FATCA Reporting on U.S. Accounts: Recent Legal Developments
Released: 2016-09-07T00:00:00

O ne of the more controversial tax laws enacted in recent years is the Foreign Account Tax Compliance Act (FATCA). FATCA is intended to curb U.S. tax evasion occurring through the use of offshore accounts. While the law was enacted in 2010 with a 2013 effective date, the IRS delayed FATCA's implementation for several years in order to give entities time to comply. The law is now fully in effect.

Key among FATCA's provisions is the requirement that foreign financial institutions (FFIs) report information on their U.S. account holders to the Internal Revenue Service (IRS). In order to implement this requirement, the United States has entered into bilateral agreements with numerous countries. Under some of these agreements, FFIs report the information to their home country, which then provides the information to the IRS. For those FFIs that are not covered by such an agreement, FATCA generally requires they report the information directly to the IRS.

This report provides an overview of the FFI reporting requirements and examines the role of the intergovernmental agreements (IGAs) in implementing them. The report then discusses the confidentiality protections provided to the information reported by FFIs and litigation in which plaintiffs have raised concerns about privacy and the use of IGAs. It ends with a summary of FATCA legislation introduced in the 114 th Congress. For further discussion of FATCA, as well as the related requirements known as Foreign Bank Account Reporting (FBAR), see CRS Report R43444, Reporting Foreign Financial Assets Under Titles 26 and 31: FATCA and FBAR .

Overview of FFI Reporting Requirements

FATCA generally requires that FFIs enter into agreements with the IRS under which the FFIs agree to report information about their U.S. account holders and comply with other requirements. The financial institutions subject to these requirements include foreign banks, investment funds, hedge funds, private equity funds, broker-dealers, and certain types of insurance companies. The requirements apply to the depository and custodial accounts maintained by the FFI, as well as equity and debt interests in the FFI (except publicly traded interests).

FFIs that fail to comply will have tax withheld at a rate of 30% on many payments made to them from U.S. sources, including interest and dividends. The withholding provision's relatively high rate and broad reach is significant because, as one commentator has explained, "[f]rom a practical perspective and due to the importance of U.S. banks to the global financial community, most foreign banks must comply or they may be effectively prevented from conducting business in many circumstances." The reporting and withholding requirements are summarized in Table 1 .

Intergovernmental Agreements

The United States has entered into bilateral intergovernmental agreements (IGAs) with numerous countries in order to implement the above FFI reporting requirements. In general, an FFI that is resident in, or organized under the laws of, a country that has entered into an IGA will be deemed to comply with FATCA's requirements so long as the terms of the agreement are met. This section examines the IGAs.

Purpose of the IGAs

Since FATCA's passage, there has been criticism of the FFI provisions and their application to entities outside the United States, generally focused on whether the United States was correct to take FATCA's unilateral approach. Questions have arisen about whether FATCA's requirements are inconsistent with existing U.S. treaty obligations; how to handle potential conflict of law issues arising when an FFI is faced with complying with FATCA or its home country's domestic (e.g., banking and privacy) laws; and whether the United States has intruded into other countries' sovereignty. These concerns, and the extent to which they may influence international views of FATCA, could be particularly important because it has been argued that FATCA's successful implementation will likely require the assistance of other countries. In order to address these concerns, the Treasury Department and IRS developed the IGAs to provide other countries with a role in implementing the FFI reporting requirements.

Different Types of IGAs

The Treasury Department and IRS have developed two model IGAs, which are used as the basis for all the IGAs currently in effect. The main differences between the two models are summarized in Table 2 . A list of the countries with IGAs in effect and whether they use a Model 1 or Model 2 agreement is found in the Appendix .

There are different versions of each model to account for whether the United States has an existing income tax treaty or tax information exchange agreement (TIEA) with the other country. In cases in which there is an existing tax treaty or TIEA, the model IGA generally uses the treaty or TIEA as the authority for the IGA's requirements and links its practices and procedures to those developed under the treaty or TIEA. If there is no existing treaty or TIEA, then the agreement creates its own practices and procedures based on FATCA's reporting requirements.

