FATCA in Canada-constitutional challenge mounting

A group of Canadians has put together a campaign to explore the constitutional violations posed by FATCA in Canada. Some of these issues were raised by pre-eminent constitutional scholar Peter Hogg, in this letter to Finance. Others arise because of the adoption of the intergovernmental agreement (IGA), which bypasses data protection laws and lacks even the minor anti-discrimination clause seen in other IGAs.

I've been asked if these issues are serious. I think they are. The issue FATCA raises for me is not so much sovereignty--though I perfectly understand the instinct on that front--but rather it is the problem of serious mismatch between the goals targeted and what will be attained by FATCA when law on the books meets law in practice. The constitutional challenge is a signal that something is seriously awry with FATCA. As with most activism, this effort demonstrates that a not-small number of people are experiencing some not-small violation of fundamental principles, and in light of government failure to respond, are forming grassroots responses in an effort to achieve a remedy.

Let's have a look at why this might be so.

The goals of FATCA are clear and the law writes a clear narrative that is palatable to the public: we must stop tax evasion. Who would possibly speak out against that goal? I don't know too many people that would.

However, the law in practice is a completely different story, with a normative dimension unique to the United States. This dimension has, as far as I can see, been completely ignored by lawmakers both in America and internationally. It involves the attempt by the United States to impose taxation of persons based on their legal status instead of their actual inclusion in American society.

I know that this s difficult to understand conceptually. An example might help.

A was born in Illinois to a Swedish mother and an American father. The family moved to Sweden when A was 6 months old, and she spent her whole life in Sweden, working there, paying taxes there, using the schools and the health care system there, and getting married to a fellow Swede. A is a US national, and therefore subject to US taxation as if A had done all of those things in America. A has always been subject to US taxation, and FATCA doesn't change that in the slightest. But A never paid any attention to US law or politics, decisions of the US Supreme Court, or Congressional hearings. Why would she? She is a resident of Sweden paying high taxes and living her life. A has bank accounts at her neighbourhood bank, and tax-deferred savings account sponsored by her government.

In the eye of FATCA, A is an offshore tax evader.

Since she is an evader, she must be monitored to ensure she is caught and brought to justice, and further that she goes forward in full compliance with all US tax laws. Since she cannot be trusted to come forward, her bank must disclose her personal and financial information, and that of her spouse (guilty by association), to the IRS. Since the bank has no incentive to do that, it must be threatened with sanctions if it fails to do so. Since banks don't want to work under that threat, Sweden must be compelled to step in and facilitate the data transfer.

As I have said often, this is an extraterritorial jurisdictional claim that requires the help of other countries. Getting help is not a choice, it is a necessity. One country simply cannot assert its jurisdiction over people who live in another country, without that other country's help. American scholars know this, and they say America should ask for the help it needs. The problem that we have seen FATCA reveal is that this help necessarily involves America's needs trumping domestic laws that apply to targeted persons in the country of their residence.

I do not think America should be demanding help from other countries in taxing the residents of those countries. America needs to learn to tax its own residents, like every other country must do. If the world's biggest economy cannot figure out how to make its own people pay for their own public goods, it is difficult to see why other countries should be enlisted to help it along.

This is why the mismatch between the law on the books and the law in practice is so troubling in the case of FATCA. Looking past the use of legal status instead of residence as a jurisdictional claim, a regime that requires financial institutions to report nonresident accounts to these account holder's home countries is absolutely necessary to protect the income tax base from widespread tax evasion facilitated by foreign bank secrecy laws.  Of that there is simply no doubt. To the extent FATCA can do that, it is to be applauded and most of all extended globally because this is a global issue. I explain and advance this argument here. 

Most countries cannot act alone in instituting this necessary regulatory structure, since foreign financial institutions would simply shun a given market rather than comply. This is the potentially positive side of what makes the United States different from most, maybe all, other countries. This also explains why the OECD is very very quickly trying to ride the coattails of FATCA (before it is too late and the US changes its mind about being part of a global data exchange system, as it has before), by gearing up to create a global FATCA, or call it a GATCA. 

GATCA is FATCA minus two key aspects: the normatively unjustifiable legal-status based tax, and most of the economic sanctions. The UK has done something similar with those same parameters with respect to a selected list of countries. (The OECD's GATCA is also fully reciprocal, but that deficiency in FATCA is another issue). These differences make a GATCA supportable exactly where FATCA is not (both systems have other major flaws but we can leave those aside for the big picture here).

FATCA's enforcement of legal-status based taxation renders it normatively unjustifiable. It violates the residence principle, which Reuven Avi-Yonah has gone so far as to call an international customary law. It is also of course completely unworkable on a global scale: imagine if other countries decided to learn from the US example and started smoking out their own disapora to enforce their own FATCA regimes. It is unimaginable that if the OECD countries got together and seriously debated status-based taxation, they would agree on a global standard to enforce it for all countries. The common reporting standard GATCA they have devised, which is so obviously based fundamentally on the residence principle, shows that the OECD recognizes that enforcing status-based taxation is not and should not be a goal of any project to counter tax evasion.

Yet no conversation is being had about the outlier, whose demands will make enforcement of GATCA more extensive and more expensive for every other country.

Residence based taxation is not perfect by any means but it is the least worst alternative if governments want to continue to use personal income taxes in a world in which individuals are to be allowed the freedom to move. FATCA deserves to fail to the extent it ignores this reality. A constitutional challenge will at minimum open a desperately needed political conversation about why this is so.

OECD's Plan for Global Tax Info Exchange: Could be Deja Vu All Over Again

The OECD has released its "Common Reporting Standard," a.k.a. a global "Standard for Automatic Exchange of Financial Account Information." The plan more or less tracks the so-called "intergovernmental agreements" (IGAs) that the US Treasury is using to try to get the Foreign Account Tax Compliance Act working. But the OECD's model for the world differs in two critical respects:

1. it is based on the global standard of residence-based taxation
2. it would require reciprocity

One obvious question is whether the US would sign on to this standard, since it represents a major reduction of the massive expansion of the US taxpayer base contemplated by FATCA. If not, can one really envision a world in which everyone shares data reciprocally except the United States, which not only does not share data reciprocally but also places the most expansive demands on everyone else? (For those not following along, the US claims people based on their legal status in the US as well as their actual residence, in contravention of the global norm reflected in the OECD standard, which rejects the former claim in favor of the latter. In terms of reciprocity, what the US calls reciprocal with respect to data sharing is so far reciprocal in name only).

