Some commentators have suggested Canada’s recently signed Intergovernmental Agreement (“IGA”) with the US violates Canada’s Charter of Rights. If they are right and the IGA is implemented, it may be overturned by Canadian courts. The IGA is an agreement that modifies the US’s Foreign Account Tax Compliance Act (“FATCA”).
FATCA and the IGA
FATCA is primarily a reporting system that requires financial institutions outside the US to identify their clients who are US persons (including US citizens, residents and green-card holders) and report their investments and income to the US Internal Revenue Service.
Persons who do not identify themselves as US or not US persons, signed under penalty of perjury, will be subject to a 30% US withholding tax on US source investment income and gross proceeds from the sales of US securities. The withheld tax may not be creditable in the taxpayer’s home country and can only be refunded by filing a US tax return.
Canada’s IGA eliminates FATCA’s 30% withholding tax requirement and excludes reporting entirely for a variety of registered plans in Canada. The excluded plans include Registered Retirement Savings Plans, Registered Retirement Income Funds, Registered Educational Savings Plans, Tax-Free Savings Accounts and more.
What if IGA Violates Charter of Rights?
If the IGA violates Canada’s Charter of Rights and cannot be implemented or is overturned then Canadians will be subject to FATCA without the benefits of the IGA. Instead of being subject to the reporting system under the IGA, Canadians including individuals, businesses and other entities resident in Canada would be subject to the 30% withholding unless they assert their status as US persons or not US persons. The reporting will include the accounts otherwise excluded under the IGA.
Where Canadian financial institutions are prevented from collecting information on whether their client is or is not a US person, then monies arising from US transactions paid to Canadians would be subject to the 30% US withholding tax. This would be a devastating result for Canadian financial institutions and their customers who exchange hundreds of millions of dollars daily with US individuals, businesses and other entities. These entities would have to wait a year or more to claim the tax refunds owed to them.
FATCA is not about the US and Canada. It is about the US and the entire world. The US now has IGAs with 31 countries to date. Those countries include most Western democracies, Chile, Japan, Mexico and a handful of tax havens including Bermuda and the Cayman Islands. Another 40 countries are actively negotiating agreements. The negotiations with Russia were recently suspended by the US.
These countries are signing IGAs for two principal reasons. Firstly, even though they might not agree with FATCA, an IGA creates an opportunity to modify its terms and limit the adverse implications that may go along with it. Secondly, they want information on their own taxpayers that have accounts outside their home countries and are using such accounts to evade tax.
FATCA’s Objective and Solutions for Canadians
FATCA is a means for the IRS to identify US persons who have accounts outside the US that they do not pay tax on or disclose as required under US tax law. Compliance with these requirements by US persons resident in the US is not strong, but of 7 million Americans resident outside the US only an estimated 1 million file annual US tax returns.
For US persons resident in Canada, the IRS’ Streamlined Filing Program for delinquent filers allows qualifying taxpayers to get their tax filings current without being subject to interest and penalties. Most of these individuals will not have any US tax liability. If you wait for the IRS to find you instead of complying voluntarily, the alternatives available to you may be less attractive.
As offended as some Canadians and others may be about FATCA, the IGA and the US tax on its citizens and green-card holders resident outside the US, it is hard to believe that the US has any intention of revoking FATCA. Doing so could be perceived to give license to those who are already evading taxes.
It is not apparent that there is any significant political will in the US to change FATCA. The US is very focused on both attacking tax evasion by US persons in the US and outside the US. FATCA has a complementary benefit of encouraging US persons resident outside the US into compliance with their US tax filing requirements. Neither tax evaders nor non-compliant US persons abroad represent an attractive political demographic. In fact, many voters in the US appear to equate these two groups.
Clearly dumping the IGA would hurt Canadians even more than complying because they would be exposed to the full force of the tax withholding under FATCA. For US persons resident in Canada, FATCA is another reason that you should comply with your US filing obligations or at least put yourself in a position so that those obligations no longer exist.
Written by Warren Dueck, FCA, CPA