December 17, 2023
FATCA – Predictions of Implementation Failure Proving True

by Denis Kleinfeld

Denis Kleinfeld examines the impact FATCA has had on the global financial industry, and why predictions that FATCA could not be implemented are proving true.

The threat of FATCA enforcement has impacted every jurisdiction in the world and the global financial industry is quaking with fear. The US Justice Department has taken the position that the entire non-US financial industry is potentially part of a continuing criminal conspiracy with some US individuals and multi-national companies to evade US income tax. The Justice Department has unilaterally forged ahead to obtain indictments and convictions over prominent foreign banks, bankers, and some of their US customers. The United States justification for claiming the moral high ground is that it is merely seeking to have all US taxpayers pay tax as required under US law.

FATCA is not happening in a political vacuum. There is a history of difficulties in Congress with enforcing its income tax system on the taxpayers as well as problems with the Internal Revenue Service (IRS) administering the burdens placed on it. A basic understanding of this is necessary in order to have a fuller comprehension of just why FATCA cannot be implemented.

In describing the 1998 Congressional Hearings on restructuring and reforming the IRS, a former IRS Commissioner referred to them as staged or show hearings. Clearly, the hearings— as with most Congressional Hearings– were carefully choreographed proceedings where maximum political outrage was expressed just in time to make the evening television news. This same sort of staged hearing was repeated in establishing the legislative justification for the enactment of the Foreign Account Tax Compliance Act of 2010 (FATCA).

Witnesses before the Senate Subcommittee holding the hearings had a witness testify under oath that US$70 billion – over 10 years in tax revenue – is lost due to offshore personal income tax evasion. The problem with the testimony was that the witness had no methodology or any evidence at all to support the claim and the Subcommittee never asked for any. (When asked during a later conference where the number came from he said he “guessed.”)

The Senate Subcommittee issued its report based on its hearing saying the tax evasion figure was US$100 billion over 10 years. The support for this US$100 billion appeared in a footnote which referred to six magazine articles. Those articles, however, similarly to the testifying witness, had no methodology or evidence to support the quantification of the estimated lost tax revenues. Nonetheless, the Senate Subcommittee Report declared as a fact that US$100 billion of US income tax revenue is being lost due to tax evasion facilitated by offshore tax havens. The United States Congress Joint Committee on Tax estimated that FATCA would raise US$792 million additional tax a year for the next 10 years.

The political truth is that FATCA was then enacted to serve as the revenue enhancement to the Hiring Incentives to Restore Employment Act of 2010 (the HIRE Act). Essentially, FATCA was put into law so Congress could justify a US$100 billion increase in spending—what is referred to in the United States as ‘pork barrel’ spending– under the HIRE Act. Conveniently, it also served as the vehicle by which the United States could get rid of those pesky gateway offshore tax haven competitors that interfered with its own tax haven operations.

Then FATCA took on a life of its own, spinning out of control. The Law of Unintended Consequences proves true once again. A whole new tax lexicon was created with terms that are nearly incomprehensible even to US tax professionals much less to non-US tax advisors and those who do not speak the American form of the English language. Hundreds of pages of regulations were issued in short order and thousands more are expected to follow. The entire concept of international automatic financial information reporting is dependent on developing software and technology that does not yet exist.

Understandably, foreign financial institutions (FFIs) and governments are all finding implementation of FATCA seemingly impossible for a growing list of reasons. Prominent among these reasons are: the direct cost of compliance, lack of effective cybersecurity, increased exposure to new and yet undefined institutional, director and officer liability and unavailability of insurance, customer resistance, inability of foreign countries to receive reciprocity in agreeing to an intergovernmental agreement (IGA) with the US, inability to cope with the US tax complexity, and an accelerating lack of trust in the United States. On the other hand, tax professionals, consultants, IT, forensic, marketing, and all the other service providers to the financial industry see FATCA as being a gold mine for fees.

There are no reliable estimates of the direct costs to the private financial sector or to governments who implement the FATCA regime. Even without considering its complexity, the reality is that the cost of establishing FATCA will remain unquantifiable for both government and private industry if for no other reasons than FATCA may very well be substantially amended, repealed or replaced. Legislation has already been entered into Congress to repeal it. The Treasury Department has declared a second delay of FATCA. This time it’s for six months, purportedly to allow for the Treasury to complete IGAs with countries across the globe before the withholding of tax begins. As of now, there is no final and definitive FATCA structure upon which to make cost computations. When FATCA was passed in Congress, the House Ways and Means Committee (which controls tax policy) did not do any cost/benefit analysis.