A related issue that already exists under FATCA and will be expanded exponentially under the OECD plan is that reciprocity means every government bears the cost of incorporating expansive financial surveillance (in the case of the US, far beyond that required for all other countries) yet as the Tax Justice Network points out, this formal equality in fact introduces substantive inequality and potentially great harm to poorer countries.

Readers of my prior work (on soft law, on the OECD's norm-creating role, and on its grappling with the issue of sovereignty) will know that I am cautious about the premise of accepting proclamations of the OECD about "global" tax norms.

In the case of residence-based taxation, however, this is not an OECD-created norm but one that dates to the very beginnings of modern income taxation and while flawed is the best available structure if more than one country in the world is going to have an income tax and people are going to be allowed to leave their countries freely if they so choose. Relax either of those assumptions and legal status-based taxation might become technically feasible, though it would still be fundamentally unjust. Neither is the reciprocity norm an OECD invention: instead, its roots trace back to post-Westphalian fundamental international legal principles.

The OECD's forging ahead with a plan that more or less relies heavily on US acceptance is eerily reminiscent of the last OECD attempt to curb tax evasion, via the harmful tax practices initiative. The US first supporting and then completely reversing course eviscerated that effort, thus cementing the status quo we witness today.

US exceptionalism with respect to who should be considered its residents and what it can be compelled to share with other countries cannot help but perpetuate a grave reciprocity imbalance that will only be exacerbated if the US does not sign up to the OECD standard, and the OECD accepts a carve-out to accommodate it.

Given that efforts toward a repeal of FATCA and an ongoing legal challenge to data reporting by US banks are currently unfolding in the US, the OECD's report comes at an interesting juncture in the process of picking up where the harmful tax practices project left off. It could unfortunately foreshadow a repeat of the events that unfolded in that project circa 2001. Or, more optimistically, it could be that the OECD report is a means of giving the US a reason and the political cover to bring its antiquated status-based tax regime up to date with the global residence-based standard, and its one-sided view of the value of data sharing in line with how the rest of the world views things. That would make global automatic data exchange of offshore financial accounts a much more clearly positive development overall, leaving room to focus on solving the other outstanding issues. Only time will tell which way this will unfold.

Canada-US Agreement Reached on FATCA Data Sharing

Things have been exciting the past few days as a long-expected agreement on FATCA between Canada and the US was announced and Canada's Department of Finance released a flurry of accompanying materials. The US Treasury has now added Canada to the list of jurisdictions deemed to have an agreement in effect. I will have more analysis soon but just wanted to provide some of the most useful links to get things up to speed.

First, here is the text of the intergovernmental agreement--it is not a signed copy unfortunately, which leaves a couple of technical questions unanswered for now.  Here is the Press Release from the United States. Here is the Press Release from Canada, and here are explanatory notes to the agreement, a "backgrounder", and an FAQ,

Canada's Department of Finance has also produced a draft legislative proposal that would implement the agreement into Canadian law. This includes text for a new section on Enhanced International Information Reporting in the Income Tax Act. Assuming that the agreement is considered to be a treaty, Parliament needs to be officially notified that an agreement has been signed and 21 sitting days must pass before legislation is introduced to implement the agreement into Canadian law, which would take us to roughly March 27.

During Thursday's Parliamentary proceedings, MP Murray Rankin offered some pointed questions on the pact and the implications for the financial privacy of Canadians, but I am afraid the answers may actually sow confusion, more on that later.

Comments on the legislative proposal can be submitted to the Department of Finance at IGA-AIG@fin.gc.ca or to the address below. The closing date for comments is March 10, 2014.

Tax Policy Branch: Department of Finance
140 O’Connor Street Ottawa, ON K1A 0G5

The media, mostly Canadian at first, has taken notice of the agreement and many are commenting on the privacy concerns as well as the reciprocity and scope of the deal:

• Patrick Cain explains the agreement and its implications;
• James Fitz-Morris explains how the pact takes some heat off Canadian banks but leaves several problems unresolved;
• Louise Egan and Patrick Temple-West discuss the agreement and challenges that remain;
• Robert Wood discusses the shrewdness of using the CRA to bypass privacy protections;
• Windsor Star Editorial discusses enduring privacy concerns;
• Theresa Tedesco at the Financial Post comments on the scope of FATCA and what reciprocity really means.

More to come as things unfold in the coming weeks.

Brian Arnold talks about BEPS: Next Monday at McGill Law

I am very pleased to be hosting internationally renowned tax expert Brian Arnold at McGill Law next Monday, where he will deliver a talk on the OECD's ongoing initiative with respect to Base Erosion and Profit Shipping ("BEPS"). The talk is scheduled to commence at 12 pm; members of the public are warmly welcomed. 

Location: McGill Faculty of Law, 3644 Peel Street, New Chancellor Day Hall, Room 202.

Date and Time: Monday, 10 February, 12:00–13:30.

Shachar & Baubock on Citizenship for Sale

Ayelet Shachar, who previously published The Birthright Lottery, a book about how citizenship is an inheritance that can make or break individuals' life chances, has edited a compilation of twelve short essays on the question of whether citizenship should be a commodity, together with Rainer Baubock. Here is the abstract:

On 12 November 2013 the Maltese Parliament decided to offer Maltese and European citizenship at the price of € 650,000, but implementation of the law has been postponed due to strong domestic and international critiques. On 23 December, the Maltese government announced significant amendments, including a higher total amount of € 1,150,000, part of which has to be invested in real estate and government bonds. Several other European states have adopted ‘golden passport’ programmes. Should citizenship be for sale? In November 2013 EUDO CITIZENSHIP invited Ayelet Shachar of the University of Toronto Law School to open a debate on these controversial policies. Twelve authors have contributed short commentaries, most of which refer to the initial law adopted by the Maltese Parliament. An executive summary by Rainer Bauböck provides an overview over the main questions raised in our forum. For further information on investor citizenship programmes see Jelena Dzankic’s EUDO CITIZENSHIP working paper on the topic and consult the news section of our observatory.

