Canadian Tax Haiku of the Week:
US tax no joke
FATCA and FBARS; whats that?
Snow Birds may need to file too!
On August 11, 2014, Gwendolyn Deegan and Virginia Hillis (the Plaintiffs) filed an appeal with the Federal Court of Canada challenging the constitutionality of the Canadian government’s efforts to allow Canadian banks to comply with the US Foreign Account Tax Compliance Act (FATCA). The Plaintiffs claim that federal government assistance in the enforcement FATCA is unconstitutional. On October 9, 2014, the Plaintiffs filed an amended statement of claim to include the Minister of National Revenue as a defendant.
Background on FATCA and IGA
Under FATCA, financial institutions enter into an agreement with the United States (US) Internal Revenue Service (IRS) to disclose the names of all “US Persons” who hold accounts with USD$50,000 or more. Failure to comply with FATCA results in a tax of 30% on gross US source income. The Canada Revenue Agency (CRA) subsequently entered into an agreement with the IRS (referred to as an Intergovernmental Agreement, IGA) that results in the CRA acting as an intermediary between Canadian financial institutions and the US. However, things took an interesting turn with the appeal to the Federal Court.
One of the issues the Plaintiffs brought before the Federal Court is the broad definition of “US Persons”. For tax purposes, the term US Persons includes all citizens of the US (regardless of where they live, whether they have every applied for a passport or otherwise involved themselves with the US), all permanent residents of the US, (regardless of whether they continue to live in the US) and anyone who passes their “Substantial Presence” test. The Substantial Presence test, in a nutshell, says if you spend more than 121 days per year in the US for three years in a row, you are likely a US Person. How many Canadian snowbirds fail that test? Probably a lot more than currently realize that they are US Persons and need to file…
Despite never having worked or lived in the US (or even holding a US passport), the Plaintiffs are subject to the US FATCA and Foreign Bank Account (FBAR) reporting requirements because they were born in the US, and thus considered to be US citizens, and therefore US Persons, whether they like it or not. The statement of claim asserts that the IGA unreasonably infringes their constitutional rights under sections 7, 8, and 15 the Canadian Charter of Rights and Freedoms. Herein lies the rub, they are complaining that the Canadian government violated their rights by allowing the US to enforce their laws on Canadian soil against Canadian citizens. Which sounds bad, be have already been allowing this to happen via the Canada-US Income Tax Convention (the Treaty), for decades, and it has never been a problem previously.
Implications for Canadians
Unfortunately for the Plaintiffs, we believe that the IGA is necessary because otherwise Canadian banks would get completely screwed over by the US due to the withholding tax on all investments in the US that the banks hold or manage on behalf of their clients. Given the serious ramifications for the entire Canadian economy if the Plaintiffs were to win, the IGA is going to be upheld.
Given that there are over one million US Persons in Canada, these new reporting requirements are certain to impact many people. Canadians who are US Persons (whether they know they are or not) ought to be reporting their FBARs and filing a US tax return, or they will face very serious potential penalties, including jail time, in the US. The CRA has ruled that pursuant to the Treaty, the CRA will not enforce FBAR reporting in Canada, but that does not mean the US will not seize US assets of anyone they deem off-side.
At the end of the day, Canadian tax rates are higher than US tax rates, and our highest rates bite at lower levels than in the US. Under the Treaty, virtually all tax paid in Canada is credited against US tax. As a result, anyone who is properly paying tax in Canada on their income will have no tax owing in the US. There are some exceptions (not all home sales are 100% non-taxable as they are in Canada) but for the most part, as far as the 1 million US Persons in Canada, the entire FATCA/FBAR mess will only result in greater management costs for the US government and not a penny of extra revenue.
The US is also grossly underestimating the cost of compliance not only for themselves but for the rest of the world. And this is the greatest risk from their misguided strategy: they are assuming that every bank and financial institution in the world has to invest in US securities in order to be taken seriously. Right now, that is true because currency/international transactions virtually all move through New York and the SWIFT code banking system, which the US controls. Since the US has the global financial system under their thumb, they will get what they want. But as it becomes less convenient to own US stocks and bonds, and the cost of doing so rises, eventually someone will come up with a way to end-run the US financial system and still be a legitimate bank. When it happens, not if, the US economy will take a bigger hit than they expect. This is not being anti-US, it is just the inevitable result of the market forces that Americans hold so dear.
We are allied with Anaford AG, a boutique law firm headquartered in Zurich, Switzerland. Anaford is comprised of my former colleagues at a global US law firm. They specialize in providing US Persons, private clients, financial institutions and fiduciary firms with tailored legal advice on multi-jurisdictional tax, wealth planning and succession matters.
There are multiple ways to deal with the FATCA/IGA fallout. Conveniently, Anaford, recently released a note setting out the options available. In a nutshell, when a US Person wishes to regularize his or her noncompliance with US tax and FBAR reporting obligations they have four options: 1) Formal IRS Offshore Voluntary Disclosure Program or “Noisy” Disclosure; 2) IRS “Streamlined” Filing Compliance Procedures; 3) IRS Service Center Filing or “Quiet” Disclosures; and 4) Delinquent FBAR or International Information Return Submission Procedures. (See http://anaford.ch/wp-content/uploads/2014/10/Regularization-Options-for-Non-Compliant-US-Taxpayers.pdf for more information)
If you are or know of US Persons who need help in navigating these issues, please let us know and we can put you in contact with our friends at Anaford.
Jonathan Garbutt (Barrister & Solicitor) and Raminder Pander (Student-at-Law)
 See http://www.fin.gc.ca/treaties-conventions/pdf/FATCA-eng.pdf , specifically Annex I, article II (A) re “Accounts not required to be reviewed, identified or reported”
 The more formal test is that they take all of the days you spend in the US this year, 1/3 of the days last year, and 1/6 of the days the year before, and if that combined total is over 183, you are a US Person for that tax year. See http://www.irs.gov/Individuals/International-Taxpayers/Substantial-Presence-Test for details.
 You can still file a “closer connection” form in the US to protect your Canadian tax residency status (see http://www.irs.gov/pub/irs-pdf/f8840.pdf) for further information
 See http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Report-of-Foreign-Bank-and-Financial-Accounts-FBAR for more information.