Canada’s FATCA pact

Thursday, 01 May 2014
Mark Fleming and Ralph Awrey consider the facts and implications of the US and Canada’s intergovernmental agreement.

While perennial sporting rivals the US and Canada were preparing to battle it out on an ice hockey rink at the 2014 Winter Olympics, their respective governments were thrashing out the final details of an intergovernmental agreement (IGA) intended to facilitate the implementation of the US Foreign Account Tax Compliance Act (FATCA).

Model 1 IGA

The IGA, which was signed in Ottawa on 5 February 2014, is of the reciprocal Model 1 variety and will see Canadian financial institutions having to identify and report financial accounts held by US clients to the Canada Revenue Agency (CRA), which will in turn exchange the information with the US Internal Revenue Service (IRS) through the existing provisions of the Canada-US tax treaty. At present, it is estimated that about one million US citizens reside in Canada, a number that may increase if one also factors in ‘accidental Americans’ (that is, people who have never lived in the US, but who qualify as US citizens because they were born on US soil, or have a US parent). As yet, it is not clear how many Americans will be affected by the IGA. What is clear is that this is a significant next step in the growing trend towards automatic exchange of information and global tax transparency.

FATCA, which was brought into US law as part of the Hiring Incentives to Restore Employment Act, enacted on 18 March 2010, has led to a web of bilateral tax agreements between the US and other countries. Aimed at tackling tax evasion and creating greater fiscal transparency, FATCA requires financial institutions around the world to identify foreign accounts held by US persons (including US citizens, regardless of where they reside, and US residents) and certain non-US entities in which US persons have an interest, and report information about the US persons and the accounts to the IRS.

Protracted negotiations

Many would have expected an agreement between the US and Canada to be reached quickly, given their significant trade and economic links, as well as the fact that Canada already has an existing automatic information-sharing agreement in place with the US. However, the negotiations between the two North American giants have been protracted and Canada was the last of the G7 nations to sign an IGA with the US.

Canadian Finance Minister Jim Flaherty raised objections to FATCA from the start, stating the existing Canada-US tax treaty allowed the US to do all it needed, as well as stating that FATCA created unnecessary paperwork. He even wrote to US newspapers in September 2011 questioning whether FATCA would, as intended, reduce tax evasion, and accused the US of looking for ‘tax havens’ where they do not exist.

In announcing the signing of the IGA, Flaherty stated that ‘Canada engaged in lengthy negotiations with the US government to address our concerns and, as a result, significant exemptions and other reliefs were obtained’. Using the CRA as a ‘go-between’ allows a mechanism for Canadians who feel they have been incorrectly flagged to appeal. It also addresses any concerns about potential breaches of Canada’s privacy laws had Canadian financial institutions been sending customer information directly to a foreign government. Under the IGA, the IRS will also provide the CRA with increased information on certain accounts of Canadian residents held at US financial institutions.

Exempt accounts and arrangements

Certain accounts and arrangements have been identified as exempt from FATCA under the IGA, and will not be subject to review and will not be reportable. Included on the list are tax-free savings accounts, registered retirement savings plans, registered retirement income funds and registered disability savings plans.

GIIN

Most Canadian financial institutions will have an obligation to register with the IRS to obtain a global intermediary identification number (GIIN) for use when reporting to the CRA and to identify themselves to paying agents as FATCA-compliant.

No withholding tax

Without the IGA, there would have been a 30 per cent withholding tax on US-source investment income and related gross proceeds received by Canadian financial institutions that didn’t enter into an agreement with the IRS to comply with FATCA, and a similar 30 per cent withholding tax on clients who failed when asked to provide responses to enquiries from their account-holding institutions as to their US tax status. This would have been unilaterally and automatically imposed as of 1 July 2014, but the signing of the IGA eliminates this withholding tax unless a Canadian financial institution is found in significant and long-term non-compliance with its obligations under the new requirements. When announcing the IGA, Kerry-Lynne Findlay, the Minister of National Revenue in Canada, was at pains to state that ‘this is strictly a tax information sharing agreement. This agreement will not impose any US taxes or penalties on US citizens or US residents holding accounts in Canada’.

