While in France, following the “Cahuzac Case” and “Offshore Leaks”, offshore accounts have caused a storm of controversy, the United States has adopted “FATCA” (Foreign Account Tax Compliance Act), a new legal instrument which identifies these accounts and fights tax avoidance.
In 2009, UBS bank was prosecuted for helping clients hide assets in foreign accounts and paid $780 million in fines to the Internal Revenue Service (IRS – the American tax authority). Since this case, the US Government has gone on the offensive against U.S taxpayers who have undeclared foreign accounts. This position is explained by the fact that US residents are required to report and pay taxes on their worldwide income.
The most serious measure was the implementation of FATCA, a subset of a provision contained in the Hiring Incentives to Restore Employment Act (“Hire Act”) of March 2010. However, due to the complexity of this act and reluctance from financial institutions, the enforcement of FATCA has been pushed back to 2014. Before FATCA, US Taxpayers needed to declare financial interests in any foreign accounts. Then, since 2011, they must declare foreign financial investments on their annual tax returns. Now, FATCA applies to Financial Foreign Entities (“FFI”) that have US citizens and US entities as clients.
According to section 1471 of the Internal Revenue Code (IRC), FFIs cover a wide range of institutions, including financial institutions that accept (A) deposits in the ordinary course of banking or a similar business, or (B) hold financial assets for the account of others, or (C) are engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest in such securities, partnership interests, or commodities. The foreign entities which don’t meet one of these three requirements are considered to be a Non Financial Foreign Entities (“NFFE”).
FATCA presumes that all US taxpayers with foreign financial assets are committing a fraud unless they report them in accordance with the FATCA obligations. Generally, an FFI is subject to a 30% withholding tax on all payments received from US. However, the purpose of this law is not to collect money but rather to coerce FFIs to unearth US account holders and to reveal information about these accounts.
To avoid this sanction, a disclosure agreement must be signed by such FFIs with the Secretary under which such institutions agree to obtain information in order to determine if any account is a US account. FFIs are also required to comply with IRS verification and due diligence requests, to report annually information about any US account (account number, bank account balance, amounts of revenues and withdrawals from US and non US sources…) and to deduct and withhold 30% of certain payments made by persons who failed to provide information to determine whether an account is a US one or not. Besides, FFIs must report certain information of NFFEs to the IRS about its substantial US owners (i.e. when US owner holds more than 10% in such NFFEs).
If FFIs don’t comply with the above mentioned reporting and withholding requirements for its US accounts, all payments from US sources are subject to this withholding. As a result, if an FFI doesn’t meet the reporting requirements on foreign accounts owned by US citizens or US entities, even non US clients of this FFI will be impacted by a 30% withholding tax on payments received from the US.
Another way to avoid this heavy sanction is for the FFI to comply with the provisions of an intergovernmental agreement (IGA). The IRS can enter into an IGA with a foreign government to remove the impediments to FATCA reporting, such as the agreement concluded between the IRS and France, Germany, Italy, Spain, and the UK in July 2012. An IGA is intended to avoid local law conflicts that may arise if an FFI complies with FATCA, a US-centric law, as well as to reduce administrative burdens and costs.
With this agreement, the United States is willing to reciprocate in collecting and exchanging on automatic basis information on accounts held in US financial institutions by residents of a contracting state.
FATCA, a law contrary to international law ?
FATCA seeks to promote compliance with US laws by obtaining certain disclosures about US citizens and US entities to ensure that all relevant US taxpayers are identified and that their investments and offshore accounts are reported. But the provisions of this law create compliance issues regarding international law.
Firstly, the exchange of information provided by this law is contrary to some tax agreements made between the US and third countries, such as the tax treaty concluded between the US and the Philippines. Indeed, article 26 of this tax agreement (which addresses the avoidance of double taxation) provides that it is forbidden to exchange information contrary to public policy, and therefore, it would be impossible to compromise the secrecy of bank deposits enforced by the Philippines.
