Canada’s financial services sector has welcomed the agreement between Canada and the U.S. to implement the U.S. Foreign Account Tax Compliance Act (FATCA), which is set to begin on July 1. The long-awaited deal will provide both Canadian firms and their dual-citizen clients much needed certainty and compliance relief.
The proposed intergovernmental agreement (IGA), announced on Feb. 5, also addresses some of the more troubling privacy concerns associated with FATCA, with financial services firms now reporting information about their U.S. citizen clients to the Canada Revenue Agency rather than directly to the U.S. government. That information then will be exchanged with the U.S. authorities under existing frameworks in the Canada-U.S. tax treaty.
“Without an IGA,” says Andrea Taylor, director with the Toronto-based Investment Industry Association of Canada (IIAC), “it would have been up to each individual financial institution to sign an agreement with the [Internal Revenue Service (IRS)] under the U.S. FATCA legislation.”
With the IGA in place, Canadian firms will be complying with domestic law and a domestic compliance regime.
FATCA, introduced by the U.S. government to help to combat offshore tax evasion, requires non-U.S. financial services firms to report to the IRS about their U.S. citizen clients. If a foreign firm chooses not to comply, the firm or its accountholders are subject to a 30% withholding tax under FATCA on all payments from the U.S.
Some 22 countries have signed IGAs with the U.S. These IGAs make the exchange of financial information reciprocal and provide compliance relief from some of the more stringent elements of FATCA.
One of the more well-received aspects of the IGA is that certain pension and savings accounts – RRSPs, RRIFs, RDSPs, RESPs, TFSAs and PRPPs – are exempt from the FATCA rules. These exemptions will reduce the compliance burden for both the industry, which will not need to concern itself with these vehicles for IGA purposes, and clients, who won’t have to provide additional documentation to open and hold these accounts.
“It’s really good that the Canadian government was able to demonstrate to the U.S. that all these registered accounts are really low risk for tax evasion, and that they should be excluded,” says James Carman, senior policy advisor for taxation with the Toronto-based Investment Funds Institute of Canada (IFIC).
Under the Canada-U.S. IGA, the U.S. will not impose a 30% withholding tax on U.S.-source payments on the clients of Canadian financial services institutions that are not FATCA-compliant, which could have happened without the IGA.
“Considering how many investors in Canada are invested in [U.S.] stocks and securities,” Carman says, “that makes a huge difference.”
The IGA also exempts smaller financial services firms that have an overwhelmingly “local,” non-U.S. tax resident client base and that qualify under the conditions set out in the IGA to be “deemed compliant.” Both the IIAC and IFIC say that there are many smaller firms among their members that may benefit from this classification under the IGA.
What the IGA doesn’t do, however, is change the tax-reporting obligations of the estimated one million U.S. citizens, green-card holders, and others designated as Americans for tax purposes who live in Canada. These individuals must file a U.S. tax return and meet their other tax-reporting obligations each year while also complying with their Canadian tax obligations. The tax treaty between the two countries prevents double taxation.
In addition, U.S. citizens living in Canada should not confuse the exemption of registered plans from the IGA as representing any change in their treatment under U.S. tax law. For example, the U.S. still does not recognize the tax-exempt status of RESPs or TFSAs. An American living in Canada still has to include income from these vehicles in their U.S. tax return.
“The IGA itself is only dealing with reporting and withholding,” says Carlene Hornby, a tax partner with KPMG LLP in Vancouver. “It doesn’t recharacterize these vehicles from a tax perspective.”
With the much anticipated signing of the IGA, U.S. citizens in Canada – the majority of whom are non-compliant – will find it increasingly difficult to stay off the radar screen of the IRS.
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