Draft legislation

Concurrently when announcing the IGA, the Canadian Department of Finance released a package of draft legislation to implement the agreement. The legislation provides additional details to Canadian financial institutions on how to implement the IGA, including timelines and penalties for non-compliance. Canadian financial institutions will be required to report information about their US accounts to the CRA before 2 May every year, beginning in 2015. The CRA will then pass the information over to the IRS by 30 September.

Improving tax transparency

The signing of the IGA is also fully consistent with Canada’s support for recent G8 and G20 commitments to improve tax transparency and fight tax evasion globally. In September 2013, G20 leaders committed to automatic exchange of tax information as a new global standard by endorsing a proposal by the Organisation for Economic Co-operation and Development (OECD). On 13 February 2014, the OECD released the Common Reporting Standard (CRS) for automatic exchange of information, modelled on the FATCA IGA. The G20 endorsed the CRS in Sydney on 22–23 February. Canada is actively participating in the work of the OECD.

Clearly, the introduction of FATCA has played a major part in international developments. Over 20 Model 1 IGAs have been signed, and many other countries have indicated that they are negotiating an agreement with the US or are at least exploring the option. Three Model 2 IGAs have also been signed, requiring financial institutions in the relevant jurisdictions to deal directly with the IRS rather than go through their local government.

The UK has also looked at FATCA as a model for its own tax-enforcement strategy and introduced the ‘UK FATCA’, an IGA that the UK has entered into with the Crown Dependencies and British Overseas Territories. These agreements will see the Dependencies and Territories exchange information relating to UK tax residents holding accounts with financial institutions based in their respective jurisdictions.

Despite this progress, FATCA remains emotive, dividing opinion. Increasing numbers of Americans living abroad are renouncing US citizenship. In 2013, 2,999 gave up their citizenship or green cards – an all-time record. Some foreign institutions also view FATCA as so onerous to implement that they have decided no longer to service US clients, thereby limiting their obligations under FATCA.

The Canada-US IGA, while not groundbreaking in the way it is structured, as it is largely a typical Model 1 agreement, will, in all likelihood, result in further IGAs being signed. FATCA has had its critics, but it has undeniably been an important step in the development of automatic exchange of information as the new international norm. Those organisations in the wealth-management arena that have long sought to avoid clients engaged in tax evasion, and to work with their clients and their advisors in a tax-compliant manner, are having to further adapt their operating practices, not least so that their client-facing professionals can speak knowledgeably to their clients and their advisors as they in turn strive to get to grips with the rapidly changing reality of global tax transparency.  

Canada’s draft legislation

Roy Berg TEP is a Director of US Tax Law and Kim Moody TEP is a Director of Canadian Tax Advisory at Moodys Gartner Tax Law LLP 

While the IGA Canada executed with the US is a standard Model 1 IGA, Canada’s draft implementing legislation is remarkable and without precedent. The draft legislation narrows the definition of ‘financial institution’ (FI) to one of 11 entity types, which excludes Canadian private trusts and other entities that would otherwise be included. The result is that some Canadian entities (including private trusts) would be classified differently under Canadian law than under FATCA or the other IGAs.

This result is problematic for all Canadian businesses. No other IGA partner has attempted to do what Canada has done and the result is directly contrary to the definitions found in Treasury Regulations, every other IGA, the guidance notes issued by the UK, and the OECD’s Common Reporting Standard.

If the draft legislation is passed into law, it may result in three undesirable consequences.

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

Second, if the legislation does bring into force the IGA (which is unlikely), a Canadian entity that is not classified as an FI under domestic law (e.g. a private trust or private holding company) but would be classified as an FI under the Treasury Regulations or other IGAs will likely face unnecessary withholdings and the concomitant obligation to seek a refund directly from the IRS.

Third, inconsistent definitions of ‘foreign financial institution’ among jurisdictions that have executed IGAs will cause increased compliance costs and uncertainty in the marketplace. The UK realised this risk early on and has taken the lead in developing its domestic legislation to provide a model framework for the consistent application of definitions and resulting entity classification.

Joseph Kellogg TEP, Kim Moody TEP and Michael Pfeifer TEP will be discussing the impact of US/Canadian tax developments on cross-border US/Canadian families at STEP's Global Congress. Find out more and register to secure your place at www.stepglobalcongress.com

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Mark Fleming and Ralph Awrey

Mark Fleming is Private Client Associate Director and Ralph Awrey is Managing Director, International Solutions at RBC Wealth Management.

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