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Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Saturday, April 30, 2011

FATCA and the Shift From Tax Enforcement to Tax Compliance

Melissa Dizdarevic (J.D. 2012, Fordham) has posted The FATCA Provisions of the Hire Act: Boldly Going Where No Withholding Has Gone Before, 79 Fordham L. Rev. ___ (2011), on SSRN. Here is the abstract:

In an effort to crack down on offshore tax evasion, the U.S. is implementing a new set of information reporting and withholding requirements on foreign banks and other foreign entities. These provisions, known as the FATCA provisions of the HIRE Act, require thirty percent withholding of the entity’s U.S.-source income, unless they disclose specific information regarding their customers’ identities and account balances. While this may be an effective way to force foreign institutions into compliance, it also raises questions about how it will function within existing tax reporting systems, where the function of withholding serves a materially different purpose.

The FATCA reporting and withholding provisions depart from the norm of using withholding as a tax enforcement mechanism, and instead use it as a coercive compliance measure. This Comment looks to current domestic and international withholding systems as a point of comparison for this new regime. By examining the objectives and operation of these existing systems as compared those of FATCA, it becomes clear that withholding income serves a drastically different purpose. Existing systems utilize withholding as a means of ensuring that taxes will be paid, while FATCA implements it as a way to force foreign banks to comply with a set of reporting requirements. Considering this is the first time withholding appears to be used in this way, it is prudent to ask whether this is a desirable use of withholding in our current international taxation system. This Comment posits that, without significant revision to account for conflicts arising with pre-existing obligations, converting the accepted concept of withholding into a drastically different punitive measure is both undesirable and unacceptable.

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The arrogance of the US Congress in enacting FATCA is simply breathtaking. Imagine if the UK government imposed 30% withholding on Citibank unless it could PROVE that every depositor was NOT a UK resident.

One reaction to FATCA is that foreign capital is trying to avoid the US. Not a great idea in the middle of a recession.

Posted by: Ed D | Apr 30, 2011 5:38:38 AM

Transparency, that's the ticket. Depending on who the King wants to make transparent.

Posted by: Sandy P | Apr 30, 2011 8:01:33 AM

Well, that's really important to economy boosting.

Posted by: wfs | Apr 30, 2011 7:55:54 PM

This regulation will give rise to a new sort of foreign financial institution that is free of US investments, and hasten the shift away from the US dollar as a reference currency, which will have an even more dire impact on all the US bonds and credit instruments held by foreign governments. What a brilliant way to stop the recovery and make the recession deeper.

The US need to add value to the world economy in order to come out of the mess they're in. This regulation will make it practically impossible for Americans abroad to do business -- they won't be able to open bank accounts, and will be treated even more like pariahs than they are today. Yet such expatriates are essential to getting US goods and services sold abroad.

What *were* Congress thinking? If this is an example of Democratic leadership, I hope the Republicans win the next elections.

Posted by: Charles B. | May 2, 2011 12:01:59 AM

So the idea is to increase tax revenue by this draconian piece of legislation?

Let me tell you about the real results. In nearly all countries US citizens and US tax residents are being kicked out of banks and financial institutions, they are asked to terminate their accounts. To make matters worse domestic US financial institutions do not let US citizens abroad keep or open accounts.

US citizens and US tax residents have become an international finical pariah, like the Flying Dutchman.

As a Swede living in the US I was kicked out from my Swedish brokerage account. I cannot open accounts in Sweden even if I still am a Swedish national. I'm after 2013 unable to continue my occupation.

We also know what happens when draconian tax laws and compliance regulations are enforced. Sweden 1970-80. Tax avoidance rose dramatically as well as tax evasion on a massive scale. The tax code and the IRS in Sweden became seen as immoral and illegitimate and evasion and avoidance stopped being seen as ethical and morally deplorable, it became seen as morally just self defense. As a result of the draconian tax code and brutal tax enforcement 1970-80 Swedes have per capita the most wealth offshore havens and the worlds most sophisticated tax planning even among regular income earners. Tax avoidance and tax evasion is a national sport and is the main topic for dinner conversations.

The US should be careful what it wishes for!

Posted by: Old Whig | May 2, 2011 8:49:53 AM

The fact is that compliance with foreign bank account reporting was probably around 10% at best before 2008 (before the government started pursuing UBS and now HSBC and Credit Suisse). And the reason was non-enforcement. It is demonstrably false that enforcement of foreign bank account reporting regulations led to an increase in offshore tax evasion. In fact, it was just the opposite.

US banks abroad will definitely take US customers. They just won't take US customers who refuse to sign a W-9 form.

With all that, I agree that FATCA seems to be an extreme step and could have negative consequences for the US economy. Then again, other up and coming countries such as India are equally eager to combat tax evasion. The wave of the future is more interchange of foreign national tax data.

Posted by: JonF | May 3, 2011 3:31:16 AM