In this episode of Tax Notes Talk, Tax Notes contributing editor Robert Goulder shares his take on the effects of the Foreign Account Tax Compliance Act and common reporting standards on the feasibility of taxing foreign assets.
Tax Notes Talk is a podcast produced by Tax Notes. This transcript has been edited for length and clarity.
David D. Stewart: Welcome to the podcast. I’m David Stewart, editor in chief of Tax Notes Today International. This week: spotlighting hidden assets.
We’ve highlighted aspects of the efforts to identify hidden assets and the taxation of them in the past, such as with FBAR [foreign bank account reporting] penalties and tax haven crackdowns. But why is the taxation of these assets so important? And how do tax authorities find and tax these hidden assets?
Here to talk more about this is Tax Notes contributing editor Robert Goulder. Bob, welcome back to the podcast.
Robert Goulder: Thanks for having me, Dave.
David D. Stewart: So could you give us a brief refresher on this issue of hidden assets?
Robert Goulder: Absolutely. The instinct to conceal an income-producing asset from the tax authorities, it’s as old as the hills. I would say it’s as old as taxation itself. From day 1 of its history, the IRS has had to trust U.S. taxpayers, to trust that they’re going to self-report their earnings. Now, typically, that’s not a problem with respect to earned income. That’s because we have these safeguards of third-party reporting and third-party withholding. So the compliance rate for that category of income is very high. Think about it: There’s little incentive to underreport your salary and wages. A., the IRS is going to know about it, courtesy of your employer sending them a Form W-2. And thanks to withholding the tax is basically already paid in advance as you earn it throughout the year. So, OK, fine. What about unearned income? What about investment income? And sure enough, that’s where our structural reliance on voluntary disclosure gets a bit tricky.
If you deposit funds with a U.S. bank, there’s no W-2, but there’s going to be a 1099. And we have 1099s for all sorts of things: 1099s for interest, for dividends, for payments to independent contractors, for gambling gains, for everything. So even though, there’s no withholding on your bank account, the IRS is going to know about it. Now, historically, the Achilles’ heel of our system has to do with foreign banks, because when an American puts a bank deposit with a foreign bank, there’s no withholding and there’s no reporting. And we’re back to what really resembles taxation on the honor system. We’re back to trusting that U.S. taxpayers are going to self-report, and that’s far from ideal.
David D. Stewart: How big of a problem did this become? How many people were hiding their assets?
Robert Goulder: Well, the speculation was that it was rampant, that a lot of people were, because there was very little that the U.S. could do about it. I mean, if you go back to the old days before FATCA [the Foreign Account Tax Compliance Act], what did we do? What did we have? Not much. We had tax treaties. So if you go back and you look at the academic research on fortifying the tax base — this is like last century — they just say, “Well, you use tax treaties.” Now, the typical bilateral tax treaty between two contracting nations is mostly about what? Providing relief from double taxation. But many of those treaties do have a provision for the exchange of information between national revenue bodies. And we have that in the U.S. model with article 26. So just for example, if you have a treaty between the U.S. and the U.K., and say that the IRS has good reason to suspect that a U.S. taxpayer has some money stashed in a bank in London, they can go through the formalized treaty procedure and make a request of their counterparts in the U.K. to give them any information that they might have.
And if His Majesty’s Revenue and Custom has that information, then they will probably share it with the IRS through this treaty procedure. Generally speaking, there was an incentive for contracting states to be cooperative because those treaty procedures were reciprocal. They worked both ways. Eventually, the shoe would be on the other foot and HMRC would be asking the IRS for help, tracking down some British gentleman who has money in New York, say. That’s how things operated for a very long time, for decades and decades, for most of the last century, that’s how it operated.
We were relying on treaties, and you’re probably thinking, well, there’s three things wrong with that. First, the U.S. doesn’t have a treaty with every country. There’s all sorts of gaps in the U.S. treaty network, and every single one of those gaps is a potential avenue for tax evasion. Second, even when you have a treaty in force, that process, it is slow, it is cumbersome, it is bureaucratic. It is far from a model of efficiency. And third, perhaps most importantly, the treaties don’t allow for what’s called a fishing expedition. In other words, the IRS can’t just call up HMRC and say, “Hey, we’ve got a treaty here. Why don’t you send us everything that you have on any American with a British bank account?” That’s called a fishing expedition, and the treaties don’t allow it.
