In the decade since the U.S. Foreign Account Tax Compliance Act (FATCA) was introduced, the legislation has reshaped cross-border tax planning considerations significantly for U.S. citizens and Canadian holders of U.S. green cards.
“[Ten years ago], it would be just a few very compliant taxpayers that would be considering issues on both sides of the border,” says Christine Perry, partner with Gowling WLG International Ltd. in Toronto. “Now really everyone has to consider those things.”
Says Kevyn Nightingale, international tax partner, tax services group, and business advisor with MNP LLP in Toronto: “The [U.S. Internal Revenue Service (IRS)] has a lot of information now” in the aftermath of FATCA, as well other tax compliance initiatives. That’s made it increasingly risky for U.S. citizens and Canadian holders of U.S. green cards to remain in the shadows.
FATCA is a U.S. law, passed in March 2010, that compels banks and investment firms around the globe to collect financial information about their clients who are U.S. citizens or holders of green cards and send that information to the IRS. The law is meant to target offshore tax evasion by Americans.
Given that the U.S. bases its tax regime on citizenship, not residency, all U.S. citizens and holders of green cards must file a U.S. tax return (as well as other financial reporting forms) disclosing their worldwide income annually — regardless of where they live.
In 2015, the Canada Revenue Agency (CRA) began exchanging information annually with the IRS under an intergovernmental agreement signed by Canada and the U.S. to implement FATCA. Last year, the CRA sent some 900,000 financial records to the IRS pertaining to Americans holding accounts at Canadian financial services institutions during the 2018 tax year.
The advent of FATCA, as well as the focus in recent years by governments around the world on combatting offshore tax evasion, has raised the stakes for American individuals in Canada who do not comply with their U.S. tax filing obligations. “Everyone is certainly aware that tax authorities have more information and are more willing to do something with it,” Perry says.
The reporting rules governing the administration of FATCA in Canada have tightened recently. The IRS previously granted a three-year grace period, covering 2017 to 2019, that permitted Canadian and other non-U.S. financial firms to submit U.S. reportable accounts without an associated U.S. Social Security number (SSN) or Taxpayer Identification Number (TIN). That grace period expired in December.
For the 2020 tax year onward, Canadian banks and investment firms will have to provide SSNs or TINs on U.S. reportable accounts — or face possible fines levied by the CRA under the Income Tax Act, including a penalty of up to $2,500 for each failure to provide full self-certification information on new accounts.
The IRS, for its part, has indicated that if a foreign financial institution does not provide SSNs or TINs on the pertinent accounts, the institution could face a punitive withholding tax on certain U.S.-source payments unless the missing information is provided within 18 months.
In January of this year, CRA personnel met with members of the Canadian financial services industry to discuss updated guidance the tax agency would be providing firms regarding both FATCA and the Common Reporting Standard (CRS). CRS is the global tax information-sharing agreement developed by the OECD that is based on FATCA. Canada signed on to the CRS and began implementing it in 2017.
“Firms really need to make sure they have tight policies for account opening to make sure that they get [SSNs or TINs] from clients,” says Adrian Walrath, assistant director with the Investment Industry Association of Canada.
Says James Carman, senior policy advisor, taxation, with the Investment Funds Institute of Canada: “When notices [from the CRA] start to come, financial [services] institutions need to go back to accountholders to get that information. Firms hopefully should be proactive and use the time before they receive a potentially large number of requests.”
The IRS did not respond by press time when asked whether the agency would extend the grace period in response to the Covid-19 pandemic.
While there is no requirement for Canadian financial services firms to close existing accounts when clients fail to provide self-certification information, the institutions may have little choice, Perry suggests: “It’s not [as if the firms] want to go around closing people’s accounts, because that’s contrary to what they’re trying to do. But the repercussions are too negative.”
Walrath says Canadian investment firms are better positioned than banks and credit unions in securing tax-residency information from clients, thanks to their account-opening procedures.
“It’s more intensive to open an investment account than a basic chequing account,” Walrath says. “There’s a different ‘know your client’ process.”
Perry says U.S.-citizen clients who receive letters from their Canadian financial institutions regarding missing U.S. tax information often are spurred to deal with their tax-filing non- compliance. “[Receiving a letter] makes it a little more real,” she says.
Nightingale says he doesn’t see FATCA or the CRS as problems in themselves, and argues that they are primarily tax information-sharing agreements that are designed to prevent offshore tax evasion. “You don’t want people to hide money in other countries to avoid paying taxes in their home country,” he says. “They shouldn’t be able to get away with something just because they have enough money to set up an account in the Cayman Islands or somewhere.”
Americans in Canada usually do not end up with a U.S. tax liability, Nightingale adds, as rules in the U.S./Canada tax treaty typically prevent double taxation. In addition, U.S. tax rates usually are lower than those in Canada. “The vast majority of our clients pay no U.S. taxes,” he says.
Nightingale says the real issues are the U.S.’s citizenship-based tax regime, which compels Americans who live abroad to file tax and financial reporting returns annually, as well as the cost and complexity of being compliant. For example, if an American in Canada has a Canadian bank account holding more than US$10,000 or owns Canadian mutual funds, there is more reporting. Failure to file these forms may result in harsh penalties.
“There comes a point where people become unable or unwilling to comply because it’s just such an oppressive burden,” Nightingale says, “and taken all together, this is an oppressive burden.”
While there have been initiatives recently to modify the U.S.’s system of worldwide taxation for non-residents, there has been little progress: “Unfortunately, there are very few people in the U.S. government, at any branch, who are willing to expend the political capital to change that system,” Nightingale says.
After FATCA’s introduction in 2010, the number of U.S. citizens who expatriated and renounced their citizenship began trending higher. In 2009, 742 Americans expatriated; by 2016, that number had risen to 5,411 before beginning to trend lower. Last year, 2,072 U.S. citizens renounced their citizenship.
Perry says Americans in Canada often ask about the option of expatriation, but have second thoughts when learning of the associated costs and consequences. For example, Americans looking to renounce their citizenship must make a host of filings, including the previous five years of tax returns. “I get to provide that bad news that they have to become compliant prior to renouncing,” Perry says.
In 2014, the U.S. raised the expatriation fee to US$2,350 from US$450 in response to the rising number of expatriations. Wealthy or high-income Americans who wish to renounce may also be deemed “covered expatriates” and face the prospect of hefty exit taxes on top of the other costs associated with expatriation.
Perry says some U.S. citizens in Canada who have always been compliant decide to renounce “just to simplify their life if they can do it,” particularly if they’re approaching retirement and have few ties remaining to the U.S.
Still, the number of expatriations relative to the number of Americans living abroad — the U.S. government estimates that there are some nine million — is small. Even with FATCA, most Americans living abroad continue to remain non-compliant, tax experts suggest. However, the U.S. government now has more information about this group.
“If you’re really an egregious offender, there’s a good chance they’ll find you,” Nightingale says.