Additionally, there are different versions of Model 1, depending on whether the agreement calls for the reciprocal exchange of information between the United States and the other country. Model 2 has no reciprocal exchange provision.

Countries with IGAs in Effect

As of August 1, 2016, there are 63 IGAs that are in force. Additionally, the Treasury Department and the IRS treat certain countries as having an IGA in effect even though the country has not taken all the necessary steps to actually bring the agreement into force. Such a country will be treated as having an IGA in effect if (1) it has signed an IGA and is taking steps to bring it into force within a reasonable time; or (2) it reached an agreement in substance with the United States on the terms of an IGA prior to November 30, 2014, and it continues to demonstrate intent to sign the IGA as soon as possible. Table 3 lists all the countries that the Treasury Department and IRS recognize as having an IGA in effect—either because the IGA is actually in force or because the country is treated as such under the above circumstances. (The Appendix provides more information about each of these countries, including the dates on which IGAs went into force, if applicable.)

In July 2016, the IRS made a significant announcement regarding the treatment of those countries without an IGA actually in force: such countries will stop being treated as having an IGA in effect in 2017 unless they comply with certain requirements by December 31, 2016. Specifically, if any country in the final two columns of Table 3 wants to continue to be treated as having an IGA in effect, it must provide the Treasury Department with a detailed explanation of why it has not yet brought the IGA into force and a step-by-step plan for doing so.

The Treasury Department will then decide whether it is appropriate to continue to treat the country as having an IGA in effect, considering the explanation and plan, as well as the country's prior conduct. If the agency determines that such treatment is not appropriate, then any affected FFI in that country will have at least 60 days to enter into the IRS agreement that is required in order to comply with FATCA (discussed above in Table 1 ) or be subject to withholding. In those cases in which the Treasury Department decides it is appropriate to continue to treat the country as having an IGA in effect, the agency will monitor the country's progress toward bringing the IGA into force and will reconsider the country's treatment if it fails to comply with the step-by-step plan.

Confidentiality Protections

Some have expressed concerns about the privacy of the information that FFIs are required to collect and report under FATCA. This section discusses the confidentiality protections contained in FATCA and the IGAs.

Statutory Protections

FATCA expressly provides confidentiality protections to the information obtained or used in connection with the FFI reporting requirements. Specifically, no person may inspect or use any information obtained under the FFI reporting provisions for any purpose other than complying with the FATCA requirements or for purposes permitted under IRC Section 6103 (which allows the disclosure of taxpayer information collected by the IRS in certain circumstances, such as sharing it with law enforcement).

If a person knowingly or negligently violates these confidentiality protections, the individual or entity whose information was inspected or used may bring a suit for civil damages against such person in U.S. district court. The law provides for damages in an amount equal to the greater of (1) $1,000 per unlawful act or (2) the plaintiff's actual damages plus, if available, punitive damages. The defendant may also be liable for court costs and attorney's fees. Any such suit must be brought within two years of the plaintiff discovering the unlawful activity.

IGAs

With respect to the confidentiality provisions contained in the IGAs, there are two basic frameworks. If the United States and the country in question have an existing income tax treaty or tax information exchange agreement (TIEA) in place, then the IGA refers to the confidentiality protections in that treaty or TIEA and may further address such protections. For example, one model IGA provides:

All information exchanged shall be subject to the confidentiality and other protections provided for in the [Treaty/TIEA], including the provisions limiting the use of the information exchanged.

Following entry into force of this Agreement, each Competent Authority shall provide written notification to the other Competent Authority when it is satisfied that the jurisdiction of the other Competent Authority has in place (i) appropriate safeguards to ensure that the information received pursuant to this Agreement shall remain confidential and be used solely for tax purposes, and (ii) the infrastructure for an effective exchange relationship….