So things got to the point in the early 2000s where people just thought, we can do better. The problem with the system is that this flow, the information exchange, it’s happening on a slow basis, item by item, file by file. It’s called on-request information exchange. Can’t we do better? Look at the world around you. You have data harvesting, you’ve got bulk data dumps. What if we can institutionalize this so that it’s programmatic? Can we move to automatic information exchange? That’s where FATCA comes along.
David D. Stewart: All right. So tell us about the basics of FATCA and how it worked. Well, first of all, where did it come from?
Robert Goulder: Well, it was a revenue raiser in a completely different piece of legislation, and it came about really because of a scandal. There was a scandal that rocked Capitol Hill. You had Senate hearings about UBS, the big Swiss bank, and it turned out there were American millionaires and billionaires stashing money in Swiss bank accounts. There was testimony from this guy, Bradley Birkenfeld, who I know you’ve written a lot about in Tax Notes. You couldn’t have a scandal like that and not have some repercussion from it. There’s the old saying in Washington that it takes a crisis to get something done. It takes a crisis to get legislation passed here. It took that offshore banking scandal to get FATCA passed.
David D. Stewart: So how did they make it work? How does FATCA break loose this banking secrecy problem?
Robert Goulder: Yeah, FATCA broke the mold. It ushered in the era of automatic exchange of information, where there’s no fishing expedition — you just send us everything that you have. And how do you make them do that? Well, you need a lot of clout to be able to make these foreign banks do something that they don’t want to do, which they’re not set up to do, and which their business models don’t really accommodate. So what FATCA does, it sort of bullies people. It goes to the foreign governments and it says, “Hey, you’ve got a domestic financial system. What if we impose punitive withholding on all of those entities that are dealing with U.S. financial assets, which are basically all your banks? We’ll hit them with punitive 30 percent withholding every time they buy, sell or trade a U.S. dollar-denominated financial security. This would bring your financial system to the brink of disaster. This could crash your economy.”
That’s a very onerous thing to say. It almost borderlines on being thuggish behavior, but it was necessary to get these foreign governments to sign what are called IGAs, intergovernmental agreements. So our treaty partners, our friends, our trade partners said, “OK, we don’t really like FATCA.” There’s nothing in it for them, but they will sign the IGAs to avoid creating headaches for their local banks. And what this means is that there’s different routes through which this can happen, but the information either goes directly from the bank to the IRS or from the foreign bank to the foreign government and then to the IRS.
So the IRS gets an in-bulk data dump. It gets all this information on any U.S. citizen or U.S. resident with a foreign bank account over the threshold amount, and that’s just a lot of information. Probably even, you might say, more information than the agency can handle. Why do the countries go along with it? Well, they don’t want to. I think there’s no country in the world that is a willing participant in FATCA. There’s nothing really in it for them. So it is not reciprocal, unlike the treaty mechanism we discussed before.
David D. Stewart: You’re saying that other countries are not particularly pleased to join the system, but they seem to have found their own way of getting this sort of information for themselves. Could you tell me about this common reporting standard?
Robert Goulder: Yes. It’s funny — as soon as FATCA was up and running, something odd happened. We noticed that every single country that signed an IGA was bitter about it, sometimes even hostile about it. But they were also jealous. There was something called FATCA envy. Everybody wanted their version of FATCA or something similar to it. It’s because they were similarly frustrated with the shortcomings and the inefficiencies of treaty-based information exchange. It just wasn’t cutting it. It was too slow. It was too bureaucratic. You don’t have tax treaties with every country, so there’s lots of holes in it. On-request information was just archaic. It felt old and slow and out of date and out of touch with the modern era, and they looked at the United States and they said, “They have automated information exchange. How can we do that?” It did not take very long for the OECD to step in and develop this thing called the common reporting standard [CRS], which countries can participate in by simply going through these formalities, signing the protocols and so forth.
And what it means is they’re going to be sharing information with other countries. And again, it sounds like they’re giving something up. They’re having to take information that they collect about foreign folks in their country who have bank accounts. They have to share that with the tax authorities and the account holders, country of residence. That sounds like it’s weakening the incentive for those folks to have those accounts in the first place. But it’s reciprocal because they get the same thing. The shoe is eventually going to be on the other foot where they can request information that their taxpayers have in a foreign bank. So the incentives behind participating in CRS and participating in FATCA are completely different. They participate with FATCA because they have to, because they’re scared of getting hit with withholding. It resembles, those IGAs resemble a contract of adhesion. Remember that from law school? Sign it or else.
