The last few years have seen the introduction of two major agreements in the international financial services sector, FATCA and CRS. In addition to adding a significant new layer to the compliance costs and complexity for financial institutions worldwide, it could be argued that these regulations are indicative of a certain hypocrisy from not only the US but also other jurisdictions. Their common aim is to reduce tax evasion by forcing financial institutions to automatically transmit information to the fiscal authorities of the country where their client is domiciled. However, as we shall see, the devil is in the detail and their practical impact may be very different.
FATCA (Foreign Account Tax Compliance Act) was implemented by the United States in 2010 and requires all non-US financial institutions to report to the US Treasury assets they hold of US persons. The definition of “US persons” is very wide and can include people who were born in the US totally by chance and the vagaries of child birth. It also extends to green card holders who do not hold US citizenship and are no longer domiciled in the US. A prominent example of this is Boris Johnson, the ex Lord Mayor of London and current Foreign Secretary of the UK. He happened to be born in New York because his parents were working there but left the US when he was five years old. However when he sold his London house recently he was forced to pay taxes to the IRS and subsequently renounced the US citizenship he had acquired by chance. If financial institutions refuse to comply they can be punished by a withholding tax of 30% on any US transactions. As a result most non-US institutions prefer not to deal with US persons and many US persons have renounced their citizenship or green card.
But it’s difficult to criticise FATCA if it prevents true US persons from not paying legitimate tax on their income and wealth. The US Treasury is quite correctly defending its own interests. However the promised reciprocity relating to assets held in the US by non-US persons and the reporting thereof to the country of domicile of the said persons has not taken place. In other words if a Mexican opens an account in the US for $20m, the US institution will perform due diligence to make sure that the money does not originate from illegal activities but will not automatically report the account to the Mexican authorities (if a specific request is made by the Mexican authorities the institution would probably disclose the information). In other words, in practice the United States is behaving in a very similar way to Switzerland and similar countries in the past where tax evasion was not considered a crime justifying disclosure to the client’s country of domicile. This is no longer the case in Switzerland, or should I say almost not the case as we shall see.
However the OECD found the perfect solution to this dichotomy in 2014 with the implementation of the CRS (Common Reporting Standard) which was based on FATCA and shared the objective of preventing tax evasion.
Indeed the rules of the CRS are even stricter than FATCA as it extends to a wider range of institutions such as trusts and foundations and, in addition, has no minimum threshold for new individual accounts and a relatively low one ($250.000) for existing accounts. It is also de facto a reciprocal agreement and not just a promise of reciprocity as is the case with FATCA. The field is changing constantly but I believe that I am right in saying that about 142 countries have signed the agreement including, surprisingly, states such as China and Russia. The United States has not signed, on the basis of arguments including the pretense that their implementation of FATCA makes such a signature redundant. This is self-evidently untrue. There are other arguments such as the fact that the US Treasury or IRS would need the backing of Congress to implement such a rule but this didn’t prevent the implementation of the supposedly reciprocal FACTA. However the US is not alone in not signing the CRS. Liberia, Lesotho, the Maldives, Burkina Faso, Papua New Guinea and several other countries have not yet signed as far as I know. But does the US really want to find itself in such company?
The signatories to the CRS have begun implementing the agreement or will do so this year. As a perverse consequence of the fact that the US has not signed, the US is in the process of becoming the last major jurisdiction where a non-US person can hide his assets from the tax authorities of his country of domicile. In other words, the US is becoming the Switzerland of the 21st century, an irony that will not be lost on the Swiss banks who had to pay huge fines to the US regulators (the difference being that such banks were actively marketing tax evasion whereas the US authorities have no interest in drawing attention to the contradictions of their newly acquired status). According to most people I speak to in the wealth management industry, this status has not however gone unnoticed by wealthy individuals who are transferring their funds from other countries to the US in droves. The playing field has indeed undergone the proverbial paradigm shift. The Swiss, for example (and this phenomenon is by no means limited to this country although it is certainly the pioneer and most prominent example), who have been running downhill for almost a century are now faced with the radically different prospect of climbing uphill. Or are they?
The result of the US not being a signatory to the CRS is that financial institutions in countries that have signed the agreement will have to treat any US entities as Non-Financial Foreign Entities. In other words they will have to determine who really controls a company or trust domiciled in such jurisdictions as Delaware or Nevada. As well a being an administrative nightmare for all parties concerned, this would prevent non-US persons from hiding their wealth by setting up structures in the US. This can be avoided in two ways. Firstly the non-US person can transfer his assets to the US so that they are no longer affected by the CRS. Secondly, and more deviously, certain countries are trying to claim that the US is actually a signatory to the CRS. This contradicts reality in the same way as claiming that the earth is flat. However the real reason is far from being ill-informed or naïve because it would enable such countries to avoid the necessity of identifying the true beneficiary owner of US based structures, thus enabling them to continue “hiding” their client assets from the relevant tax authorities. I believe that Switzerland and Luxembourg have resorted to this claim and that Panama and other jurisdictions have tried to but eventually backed down. As the situation is constantly evolving, I’m not sure what the current status is regarding this contentious issue and welcome any comments or updates. If this is still the case it would give a clear and unfair advantage to such countries.
In conclusion, the CRS seems to be an extremely worthy cause but without the adherence of the United States it will be far less effective and, in part at least, merely serve to transfer the problem elsewhere. And if countries continue their attempts to exclude US entities held by non-US persons from the reporting requirement of the CRS this problem will only be compounded. People outside the US can claim with a certain justification that they are David fighting Goliath. However in this example Goliath will probably win.