When there is no existing treaty or TIEA, the IGAs provide express confidentiality protections. For example, one of the model IGAs to be used when there is no treaty or TIEA provides that:

The [FATCA Partner] Competent Authority shall treat any information received from the United States pursuant to Article 5 of this Agreement as confidential and shall only disclose such information as may be necessary to carry out its obligations under this Agreement. Such information may be disclosed in connection with court proceedings related to the performance of the obligations of [FATCA Partner] under this Agreement.

Information provided to the U.S. Competent Authority pursuant to … this Agreement shall be treated as confidential and may be disclosed only to persons or authorities (including courts and administrative bodies) of the Government of the United States concerned with the assessment, collection, or administration of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, U.S. federal taxes, or the oversight of such functions. Such persons or authorities shall use such information only for such purposes.

Such persons may disclose the information in public court proceedings or in judicial decisions. The information may not be disclosed to any other person, entity, authority, or jurisdiction. Notwithstanding the foregoing, where [FATCA Partner] provides prior, written consent, the information may be used for purposes permitted under the provisions of a mutual legal assistance treaty in force between the Parties that allows for the exchange of tax information.

U.S. law, meanwhile, expressly requires that tax treaty information be kept confidential unless such disclosure is permitted under the treaty's terms. Protected information includes information exchanged under the treaty, applications for relief under the treaty, and documents relating to the treaty's implementation. There are limited exceptions in which disclosure is permissible, such as providing information to law enforcement regarding terrorist activities. If information is impermissibly disclosed, the individual disclosing it is subject to a penalty of up to $5,000 and imprisonment for up to five years. Additionally, the person whose information was disclosed may sue for damages under the same authority discussed above.

Litigation About IGAs

While some argue that the use of IGAs may have positive outcomes, including reduced compliance costs for foreign entities and avoidance of international conflict of law issues, others have taken issue with them. Concerns about IGAs are illustrated in two lawsuits—one in the United States and one in Canada. These are discussed below.

Crawford v. Department of Treasury

The case in the United States is Crawford v. De partment of the Treasury . It was brought in 2015 by several U.S. citizens living abroad and Senator Rand Paul, who argue that IGAs are unconstitutional, among other claims. The plaintiffs characterize IGAs as sole executive agreements (in contrast to treaties submitted to the Senate for its advice and consent) that are only permissible if they "fall within the President's independent constitutional authority to make international agreements." As such, the plaintiffs argue that the President is without such authority here because IGAs deal with tax issues and thus fall within the taxing power reserved to Congress under the Constitution. The plaintiffs further argue that IGAs are unconstitutional because they override the statutory provisions passed by Congress in FATCA. Their argument is that FATCA and IGAs are incompatible because (1) FATCA requires FFIs to report directly to the IRS, while IGAs allow FFIs to report to their home government; and (2) FATCA requires FFIs to get a waiver of local privacy laws from account holders, which IGAs circumvent by having foreign governments collect the information.

In April 2016, a U.S. district court in Ohio dismissed the case after determining that the plaintiffs lacked standing. Standing is required by Article III of the U.S. Constitution, which provides that federal courts may only decide actual cases or controversies. The Supreme Court has interpreted this provision to mean that, in order to bring suit in federal court, a plaintiff must establish that (1) he or she suffered an injury; (2) there is a causal connection between the injury and the defendant's action; and (3) it is likely the injury will be redressed by a favorable court decision. The court in Crawford ruled that none of the plaintiffs had met all three requirements. For example, the court determined that injuries based on privacy concerns were insufficient because the reporting requirements were not "an invasion of a legally protected interest," and that none of the plaintiffs had alleged a concrete, non-hypothetical injury because none had actually been subject to the 30% withholding or any other penalty. Plaintiffs have appealed the decision to the U.S. Court of Appeals for the Sixth Circuit, and that court has not yet issued a decision.

