INTERNATIONAL LAW: THE INTRODUCTION OF THE FOREIGN ACCOUNT TAX COMPLIANCE ACT (FATCA) AND WHAT YOU NEED TO KNOW

The Foreign Account Tax Compliance Act, or FATCA as it is universally known, is the centerpiece of U.S. efforts to curb tax evasion everywhere.  It was introduced in 2010 as the revenue-raising portion of the domestic jobs stimulus bill, the Hiring Incentives to Restore Employment (HIRE) Act, but its impact is only now being felt.  Since being passed into federal law, the U.S. government has negotiated various agreements with foreign nations effectively extending the enforceable application of FATCA to the global stage.

The historic legislation has made significant waves internationally, particularly in offshore financial centers where local secrecy and confidentiality laws had often made it incredibly difficult for the U.S. authorities to identify and tackle tax evasion.

"The U.S. topped a list of countries most effected by tax evasion, with the nation projected to be losing approximately $337 billion a year."

In 2011, the Tax Justice Network estimated that tax evasion represented 5% of global GDP.  The U.S. topped a list of countries most effected by tax evasion, with the nation projected to be losing approximately $337 billion a year.  Given increasing global trade and growing international investment opportunities, it is a figure that was only going to spiral unless action was taken.  The U.S. government's response was FATCA.

Life before FATCA

Before the introduction of FATCA, the IRS was largely reliant on the honest and accurate reporting by individuals, corporations and trustees of their foreign assets and income.  International confidentiality and secrecy laws meant that the IRS could not undertake a review of foreign bank accounts and assets owned by U.S. citizens or corporations held abroad.  Although the U.S. Treasury could seek the assistance of foreign courts in cases where there was clear and compelling evidence of tax evasion, it could not gain access to financial accounts on suspicion alone.

The IRS’s inability to effectively investigate tax reporting created a culture of casual tax evasion. It should be noted that unlike tax avoidance, which is the legal application of loopholes in the law to minimize tax liability (as discussed on our previous blog on Offshore Financial Centers), tax evasion is a criminal offense punishable by hefty fines and prison sentences.  

"The IRS’s inability to effectively investigate tax reporting created a culture of casual tax evasion."

Shell companies would be set up offshore with a sole U.S. director and shareholder, but the income would either not be reported or would be inaccurately reported. Given that several offshore jurisdictions have legislation keeping directors' registers and shareholders' registers confidential, the IRS had no way of conducting compliance checks to see what interests U.S. citizens had in foreign companies.  Foreign trusts would be established to hold assets including corporations, real estate, stock and foreign currencies, but again the assets would not be properly reported as the assets of trusts are also protected by foreign confidentiality laws.  Furthermore, U.S. citizens and green card holders were living abroad, sometimes earning substantial tax-free wages, without ever declaring their foreign earned income to the IRS.

Collectively, this lax attitude towards accurate financial reporting, whether it be intentional, reckless or negligent, became alarmingly common, particularly as the movement of financial assets became easier and less expensive in an increasingly global economy.  The cost to the U.S. Treasury was massive.

"Countries with Largest Tax Evasion Amount v3" by Guest2625 - Own work. Licensed under CC BY-SA 3.0 via Commons

The Introduction of FATCA

In March 2010, FATCA became law and compelled all foreign financial institutions (FFIs) to search their records for suspected U.S. persons who held accounts with them and report their assets and identities to the U.S. Treasury.  FATCA’s stated objectives include: -

• FATCA targets tax non-compliance by U.S. taxpayers with foreign accounts.
• FATCA focuses on reporting:
  • By U.S. taxpayers about certain foreign financial accounts and offshore assets
  • By foreign financial institutions about financial accounts held by U.S. taxpayers or foreign entities in which U.S. taxpayers hold a substantial ownership interest
• The objective of FATCA is the reporting of foreign financial assets; withholding is the cost of not reporting.

The consequences under the law for FFIs’ non-compliance are severe.  If an FFI fails to enter into the necessary reporting arrangements with the IRS, a 30% withholding tax is imposed on U.S. source income and other U.S. related payments of the FFI.  This is not a position any FFI wants to find itself in.

