Article on Taxing Administration for Offshore Accounts (2/2/13)

I just reviewed a recent article by Itai Grinberg, a Georgetown University Law Center professor, titled The Battle Over Taxing Offshore Accounts, 60 UCLA L. Rev. 304 (2012), here.  Until the summer of 2011, Professor Grinberg

served in the Office of International Tax Counsel at the U.S. Department of the Treasury. In that capacity, he was substantially involved in the Obama administration's legislative and regulatory efforts to address offshore tax evasion, and he also represented the United States at the OECD and at the Global Forum on Transparency and Exchange of Information for Tax Purposes.

The article addresses the roles and interests of the various players in the offshore account phenomenon.  The article is very good, so I commend it.  The author does caution in footnote 3 that, because of how the article developed:  "Readers should view events after July 1, 2012 as generally beyond the scope of this Article."

Here is the abstract:

The international tax system is in the midst of a contest between automatic information reporting and anonymous withholding models for ensuring that nations have the ability to tax offshore accounts. At stake is the extent of many countries' capacity to tax investment income of individuals and profits of closely held businesses through an income tax in an increasingly financially integrated world. 

Incongruent initiatives of the European Union, the Organisation for Economic Cooperation and Development (OECD), Switzerland, and the United States together represent an emerging international regime in which financial institutions act to facilitate countries' ability to tax their residents' offshore accounts. The growing consensus that financial institutions should act as cross-border tax intermediaries represents a remarkable shift in international norms that has yet to be recognized in the academic literature. 

The debate, however, is about how financial institutions should serve as cross-border tax intermediaries, and for which countries. Different outcomes in this contest portend starkly different futures for the extent of cross-border tax administrative assistance available to most countries. The triumph of an automatic information reporting model over an anonymous withholding model is key to (1) allowing for the taxation of principal, (2) ensuring that most countries are included in the benefit of financial institutions serving as cross-border tax intermediaries, (3) encouraging taxpayer engagement with the polity, and (4) supporting sovereign policy flexibility, especially in emerging and developing economies. This Article closes with proposals to help reconcile the emerging automatic information exchange approaches to produce an effective multilateral system.

The article is very good in addressing the policy matters and how, on balance, the best resolution is automatic information reporting.  In the process, the author discusses the history of the approaches to the phenomenon.

In the Introduction, the author says (pp. 31-313, footnotes omitted):

This Article makes three key contributions. First, it highlights the commonality between automatic information exchange and anonymous withholding, and it argues that we are witnessing the birth of a new international regime in which financial institutions act as cross-border tax intermediaries with respect to offshore accounts.  Second, it explains why automatic information reporting solutions are preferable to anonymous withholding solutions. Finally, this Article begins to address how to reconcile the emerging and incongruent proposals for automatic information reporting in a manner that will promote the emergence of a multilateral automatic information reporting system. 

* * * * 

At present it remains unclear whether the world is on the path toward automatic information exchange, anonymous withholding, or some combination thereof. Part IV provides proposals as to how the emerging information reporting models could be harmonized to encourage the development of a multilateral automatic information exchange system. It also proposes safeguards to address concerns that information exchanged automatically might be misused in some countries. 

Finally, perhaps more immediately practical to readers of this blog, the author describes FATCA as follows (pp. 334-339, footnotes omitted):

3. FATCA 

In 2010, following the UBS scandal and President Obama's campaign commitment to crack down on offshore tax evasion, the U.S. Congress enacted sections 1471 to 1474 (generally known as FATCA) of the Internal Revenue Code. Under FATCA, foreign financial institutions are generally required to report information on financial accounts of U.S. persons and foreign entities with significant U.S. ownership (U.S. accounts) directly to the IRS beginning in 2014. Foreign financial institutions must report the account balance or value of each U.S. account and the amount of dividends, interest, other income, and gross proceeds from the sale of property credited to a U.S. account. The rules are intended to provide reporting both on accounts held directly by individuals and on interests in accounts held by shell entities for the benefit of U.S. persons. 

Congress explained that in enacting FATCA, it intended to "force foreign financial institutions to disclose their U.S. account holders or pay a steep penalty for nondisclosure." Accordingly, FATCA imposes a withholding tax on the gross amount of certain payments from U.S. sources and the proceeds from disposing of certain U.S. investments (withholdable payments) on foreign financial institutions that do not comply and become a "participating foreign financial institution." This withholding tax also applies to certain other payments to the extent that the funding for those payments may be attributed to withholdable payments ("passthru payments"). Importantly, this withholding tax is not limited to payments to U.S. persons. In other words, if foreign financial institutions will not agree to report to the United States on income earned by U.S. persons through accounts at those institutions, FATCA requires withholding on a wide range of payments from the United States to those same financial institutions, regardless of whether the payments are beneficially owned by U.S. persons on which the IRS wants reporting, by non-U.S. customers of the institution, or by the institution itself. Section 1471 also requires participating foreign financial institutions to withhold on payments to nonparticipating foreign financial institutions. It thus was intended (1) to induce foreign financial institutions that are investing in or through participating financial institutions, but that are not investing in the United States, to also agree to participate in FATCA, and (2) to disincline participating foreign financial institutions from doing business with nonparticipating financial institutions because business between participating and nonparticipating financial institutions may require withholding under U.S. law. Through the pass-thru payment mechanism, FATCA as legislated tried to use the combined weight of U.S. financial markets and financial institutions that must, as a practical matter, do business in the U.S. marketplace as leverage with other foreign financial institutions to ensure near-comprehensive participation in FATCA's cross-border information reporting. It is clear, however, that the United States could neither implement broadly applicable pass-thru payment withholding nor achieve near-comprehensive financial institution participation through unilateral measures alone. 