The issue of taxation is peripheral at best in most of these contributions. Yet for those interested in fundamental questions about belonging that are as yet unanswered in the tax policy literature, and specifically how FATCA and other automatic information exchange developments increase the possibility of citizenship-based taxation like never before, understanding whether and why citizenship should be a tie that binds a person to a state is fast becoming a critical issue.

Canadian Government Responds to FATCA Questions

Last October, Canadian MPs Ted Hsu and Scott Brison issued a set of questions to the Canadian government on FATCA (on which I consulted). Today I received two pdfs with the Government's answers to the questions, and I have put them in dropbox in order to share them:

Here are the government's answers to Ted Hsu's questions.

Here are the government's answers to Scott Brison's questions.

Most of the questions remain unanswered for one of two reasons: (1) FATCA is US law, not Canadian law, so no one in Canada is in charge of enforcing it, and therefore most agencies have little or no information and (2) Canada is negotiating with the US on an IGA and so nothing can be estimated about the scope, cost, implications, or consequences of FATCA in Canada unless and until such agreement is in place. (costs to the government in negotiating and internal briefing on the law "have been absorbed within existing resource levels.")

More review to come.

Citizenship-Based Taxation and Taxpayer Rights Don't Mix

In this brief analysis, Taxpayer Rights, On and Offshore: the 2013 Taxpayer Advocate's Report to Congress, I looked at the problem created when an under-resourced tax agency is charged with implementing an over-expansive tax jurisdiction. Abstract:

In the 2013 National Taxpayer Advocate's Report to Congress, two concerns take center stage: the need for greater protection of taxpayer rights, and the increasing pressure on the system created by the U.S. tax regime’s extraterritorial reach. Neither of these issues is new; indeed, the NTA has repeatedly attempted to raise awareness of each over several years. But the Report demonstrates that these two concerns are on a collision course, and impact looks imminent for 2014 as the US doubles down on long under-enforced jurisdictional claims over nonresidents with US nationality or legal status. The basic impracticality of finding and claiming nonresidents with US ties is compounded by the violation of internationally recognized tax jurisdiction norms, creating an unsustainable enforcement rift that directly challenges the voluntarism theme that Olsen views as key to the fiscal system as a whole.

Further in, I argued that the NTA Report illustrates that taxing people on the basis of their nationality or legal status rather than their actual residence poses a serious problem for tax administration and violates international norms.

As a practical matter, globally rounding people up based on one government's ideas about their legal status is quite obviously unenforceable without assistance from other governments. This assistance fundamentally conflicts with a universally recognized (and far more just) jurisdictional claim based on actual residence. It is one thing for the US to say to individuals: if you have status under our law you must follow all of our laws no matter where you are. It is another to say to other countries--and much less individuals in other countries--if people who live in your country have US status as we define it, you are harboring potential criminals and you must help us find them and enforce our claim over them even if your government also claims them and even if our claim conflicts with your government's own law.

Thus status-based taxation is no less a poaching of other countries’ internationally recognized jurisdictional claims over taxpayers than the kind of poaching FATCA was ostensibly designed to attack (namely, that of the US tax base by other countries via bank secrecy). The basic unenforceability of status-based taxation coupled with its poaching of other jurisdictional claims would make it a total non-starter were nations to get together and discuss a multilateral adoption of status-based taxation as a policy everyone could get behind.

 But FATCA is a big stick that is bypassing any such conversation, going straight to the technical problem of compliance and enforcement under the banner of stopping tax evasion. There might be no remedy in international law for tax jurisdictional overreach but that only confirms that it must be challenged from both within and without the nation engaging in the bad behavior.

Tax Competition: Not a Law of Nature but a Policy Decision

This was published this back in December but I neglected to post it here: "What the Baucus Plan Reveals About Tax Competition" is a brief (5 pages only!) analysis of US Senator Max Baucus' "Option Y" plan to reform the US corporate tax regime, by in effect imposing a global minimum corporate tax on US-based multinationals. I argue that the plan demonstrates that tax competition is not and has never been a law of nature operating outside of the control of individual governments, but instead it has always been the product of policy decisions that can be reversed by other policy decisions. Accordingly, political will is the reason why tax competition has become the overwhelming force that it is today.

I suggest that the Baucus plan demonstrates that the US has been a major force in creating the conditions for global tax competition and its language implies that the US could, should it chose to, act unilaterally to put a stop to the practice. As always, I welcome your comments.

Rick Mercer explains how the rest of the world sees FATCA in one hilarious minute

Must see for anyone who is, or was, or may be or might have been an American...

Ireland: Oasis for American multinationals, desert for Irish workers

From last Sunday's NY times, opinion write Fintan O'Toole discusses life in Ireland, after it first gorged on a panoply of tax reforms meant to lure in multinationals, and then starved under austerity under financial crisis. Of note:

...Ireland has two economies: a global one dominated by American high-tech companies, and a domestic one in which most Irish workers have to make their living. The first is indeed booming. Not least because of those low corporate taxes, large global corporations find Dublin convivial for reasons other than its pubs and night life. The sheer scale of Ireland’s dependence on this kind of investment for its exports can be judged by the fact that Irish gross domestic product took a serious hit in 2013 when Viagra (which is made by Pfizer in County Cork) went off patent in Europe. Broadly speaking, however, the global side of the Irish economy has remained robust. 

But home is where the heartache is: in the domestic economy outside the gated community of high-tech multinationals. Outside Dublin, property prices are still falling. Wages for most workers have dropped sharply. Unemployment remains very high at 12.8 percent — and that figure would be higher if not for emigration. There’s always been a simple way to measure how well Ireland is doing: Go to the ports and airports after the Christmas vacation and count the young people waving goodbye to their parents as they head off to the United States, Canada, Australia or Britain, where they have gone to find work and opportunity. 

...[People in Ireland] are not convinced that the cruel scale of the punishment was necessary or that the nasty medicine has, in fact, worked. 

Behind both of these propositions looms the great contradiction in the supposed success story of Irish austerity. It was austerity only for citizens. Running parallel to all the cuts in public spending and all the calls for fiscal responsibility has been a program of spending so lavish that it makes a drunken sailor look stingy. 

The converse proposition is that when it comes to contributing to the mechanisms of the state--rule of law, infrastructure, educated workforce, etc etc, which fully support those multinational gated communities--the state looks primarily to workers to do the bulk of the heavy lifting, in the form of personal income taxes (41% at the top) and consumption taxes (23% on most goods). But Ireland is not alone in this political decision.