Intergovernmental Agreements

The U.S. has learned over several decades that without the appropriate international compliance and enforcement regime, federal law is of limited value.  After all, FATCA has not introduced anything new in terms of taxation; U.S. citizens and residents have long been subject to reporting foreign financial interests and paying tax on their worldwide income.  What FATCA sought to change was compliance with the tax code that was so regularly ignored by corporations and individuals alike.

To make FATCA effective, the U.S. used its considerable trade and political leverage to enter into intergovernmental agreements with the majority of developed foreign nations, which implemented FATCA into local law and established tax information exchange protocols.  A full list of the countries that have already signed treaty agreement with the U.S. can viewed here - list of treaties.

Impact of FATCA

Despite being introduced into Federal law in 2010, most of the foreign reporting obligations did not come into force until 2013-14, following the introduction of the key filing and reporting dates contained in the intergovernmental agreements discussed above.  Now that FATCA has been adopted by local law around the world, meaning enforcement of non-compliance is a much less burdensome process, FFIs have become acutely aware of their reporting obligations.  The result is that the vast majority of FFIs have systematically reviewed their clients’ identities and their financial interests, ensuring they are ready to report to the IRS directly, or indirectly through their national tax authority, depending on the form of the intergovernmental treaty entered into.

"...the burden placed on FFIs has prompted several foreign financial institutions to turn away U.S. citizens or residents looking to open up a bank account."

For FFIs, the cost of opening a bank account, complying with the due diligence and reporting each year to the IRS, often makes it unprofitable to provide a banking service to U.S. citizens. So much so that the burden placed on FFIs has prompted several foreign financial institutions to turn away U.S. citizens looking to open up a bank account.   Furthermore, companies are reluctant to appoint U.S. citizens as directors or officers given the heightened reporting obligations which accompany their appointment.

What can we expect going forward?

The best way to look at what the future holds is to appreciate that for the first time the IRS will be able to cross reference the tax filings and foreign bank account reporting (FBAR) of each U.S. individual and corporation, with the information reported by FFIs.  The implications are massive and are expected to expose widespread tax evasion.

The reporting obligations of FFIs includes any interest in bank accounts, mutual funds, hedge funds, private equity, directors fees, pensions, annuities, real estate, beneficial interests in trust assets and much more.  If U.S. persons or corporations have not fully reported any interest they will be in breach of U.S. tax code.  Inaccurate reporting can now be identified with little effort. Even if U.S. individuals or corporations who have previously failed to report their foreign interests do begin to accurately report, it will not change the fact the IRS will have evidence of past negligent or fraudulent reporting.  For example, if an FFI reports an individual has had an investment account in the Bahamas for the last ten years, which they have never reported to the IRS and from which they receive annual dividends, that individual will be in hot water regardless of how he reports in the current tax year.

Over the next few years you can expect to hear about the IRS pursuing those individuals or companies that have avoided paying substantial tax liability through inaccurate tax reporting, which in most cases will be treated as tax evasion. Exactly how the IRS pursues more modest sums of money that have not been properly reported remains to be seen, but there is no question the IRS will have substantial evidence to pursue thousands of individuals and corporations should it choose to.

As legal advisers, we would strongly recommend that all U.S. citizens and green card holders, wherever they reside in the world and wherever their income is generated, to seriously consider the impact of FATCA and the fundamental change in culture that is unfolding.  The U.S. authorities now have the tools they has long been seeking to uncover a wide variety of tax fraud.  The IRS will treat any breaches of U.S. tax code far more favorably if the individual or company comes forward, as opposed to the IRS contacting them.  If you require advice on FATCA and the compliance regulations placed on FFIs, please contact the McGill Law Office.  If you believe you are in breach of U.S. tax code and require advice on exploring your options we recommend you contact your accountant or a specialist tax attorney.

Content prepared by Richard Parry. © Richard Parry, 2015

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This message and the information presented here do not create or evidence an attorney-client relationship nor are they intended to convey legal advice or counsel.  You should not act upon this information without seeking advice from a qualified lawyer licensed in your own state or country who actually represents you. In this regard, you may contact The McGill Law Office and then representation and advice may be given if, and only if, attorney Edmond McGill agrees to do so in a written contract signed by him.