A related difficulty is that as legislated, FATCA's reporting is also unilateral; it benefits the United States alone, while putting significant burdens on foreign financial institutions. Furthermore, FATCA as legislated routes information reporting directly to the U.S. government and could be understood to require closure of certain account holders' accounts, withholding on payments made by a foreign financial institution to account holders and other foreign financial institutions, or both. As a result, compliance with FATCA may require foreign financial institutions in many jurisdictions to violate contractual relationships as well as data protection, bank secrecy, or other laws of the jurisdiction in which they are located. Beginning with her first major public address on these issues on December 16, 2011, Emily McMahon, the Acting Assistant Secretary for Tax Policy at the U.S. Department of Treasury, acknowledged the difficulties associated with FATCA's unilateral approach. She stated that the United States could not ask foreign financial institutions to report to the United States routinely if the United States did not routinely collect certain information on nonresidents from domestic financial institutions that it could provide to cooperating foreign sovereigns. She went on to suggest that the United States was committed to entering into bilateral and multilateral agreements that would allow financial institutions to comply with FATCA without violating local law. Finally, McMahon described FATCA as a vehicle to achieve a transition to a multilateral system. 

Then in February 2012 the Treasury Department issued a joint statement (Joint Statement I) with France, Germany, Italy, Spain, and the United Kingdom providing for an intergovernmental approach to FATCA implementation. The joint statement acknowledged that FATCA "has raised a number of issues," including that financial institutions in the European joint statement countries "may not be able to comply with the reporting, withholding and account closure requirements because of legal restrictions." The framework adopted in Joint Statement I is accordingly based on reporting by financial institutions to the tax authority of the country in which they are located, followed by reciprocal automatic information exchange between governments. Thus, non-U.S. financial institutions would report information on U.S. persons to the country in which the institution resides and then have the information transferred to the United States by the foreign sovereign, and vice versa. That routing mechanism, in contrast to FATCA's statutory direct, one-way reporting to the IRS, would resolve the conflict of law issues largely by bringing the United States into line with the routing mechanism of the EUSD. 

Joint Statement I also suggested that the six governments would develop a shared approach to incentives, reporting, and customer identification. For example, with respect to incentives (and mandates), the joint statement provides that the framework for an intergovernmental approach would also include a practical and effective alternative approach to achieving the policy objective of pass-thru payment withholding. As described above, that policy purpose is to ensure (by means of coercion) near-comprehensive participation by financial institutions in an automatic information reporting system. Joint Statement I thus suggested that a shared approach to incentives (which could also be described as "defensive measures") was under consideration to ensure that other countries and institutions join an automatic information exchange system. The joint statement similarly provided for the development of common "reporting and due diligence standards." Joint Statement I and the Treasury's public statements represented a substantial multilateral turn for FATCA implementation, given that the statute itself adopts a distinctly unilateral approach. 

Then, in June 2012 the United States and Switzerland issued a joint statement (Joint Statement II) that generally provided for Swiss financial institutions to report on consenting U.S. account holders directly to the IRS and report on nonconsenting U.S. account holders on an aggregate basis consistent with FATCA rules. Switzerland then agreed to provide information exchange upon request with respect to such ascertainable groups. Unlike the anonymous withholding agreements with countries like Germany and the United Kingdom, the Swiss-U.S. agreement will not provide the United States with information on the jurisdictions to which U.S. account holders most commonly choose to move those untaxed assets in advance of the FATCA effective date. Joint Statement II represents a victory for the United States standing alone in that Switzerland accepted a modified form of FATCA compliance. On the other hand, Joint Statement II may represent an effective Swiss rearguard action against multilateral automatic information exchange in that it (1) continues to reject automatic information exchange in principle, (2) largely defuses the coercive force of FATCA withholding as a source of pressure that might help obtain automatic information exchange from Switzerland for other jurisdictions, and (3) allows Switzerland to continue promoting an anonymous withholding alternative to other countries that are able to pressure it for enhanced cooperation. 

The EU, OECD, and the original, purely legislative U.S. approaches to cross-border tax information exchange are challenging to reconcile because they inconsistently address identification, reporting, scope, verification, routing, and incentive issues, while also presenting different models of inter-nation cooperation. Part IV returns to these inconsistencies and makes some observations on how they can be reconciled. The key point at this juncture is that the shared commitment to information exchange sets TRACE, the EUSD, and FATCA apart from the anonymous withholding alternative that the Swiss government has aggressively promoted.