The idea that a government run computer system containing private financial information can be secured from information theft is ludicrous on its face. Among high value financial targets which have been hacked is the Federal Reserve. Details as to banker’s login information, credentials, internet protocol addresses, and contact information on more than 4,000 banks were stolen. The Federal Government’s General Accountability Office reported as follows:

“Cyber threats and incidents are increasingly prevalent. Threats to systems supporting critical infrastructure and government information systems are evolving and growing. These threats come from a variety of sources and vary in terms of the types and capabilities of the actors, their willingness to act, and their motives. For example, advanced persistent threats—where adversaries possess sophisticated levels of expertise and significant resources to pursue their objectives—pose increasing risks…

The many continuing cybersecurity challenges faced by the government highlight the need for a more clearly defined oversight process to ensure agencies are held accountable for implementing effective information security programs. Further, until an overarching national cybersecurity strategy is developed that addresses all key elements of desirable characteristics, overall progress in achieving the government’s objectives is likely to remain limited.”

This information comes from GAO’s 2013 High Risk Report. This report is updated every two years, at the start of each new Congress.

No doubt cybersecurity should be an important factor in any governmental or private financial institution’s relevant cost/benefit and risk analysis before participating in FATCA.

Breaches of cybersecurity are going to bring fresh rounds of litigation against financial institutions. Possible actions include class actions, derivative lawsuits, and new waves of government actions such as securities enforcement to name but a few. FATCA compliance does not bring with it any waiver of liability or immunity from lawsuits or government actions. Clearly, if something is worth being taxed then it is worth stealing. Organising detailed private financial information for FATCA automatic information reporting is, to use an analogy, like teeing up a golf ball for a thief to take a swing at. While director and officer liability has not been given any consideration by government or financial industry advisors, it is hard to get around the fact that not only may there be institutional liability but also personal liability on the part of the institution’s officers and directors. The risk exposures to possible liability due to FATCA should be reviewed closely to determine if insurance coverage is available and at what premium cost.

Competition in the financial services industry is fierce. And that is putting it mildly. Customers want to have peace of mind when dealing with their financial affairs and a trusting relationship with their financial professionals. FATCA is directed towards the collection of US tax from people otherwise avoiding or evading paying. The tax compliance regime being imposed on the world by the United States is not designed to create good will with private institutional customers. What the customer thinks or feels is irrelevant. Each foreign financial institution will need to determine for itself whether its customers or clients will pay the additional fees and costs and agree with the potential disclosure to the government of deeply private information and secrets or they do not. It may reasonably be suspected that some FFIs and governments may determine that it pays for them not be involved in the FATCA system and thereby become attractive to customers who want to be free of any connection to the US tax system.

One form of the model IGA is designed as a one way information street. The other form of model IGA is supposed to work as a two way street. There is a problem with the second model IGA. The Treasury has no legal authority to make US institutions comply with FATCA for the benefit of foreign governments. Whatever reciprocity was promised in negotiations for the IGA, the Treasury is not able to deliver on it until the Congress passes legislation granting the legal authority. The Administration has proposed this change in its 2014 Budget proposal since the Treasury recognises the problem. For FFIs whose government has not yet signed an IGA or passed enabling legislation this becomes a serious dilemma.

FATCA compliance will not be simple. Nothing involving US taxation is ever easy. The Taxpayer Advocate Service (TAS), a part of the US Treasury, reports that the most serious problem facing the US taxpayers, and the IRS, is the complexity of the tax code. The TAS states in its latest report that the tax code requires ‘excessive’ time to comply, obscures comprehension, facilitates tax avoidance and provides criminals with opportunities to commit tax fraud, undermines trust in the system, and overburdens the IRS. Numerous other US governmental agencies report that the IRS is overburdened, undermanned and underfunded. Only 16 per cent of taxpayers think the tax laws are fair. Just 12 per cent think taxpayers pay their fair share. The National Taxpayer Advocate “finds this extraordinary lack of public trust in the method by which our government is funded profoundly disturbing.” The latest Gallup poll shows that trust and faith in the American government is lower than during Watergate.

Americans are not alone in not trusting the US government. The current Administration is mired in scandals of momentous proportions. Various people at the IRS have raised their constitutional right (taking ‘the Fifth’) to refuse to testify before Congressional committees about targeting political groups, Benghazi, Rosengate (involving news reporting), Fast and Furious (where the Attorney General has been held in contempt of Congress, Solyndra, and a long list of other disputes which also includes Congressional actions all of which impacts the overall credibility of the administration of the US government. The FATCA anti-privacy offensive has been linked to the US surveillance operations being conducted by the National Security Agency (NSA) and its wide-ranging covert operations. This is part of the collective atmosphere and environment that will influence the operations of an FFI when they agree to participate in the FATCA regime.

There has long been a battle over the income taxation of domestic and foreign related transactions. FATCA appears to be only the latest. Prominent commentators have stated that the United States is in an income tax crisis which has now reached new depths. They have pointed out that the federal tax base is under ‘widespread assault.’ For nearly the 100 years of the existence of the income tax in the United States Congress has been unsuccessful in reforming it. The spectacle of politicians pledging to overhaul the tax system is the recurring theme of every election. It is not tax evasion that has created the need for offshore tax havens. Tax havens exist because of the income tax system. Whether the totality of events of which FATCA has become a prominent feature will finally result in adoption of a more efficient and effective tax system world-wide remains to be seen. What can be said for now is that predictions that FATCA could not be implemented are proving true.