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Leaked guidance notes threaten to invalidate Canada’s FATCA IGA

Tuesday, 1 April, 2014

By Roy A Berg TEP and Kim G C Moody TEP

Canada risks finding itself on the wrong side of history according to confidential CRA guidance notes leaked on March 26, 2014 and legislation buried in the 2014 Budget Implementation Bill tabled on March 28.  The legislation and notes are necessary to bring into force Canada’s intergovernmental agreement (IGA) with the US Treasury regarding the Foreign Account Tax Compliance Act (FATCA).

The legislation was buried in the 396-page bill that implements key elements of the 2014 Economic Action Plan, the press release for which did not reference FATCA or the IGA. The notes and legislation confirm Canada’s attempt to unilaterally restrict the definition of “financial institution,” which places it squarely out of step with the IGA, US law, IGAs with other countries, and the OECD’s common reporting standard for the exchange of financial account information.

FATCA is designed to stem the USD100 billion the US congress calculates it loses annually to tax evasion by US citizens who secret assets offshore. The OECD has used the FATCA architecture as the template for the worldwide effort to combat tax evasion. OECD member countries, of which Canada is one, have agreed to implement these standards beginning 2015.

The US’s FATCA legislation is stunning in its ambition, reach and its complexity and if Canada had not entered into the IGA with the US, FATCA would have applied unilaterally, and all Canadian entities would have faced the dilemma of complying with Canadian law (and suffering the consequences under FATCA) or complying with FATCA (and suffering the consequences under Canadian law). All right-minded people will agree that life under the IGA is better than life under FATCA.

However Canada’s legislation and leaked guidance notes threaten to invalidate the IGA and cast certain Canadian entities, including private trusts, out of the walled garden of the IGA and into the inky blackness of FATCA.

Pundits and commentators that either admonish Canada for entering into the IGA or encourage Canada to take a stand against the US, frankly do not understand how FATCA withholding works. Simply put, FATCA is self-executing and does not require enforcement by any sovereign. FATCA is enforced by the rational economic decisions made by market participants. In that sense, FATCA works like a sales tax: the merchant is obligated to withhold and remit the sales tax, and if it fails to do so it is liable.

If the legislation is passed into law it will likely result in three undesirable consequences.

First, the US Department of the Treasury could conclude that the legislation has failed to validly implement the IGA, which would nullify the IGA and subject Canadian entities to the full force and effect of FATCA.

Second, If the legislation does bring into force the IGA (which is unlikely) a Canadian entity that is not classified as an financial institution under domestic law (for example a Canadian private trust) but would be classified as an financial institution under US law or other IGAs (for example a Canadian private trust) will face unnecessary withholdings and the concomitant obligation to seek a refund directly from the IRS.

Third, inconsistent definitions of the term financial institution among jurisdictions that have executed IGAs will cause increased compliance costs and uncertainty in the marketplace. Both the OECD and UK recognized the need for consistent definitions and have taken the global lead in developing model and domestic legislation to provide a framework for the consistent application of definitions and resulting entity classification.

The global effort to combat tax evasion has changed the world, and we are only now beginning to feel the repercussions. The IGA goes a long way to mitigate the compliance cost and consequences of non-compliance. However, the Canadian legislation threatens to derail the benefits otherwise conferred under the IGA and force all Canadian institutions into the dilemma of complying with FATCA or complying with Canadian domestic law. As the OECD’s common reporting standards are adopted by member countries in the next few years, Canada’s reluctance to adopt standard entity classifications threatens its credibility as a country committed to the global attack on tax evasion.

We can’t go back: FATCA has changed the global banking and business and tax landscape and more changes will follow.

Roy A Berg TEP and Kim G C Moody TEP are Managing Directors at Moodys Gartner Tax Law LLP

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