The story of feasts for corporations, famine for workers is a familiar one, and the trade off is supposed to be the positive externalities corporations bring. In other words, the political tradeoff that politicians think they are making goes as follows: we can give up our tax on corporate income if that lures more corporations into our jurisdictions which then hire our workers, whom we can then tax on their incomes and then again on their consumption, to pay for luring in more corporations, in a virtuous cycle. O'Toole's column strongly suggests that the externalities are not anywhere near what was expected or would be needed to continue the virtuous cycle.

The problem for the state is that the owners of corporate capital have received their benefit up front, but when they do not produce their side of the equation in exchange, there is no way for government to demand a refund.

Thus we can add Ireland's story to the multiple examples that exist in various iterations of it around the world, including for example the constant intra- and inter-state fights to lure in manufacturers, filmmakers, and sports teams. Maybe governments should be thinking about adding a carve-back clause to the fiscal bargain that creates oases for bargain-seeking multinationals, which would disgorge untaxed profits when it is clear a party to a tax incentive-fueled deal is not bringing what they said they would or could.

FATCA rising in Canadian Media

The Canadian media has increased its interest in FATCA over the past week or so, with a number of news stories, including television segments. Here are a couple of stories to which I contributed in which I may (or may not) have shed some light on what FATCA looks like from outside the United States:

• U.S. tax law called ridiculous 
• U.S. FATCA tax law catches 'accidental Americans' 
• How will the new U.S. tax law affect Canadians?
• U.S. FATCA tax law catches unsuspecting Canadians in its crosshairs

It is clear that the nerve touched by FATCA is citizenship- or status-based taxation, a concept that remains a mystery and a surprise to many outside America, especially in a country in which a vast majority of the population lives within striking distance of the border and there is a high level of interrelationship, both personal and business. I expect the pressure on status-based taxation to grow exponentially as FATCA actually begins to "smoke out" the world's non-resident Americans when it comes into effect later this year, and more stories like that of Carol Tapanila's family demonstrate the injustice created by legal regimes that apply to individuals based on their legal status alone.

US renunciations passed 3,000 in 2013; Number abandoning status likely much higher

The Canadian press seems to be taking increasing notice of US citizenship issues, probably because there are so many persons with US status living and working in Canada and as the US clamps down on its citizens across the globe, the effect is deeply felt here. Patrick Cain has covered these issues before and in his latest article he reviews the murkiness surrounding the renunciation number--it is not by any means a comprehensive view of the number of people shedding their US status:

The FBI data captures only part of the total number of ex-Americans. Some people “relinquish” U.S. citizenship – for example, by taking citizenship in another country while intending to lose U.S. citizenship, then asking the State Department to document the loss. Relinquishing is more attractive for several reasons, not least because it’s free – a renunciation costs $450 US.

As Cain points out, you can FOIA all you want, you won't get a full picture of the exit door. Cain compares this to the Canadian side of things:

Between 2008 and 2012, an average of 172 Canadians renounced their citizenship each year – typically because they want to run for office in a foreign country, join a foreign country’s military or become citizens of a country that doesn’t allow dual citizenship, Citizenship and Immigration spokesperson Mary Jago explained in an e-mail.

As to "wanting to run for office in a foreign country":  a likely rare but politically interesting sub-category. Canada is of course a much smaller country than the US so we can expect the number to be accordingly much more modest, still, here it is just about 5% of the documented US number, and therefore likely a tiny fraction of the whole US picture. I expect that picture to substantially expand again in 2014.

Dorfman on the Cost of US Citizenship Abroad

I missed this student's point of view on the Cost of United States Citizenship Abroad when it was posted early last month, and it is of interest. The student notes that the US is the only country* in the world to impose worldwide taxation on the basis of citizenship instead of residence, that "there are no philosophical grounds" for this position, and that the position creates unnecessary obstacles to human mobility that serve no policy purpose. Excerpts of note that I wish US lawmakers could understand as well as this student apparently does:

[T]his archaic policy is not only unjustified, but is frustrating and alienating expatriates across the globe. 

... In general, [US] citizens pay the difference between their domestic taxes and what they would have been taxed in the US – so, if a citizen’s domestic taxes are higher than what they would owe in the US, they pay no additional taxes. However, an exemption from additional taxes is not an exemption from the inconvenience, penalties, and hidden costs that come with filing US taxes abroad.

... the vast majority of expatriates are not living abroad to duck taxation – they have simply moved away for work, education, or family reasons and have not returned. 

Many non-resident citizens have inherited United States citizenship by birth, but have never actually resided there– they’ve received no services from the US government, yet must file American taxes every year or face severe penalties. 

...In attempting to punish tax dodgers, the US government is heaping financial penalties, stress, and even criminal charges upon the blameless.

...At its core, citizenship based taxation makes it harder for American citizens to live and thrive outside of the United States. This is a significant obstacle to the freedom of Americans to emigrate abroad in an increasingly globalized world. 

The United States has also implemented barriers to renouncing American citizenship. ...The Economist has dubbed these obstacles “America’s Berlin Wall”.  

 The author concludes:

It is no wonder that American expatriates frequently report feeling frustrated, harassed, and persecuted – the United States system has been built to punish them for merely residing outside of its borders. The United States needs to get with the times and abolish citizenship-based taxation. The policy is tremendously unfair and detrimental to Americans living abroad, and it serves to anger and alienate citizens, many of whom have a lot to contribute to the United States in terms of international experience and skills. It is ironic that a citizenship so widely desired has come to feel like a burden for so many.

Well said, but I am afraid it is falling on deaf ears in Congress where every move concerning the taxation of humans--in stark contrast to that of multinational companies--is moving in the direction of protectionism and penalty rather than export and free mobility.

* Eritrea also apparently taxes its citizens abroad at a rate of 2 (two!) %. For this it has been condemned  and sanctioned by the United Nations Security Council after then US Ambassador, now US National Security Adviser Susan Rice stated that the country was "funding its [war-related] activities through its diaspora tax." Rice added that "Eritrea must confirm through its actions that it was ready to re-emerge as a law-abiding State." One can but hope that such statements can be made only by someone who is blissfully unaware of the comparatively much more expansive--and punitive--US disapora tax.