CRS is a completely different model. It’s a two-way street as opposed to a one-way street in terms of the information flow. It’s up and running now. Countries are generally happy with it. So happy that some foreign countries say, “Hey, U.S., now that the OECD-engineered common reporting standard is viable and has been proven effective and it’s up and running, why don’t you get rid of FATCA?” In effect, the U.S. doesn’t really need FATCA anymore if it can get that same information by participating with CRS. The problem is the United States can just say, “No. No, thanks. We were there first. We ushered in the age of automated information exchange. We’ve spent all this time getting FATCA up and running. We don’t need to change it.”
David D. Stewart: Well, now that we have these two different systems that are causing information to flow freely, what sort of results are we seeing from them?
Robert Goulder: Well, that is a function of how well a country funds its revenue agency. If you have the resources, they can go through this bulk data and they can say, “Ah, there’s a person over here who’s got a foreign bank account. Let’s just ask some questions. Don’t need to bring the hammer down on them. There may be a perfectly reasonable excuse as to why they have that account. They might be declaring all the income.” Remember, there’s nothing illegal or immoral about having an offshore bank account. It becomes problematic when you don’t self-report the associated income on your home country’s tax return. So if you have the resources, this is all good stuff. Query whether the IRS is in that position. There’s part of Treasury, the inspector general. They looked at this issue a couple of years ago, and they came to a conclusion that was maybe not so great.
Basically, saying a lot of the benefits of automated information exchange are not being realized because the IRS doesn’t have the organizational resources to process all of this data that’s coming in. Because remember, this is data harvesting. It’s a data dump. The information just keeps coming and coming and coming. They’re not asking for it at this point. It just happens by nature. It just keeps coming. As we’re speaking here today, the information is just flowing into some mainframe computer, some server the IRS has somewhere. What are they going to do with it all? Ultimately, there’s a funding issue that needs to be resolved because I think the way things stand right now is some countries, where they fund their revenue agency more properly, they can make use of all of this. They can connect the dots and they can translate the information collection into audits and revenue. And the U.S. seems to be having a hard time doing that because over the last however many years now — it’s been a decade or more — we’ve been denying them the resources to really go at that full bore.
David D. Stewart: So we have these two regimes. They’re very targeted at these foreign bank accounts. Do they leave some gaps behind? Because people will always find a loophole in order to avoid something like this. So what loopholes are still out there?
Robert Goulder: Well, you are a wise man, Dave, and there are definitely gaps in FATCA. How problematic they are, well, that’s more of a matter of opinion. But I like to say that there are FATCA dead zones, the same way there are dead zones with your cell phone’s 5G network. If you’re in the elevator, if you are in the garage, if you’re out on a hike in the country someplace, there are going to be some places where you just don’t have internet connectivity. There’s lots of places where we don’t have FATCA connectivity, to put it like that. Roughly speaking, how many countries are there in the world? About 220. How many IGAs do we have of these FATCA intergovernmental agreements? Last time I checked, around 110, 115 IGAs. So there’s at least a hundred countries out there that have not signed an IGA. So they’re completely outside the FATCA loop. So they’re going to be FATCA dead zones.
Should the IRS be worried about that? Because if you don’t have FATCA, we’re back to that old system of taxation on the honor system, where you have no reporting and no withholding, no 1099. Just as a sort of a tangent here, the list of countries with whom we don’t have an IGA more or less corresponds to the list of countries with which we don’t have a tax treaty. So for these FATCA dead zones, you don’t even have the treaty mechanism to fall back on. I don’t mean to sound dismissive about it, but those tend to be places that do not have well-developed banking sectors. Therefore, it’s not like a wealthy American with some serious money to invest is going to be rushing to stash their family’s nest egg in such places. I mean, speaking for myself, I wouldn’t put my assets offshore in some rogue nation just to avoid FATCA because you might never see your money again. So yes, there are FATCA dead zones, but they’re not real money havens.
David D. Stewart: So what is the future of this? Where are we going with this giant world of tax information exchange?
Robert Goulder: What’s the saying? You cannot put the genie back in the bottle. You can’t put the peel back on the banana. There is such a significant difference between automated information exchange. The way we’re doing it now with FATCA or with CRS, such a difference between that and the bad old days of the slow, bureaucratic, inefficient treaty-based approach. There’s no way the governments of the world are going to go back to that. So sorry, taxpayers: That’s just how it is. People didn’t like it. People wanted to fight about it. Once the U.S. had FATCA, there’s no way the rest of the world wasn’t going to try to mimic that in their own ways, and they did. So I think for the rest of the human race, for time immemorial, we’re going to be talking about automated information exchange. There’s no going back, Dave.
David D. Stewart: Well, Bob, thank you so much for being here.
Robert Goulder: My pleasure.
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