INTERNATIONAL... CUSTODY

Just what does actress Kelly Rutherford have in common with a California company mining gold in Alaska?  Read on and see how George Washington’s caution about “foreign entanglements” applies to both.

Gold Rush, LLC, a California based prospecting and treasure hunting company, is being threatened with suit in New York for defaulting on a loan from Empire Bank.  The loan was made to purchase the specialized gold mining equipment ordered from Walkabout Digs, an Australian Company that had the equipment manufactured in China by Ling Solutions, Ltd.  The equipment was delivered directly to the waterfront land in Alaska were Gold Rush leases mineral rights.  Walkabout has a standing relationship with Empire Bank and requires that all financing arrangements made by US companies for the purchase of its Chinese manufactured equipment be made through this New York bank. Gold Rush contracted with Golddiggers, Inc. to do the actual mining in Alaska.

Golddiggers’ workers say that the equipment doesn’t work.  Walkabout and Ling say that Golddiggers’s workers were incompetent and do not know how to use the equipment.  Walkabout’s friendly bank in New York says that it does not care.  It just wants to be paid. Will there be lawsuits all over the world? Will the law of New York apply or the law of China or the law of California or Alaska’s law? How will a court’s order from one country be enforced in another?  You just wanted the gold.  Oh, what a mess.

"Actress Kelly Rutherford is learning all about the complications of disputes that involve multiple jurisdictions, domestic and foreign."

Ah, but this is nothing compared to other complicated and heartbreaking multi-jurisdictional disputes involving the children of disputing parents who are citizens and residents of different countries.  When Irene from Seattle marries Philip from Paris or Henry from Philadelphia marries Olga from Saint Petersburg, bliss is followed by children and then, sometimes, children are followed by international marital warfare.

Actress Kelly Rutherford is learning all about the complications of disputes that involve multiple jurisdictions, domestic and foreign.  More precious than gold are the objects of contention in her court cases in California and New York.  The bi-coastal court fight has already bankrupted Rutherford and, now, courts in both American states disclaim jurisdiction over the children because they live primarily with their father in the little country of Monaco.  A next round will have to be brought expensively in European courts.  

"While her children are visiting under the joint custody order issued by a Pennsylvania judge, Olga refuses to return the children to Pennsylvania and seeks an order from a Russian court giving her sole custody."

Irene, who married Philip, appears in a French court waiving the order from an American court giving her custody of her children who were spirited out of the United States by their father.  While her children are visiting under the joint custody order issued by a Pennsylvania judge, Olga refuses to return the children to Pennsylvania and seeks an order from a Russian court giving her sole custody.  Is that order from the Pennsylvania judge going to fly in Russia?  Oh, for a dispute over gold mining equipment!

It certainly is a smaller world in our modern times. Business deals and personal relationships bridge across continents and oceans from state to state and from nation to nation.  But whether you are mining gold in Alaska with Chinese machinery purchased from an Australian company or forming families with Peggy Sue from Tennessee and Hans from Salzburg, you are subject to the tangles, contradictions and competitions from courts in different places with different laws and different loyalties.  

So whether you are a California prospecting company seeking glittering fortune in the far north of Alaska or an American actress fighting for custody of her children in California, New York and Monaco, be advised that you may find yourself in a tangle of competing courts, thousands of miles apart, applying different laws, protecting different interests and ordering different solutions.

© 2015 Edmond McGill

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Facts, including the names of the companies, related to gold mining in Alaska are fiction and neither this part of the narrative nor the fictional companies should be confused with actual companies or their businesses.

This message and the information presented here do not create or evidence an attorney-client relationship nor are they intended to convey legal advice or counsel.  You should not act upon this information without seeking advice from a qualified lawyer licensed in your own state or country who actually represents you. In this regard, you may contact The McGill Law Office and then representation and advice may be given if, and only if, attorney Edmond McGill agrees to do so in a written contract signed by him.

INTERNATIONAL LAW - OFFSHORE FINANCIAL CENTERS: WHAT ARE THEY AND WHAT DO THEY OFFER?