Stewart on the G20 and the taxing issue of making big business pay

Professor Miranda Stewart has published a short article today in which she nicely sums up the G20 agenda for 2014: base erosion & profit shifting, thin capitalization and transparency/information exchange. She concludes with some of the challenges for reform:

The G20 ... says that fixing global tax regulation is key to fighting poverty. A 2012 UN General Assembly Resolution 66/191 calls on the international community to develop effective international company tax rules and to increase participation of developing countries in tax policy processes. But ... it is only recently that OECD member countries have begun to acknowledge that their own tax rules and harmful tax competition are making it more difficult for developing countries to raise adequate taxes. 

There may be some tensions in the G20 about how to reform our fundamental international tax principles for the future. The OECD BEPS project mostly aims to protect the residence basis of taxation for multinationals. This will help prevent corporate tax base erosion for rich, capital and intellectual property-exporting countries. Current OECD profit shifting rules, which emphasise the arm’s length transfer pricing principle, can be strengthened. But these current rules for allocation of the right to tax business profits between countries are under attack from capital importing countries who seek to protect and enhance source taxation of business activity.

India, South Africa, Brazil and China may benefit more from a “formulary apportionment” approach, which has also been called for by activist organisations such as Oxfam and Christian Aid. We might begin to see cracks in the G20 on these fundamental international tax principles in 2014.

A nice overview of what to look for from the G20 in 2014.

Cockfield on governance and the international tax regime

Art Cockfield has published his article, The Limits of the International Tax Regime as a Commitment Projector, which examines how governments use and abuse the pluralistic nature of the international tax law regime to achieve their goals. He presented this as a paper in draft form last year at McGill and it is highly recommended reading. Here is the abstract:

As explained by Ronald Coase, transaction costs are the costs associated with discerning a price on a given exchange. This article conceptualizes the international tax regime as a political and legal system striving to address transaction cost challenges, and claims it has an uneven record. On the one hand, the international tax regime lowers transaction costs and hence promotes global economic growth. It does this by facilitating credible government commitments to ensure that the same cross-border profits are not taxed twice by two countries. Multinational firms are thus protected against the risk that their cross-border activities will be unduly deterred by taxation, which encourages more global economic activities.On the other hand, governments are unable to offer credible commitments that they can effectively address other important international tax policy concerns. First, despite ongoing reform efforts governments are not able to offer reasonably reliable promises that they will inhibit aggressive international tax planning that dilutes revenues in countries like the United States. Second, the international tax regime affords governments opportunities to develop their own policy solutions (such as the 2010 U.S. anti-tax evasion initiative to create a global tax information reporting system through the Foreign Account Tax Compliance Act) and thus governments can renege on earlier promises to abide by traditional international tax norms.

The article includes a tremendously interesting section on "Breaking Commitments through Unilateralism," in which Prof. Cockfield discusses the US adoption of FATCA and how this legislation violated international tax norms as well as circumvented longstanding international commitments under existing treaties. Prof. Cockfield is optimistic that despite its faults, FATCA could help lead the world to global automatic information sharing. I am very much less optimistic because of the grave imbalance of resources and the high transaction costs he describes, and because I view the intergovernmental agreements that purport to commit the US to greater information exchange as aspirational at best.

In the conclusion, Cockfield sums up the current status quo of global tax governance:

The fact that the ITR [International Tax Regime] evolved as a largely noncooperative government game is understandable given the desire on behalf of governments to preserve political control over their tax systems. Nevertheless, by eschewing its traditional reliance on limited bilateral and multilateral cooperation, the recent U.S. initiative through FATCA to create a global tax reporting system to address tax evasion concerns — a system that operates in contravention of the formal and informal rules of the ITR — shows another limit of the ITR as a projector of reasonably reliable commitments. In a noncooperative game without any binding multilateral rules, governments may be tempted to break their promises to follow international tax norms in order to pursue their own domestic policy goals. 

...The analysis in this article has shown how, depending on how the context affects the ability of governments to exchange credible commitments, the ITR lowers or raises transaction costs. Thus, it disagrees with the tentative claim that, in the long run, international taxation will find its most transaction-cost-efficient governance structure. This conclusion is consistent with the view of North that, unconstrained by market forces, “the political market has been, and continues to be, one in which the actors have an imperfect understanding of the issues affecting them and equally in which the high costs of transacting prevent the achievement of efficient solutions.”

Taxing the Corporation: Home Depot and the State's Claim of Right

The Arizona Court of Appeals recently issued a decision in the Home Depot case, which involves determining when the state has jurisdiction to tax a corporation. The case is about a domestic multi-state business but it has interesting implications for the taxation of multinationals. In brief, Home Depot (a Delaware corporation headquartered in Georgia) formed a subsidiary in 1991 to hold its trademarks. It then entered into a licensing agreement with the sub, Homer, under which it paid a royalty for the use of the trademarks. The royalty started at 1.5% of gross sales, and increased to 4% in the years at issue. The Arizona Department of Revenue decided that Homer and Home Depot constituted a unitary business for Arizona state tax purposes, the Arizona Tax Court agreed, and the Court of Appeals affirmed.

So here we have a Delaware corporation, headquartered in Georgia, doing business in Arizona through retail stores, but stripping its income out of the state in order to avoid the state level corporate income tax. That is, of course, the basic modus operandi of Google, Apple, Starbucks, GE, Amazon, et al, each of which sells products and services around the world yet pays low single digit corporate tax rates in each jurisdiction by stripping out its income in the form of license fees, interest, and other inter-company payments to subsidiaries located in low-tax jurisdictions.

Internationally the defense that countries employ against this behavior is the arm's length standard, under which each government that claims jurisdiction over any part of the multinational treats that part as if it was an independent party acting at arm's length with respect to the rest of the company. Indeed Home Depot raised its compliance with the arm's length standard as a reason for the court to dismiss the Arizona revenue authority's jurisdictional claim over Homer. But the Court points out that compliance with arm's length is not the issue in a question about establishing a jurisdictional claim:

Home Depot, nevertheless, argues its transactions with Homer have been at arm’s length, and points out that the Department has not challenged the appraisal establishing the legitimacy of the royalty it pays Homer. [Under prior case law] the principle [is] that unitary treatment will be imposed or allowed whenever the activities of the affiliated organizations affect the other(s) in ways that are "so pervasive as to negate any claim that they function independently from each other."

