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Paying the IRS piper

A blunt-instrument U.S. tax law is stressing out Canadian credit unions and their members

May_2014_F4-FATCA1-C1_LisingLynne Swanson describes the day that she learned that she might be forced to pay the U.S. government thousands of dollars in back taxes as her “Oh-my-God moment.”

The 63-year-old resident of London, Ontario – a retired human resources executive – emigrated from the U.S. to Canada in 1969 and became a full-fledged Canadian citizen in 1973. The U.S. consulate told her then that she had “permanently and irrevocably relinquished” her U.S. citizenship.

Fast forward to August 2011 when Swanson received a troubling letter. “A friend sent me an email saying, ‘Have you seen this? Are you compliant with the IRS? If not, you need to get in line and file or they’ll seize 50 per cent of your assets by the end of August. If you do it on time, they’ll only take about 27.5 per cent.’”

Swanson, a member of Libro Financial Group ($1.8 billion in assets, 59,000 members), believed the situation didn’t apply to her because she was no longer a U.S. citizen. But just to be certain, she started doing some research. “And then I had what many, many Canadians have had – my ‘Oh-my-God moment,’” she says. It turns out that the U.S. consulate had been wrong and the only way she could settle things was by formally renouncing her U.S. citizenship. Worse, unlike all other countries but one, the U.S. demands that its citizens file annual U.S. tax returns no matter where they live and work. Swanson could have still officially given up her American citizenship, but before doing that, she would have also had to file five years of U.S. income tax returns and pay any amount owing.

The hard facts about FATCA

What happened to Swanson was the result of the Foreign Account Tax Compliance Act (FATCA), which the U.S. government introduced in 2010. The legislation is meant to force U.S. citizens living abroad to report any financial accounts they hold outside the States – a broad-brush-stroke attempt to catch tax cheats. The law applies to so-called “U.S. persons.” That designation includes U.S. citizens living in other countries who have not renounced U.S. citizenship; U.S. green card holders; people residing in the U.S.; and people who spend a significant number of days in the U.S., including some Canadian snowbirds.

FATCA has had a major effect on the estimated one million American nationals and their families living in Canada, most of whom who have been dutifully paying income tax to Ottawa.

It may also take a major toll on Canadian financial institutions. Initially, the U.S. ordered banks and credit unions to pass along to the U. S. Internal Revenue Service (IRS) the account information of all those with U.S. connections. If they failed to do so, the States would retaliate with a 30 per cent withholding tax on all U.S. transactions. Experts anticipate that keeping track in this manner would cost FIs hundreds of millions of dollars. That, plus the 30 per cent penalty, as well as concerns about privacy and sovereignty, prompted Canada to protest. Finance Minister Jim Flaherty (who resigned in March 2014) spearheaded negotiations with the U.S. and on February 5, Ottawa announced it had signed an Inter-Governmental Agreement (IGA) scheduled to take effect July 1.

Under the IGA, Canada persuaded the U.S. to allow banks, credit unions and other financial institutions to submit the information collected about the accounts of U.S. persons to the Canada Revenue Agency (CRA) rather than the IRS. The CRA would then review any such information before determining whether to pass it along to the IRS. This concession may help mitigate the costs of tracking accounts with U.S. connections, but it remains to be seen by how much, since the CRA will still need these records.

Compliance and credit unions

Regardless, says Gary Rogers, a tax expert who has just retired as vice president of financial policy for Credit Union Central of Canada, Canada’s credit unions will not have to pay anywhere near as much to comply as the chartered banks, two of which claim doing so could cost them each $120 million. “When a bank mentions that number they are talking about their operations around the world,’’ he says. “Some of them are operating through a number of countries in South America, in Asia and elsewhere. Credit unions operating in only one country don’t have the magnitude of complexity of building a system. Mostly it will be a matter of using their own banking systems and adding their own fields. I don’t anticipate there would be huge costs for any credit union.”

On other fronts, the IGA also set out several reporting exemptions, including RRSPs and RESPs, pension plans and escrow agreements, among other financial vehicles. Credit unions whose assets under administration total less than $175 million would be excluded from reporting requirements, as would be credit unions with no member accounts exceeding $50,000.

“I don’t think 10 per cent of congressmen and senators would be able to tell you what FATCA was.”

—Jim Jatras, lobbyist, Global PR Strategies

Still, the deal with the U.S. certainly doesn’t satisfy the throngs of people who want to see FATCA revoked entirely. Jim Jatras, a lawyer and former diplomat, who is now a lobbyist with the Washington, D.C.–based firm Global PR Strategies, is one of the leaders fighting FATCA in the U.S. He’s been preaching the need to repeal it to anyone who will listen on both sides of the border. He admits it is an uphill battle, given that even the politicians who passed FATCA know little about it. When it travelled through the U.S. Congress and Senate, FATCA received little attention because it was tucked into larger legislation on a completely different issue, he says.

“It . . . passed in the dead of night,” says Jatras. “I don’t think 10 per cent of congressmen and senators would be able to tell you what FATCA was. I don’t know of any other law that purports to regulate foreign activity – and only foreign activity – with no requirement of presence or activity in the United States. And [the U.S.] threatens economic sanctions against [other countries] if they do not comply? How can the United States do this? Well, because we think we can.”