Possible Implications of a Ruling on the Merits

If a court were to rule in the plaintiffs' favor on the merits of the IGA issue, such a ruling would likely affect the way in which FATCA is administered but might not change the law itself. FATCA's reporting and enforcement provisions are not legally dependent on the use of IGAs, and these provisions would appear to still have legal force even if IGAs were found to be unconstitutional. Thus, FFIs and other entities would still be subject to FATCA, but would no longer be able to report information to their home country under the IGA or take advantage of other provisions in the IGAs.

Possible implications for Congress of a ruling that IGAs are outside the President's authority could include passing legislation to authorize these types of agreements; potentially reexamining FATCA, particularly in light of compliance issues that might arise without the use of IGAs; or taking no action and letting the law continue without IGAs. If Congress chose not to make any legislative changes, possible options for the Treasury Department and IRS, should they conclude that IGAs are a useful tool, might include implementing the agreements through the regular treaty process, which would require the Senate's approval.

Hillis v. Attorney General of Canada

The litigation in Canada concerns the validity of that country's FATCA IGA. In the case, Hill is v. Attorney General of Canada , dual U.S.-Canadian citizens have raised two arguments against the Canadian legislation implementing the IGA: (1) the information exchange authorized by the IGA is inconsistent with the U.S.-Canada income tax treaty and Canadian tax law; and (2) it runs afoul of Canada's constitution. In September 2015, the Federal Court of Canada held that there was no legal impediment to implementation of the IGA under the income tax treaty or Canadian tax law, and allowed the first exchange of information under the IGA. The court permitted the plaintiffs to continue to assert their constitutional claim, but the status of such claim is unclear.

Possible Implications of a Ruling on the Merits

If the court were to hold that the IGA is invalid under Canada's constitution, this would not appear to change FATCA's underlying requirements. That is, banks and other financial entities in Canada would still be subject to FATCA reporting requirements, which might then lead to potential conflict of law questions. One possible outcome of such a ruling might be for the United States and Canada to attempt to find a mechanism that would be consistent with both countries' laws (e.g., amending the existing income tax treaty, which would require U.S. Senate approval). Another possible consequence of such a ruling is that it might encourage U.S. expatriates living in other countries to challenge those countries' IGAs, particularly since many have similar bilateral income tax treaties with the United States.

FATCA Legislation in the 114th Congress

Several bills have been introduced in the 114 th Congress that would amend or otherwise address FATCA. First, S. 663 , whose stated purpose is "[t]o repeal the violation of sovereign nations' laws and privacy matters," would repeal many of FATCA's provisions, including the FFI reporting and withholding requirements.

The Stop Tax Haven Abuse Act ( H.R. 297 and S. 174 ) includes a provision with the stated purpose of "strengthening" FATCA. Among other things, the bill provision would expand the reporting requirement for passive foreign investment companies; expand the definition of "financial account" to include transaction accounts; expressly include entities engaged in investing in derivatives and swaps in the definition of "financial institution"; and include beneficial owners within the definition of "substantial U.S. owner." The provision would also make it easier for information to be disclosed in certain circumstances.

Finally, the Commission on Americans Living Abroad Act ( H.R. 3078 ) would establish a commission to study how federal laws and policies, including FATCA, affect U.S. citizens living in foreign countries.

Appendix. Countries with IGAs in Effect

The countries that have IGAs in effect—either because the IGA is actually in force or because the country is treated as such—are listed in Table A-1 . As discussed above, Treasury and the IRS treat certain countries as having an IGA in effect even though the country has not taken all the steps necessary to actually bring the agreement into force under two circumstances: (1) it has signed an IGA and is taking steps to bring it into force within a reasonable time; or (2) it has reached an agreement in substance with the United States on the terms of an IGA prior to November 30, 2014, and it continues to demonstrate intent to sign the IGA as soon as possible. In addition to providing such status information for each country, Table A-1 also notes whether each country uses a Model 1 or Model 2 IGA and provides relevant dates.