Under a statutory regime that allows for unitary taxation, in other words, the state can claim jurisdiction to tax with respect to any corporation anywhere, if it can establish pervasive links among affiliated corporations, or "operational integration." And what are the marks of such operational integration, such that the state's jurisdiction to tax is established? The Court lists fifteen, pursuant to Arizona state law:

1. The same or similar businesses conducted by components;
2. Vertical development of a product by components, such as manufacturing, distribution, and sales;
3. Horizontal development of a product by components, such as sales, service, repair, and financing;
4. Transfer of materials, goods, products, and technological data and processes between components;
5. Sharing of assets by components;
6. Sharing or exchanging of operational employees by components;
7. Centralized training of operational employees;
8. Centralized mass purchasing of inventory, materials, equipment, and technology;
9. Centralized development and distribution of technology relating to the day-to-day operations of the components;
10. Use of common trademark or logo at the basic operational level;
11. Centralized advertising with impact at the basic operational level;
12. Exclusive sales-purchase agreements between components;
13. Price differentials between components as compared to unrelated businesses;
14. Sales or leases between components; and
15. Any other integration between components at the basic operational level. 

Not every listed factor must be present in order to establish operational integration. Having established its jurisdictional claim, the state does not claim all of the income of the entire multistate operation, but rather applies its own internal formula for determining what portion of the whole is attributable to the group's Arizona operations. 

Herein lies the lesson for international taxation: corporate taxation of a multi-state group is possible on a unilateral basis--a state need only stake its own jurisdictional claim and have the werewithal to enforce it. Arizona's Court of Appeals seems to be suggesting that the state's jurisdictional claim need not be hampered by any artificial constructs, whether these be rules assigning corporate residence or contracts allocating rights. Presumably the allocation formula cannot be 100% but also relies on some decision about the extent of the jurisdictional claim--although this has not been argued or established here. The decision further implies that enforcement is possible as a practical matter, presumably on the basis of the operations and assets that are currently in the state. The question raised is whether the Arizona market will continue to be attractive to Home Depot, such that it will accept unitary taxation by the state in order to continue to do business there. These are empirical questions, and the economic evidence I have seen so far suggests that the business will not leave solely as a result of the tax (especially if there is no alternative market that would deliver the same profits at a lower tax cost: here is a short summary that covers some of the bases on this question).

Substituting nation-state for state in these assumptions, these are big normative claims about the right of the state to assert a jurisdictional claim to tax, as well as its ability to follow through once the claim of right has been established. These assumptions raise even bigger normative claims about the fairness and efficiency of any system that fails to exercise a jurisdictional claim where it exists, since failure to exercise a claim in one sector forces the other sectors to take up the slack thus distorting tax outcomes on the basis on noneconomic factors. 

FATCA Q&A--A Work in Progress

Just a few questions I get a lot, together with some of the answers I typically give. This is not an exhaustive account of anything, nor is it legal advice. If you have or think you have FATCA-related problems, you need to consult legal counsel.

What is FATCA?

• FATCA is the Foreign Account Tax Compliance Act. It is law in the United States, enacted as part of the Hiring Incentives to Restore Employment Act, (HIRE Act), which was signed into law by President Obama on March 18, 2010. (It is found at §§ 501-531, Pub. L. No. 111-147, 124 Stat. 71 (2010). It has been codified in scattered sections of the Internal Revenue Code.
• In brief, the law requires foreign financial institutions (broadly defined) to identify any of their accounts (also broadly defined) held by "US persons" (expansively defined) and then furnish the US with periodic reports on those accounts including identifying information and amounts of transfers in and out of the accounts. Targeted institutions that fail to comply are to be penalized with a 30% toll charge on all of their US-source payments (again expansively--not just payments connected to targeted accounts).
• There are numerous rules and exceptions and exceptions to the exceptions applicable to the above statement.
• "US person" includes everyone in the world who is a US citizen, whether or not that person lives or has ever lived in the US and whether or not that person is also a citizen of somewhere else. The US is the only country in the world that taxes its citizens on this basis. Citizenship-based taxation violates the membership principle as well as the global standard of residence-based taxation, and has therefore been denounced as unjust or bad economic policy or both by most academics, including Reuven Avi-Yonah and myself among others.
• The US considers any account to be foreign if it is not in the US, so for people who live in other countries, their neighbourhood bank where they have their checking account in the local currency is "foreign."

Why was FATCA part of the HIRE Act?

• The HIRE Act was a jobs bill that included payroll tax holidays and other credits for employers. FATCA was unrelated to this purpose, but was included in the form of revenue-raising “Offset Provisions”. The Chair of the House Budget Committee claimed that the HIRE Act was a responsible piece of legislation that “was fully paid for… by cracking down on overseas tax havens." Congressional Record (4 March 2010) page H1152 (statement of Sen. Allyson Schwartz). However, no cost-benefit analysis appears to have been undertaken, and pursuant to CBO projections, the sums to be raised under FATCA could do little by way of offset, even if they were fully implemented (see below, What is the cost/benefit of FATCA).
• The placement as a revenue raiser tacked onto a bill aimed at unrelated objectives has been viewed by opponents of FATCA as a sign that its passage was undertaken with some degree of stealth. See, e.g., Recovery Partners, “FATCA: The Empire Strikes Back” (4 July 2011); Koshek Rama Moorthi, “FATCA: Obama’s New Year Surprise Against American Expats” (30 November 2012), The Examiner; American Citizens Abroad, “ACA’s Voice in the News” (October 2012) online. The addition of unrelated riders and last minute addenda, especially revenue raisers, is a standard feature of US lawmaking, though it may appear anomalous to observers from other countries. For a brief discussion of how reconciliation and pay-as-you-go rules and standards affect tax policymaking in the US, see Center on Budget and Policy Priorities, “Policy Basics: Introduction to the Federal Budget Process” (3 January 2011).
• Presented as a revenue offset at the tail end of a long, complex, and contested piece of legislation did allow FATCA to pass with minimal debate or discussion in 2010. But the seeds for FATCA had been sown in earlier (failed) legislative attempts, both in Senator Levin’s Stop Tax Haven Abuse Act of 2009 and Senator Baucus’ stand-alone FATCA Act of 2009. See Carl Levin, “Summary of the Stop Tax Haven Abuse Act” (2 March 2009); H.R. 3933 (111th): Foreign Account Tax Compliance Act of 2009 (27 October 2009); See also Douglas Shulman, “Prepared Remarks of Commissioner Douglas Shulman before the 22nd Annual George Washington University International Tax Conference” (10 December 2012) (stating that “the Administration and the IRS are focused on a multi-year international tax compliance strategy…to put a serious dent in offshore tax evasion” and expressing support for the FATCA Act of 2009).

