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Countries around the world are desperate for revenue, and the United States is no exception. There is a widespread impression that great funds could be raised, if only the tax cheats paid up. Of course, catching the cheaters is easier said than done, especially when they (or their money) are outside the country.
By now, most Canadian tax practitioners know that US citizens and Lawful Permanent Residents (“green-card” holders) need to file US tax returns annually, reporting worldwide income, even if they live in Canada.1 Americans also need to report many foreign (non-US) corporations, partnerships and trusts with which they are associated. If, at any time during the year, an American has over US$10,000 in total in foreign financial accounts, then all such accounts must be reported in a Report of Foreign Bank and Financial Accounts (“FBAR”). The penalty for failure to file each of these supplementary information reports is typically $10,000, and can be much higher.
A while ago, there was a very public scandal where Americans were found to be hiding money with UBS and LGT. As a result, for about two years the IRS has been focusing on the FBAR.
On February 8, 2011, the IRS announced its latest plan to bring nonfilers into the foreign accounts reporting system, the Offshore Voluntary Disclosure Initiative (“OVDI”). The initiative covers years 2003-10. Reporting is required for each year where income tax returns and FBARs were not filed or have been improperly completed. To participate, a taxpayer must:
Filing must be completed by August 31, 2011.
Most Canadians would anticipate a parallel with CRA’s Voluntary Disclosure Program, but there are major differences. The OVDI doesn’t guarantee that criminal charges will not be laid, but has said relief will almost always be given.
The major difference from the Canadian system is that to obtain this relief, the taxpayer will have to pay penalties, and hefty ones at that:
In limited circumstances, the special penalty can be reduced. For example, the penalty is 12.5% if the maximum value over that period of time was less than $75,000. It is only 5% if the individual didn’t know s/he was a US citizen. This could be the case where the person was born in Canada to US parents.
Special rules apply where the taxpayer had an interest in a Passive Foreign Investment Company.2 Interest also applies.
A person who has properly filed US returns (form 1040), but missed the supplementary reporting (e.g. FBAR, 3520, 5471) can file these forms outside the OVDI without penalty until August 31, 2011.
What is not clear at this point is whether someone who has not filed form 1040, but has no taxable income and/or tax owing (a very common scenario in Canada), would be eligible for this opportunity. It is clear that someone owing $1 of tax would not be eligible.
With these ugly penalties, what is to make an American come forward? As part of the HIRE Act (March 18, 2010), the United States brought in FATCA. It attacks the problem of evasion through Foreign Financial Institution (“FFIs”). The term FFI includes entities such as banks, trust companies, credit unions, mutual funds, brokerages, investment corporations, and even family trusts.
Effective 2013, each participating FFI will require each account holder to state, under penalties of perjury, whether or not s/he is a US person. This reporting will also apply to non-FFI entities which have a 10% or more US owner.
Each participating FFI will report each American’s income to the IRS in a manner similar to that of a US bank. A non-participating FFI is not required to report.
With these obligations, why would a Canadian institution agree to participate? If it doesn’t, then every item of US income received by the institution, and all proceeds of disposition of US assets become subject to 30% US withholding at source. This withholding is onerous, even if it is entirely refundable upon filing a return (and not all would be). It is possible for a FFI to avoid the 30% withholding by refusing the business of any American. Another option for the FFI is to simply not invest in any US securities.
Few major Canadian institutions could manage their businesses with these impediments. So most will choose to participate.
The IRS has provided some safe harbors, where a participating FFI need not determine the US tax status of the owner. Where the total value of a client’s accounts is under $1,000,000 and there is no indication of US ownership (e.g. US address or communication from client), or the value is under $50,000, the FFI need not query the US ownership. However, given the potential of account values to vary, and the banks’ need to standardize procedures, my expectation is that they will require completion of US forms W-9/W-8BEN as a matter of course.
Soon, a US nonfiler is going find it lot harder to stay out of the system.
What should a nonfiler in Canada do? One obvious option is nothing. She could restrict her business to nonparticipating FFIs, which will generally be smaller institutions. For many people that will not be a practical answer. Also, there are many other ways the IRS can eventually find her. The exposure to penalties can only grow.
At the opposite extreme, she could enter the OVDI. This approach may be very costly
Some people are choosing to file “quietly” (i.e. not through the OVDI), either for several prior years, or for the current and future years only. There is a risk of regular penalties, which could exceed the OVDI penalty, but as a practical matter this may be the best value option (penalty exposure multiplied by risk of being assessed).
A US tax practitioner may not recommend that a client not file for a particular year, but ultimately the decision is the client’s.
Renouncing citizenship or green-card status is another option, but that action may create other adverse tax consequences.
Unfortunately, for most Americans in Canada looking to become compliant, there is no good answer. Every approach has costs and risks.
For more information, please contact Kevyn Nightingale, CA, CPA, at 1.877.251.2922
1 One can be a US resident under other rules, but they are beyond the scope of this article
2 A PFIC is, in broad strokes, a foreign corporation used primarily for investment activities where Americans own a non-controlling interest
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