In business, people often talk about offshore ventures and the advantages associated within offshore investment.  But what exactly is meant by doing business ‘offshore’ and why do so many businesses and individuals invest money, move assets and incorporate companies in these foreign jurisdictions? 

Over the last decade the media and political spotlight has begun to focus heavily on the hoards of cash that U.S. corporations are stockpiling offshore.  In 2014, a securities filings review by Bloomberg revealed that U.S. multinationals had stockpiled $2,100,000,000 ($2.10 trillion) in profits overseas to avoid taxes.  Tax avoidance is the legal usage of tax regimes to reduce the amount of tax payable.  Several loopholes exist both domestically and internationally that hundreds of U.S. corporations take advantage of to great effect.

"U.S. multinationals have stockpiled $2,100,000,000,000 (2.10 trillion) in profits overseas to avoid taxes"

In a world where global trade and investment is expanding at a rapid rate, it is important to understand these issues.  Businesses and individuals are looking at how offshore financial centers can benefit them and lawyers are increasingly being asked to advise on the advantages that can be gained from such opportunities.

So what is an offshore financial center?

There is no agreed definition of what constitutes an offshore financial center.  Tolleys, a leading global tax guide, has sought to define them as the politically correct term for what used to be known as tax havens.  An IRS publication in 1981 famously stated that "a country is a tax haven if it looks like one and if it is considered to be one by those who care".  These are not particularly helpful definitions and impart connotations of money laundering and tax evasion.  They are also somewhat misleading in the modern day in light of increased regulation in the offshore world as well as extensive mutual assistance treaties and intergovernmental agreements that have enhanced transparency and compelled tax reporting from foreign financial institutions. 

Generally speaking, it is accepted that an offshore financial center is a country that satisfies the following criteria. 

• Relatively small jurisdiction
• Low or no tax
• Specializes in commercial and corporate services
• Offers those services to non-residents
• Focuses on investment and asset protection

These countries also share common characteristics that have been important factors in their recognition as leading offshore financial centers.  They usually have politically stability, a respected legal and judicial system, low regulation and experienced professionals.  It is for this reason that several offshore financial centers are British Crown dependancies, British overseas territories or former parts of the British empire. 

Where are these financial centers?

The most common offshore financial centers include Bermuda, Cayman Islands, British Virgin Islands, Bahamas, Hong Kong, Singapore, Luxembourg, Switzerland and Panama.  Ireland and New Zealand are also becoming more prominent in the offshore market, despite traditionally being regarded as primary jurisdictions.  Even the U.S. state of Delaware is regularly seen as an offshore financial center given the disproportionate number of companies that are incorporated in the state.

"The Cayman Islands has no income tax, no corporation tax, no inheritance tax and no capital gains tax."

Each of these jurisdictions is prominent in one or more of the major offshore markets.  The Cayman Islands has no income tax, no corporation tax, no inheritance tax and no capital gains tax.  It leads the collective investment market thanks to its accommodating mutual funds legislation.  It is estimated to house about 75% of the world’s hedge funds and nearly half the industry's projected $1.1 trillion of assets under management.  It is also a major player in the captive insurance market.  The Bahamas and Panama lead the market in registered vessels while the British Virgin Islands is the registered home to the largest number of offshore companies in the world (roughly 600,000).  The British Virgin Islands has approximately 30 registered companies per capita, which is the highest ratio of any country.

Switzerland has more recently focused on tax exemptions and Singapore is rapidly becoming a leader in private banking, hedge funds and wealth management. Bermuda leads the captive insurance market and has established a growing presence in the primary insurance market, an industry not traditionally associated with offshore centers, becoming the third largest in the world.  It is also popular for fund management and aircraft registration.  Ireland offers a competitive 12.5% corporate tax rate and provides attractive legislation that allows companies incorporated there to obtain an effective tax rate closer to 2% by utilizing its territorial tax regime.

"The British Virgin Islands has approximately 30 registered companies per capita, which is the highest ratio of any country."

The management of subsidiaries, or shell companies as they are often referred to, is well illustrated by Ugland House, a five-story office building in the Cayman Islands that is the registered office for 18,857 companies.  Like many other offshore jurisdictions, the Cayman Islands levies no income taxes on companies incorporated in the country.  Simply by registering subsidiaries in the Cayman Islands, U.S. companies can take advantage of the Cayman Islands' tax regime and pay no tax on their foreign earned income.  They may also be able to utilize accounting loopholes so that portions of U.S. earned income can be recorded as being earned in the Caymans.