A draconian and inefficient weapon

Jatras says FATCA is both a draconian and incredibly inefficient weapon. One report to a U.S. congressional committee, he says, estimated that FATCA would recoup less than a $1 billion U.S. a year in tax revenue while costing foreign financial institutions (FFIs) potentially hundreds of billions of dollars to comply. He continues to fight in spite of the odds, saying that if Canada refused to play along with FATCA, it “would scare the hell out of people down here” and give the Repeal FATCA movement a shot in the arm.

Many people like Swanson believe the IGA was a capitulation to the U.S. that allows a sinister legislation to stand. She’s not alone. The NDP, the Liberals, the Green Party and the Canadian Civil Liberties Association, among others, have all cried foul over the IGA, particularly the manner in which it was adopted with little or no consultation at the parliamentary level.

Murray Rankin, the NDP’s finance critic, says the party has received thousands of letters from angry Canadians. His party has concerns about how the IGA violates privacy laws, which he says are already woefully outdated, and by the fact that the IGA creates another category of citizen.

“Are we second-class people in Canada if we happen to be U.S. persons under this U.S. law?” he asks. Rankin also believes the IGA comes with a steep price tag. “I don’t believe the banks and the credit unions are going to absorb all of those millions of dollars in expenses [for complying]. Of course they are going to be passed on to you and me.”

A Charter violation?

As for FATCA itself, Peter Hogg, a leading Canadian constitutional expert, warned the federal government in December 2012 that if accepted by Canada, the U.S. law would likely be deemed unconstitutional here and would violate the Canadian Charter of Rights and Freedoms. Hogg says the IGA, as it currently stands, requires financial institutions to treat people differently based on their place of birth or citizenship, which is prohibited under Section 15 of the Charter.

Meanwhile, most credit unions approached by Enterprise declined to comment on FATCA, noting that they were still studying the legislation and awaiting more specific information on compliance requirements from the CRA. “We’re still working through the implications of the recent FATCA agreement ourselves and are not equipped to answer questions at this time,” says one credit union executive.

Vancity ($17.1 billion in assets, 497,000 members), however, has already gone public with its concern. “What I can say is that we believe that fundamental social justice issues regarding personal privacy and freedoms, quality of life, due process and financial well-being and self-determination for our members and all Canadians are at risk with FATCA,” says Anita Braha, co-chair of Vancity’s board of directors. Braha, however, is pessimistic that much can be done at this stage to stop the implementation of the IGA. “We’re not pleased with the outcome, but of course we will comply,” she adds.

Several accounting experts, and even federal politicians who have been fighting the IGA all along, say they see the IGA as fait accompli. “Canada came out opposed to FATCA when it first appeared,” says Carlene Hornby, a FATCA expert who works for the accounting firm KPMG’s Vancouver office and was a panellist at a credit union conference last year. “Canada really didn’t have a choice but to sign the IGA. It would have been harder on financial institutions if it hadn’t signed.”

A major global trend

Hornby says the 30-country Organisation for Economic Co-operation and Development (OECD) is already moving toward greater exchange of tax information, indicating a major global trend. At the same time, she sympathizes with people like Swanson.

“We do have a lot of innocent Americans in Canada who didn’t know that they had to file a U.S. tax return. Those are the ones you feel badly for. What we have heard is that there are quite a number doing voluntary disclosures to IRS and the IRS has been quite lenient in terms of waiving penalties.

“Then there are others, who deliberately don’t want to file their tax returns, and for good reason. They pay taxes in Canada and don’t think they should have to pay taxes in the U.S. But the law says if you keep your citizenship you are required to file a return.”

Tax expert Rogers agrees FATCA is here to stay. “I don’t expect any more delays or postponements of deadlines,” he says. “We had better be ready for it.” Rogers adds that although compliance costs might not hit credit unions hard, they’ll have to endure other expenses. “What probably won’t be captured in any costing is the time it takes to learn the rules, get this started up and the first reporting period,” he says. “From the credit union perspective, it’s one more compliance burden that they just don’t need. They are really unhappy that they have to even think about this.”

A Charter challenge underway

For her part, since her epiphany back in 2011, Swanson has embarked on what could be described as a Kafka-esque journey that may ultimately lead her and others to the Supreme Court of Canada. Swanson, along with another person, is launching a legal challenge of the IGA. The pair established the Canadian Charter Challenge Fund and quickly raised close to $18,000 for an initial legal analysis by leading constitutional lawyer Joe Arvay. Arvay has already said he believes FATCA might violate several sections of the Canadian Charter of Rights and Freedoms.

That’s heartening for some law-abiding taxpayers like Carol Tapanila of Calgary. She has already paid $42,000 in accounting fees to file tax returns and get other advice over an ongoing saga that included successfully renouncing her mentally challenged son’s U.S. citizenship because of taxation that she calls totally unfair.

“Remember, the War of 1812 was not over until 1815,” she says. “We should likewise expect our battle to be long, messy and expensive.” ◊