FATCA, GATCA and the Controversial Withholding Provision

Abigail Zeitlin, Vol. 36 Associate Editor

For many years, there have been large discrepancies between different countries’ tax reporting standards.  This has allowed for certain countries, like the United Kingdom or Switzerland,[i] to become tax shelters and for other governments to lose out on millions of dollars in tax revenue. [ii] In the United States alone, it was estimated that the government lost out on $100 billion of tax revenue a year due to tax havens.[iii] This phenomenon led to the enactment of the Foreign Account Tax Compliance Act, or FATCA, in 2010.[iv]  One major provision of FATCA requires foreign financial institutions to disclose the names of U.S. citizen account holders and their various transactions, with limited exceptions.[v]   If the institution does not report under FATCA, the U.S. will impose a 30% withholding tax on all transactions involving U.S. money and securities.[vi]   Although FATCA was enacted in 2010, because of the immense amount of bureaucratic muscle necessary to enforce FATCA, it is set to begin being enforced in 2016.[vii]

Naturally, FATCA has stirred a lot of controversy regarding the extraterritorial reach of the IRS and the ability of the U.S. government to impose steep penalties on foreign institutions. Compliance with FATCA is largely on the individual financial institutions’ dime and is very expensive.[viii]  For example, Canada’s five major banks have already spent an estimated $700 million on FATCA compliance.[ix]  Further complicating matters, many large, international banks have branches or subsidiaries in different countries, each with different reporting requirements under FATCA.  Some are located in countries with intergovernmental agreements (IGAs), in which the national governments have reciprocal information swap IGAs, or an IGA in which foreign institutions report directly to the IRS.[x]  Some, however, are located in jurisdictions with no IGA and so these institutions must register under FATCA as a foreign financial institution.[xi]  Each of these three regimes requires various bureaucratic steps and inefficiencies that create large exposures to non-compliance.

Some of the controversy as well as the compliance problems with FATCA have been alleviated by global agreements, namely the “Common Reporting Standard” (informally known as GATCA, or ‘global’ FATCA).  On May 6, 2014, the Declaration on Automatic Exchange of Information in Tax Matters was approved at a meeting of the Organization for Economic Cooperation and Development (OECD) ministers.[xii]  This declaration provided a tentative agreement between 47 countries for a new “Common Reporting Standard” (informally known as GATCA, or ‘global’ FATCA).  On October 29, 2014, 51 nations signed on to GATCA, and over 40 more have become signatories since.[xiii]   Under this agreement, set to begin enforcement in 2017, parties to the agreement must automatically exchange information on all accounts with one another.[xiv]

While GATCA and FATCA have many similarities, there are some major differences.  The most crucial discrepancy relates to penalties.  GATCA does not impose a strict penalty for non-compliance on individual institutions; the enforcement mechanism is largely jurisdictionally based.[xv]  Meanwhile, FATCA, imposes a harsh withholding requirement in which agents must withhold a 30% tax from foreign institutions if they do not file proper information about their account holders.[xvi]  This essentially requires institutions to comply through coercive measures by withholding until compliance—a first in international tax law.[xvii]  Before FATCA, withholding was simply used as a pre-emptive enforcement measure.  Now, FATCA creates pre-emptive punishment.  FATCA also does not take into account any current tax treaties the United States has with other nations, such as double taxation treaties.[xviii]  Under FATCA, the 30% withholding tax would come out on all payments to foreign entities and then could be taxed again when it lands in its final country.  This is contrary to many treaties the United States has signed to explicitly avoid this ‘double taxation’. [xix]

Although many of FATCA’s provisions are controversial from a logistical and economic perspective, the withholding tax provision brings up the most salient legal problems.  First, the ability of the United States to pre-emptively tax a foreign entity under its own domestic laws is tenuous.  Extraterritorial jurisdiction is exercised elsewhere in the US tax code—it directly taxes, or forgoes taxation through agreements of US citizens living abroad.  However, the key difference from other tax laws from those in FATCA is that FATCA imposes penalties on foreign entities.  The normal ‘nationality principle’ as a basis for tax jurisdiction would not apply here because these are neither US citizens, nor US entities.[xx]

Extraterritorial jurisdiction of the provision may be argued as internationally legal under the ‘territorial principle’ of foreign relations as “conduct outside [the United States’] territory that has or is intended to have substantial effect within its territory.”[xxi]  Perhaps the tax evasion could be seen as having a ‘substantial effect’ within the territory by keeping millions out of the federal government’s hands. [xxii]  However, this would suffer from the same issues that international antitrust law currently suffers—countries may choose whether or not to comply, as the US law may be repugnant with their domestic laws. [xxiii] The difference here is that the direct taxation of foreign institutions before the money even leaves the United States does not allow for foreign governments to protect their institutions.  The institutions thus have little international legal recourse because their governments are not involved in the actual withholding—they must themselves choose whether or not to engage in US-source transactions.

Second, the fact that these withholding taxes can contravene any previous treaties the U.S. has signed is extremely problematic.  Congress has not actively repealed any of the previous taxation treaties that the United States has signed with other nations, so these treaties are still in effect under domestic and international law.  Congress has unilaterally imposed sanctions on individual institutions that in effect make many of these treaties invalid.  This will create confusion and uncertainty, as well as undo the policy rationale behind the preceding treaties—namely, to prevent double taxation of these entities.

