FATCA - Cardinal Point Wealth Management

July 1, 2014 is supposed to be the celebration of Canada Day!. But on that day, the first phase of the dreaded U.S. legislation known as the Foreign Account Tax Compliance Act (FATCA) is to be implemented. For some Americans in Canada, this is not a cause for celebration.   Many Americans in Canada believe that this Act disregards all Canadian privacy laws and the Canadian Charter of Rights and imposes significant hardships on them and the financial institutions and advisors they maintain relationships with.   For the roughly 1 million Americans in Canada, FATCA might very well stand for: Forget About Trusting Canada Again!

Did Canada Really Have a Choice? 
In 2010, the U.S. Congress passed legislation and the provisions of FATCA as part of the Hiring Incentives to Restore Employment (HIRE) Act.   The Act was passed to help the struggling U.S. economy and as a means to circumvent the significant amount of tax evasion by U.S. citizens and residents abroad and the foreign financial institutions in which they may have held money.  Further, this Act was a means to generate additional revenue by forcing some 7 million Americans who live or work abroad into tax compliance with the Internal Revenue Service (IRS) by “coming clean” through a variety of programs that were established to encourage U.S. taxpayers to file their annual U.S. tax returns and related reporting requirements.  Since 2009, it is reported that more than 33,000 taxpayers have participated in these programs, with the IRS collecting more than $4.3 billion to date.

FATCA will now require non-U.S. financial institutions to provide the IRS with information related to a U.S. person’s bank, brokerage, mutual funds, insurance and other financial accounts. Failure to sign the Intergovernmental Agreement (IGA) with the United States government would have required non-U.S. financial institutions—known as Foreign Financial Institutions (FFIs)—to withhold 30% tax from any U.S. source income. Given the hundreds of millions of dollars traded between Canada and the United States on a daily basis by individuals and financial institutions, most countries around the world, including Canada, really did not have much choice but to sign and accept the IGA.

Canada’s largest bank, TD Canada Trust, expects the cost to comply with FATCA to be almost $100 million.  This amount will likely be similar for the other major Canadian banks and financial institutions.  These are massive numbers given that it has been reported that the IRS has only spent some $8.6 million in ramping up for FATCA.  Many are unsure as to whether the IRS is truly ready to take on this monumental global task.  As recently as May 2, 2014, the IRS released additional guidance in Notice 2014-33 that provides additional leniency for those financial institutions who have made “good faith” efforts in trying to register and comply with the FATCA regulations. Perhaps Catherine Sibelius, the former head of the failed Obamacare rollout, can help the IRS out given that she is currently out of a job?

According to the U.S. Department of Treasury website, some 60 countries have signed IGAs with the United States as of May 15, 2014.  Currently, there are 30 countries that have signed under the Model 1 and Model 2 IGAs. This list includes such perceived tax havens as the Cayman Islands, Guernsey, Bahamas, Liechtenstein and another major tax haven that has been used by many Americans in Canada: Canada!  However, the list presently does not include countries like China, Saudi Arabia and (surprise, surprise) Russia, which recently ended discussions with the U.S. related to its IGA.

On February 5th of this year, Canada signed the IGA with the United States government.    Effective on July 1st, the Canada Revenue Agency (CRA) will be obligated to inform the IRS about the financial accounts of U.S. persons in Canada. A U.S. person would be defined as a U.S. citizen, U.S. green card holder and/or someone who could conceivably meet the U.S. Substantial Presence Test.  As most advisers are aware, these individuals are required to file U.S. income tax returns on an annual basis and report worldwide income and additional reporting compliance requirements to the IRS.   Given that many Americans in Canada can utilize the Foreign Earned Exclusion (FEI) on Canadian employment income and foreign tax credits on their U.S. tax returns, in most cases U.S. persons might find that no additional U.S. tax is required to be paid. That being said, there are a host of other compliance and reporting requirements that are imposed on U.S. taxpayers who hold foreign accounts, including Canadian mutual funds, registered assets and Tax-Free Savings Accounts (TFSAs).   Further, with the passage of Obamacare last year and the imposition of the 3.8% Medicare surtax on net investment income, some Americans in Canada might be surprised to find their exposure to additional U.S. tax, beyond the use of the FEI and foreign tax credits.

Impact on Clients
As an advisor, it is important that you make your U.S. resident clients aware of the implications and reporting requirements under FATCA.   Many banks and financial custodians in Canada have already taken steps to become registered with the IRS.    In fact, many of you have already seen additional Know Your Client (KYC), Anti-Money Laundering (AML) and other documentation requirements for your U.S. resident clients. These requirements would include obtaining copies of the client’s U.S. passport and certification of U.S. tax status through the signing and retention of IRS Form W-9 or the signing off of IRS W-8BEN. Additionally, many Canadian financial institutions are also requiring new self-certification declarations for existing and new accounts.

