TaxProf Blog

Editor: Paul L. Caron
Pepperdine University School of Law

Friday, April 7, 2017

Weekly SSRN Tax Article Review And Roundup

This week, Ari Glogower (Ohio State) reviews a new article by Shu-Yi Oei (Tulane), The Offshore Tax Enforcement Dragnet

Glogower (2016)In the late 1980’s, the tuna-eating public grew concerned with the ensnarement of dolphins in tuna nets.   Fisheries responding by changing harvest methods to avoid dolphin bycatch, and affixing “dolphin-safe tuna” labels to tuna cans.  The reassured public returned to their tuna sandwiches with clear consciences, evidently untroubled by the incongruity of canning and consuming one majestic ocean-dweller, while safeguarding another.  One wonders if an alternate society, with different preferences, would feel just as strongly about the ethics of eating tuna-safe dolphins.

Similarly, the U.S. government flings its net over the seas, and drags tax avoiders out of the murky depths of foreign financial institutions.  Shu-Yi Oei’s new work argues that FATCA and other initiatives designed to prevent offshore tax evasion by wealthy tax-avoiders have ensnared unintended bycatch, including recent immigrants to the U.S. who still hold assets in their home country, Americans expats living (and saving) abroad, and “accidental Americans” unaware of their U.S. citizenship.

Oei argues that the unnecessarily severe impact of FATCA (and, to an extent, of related programs such as the FBAR, the DOJ Swiss Bank Program and the Offshore Voluntary Disclosure Program) is not due to design glitches, but to fundamentally problematic policy goals.  First, these rules impose harsh reporting obligations and penalties on taxpayers holding assets offshore, without sufficiently accounting for the different circumstances among those subject to these rules (“intra-offshore distinctions”).  Second, the rules focus on revenue collection and enforcement, without due consideration for compliance costs and other taxpayer burdens.

For example, FATCA requires foreign financial institutions to report account information of U.S. persons, or face 30% gross withholding from U.S. payors.  Individual Taxpayers must file Form 8938, the Statement of Specified Foreign Financial Assets, in addition to the FBAR, and face heightened penalties for reporting failures or underpayments attributed to undisclosed assets. 

These rules, Oei argues, impose burdensome compliance and financial costs on expats, immigrants, and accidental Americans, in addition to the target population of high net worth (“HNW”) tax cheats.  Many persons caught in the FATCA net may have legitimate reasons for holding assets abroad, or may be “minor offenders” who were merely negligent in failing to report.   These individuals may have less access to compliance assistance and legal advice, and may face excessive collateral consequences.   For instance, green card holders who fail to comply may jeopardize their naturalization prospects.

Undoubtedly, the experiences and grievances of individuals caught up in the offshore tax enforcement dragnet will vary.  It is critical, however, to distinguish between objections to the enforcement of U.S. tax law and objections to the substance of U.S. tax law (including the worldwide taxation of income earned by citizens and residents).  One wonders if resistance to FATCA from some corners is motivated by the latter as much as the former.  The policy justifications for taxing citizens and residents on their worldwide income can be questioned and debated (for example, see Ruth Mason’s (UVA) recent work on citizenship taxation), but these considerations should not influence the propriety of FATCA, and the separate question of how the U.S. should enforce its tax laws. 

The question then becomes, what measures are necessary to enforce the U.S. tax law overseas, and what additional deterrence may be justified to counteract the simple fact that it’s easier to hide assets beyond our borders.  As Oei notes, the compliance costs for taxpayers are non-trivial, particularly for smaller fish, so to speak, and any revenue gains must be weighed against these costs.   Just this week, an op-ed in the Wall Street Journal by a vocal FATCA objector decried the fee bonanza enjoyed by FATCA compliance firms.  As both Oei and the op-ed author note, however, the actual costs to taxpayers of FATCA compliance are uncertain, and more empirical data is needed in order to effectively weigh overall costs and benefits.  Furthermore, is reasonable to assume that compliance costs will decline over time, through competition among service providers and the development of more efficient compliance systems.   

The article concludes with a series of reforms that would mitigate the burden on FATCA’s collateral victims.  First, penalties for non-reporting and non-payment could be more closely tailored to a taxpayer’s circumstance and motives.  A same-country exemption could relieve the burden on Americans living abroad and holding accounts where they reside.  Compliance burdens could be reduced by consolidating the FBAR and Form 8938, and by requiring reporting of income streams instead of gross assets.

While these reforms would undoubtedly mitigate the burden on good actors and minor offenders, the system would also benefit from a more effective net, that identifies and deters wealthy tax cheats while minimizing overall costs. As Oei implies earlier in the work, one possibility is to impose even harsher penalties for major offenders. The government could also incentive innovation among third-party compliance services, to increase competition and efficiency, and drive down fees paid by taxpayers.  

Finally, one could argue that the broader goal of FATCA is to encourage compliance among all U.S. taxpayers overseas, and the relevant distinction among taxpayers is not their relative wealth or income, but their history of tax compliance. In other words, maybe dolphins and tunas are not so different, as long as they pay their taxes. From this perspective, one possible avenue for reform would be reducing the compliance burden for taxpayers with a proven history of accurate tax reporting and payment. 

The article arrives at an auspicious time, as the OECD and other countries develop new global systems for cross-border information exchange, such as the Common Reporting Standard. The lessons from the first half-decade of FATCA, and the insights of Oei’s work, will inform the next steps in the evolving global effort to combat tax evasion.  

Here’s the rest of this week’s SSRN Tax Roundup:

http://taxprof.typepad.com/taxprof_blog/2017/04/weekly-ssrn-tax-article-review-and-roundup.html

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