Third, the withholding tax puts institutions in countries with different privacy laws from the United States in the uncomfortable position of either violating domestic law or closing all U.S.-affiliated accounts.[xxiv]  This jeopardizes U.S. economic relationships and puts U.S. citizens with accounts abroad in a situation in which they choose between their citizenship and their assets.  U.S. citizens denouncing citizenship has risen sharply since 2010 and the enactment of FATCA, the 5 years with the highest totals of denouncers have all occurred since 2010.[xxv] Some international financial institutions have already stated they would divest from the US market if FATCA compliance becomes too burdensome.[xxvi]

In conclusion, although some of the controversial effects of FATCA have been alleviated by the passage of GATCA, the withholding tax provision still provides a source of legal stickiness.  It is the first provision with the scope of its kind, and creates jurisdictional issues, as well as conflicts with foreign and domestic laws.  This could lead to disastrous consequences for continuing the robust participation of the United States and its citizens in the international financial market.  Only time will tell the true effects of FATCA’s enforcement.


[i] Richard Murphy, World’s Best Tax Havens, (June 7, 2010), http://www.forbes.com/2010/07/06/tax-havens-delaware-bermuda-markets-singapore-belgium.html.

[ii] Kary Crassweller et al., What You Need to Know About Foreign Account Tax Compliance Act’s (FATCA) Impact on Non-U.S. Retirement Plans (Mar. 22, 2013), http://www.natlawreview.com/article/what-you-need-to-know-about-foreign-account-tax-compliance-act-s-fatca-impact-non-us.

[iii] 156 Cong. Rec. S1635 (daily ed. Mar. 17, 2010) (statement of Sen. Carl Levin).

[iv] Crassweller, supra note 2.

[v] 26 U.S.C. §1471(c)(1) (2010).

[vi] American Citizens Abroad, Why FATCA is Bad for America and Should Be Repealed (July 2012), http://web.archive.org/web/20130601041733/http://americansabroad.org/ issues/fatca/fatca-is-bad-for-america-why-it-should-be-repealed/.

[vii] Joe Harpaz, FATCA Poised to Go Global (Aug. 13, 2014),  http://www.forbes.com/sites/joeharpaz/2014/08/13/fatca-poised-to-go-global/.

[viii] Joe Harpaz, With Clock Ticking on FATCA, Financial Firms Brace for Headaches (Apr. 2, 2014), http://www.forbes.com/sites/joeharpaz/2014/04/02/with-clock-ticking-on-fatca-financial-firms-brace-for-headaches/.

[ix] Harpaz, supra note 7.

[x] Harpaz, supra note 8 (quoting Risk magazine report, available at http://www.risk.net/operational-risk-and-regulation/news/2336553/oprisk-north-america-uncertainty-remains-over-fatca-day-one).

[xi] Id.

[xii] William Byrnes, 47 Countries Endorse OECD’s GATCA/CRS (May 10, 2014), http://profwilliambyrnes.com/2014/05/10/47-countries-endorse-oecds-gatca-crs/.

[xiii] Automatic Exchange of Information on Financial Accounts (Nov. 3, 2014), https://thebanks.eu/articles/automatic-exchange-of-information-on-financial-accounts.

[xiv] Id.

[xv] Id.

[xvi] American Citizens Abroad, supra note 6.

[xvii] Melissa A. Dizdarevic, Comment, The FATCA Provisions of the Hire Act: Boldly Going Where No Withholding Has Gone Before, 79 Fordham L. Rev. 2967, 2989 (2011).

[xviii] Id. at 2981.

[xix] Id.

[xx] See Jeffrey L. Dunoff et al., International Law Norms, Actors, Process: A Problem-Oriented Approach 346 (Aspen Publishers 3rd ed. 2010) (discussing the nationality principle as a basis for extraterritorial jurisdiction).

[xxi] Restatement of the Law (Third), Foreign Relations Law of the United States §402.

[xxii] See Timberlane Lumber Co. v. Bank of Am., 549 F.2d 597, 614 (9th Cir. 1976) (giving the factors to meet ‘substantiality test’ including extent to which enforcement can be expected to achieve compliance, nationality of parties, extent to which there is explicit purpose to harm or affect American commerce, etc.).

[xxiii] See Hartford Fire Ins. Co. v. California, 509 U.S. 764 (1993) (discussing the ‘presumption against extraterritoriality’ which must be overcome to apply US law abroad, as well as the construction of a statute to never “violate the law of nations if any other construction remains”).

[xxiv] Deloitte, FATCA Frequently Asked Questions (June 30, 2013), at 6, available at http://www.deloitte.com/assets/dcom-unitedstates/local%20assets/documents/tax/us_tax_fatca_faqs_061711.pdf.

[xxv] Aimee Picchi, Record Number Renouncing American Citizenship, (Feb. 12, 2015) http://www.cbsnews.com/news/a-record-number-of-americans-are-renouncing-citizenship/.

[xxvi] American Citizens Abroad, supra note 6.

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