Why was FATCA created in the first place?

• The clear impetus for FATCA was the UBS scandal, involving thousands of bank accounts held in Switzerland by Americans living in the United States. It seems clear the target was rich tax cheats who live in America but don't want to pay taxes there, and who have been helped in that quest via unscrupulous sales pitches by offshore bankers offering banking secrecy as a shield against taxation by the USA. The legislation failed twice as stand alone bills (see above), and was tacked on to another, unrelated bill in 2010 (the HIRE act) as a revenue raiser, without any discussion or much analysis by US legislators. Many appear to have never even heard of FATCA.
• A lot of people seem to think FATCA was intended to smoke out and punish Americans who live permanently in other countries and who have not kept up with their US tax obligations out of ignorance or otherwise. I do not think that is the case. I think these Americans have become collateral damage of FATCA.

What is the cost/benefit of FATCA? 

• To my knowledge, no cost analysis has been undertaken with respect to FATCA.
• Amounts expected to be raised by FATCA were projected to be $343 million, $448 million, and $710 million, for 2010, 2011, and 2012, respectively. See Congressional Budget Office (18 February 2010) “Letter and Table Outlining Budgetary Effects of HIRE Act” ). The HIRE Act was expected to produce a revenue deficit in the amount of $4,380,000 despite the bold claim that it was "was fully paid for… by cracking down on overseas tax havens." See Congressional Record (15 April 2010) page S2368 “Budget Scorekeeping Report: Table 2: Supporting Detail for the Current Level Report for On-Budget Spending and Revenues for Fiscal Year 2010, as of April 9, 2010. 
• This precarious budgetary situation was aggravated by the fact that while the spending provisions of the HIRE Act were apparently immediately implemented, most of the FATCA provisions have yet to be enforced. For example, the disclosure of US accounts by foreign financial institutions was, according to the statute, to begin after December 2012, but the enforcement has been delayed more than once. See IRS, “Notice 2012-42” (24 October 2012) (which delayed the implementation of information reporting until 31 March 2015 and gross withholding until 1 January 2017); see also chart of initial and revised implementation times, DLA Piper, “Comparison of FATCA Timeframes” (October 2012).
• I have not found any information about whether any amount of taxes or penalties has been collected pursuant to FATCA to date.

What is an IGA?

• An IGA is an "intergovernmental agreement." The US has been signing these with some countries and is looking to sign a lot more with a lot more countries. 
• There are two categories of IGAs. In one category, the foreign country agrees to change whatever domestic law exists that might bar their financial institutions from complying with FATCA (e.g., consumer privacy protection laws). In the other category, the foreign country agrees to act as intermediary, collecting the info the US wants and handing it over as a government-to-government exchange. This typically bypasses any privacy protection regimes that might exist as people don't generally have privacy protection as against their own government's tax authority.
• IGAs are not treaties from the US perspective, in fact, just what exactly they are is a mystery. Treasury has implied that to the extent the US undertakes anything in these IGAs (in fact, precious little), they are "interpretive" in nature that is, they interpret existing tax treaties. Hence perhaps some confusion: if a country wants an IGA which involves the US providing anything in return, Treasury is suggesting a treaty will be needed for the IGA to "interpret." In my own view the idea that IGAs are interpretive in nature is a stretch: IGAs look like sole executive agreements to me. Treasury will not be putting them through any ratification procedures. Other countries have been typically (but not universally) treating these as they are, which is to say they are new treaties that require internal ratification procedures to place in force.

What are the IGAs for?

• In general the purpose of the IGA is to override the statutory structure of FATCA, making the unilateral statute less onerous than it otherwise would be, and to overcome domestic consumer privacy protections to enable institutions in other countries to pass personal financial information to the IRS. Thus, IGAs are a way of reducing both the administrative and the political burden Congress created for Treasury with FATCA. 

How does or will FATCA impact non-US financial institutions? 

• I can only speculate on this as I am not a compliance expert. However, it is to be expected that at minimum, compliance costs and risk of penalty from the US goes up, and if other counties implement their own regimes as the UK is currently doing, the costs and risks will be multiplied. 
• It seems to me possible that financial institutions face litigation risk with respect to customers who are mistakenly identified as having US indicia and whose information is turned over to the IRS, or whose accounts are closed, or who are asked for personal information that is not required to be asked or not allowed to be shared with third parties under domestic banking laws, whatever those may be. It seems possible that this risk might make an IGA seem more palatable than direct compliance with FATCA, from the perspective of a financial institution.

How will FATCA impact consumers? 

• Again I can only speculate, based on what people tell me. 
• First, a generalized fear seems to be setting in about US surveillance and a powerful and determined IRS that is interested in imposing, anywhere it can, enormous penalties all out of proportion to any taxes that might have been owed. The US Taxpayer's Advocate has expressed dismay at this state of affairs.
• Second, it is likely that everyone will see increased costs for financial services across the globe, even for those with no ties to the US of any kind, as compliance will have to be done on every account and institutions can be expected to pass on these costs in the form of higher fees and charges. 
• Third, it seems that data security risks rise as bulk data including social security numbers, account numbers, financial transactions, and other personal information is collected and shared with the IRS. If the info will be shared with other US federal agencies, as Senator Levin has suggested ought to be the case, this seems to compound the data security risk. 
• Fourth, there appears to be no remedy for error, compounding the problems noted above. If an institution flags a person as a "US person" in error, that person seems to be caught in a system with little or no review mechanisms in place. I am not sure how a person manages a case of mis-characterization. 
• Finally tax compliance is extremely costly when you live in another country, so as more Americans try to get compliant the global personal compliance industry (e.g. tax accountants and lawyers with US expertise) stands to profit handsomely. This is another payoff in the form of rent seeking courtesy of the regulatory state. This is also a boon to the institutional compliance industry, i.e., software and systems designers, auditors, risk assessors, and so on, who will benefit from selling their products and services to financial institutions. It also seems to be a boon to people who know how to help one expatriate from the US--which is neither a straightforward nor cheap option.