Can U.S. businesses legally avoid or reduce their taxes by setting up companies offshore?

The U.S. worldwide system of corporate taxation requires multinational corporations to pay taxes twice, first to the foreign country in which they do business and then to the IRS once they repatriate their profits.  U.S. businesses are required to pay the 35% federal corporate tax rate on their income no matter where it is earned - domestically or abroad.

Corporations operating in foreign countries pay income taxes to the country in which those profits were earned. For example, if a subsidiary of a U.S. company earns $100 million in profits in Singapore, it pays the Singapore corporate income tax rate of 17% (or $17 million) on those profits.  When those profits are brought back to the U.S., an additional tax equal to the difference between the U.S. tax rate of 35% and the Singapore corporate rate of 17% ($18 million in this case) is collected by the IRS. Between the two nations, the U.S. company will have paid a total of $35 million, or 35%, in taxes on its foreign profits.  If a U.S. company that was incorporated in the Cayman Islands earned $100 million, it would not pay any corporate tax to the Cayman Government, as there is no corporation tax in the jurisdiction.  The company would however be liable for the full 35% federal corporate tax when it brings the funds into the U.S.

U.S. companies can delay paying U.S. tax on their foreign profits choosing instead to pay the additional tax when the profits are eventually repatriated.  If the business does not need to bring the profits of its foreign business back in to the U.S., it is able to defer its tax liability until such time that is chooses to repatriate the money and can instead utilize the funds offshore, paying no or nominal tax to a foreign government.  Large companies can reinvest the money to expand their global business and some are said to have used sophisticated methods of exploiting tax code to invest the money held by offshore subsidiaries in U.S. assets and securities.

General Electric leads the long list of U.S. corporations that store cash offshore, currently holding $119 billion overseas. However, in terms of recent performance, it was Microsoft and Apple that stacked up the most foreign profits offshore in 2014.  The eight largest tech companies, including Microsoft Corp., Apple Inc., Google Inc., and IBM Corp. account for more than a fifth of the $2.1 trillion currently being stockpiled offshore by U.S. corporations.  Last year alone saw the eight largest tech giants amass $69 billion in offshore profits.

Bloomberg has reported that Apple generated $23.3 billion in offshore profit during 2014, the vast majority of which is held by Irish subsidiaries.  That amounts to the entire annual budget for both the Department of Transportation and the Social Security Administration.  Microsoft generated even more foreign profit, raking in $29 billion, all of which is stockpiled offshore.  

Last year President Obama proposed applying a 14% mandatory tax on the stockpiled profits and a 19% minimum tax on foreign earnings going forward. The one-time tax would generate $268 billion over six years, which Obama wants to use for infrastructure.  Obama’s plan hasn’t advanced in Congress, amid Republican objections, and it appears that the current tax loopholes are here to stay, at least for the short-term future.

"General Electric currently leads the long list of U.S. corporations that store cash offshore, currently holding $119 billion overseas."

As most small and medium sized businesses rely on the profits of foreign earned income, they do not have the luxury of keeping the profits offshore.  Such an arrangement also prevents companies from using the funds to pay dividends to its shareholders.

Despite not being able to reduce their tax liability per se, large U.S. multinationals regularly structure their businesses so that they may take advantage of offshore tax regimes, allowing them to avoid U.S. tax and reinvest the funds to further global business expansion. It would seem that the U.S. corporations with offshore stockpiles are waiting for a government incentive to repatriate their cash, as was the case in 2004 when a law was passed that gave companies a voluntary repatriation holiday with a 5.25% tax rate.  President Obama and top Republicans on the tax-writing committee have stated there would not be a repeat of the 2004 law, but it would not be surprising to see some form of incentive to be tendered to attract large multinationals to bring home some of the $2.1 trillion currently sitting offshore.

So what are the benefits of incorporating, registering or investing in an offshore financial center?