Under the IGA, if a client account exceeds $50,000 (aggregated), the FFI is required to provide the following to CRA:

1. “The name, address, and U.S. [Tax Identification Number] TIN of each Specified U.S. Person that is an Account Holder of such account;
2. the account number (or functional equivalent in the absence of an account number);
3. the name and identifying number of the Reporting Canadian Financial Institution;
4. the account balance or value (including, in the case of a Cash Value Insurance Contract or Annuity Contract, the Cash Value or surrender value) as of the end of the relevant calendar year or other appropriate reporting period or, if the account was closed during such year, immediately before closure;
5. in the case of any Custodial Account:
   1. the total gross amount of interest, the total gross amount of dividends, and the total gross amount of other income generated with respect to the assets held in the account, in each case paid or credited to the account (or with respect to the account) during the calendar year or other appropriate reporting period; and
   2. the total gross proceeds from the sale or redemption of property paid or credited to the account during the calendar year or other appropriate reporting period with respect to which the Reporting Canadian Financial Institution acted as a custodian, broker, nominee, or otherwise as an agent for the Account Holder;
6. in the case of any Depository Account, the total gross amount of interest paid or credited to the account during the calendar year or other appropriate reporting period; and
7. in the case of any account not described in subparagraph 2(a)(5) or 2(a)(6) of this Article, the total gross amount paid or credited to the Account Holder with respect to the account during the calendar year or other appropriate reporting period.” ⁱ

If that is not “scary” enough, FFIs are also required to search for U.S. “Indicia.”  FFIs will be obligated to perform electronic records searches to determine:

1. “Identification of the Account Holders as U.S. citizens or residents
2. Unambiguous identification of a U.S. Place of birth
3. Current US mailing or residence address (including US PO Box)
4. Current telephone number
5. Standing instructions to transfer funds to an account maintained in the U.S.
6. Currently effective power of attorney or signatory authority granted to a person with a U.S. address; or
7. An ‘in-care-of’ or ‘hold mail’ address that is the sole address the Reporting Canadian Financial Institution has on file for the Account Holder.” ⁱⁱ

In addition to the electronic and paper record searches described above, the Reporting Canadian Financial Institution must treat as a U.S. Reportable Account any High Value Account assigned to a relationship manager (including any Financial Accounts aggregated with such High Value Account) if the relationship manager has actual knowledge that the Account Holder is a Specified U.S. Person.  This is referred to as the “ACTUAL KNOWLEDGE” issue.

Notwithstanding the above under the Canadian IGA, registered savings plans (such as Registered Retirement Savings Plans, Registered Retirement Income Funds, Registered Educational Savings Plans (RESPs), TFSAs and certain other accounts under $50,000) are exempt from reporting by CRA to the IRS. Even though that is the case, Americans in Canada still have to report and pay taxes on TFSAs and RESPs and make elections to defer income tax on registered accounts.

Even though CRA will be providing this information to the IRS, Canadian authorities have indicated they will not be a party in collecting and assessing tax and penalties against Americans in Canada.

Advising Clients
If you have clients who are U.S. residents, it is extremely important that you encourage them to review the options available to them if they have not done so already. This would include ensuring that they are fully compliant with their U.S. tax filing obligations. This might be available under the two current programs offered by the IRS. The first is the more onerous and punitive Offshore Voluntary Disclosure Program.  The second is the Streamlined program available to qualifying taxpayers.

For clients who choose to become compliant, it is important that they recognize additional planning will need to be attended to with respect to their unique estate planning matters and the composition and structure of their nonregistered investment accounts.

Lastly, although many advisors are quick to suggest that U.S. persons should renounce or abandon their green cards as a means to avoid these rules, significant income tax and U.S. lifestyle implications could be created without proper advice.

Terry Ritchie is the Director of Cross-Border Wealth Services at the Cardinal Point, a cross-border wealth management organization with offices in the United States and Canada.  Terry has been providing Canada-U.S. cross-border financial, investment, tax, transition, and estate planning services to affluent families for over 25 years.  He is active as an author, speaker and educator on international tax and financial planning matters. www.cardinalpointwealth.com

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ⁱ Agreement between the Government of the United States of America and the Government of [FATCA Partner] to Improve International Tax Compliance and to Implement FATCA
ⁱⁱ Annex I: Due Diligence Obligations for Identifying and Reporting on U.S. Accounts and on Payments to Certain Nonparticipating Financial Institutions