What should people who are worried about FATCA do? 

• I cannot and do not give legal advice on this. I urge those who are or may be harmed by the injustice of US citizenship-based taxation on themselves, their children or parents or other loved ones, to contact their local government representatives and the senators and congress members of any state to which they have any ties in the USA, to tell their stories and ask why the USA wants to tax their children's education savings plans or other government-sponsored savings plans in the countries where they live, why it is in the interest of the US to make life so difficult for Americans and dual citizens who engage in small businesses in other countries, why the US is so hopelessly out of step with international standards which impose taxation based on actual residence rather than inherited nationality, and why the US expects all of its citizens no matter where they live to fulfill tax obligations yet withholds tax benefits that help the poorest, such as the earned income tax credit. 

Send me additional questions in comments or by email and I will update this post.

Call for US Citizenship-based tax/FATCA stories

If you are in the Montreal area and would like to speak to the media about your experience as a Canadian who is or was affected by US citizenship-based taxation, whether or not you are or could be impacted by FATCA, and whether you wish to speak anonymously or not, could you please get in touch with me either in the comments to this post (moderated, so just indicate if you do not wish publication) or through my contact info, here?

Monday at McGill: Diane Ring on Sovereign Harmony, Domestic Discord

The 4th Annual Tax Policy Colloquium at McGill Law concludes Monday with a presentation by Professor Diane Ring of Boston College on her paper, Sovereign Harmony, Domestic Discord: Democracy and the Gap Between International Tax Cooperation and Domestic Politics (draft not yet available). Professor Ring explores how to understand the interplay between domestic tax politics and the need for nations to speak with one voice on the international stage. She argues that the more fractured internal politics, the less hope there seems to be for the kind of international cooperation that would make the tax system more coherent both nationally and internationally. Here is the Abstract:

The challenges of the international tax system have become ubiquitous. Newspapers recount the tax exploits of multinational corporations that are household names and announce the jail sentences of the latest Swiss bankers and U.S. taxpayers to fall in the ongoing attack on tax evasion. The twin pressures on effective income taxation captured by these stories are those of tax evasion (typically engaged in by individual taxpayers) and tax avoidance (typically characterized by the planning and structuring undertaken by multinational corporations). In both cases cooperation between and among states plays a pivotal policy and enforcement role. That is not to say that cooperation (in its various iterations) is a universal or achieved objective. Rather, the question of whether states can identify a shared goal and move cooperatively toward that goal is an important focus of international tax policy discussions. With respect to the problem of tax evasion there have been some notable steps of cooperation through information sharing measures (including Tax Information Exchange Agreements) as well as domestic changes designed to increase transparency. Less agreement and coordination has been evident for the problem of tax avoidance. The current context in which these questions are being explored communally is the Organization for Economic Cooperation and Development (OECD) project on “Base Erosion and Profit Shifting” (the “BEPS” project). 

But regardless of the degree of current cooperation, agreement, and coordination achieved on these international tax issues, the focus on the status of state-to-state relations can obscure another critical factor in the international tax system: domestic politics. Even if and when states reach a shared understanding of a dimension of the evasion or avoidance problems, a resulting agreement by states is not the end game. Although states must act and negotiate as monoliths in their state-to-state interactions, there remains the ever-present constraint of democracy at home and the possibility that a deal struck on the global stage is undone in the domestic sphere. This dynamic between international relations and domestic “politics” is neither new nor limited to taxation. But the serious attention to and heightened expectations from cooperation among nations regarding major issues of international tax policy requires that comparable attention be directed at the domestic side of cooperation. 

The task of this paper is to explore how domestic politics can impact the heart of the international tax system – agreements among states on important issues of tax policy design and practice. Through a better understanding of the intersection of domestic politics with international debates and agreements, we can consider how and under what circumstances states might diminish the likelihood that domestic discord will ultimately undermine sovereign harmony (i.e. international agreement). Part I outlines three recent examples of international agreement or cooperation that risked rejection or at least significant undermining on the domestic front. Part II reviews the literature regarding international cooperation to develop a framework for approaching the case studies on domestic politics in international tax. Part III draws upon the theoretical work reviewed in Part II to develop a framework for understanding the intersection of international tax and domestic politics. In light of the increasing role that global cooperation and coordination plays in the development of successful international tax policy and practice, the Conclusion considers further research that could illuminate the domestic side of international agreements.

The McGill Tax Policy Colloquium features distinguished visiting academics and offers a forum for students, professors, and local practitioners to discuss issues of tax policy and theory, along with related issues of economics and social justice. Professor Ring's talk will commence at 2:30 pm tomorrow; members of the public are warmly welcomed.

Location: McGill Faculty of Law, 3644 Peel Street, New Chancellor Day Hall, Room 203.

Date and Time: Monday, 25 November, 14:30–16:30.

From John Prebble : Teaching Tax in a Sculpture Park

John Prebble (customarily at Victoria University of Wellington, New Zealand) sends over this post from Austria, where he is currently teaching a course on “Jurisprudential Perspectives of Taxation Law” in WU (Vienna University)’s doctoral programme in international business taxation. As you can see from his remarks below, this would be a very fun place to do a doctorate.

John Prebble

In September 2013, the Institute for Austrian and International Tax Law, together with all the rest of Wirtschaftsuniversität Wien, moved to an entirely new campus, on land on the edge of the Prater, Vienna’s equivalent of Hyde Park in London or Central Park in New York, between the Danube and the Danube Canal. The campus design and the buildings were the product of international competitions.

For gastprofessors like myself, it’s like teaching in a sculpture park: I was the first occupant of the study that projects from the fourth floor of the orange and yellow Law School, designed by Sir Peter Cook, architect of the London Olympic Stadium. The exterior timbers are purely a “poetic fancy”; from the inside your eye scarcely registers them as you focus on the view beyond:

Next is the teaching building, by Carme Pinós, of Barcelona, where I had first use of one of the new lecture theatres. The rusty look of the cladding is indeed rust, but a special sort of rust that protects its steel, so there is no need for paint:

Finally, below are the exterior and interior of the library, by Zaha Hadid, from her Hamburg office. The elevated wedge is the main reading room. Readers’ desks are in tiers and point roughly south-west, giving everyone marvellous views across the woodlands of the Prater. The atrium is an excellent example of the famous sinuous lines of Ms Hadid’s work.