With tax reduction being a benefit that can only truly be enjoyed by corporations with substantial foreign profits, why would businesses or individuals look to set up a company, fund or trust offshore?

Asset Protection - Wealthy individuals who live in politically unstable countries utilize offshore companies or set up foreign trusts to hold family wealth to avoid potential expropriation in the country in which they live. Trusts are also widely used by many, including U.S. citizens, to prevent their assets from being seized by creditors or becoming subject to lawsuits.  Given that U.S. courts can assert jurisdiction over assets located within the U.S., it is wise to ensure that any assets an investor is looking to protect by utilizing offshore laws are not physically held within U.S borders.

Avoidance of forced heirship provisions - Many countries from France to Saudi Arabia (and the U.S. State of Louisiana) continue to employ forced heirship provisions in their succession law, limiting the testator's freedom to distribute assets upon death. By placing assets into an offshore corporation, and then having probate of the shares determined by the laws of the offshore jurisdiction (usually in accordance with a specific will or codicil sworn for that purpose), the testator can sometimes avoid such restrictions.

Collective Investment Vehicles - Mutual funds, hedge funds and private equity funds are formed offshore to facilitate international distribution. By being domiciled in a low tax jurisdiction, investors from around the world only have to consider the tax implications of their own domicile or residency.  This makes the management and distribution of these funds significantly easier and more cost effective.

"High-profile investors do not want rivals or the public knowing what stocks they're investing in."

Confidentiality - Most offshore financial centers give the benefit of secrecy legislation or a form of conditional relationship law. These laws provide investors and shareholders with the privacy protection afforded under strict corporate and banking confidentiality. Breaching these laws can have serious consequences for the offending party. Disclosing information in relation to an account holder is a breach of banking confidentiality and disclosing information about shareholders is a breach of corporate confidentiality.  It is often wrongly perceived that those corporations and individuals who rely on these banking secrecy and confidentiality laws are criminals seeking to hide their actions. But the reality is that many high-profile investors can gain a substantial economic advantage keeping their identity secret while accumulating shares of a public company.  High-profile investors do not want rivals or the public knowing what stocks they're investing in. If they did, they could lose a significant commercial advantage as smaller investors buy the same stocks that they have targeted for large volume share purchases, which drives up the price.  Despite the strict enforcement of these confidentiality laws, where there is clear evidence of drug trafficking, money laundering or other illegal activities, the regulators and judicial systems will not serve to protect offending parties.

The Sao Paulo Stock Exchange (Bovespa) by Rafael Matsunaga, CC

Diversification of Investment – Regulators in some countries, including the U.S., restrict the investment methods and opportunities of citizens, much to the frustration of investors who are seeking to diversify their investments and manage them in such a way that allows them to take advantage of market conditions without regulatory interference. Funds and accounts registered offshore are much more flexible, in many cases allowing investors unlimited access to international markets and to all major exchanges.  There are no restrictions on investment objectives or trading strategies.  Importantly, investors are free to take advantage of opportunities in developing nations, particularly those that are privatizing industries previously run by the state.  China's decision to privatize some sectors has investors lining up to invest in the world's largest consumer market.  Africa is also attracting substantial foreign investment in its private sectors (technology, retail and business services) and its former state-run industries.

In conclusion, as global trade and investment increases, there is a greater need to understand the services, key legislation and opportunities available in offshore financial centers.  The offshore world does not necessarily present the direct tax reductions with which they are often associated (at least not for U.S. citizens and U.S. corporation), but they do offer significant benefits.  Most notably, more and more U.S. corporations are engaging in offshore corporate restructuring to increase net profit margins and develop their global operations, while growing numbers of investors are turning to offshore registered funds to benefit from the greater opportunities available in global markets, free from the burdensome U.S. regulatory framework and protected by confidentiality laws.

Content prepared by Richard Parry. © Richard Parry, 2015

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This message and the information presented here do not create or evidence an attorney-client relationship nor are they intended to convey legal advice or counsel.  You should not act upon this information without seeking advice from a qualified lawyer licensed in your own state or country who actually represents you. In this regard, you may contact The McGill Law Office and then representation and advice may be given if, and only if, attorney Edmond McGill agrees to do so in a written contract signed by him.