ranging from enjoying the fact that inspectors make certain your food isn’t laced with arsenic, to the availability of emergency services, whether or not you need them. But if you are not living in that nation, say, you are a Canadian citizen who also is an American citizen, then you are not using those services. You’re using —and paying for— Canadian services. Again, this American style of extraterritorial taxation system is nearly unique on the planet.

The second problem is quite simple: This makes it toxic to work with expatriate Americans, their families, their businesses, or for that matter anything they might touch, especially if you’re a financial institution. FATCA makes use of frankly bullying tactics, including a 30 percent withholding tax on “non-compliant” institutions. In this case, determining compliance is A. Very difficult and B. Essentially opens up vast amount of information to a nation that has had, shall we say, a mixed record when it comes to keeping information confidential. In the worst case, a bank might find themselves penalized by the United States at the same time they’re being sued by their customers because somebody’s financial information ended up on the Internet. Not only that, but what happens after FATCA? A nation that has already claimed the nearly unique right to demand your complete cooperation in how they deal with individuals living in your own nation (not America) may later decide to add other requirements.

What has happened is that these banks are starting to make a simple choice— if having a customer who has dual citizenship could expose you to potentially business-ending consequences… jettison the customer. Suddenly, these individuals are being left without any access to the banking institutions in countries where they have lived for decades, if not their entire life.

As an exercise for the class, imagine what would happen if say, news stories popped up about this behavior on the part of say, China. Congress would collectively go berserk. We might consider that when deciding if this is a good idea.

Dump the Citizenship-Based Tax

There are some solutions to this, but the best solution is also the simplest— go to a residence based tax. The fact that virtually every other nation on the planet, including those with much higher tax rates than America, have residence-based taxation and don’t seem the worse for it is a very good argument for dumping our current system. After all, what does FATCA get us, other than angry allies, increased enforcement costs and victimized expatriates who are getting taxed twice?

Well, sad to say, not much because FATCA is quite likely to cost nearly as much or even more than the tax revenue it obtains for the US.

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