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U.S. congress passed the Foreign Accounts Tax Compliance Act (FATCA) in 2010 to improve tax compliance by U.S. taxpayers holding foreign accounts. FATCA accomplishes this through two ways: (1) by foreign financial institutions (FFIs) reporting financial accounts held by U.S. taxpayers or foreign entities in which U.S. taxpayers hold a substantial ownership interest and (2) by U.S. taxpayers reporting their interests in certain foreign financial accounts and / or offshore assets.
On September 16 and September 29, 2015, the Canadian Federal Court and the U.S. District Court (Southern District of Ohio), respectively, decided not to enjoin the application of FATCA.
The U.S. case proceeded as a motion for a preliminary injunction with respect to the application of the Canadian, Czech, Israeli and Swiss Intergovernmental Agreements (IGA). The Canadian, Czech and Israeli IGAs are so-called “Model 1” IGAs permitting domestic (e.g., Canadian) information sharing between domestic financial institutions and the domestic tax authority with the domestic tax authority in turn sharing the information collected with the Internal Revenue Service (IRS). The Swiss IGA is a so-called “Model 2” IGA, which provides for information sharing directly between local financial institutions and the IRS.
The plaintiffs in this action were U.S. Senator Rand Paul of Kentucky and a number of private individual residents abroad, some of whom had previously renounced their U.S. citizenships. The strongest argument advanced by the plaintiffs, was that U.S. citizens living abroad should be subjected to a constitutionally impermissible heightened financial reporting requirement compared to U.S. citizens residing in the U.S., where it would be considered a Fifth Amendment violation (the federal equal protection clause). The heart of the court's rejection of this argument was that impugned rules apply to all U.S. citizens, whether residing abroad or in the U.S. and that “mere disparate impact is insufficient to demonstrate an equal protection violation.” Further, that any distinction is rationally related to a legitimate government interest: “[t]he information reporting required by FATCA is intended to address the use of offshore accounts to facilitate tax evasion and to strengthen the integrity of the voluntary compliance system by placing U.S. taxpayers that have access to offshore investment opportunities in an equal position with U.S. taxpayers that invest within the United States.”
On the Canadian side, two so-called “accidental citizens” of the U.S. have been challenging the legislation implementing the IGA between Canada and the U.S. In advance of the September 30, 2015 date for the first bulk FATCA information transfer from the CRA to the IRS, the Federal Court issued its reasons rejecting the injunction application. Note that the Federal Court has not decided the constitutional challenge at this point, limiting its reasoning to the technical analysis of whether the collection and transfer of information to the IRS is legally authorized and consistent with the Canada-U.S. tax treaty.
The Federal Court surveyed a broad swath of U.S. tax compliance and referred to at least two expert reports along with Senate Committee testimony. The technical argument raised by the plaintiffs, on the basis of which they were seeking the injunction, was as follows: under Article XXVIA of the Canada-U.S. treaty, Canada will not provide the U.S. with assistance in the collection of revenue claims if the taxpayer in question was a citizen of Canada at the time the revenue claim arose. In effect, the plaintiffs argued that the CRA's disclosure of information pursuant to the IGA was assistance in collection, which is prohibited by the treaty. Secondly, the plaintiffs argued that Article XXVII of the Canada-U.S. treaty precludes bulk information exchanges, stating instead that such provision requires any information must “be relevant for carrying out the provisions of this convention or of the domestic laws of the contracting states concerning taxes to which this convention applies. In this case the plaintiffs basically were arguing that since the vast majority of individuals in Canada will not owe U.S. taxes, the information collection generally has no “relevance” to the imposition of U.S. taxes and therefore does not satisfy Article XXVII of the Treaty.
Justice Martineau found these arguments to be “unfounded in law or otherwise unconvincing in light of the evidence on record.” In effect, the court held that the Canada-U.S. treaty must be interpreted in light of the IGA and the IGA implementing legislation. In particular the “plaintiffs' reading of the “may be relevant” standard was erroneous because it rested on fundamental misconceptions about the purposes of the Canada-U.S. Tax Treaty, the purpose of FATCA and the correct approach to treaty interpretation. Further, the court held that the Article XXVIA limitation applies “only to cases in which tax liability has been determined and is enforceable”.
Ultimately observing that “[j]udicial courage requires that judges uphold the Rule of Law” Justice Martineau quoted Crown counsel's oral pleading as a response to the fairness plea that accidental Americans will be punished not for evading taxes but for not complying with the laws of a foreign jurisdiction:
“Those are all policy issues for the U.S. government and the U.S. Congress. They've made their decision as to what their laws will be. We have committed to live with that within the treaty. The treaty does not give us an opportunity to say to them, we disagree with your policies and we will not assist you to implement them. We have agreed to assist them to the extent that information is relevant to their laws, and that's their realm.”
For more information on international tax compliance and FATCA, contact Bradley Thompson, Leader of MNP’s International Tax Services group in Montréal at 514.315.3680 or [email protected].
Related Topics:International Tax; FATCA
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