Law Times

Page 10 august 4, 2014 • Law Times www.lawtimesnews.com FOCUS Doubts remain about U.S. tax deal Treasury Department may not approve controversial implementing law By Julius melniTzer For Law Times mid significant criti- cism, the intergov- ernmental agreement between Canada and the United States that exponentially expands the shar- ing of tax-related information between the two countries came into effect on July 1. "What the [agreement] means is that the Canada Revenue Agen- cy will now exchange financial information about Americans living in Canada with the Internal Revenue Service," says Veronika Chang, a foreign legal consultant with Toronto-based tax boutique Morris Kepes Winters LLP. In the process, however, the agreement amends the reporting and withholding obligations of foreign financial institutions and others who make payments to a "U.S. person," as the U.S. Foreign Account Tax Compliance Act (FATCA) defines the terms. But the designation as a foreign finan- cial institution can be misleading. "Any entity, both financial and non-financial, must consider whether it is subject to FATCA because FATCA is not limited in scope to the financial services industry," says Roanne Bratz, a partner at Stikeman Elliott LLP's Montreal office. All foreign financial institu- tions must report the activities of their U.S. clients to the IRS and withhold funds in appropriate circumstances. But the agreement allows Canadian institutions to report to the CRA instead. This aligns the reporting obligations of financial institutions under U.S. and Canadian law. This aspect of the agreement is, however, a double-edged sword. "On the one hand, the fact that the legislation requires Canadian institutions to f lag their U.S. ac- counts to the Canada Revenue Agency rather than the Internal Revenue Service removes some pressure from Canadian banks in terms of their privacy obligations under Canadian law," says Roy Berg, director of U.S. tax law at Calgary-based Moodys Gartner Tax Law LLP. "On the other hand, it changes the landscape for any entities characterized as foreign financial institutions by imposing an obli- gation on them to figure out who their U.S. account holders are." The upshot is that the agree- ment has major implications for Americans living in Canada and others defined as "U.S. persons" under the U.S. law. Indeed, the law's main purpose is to track down Americans who are avoid- ing their obligations to pay tax on their worldwide income. "The reason for FATCA's creation was that many Ameri- can citizens, including those not residing in the U.S., were not reporting their worldwide in- come," says Bratz. "But instead of going directly after the non- reporters, the U.S. approach appears to be to have the world police the situation for them." Still, these developments might come as a surprise to a significant number of U.S. citi- zens living abroad. "Many Americans living in Canada and elsewhere don't un- derstand that the U.S. is one of only two countries in the world that require its citizens to file tax returns no matter where they are living," says Berg. The gap in understand- ing could be costly. "Even U.S. citizens who have lived most of their life in Canada can be con- sidered to have tax obligations under U.S. law and could face heavy penalties of up to $10,000 for each year they have failed to file tax returns," says Chang. "It's even possible that a person born in Canada who has an Ameri- can parent could be affected." To comply with the law, Ca- nadian foreign financial institu- tions, including subsidiaries of U.S. parents, must use due dili- gence in searching for U.S. indicia that will identify U.S. accounts and report specified information about them to the CRA. The Ca- nadian agency will in turn share the information with the IRS on an automated basis. The task is daunting, all the more so because Canada's draft implementing legislation pro- vides for significant penalties for non-compliance. "Regardless of the method Canadian banks use to identify U.S. account holders, they will be undertaking a monu- mental project that is ongoing and not time-limited," says Chang. Indeed, Chang suggests FACTA projects amount to a significant internal restructur- ing for many organizations. "The restructuring will be aimed at better aligning an in- stitution's tax function and its operating structure with the aim of improving communica- tion between in-house counsel, the tax department, and the cli- ent relationship department and its managers," she says. Complicating the issue is the fact the implementing leg- islation appears to have many problems. Some prominent tax lawyers, for example, believe it eviscerates the agreement. "The U.S. Treasury Depart- ment may ultimately view the leg- islation as an invalid implementa- tion of the [agreement] and may therefore not afford Canadian fi- nancial institutions the benefit of the agreement," says Berg. By way of example, the Cana- dian definition of financial insti- tution is considerably narrower than the one contained in the agreement, U.S. treasury regula- tions, intergovernmental agree- ments executed by other jurisdic- tions, and guidance notes issued by Britain and Ireland. "The result is that many enti- ties that would be classified as financial institutions, such as private trusts and private holding companies, would not be so clas- sified in Canada," says Berg. Should the United States re- gard the Canadian legislation as an invalid implementation of the agreement, Canadian institu- tions would face the dilemma of complying with Canadian law and suffering the consequences under FATCA or complying with FATCA and suffering the conse- quences under Canadian law. As well, Canadian entities not considered financial institutions under Canadian law but so clas- sified under U.S. law would likely face withholding rules for which they would have to seek refunds directly from the IRS. Finally, inconsistent defini- tions among jurisdictions that have executed intergovernmen- tal agreements with the United States will cause increased com- pliance costs and uncertainty in the marketplace. "The U.K. realized this risk early on and has taken the lead in developing its domestic legislation to avoid this result," says Berg. But even if the Canadian leg- islation ultimately satisfies the United States, a constitutional challenge may be looming. Pe- ter Hogg, scholar-in-residence at Blake Cassels & Graydon LLP's Toronto office, has warned the legislation may violate the Charter of Rights and Freedoms. But the IRS keeps on coming. U.S. authorities have recently added another tool that will help them keep track of the comings and goings of U.S. citizens and others crossing the Canada- U.S. border and perhaps assist in identifying U.S. citizens who are residents of Canada or have financial dealings here. As of June 30, 2014, travellers must swipe their passports both when they enter and depart each country with the two ju- risdictions sharing the informa- tion the new practice provides. These changes, part of the entry- exit initiative and the perimeter security and competitiveness action plan, fall under a larger co-operative effort announced in February 2011. Previously, each country counted individuals only when they entered but not when they left. Because they rarely shared even that limited information, typically neither country knew how long someone had been within its borders. "Now both countries will be able, for the first time and in real time, to independently determine the number of days spent in each country," says Berg. LT Draft your own customized documents with O'Brien's Encyclopedia of Forms, Eleventh Edition, Corporations, Division II. This service provides, both in looseleaf and electronic formats, a comprehensive collection of documents that can be easily adapted to suit your clients' needs. It covers the federal jurisdiction and the provinces of Ontario, British Columbia, Alberta, Saskatchewan, Manitoba and Nova Scotia. 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Prices subject to change without notice and subject to applicable taxes. 00218EB-A43204 CANADA LAW BOOK ® Available risk-free for 30 days Order online: www.carswell.com/obriens Call Toll-Free: 1-800-387-5164 In Toronto: 416-609-3800 A The U.S. Treasury Department may view Canada's legislation as an invalid imple- mentation of the agreement, says Roy Berg.

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