In addition, it should be noted that IGAs don’t seem to replace bilateral tax treaties1, but rather interpret the convention on mutual administrative assistance in tax matters as per the new US rules. Besides, unlike tax treaties, an IGA is not signed between both governments of the contracting states, but between the IRS and the Government of the other contracting state. That means that if an IGA conflicts with the provision of a tax treaty , then an issue may rise as to which one will apply.
Also, by subjecting taxpayers to a 30% withholding tax on all US source payments of an FFI in the case of a lack of information exchange, FATCA overrides international tax treaties which provide lower tax rates.
However, while in France a hierarchy of sources is obvious (international treaties are superior to domestic laws), American law applies the “last in times” rule2. This rule states that Federal law and international treaty are on equal footing and as a result, insofar as domestic law entered into force after a tax treaty, the domestic law shall prevail over the tax treaty.
This rule may raise concerns, especially in France. Indeed, under international law, a party cannot invoke the provisions of its internal law as justification for its failure to perform with a tax treaty (Article 27 of Vienna Convention on the law of treaties). Based on this principle, the French tax authorities reject imputation of tax credit in France or any deduction corresponding with the withholding surcharge (even if no surcharge should apply being that France is a signatory to an IGA with the US).
The difficulties of implementation in France
In order to prevent tax avoidance, France has many legal instruments, in particular controlled foreign corporation rules (CFC rules). However, France has few means to identify offshore accounts. This is a problem, being that the way to hide money is by putting it into accounts located in tax heavens where banking secrecy is protected.
France provides only deterrent and not coercive instruments to identify offshore accounts. In fact, pursuant to article 1649 A of the French Tax Code (FTC), each individual person shall only declare his foreign accounts to French tax authorities. It should be added that commercial corporations are not subject to this declaration. Pursuant to article 1736-IV of FTC, failure to comply with this requirement may render the person concerned liable to a penalty of € 1500, or € 10K if the account is located in a country which has no convention on administrative assistance with France including requiring the exchange of bank information, and up to 5% of bank account balance if the total undeclared amount exceeds € 50K.
In addition to this penalty, since the last amended financial bill in 2012, hidden amounts in foreign accounts are deemed to be, in the absence of evidence to the contrary, fictitious and are therefore taxed at a rate of 60%. Moreover, the statute of limitation (SOL) is 10 years, whereas the normal SOL is 3 years.
To its credit, FATCA forces FFIs to exchange information about US account holders. However, the assumption of an implementation into French law could cause pitfalls, beyond the issues of the aforementioned international law. First of all, France might have difficulties imposing the same mechanism on other countries, seeing that France does not have the same economic power to force the exchange of information on behalf of FFIs.
Also, regarding European law, this mechanism is incompatible with the European Union (EU) principle of free movement of capital. And, even if one might contemplate a measure applicable only to countries outside of the EU, the EU prohibits all restrictions on the movement of capital between Member States and third countries, except in case of appropriate justification, such as tax avoidance. Nevertheless, this justification might be challenged regarding the proportionality principle, which means the content and form of the action must be in keeping with the aim pursued, and in particular that no alternative and less intrusive measures be available.
Thus, a closer cooperation between EU countries appears to be the only solution to implement a version of FATCA in Europe. However, as with many tax matters, some reluctant countries (especially Austria and Luxembourg) will probably protest in order to keep their favorable regimes and banking secrecy. Since April 9, five EU countries, including France, Germany, Italy, Spain, and the UK, announced an agreement to develop and pilot multilateral tax information exchange arrangements and ask the European Commission to establish a “European FATCA”.
Thibault Stumm & Florian Tumoine
Interns at Barclais USA, LLC
1 See Point A- 7 of Joint statement between US Treasury Department and France
2 Whitney v. Roberston (1888)
For more information : Sections 1471 through 1474 of the Internal Revenue Code of 1986.