Frequently Asked Questions: Foreign Account Tax Compliance Act (FATCA) and the Intergovernmental Agreement for the Enhanced Exchange of Tax Information under the Canada-U.S. Tax Convention
What is FATCA?
On March 18, 2010, as part of the Hiring Incentives to Restore Employment (HIRE) Act, the United States (U.S.) enacted the provisions known as the Foreign Account Tax Compliance Act (FATCA).
FATCA requires non-U.S. financial institutions to enter into an agreement with the U.S. Internal Revenue Service (IRS) to report to the IRS accounts held by U.S. residents and U.S. citizens (including U.S. citizens that are residents or citizens of Canada). If a financial institution is not compliant with FATCA, FATCA requires U.S. payors (i.e., corporations and others that pay amounts, such as interest or a dividend) making certain payments of U.S.-source income to the non-compliant financial institution to withhold a tax equal to 30 percent of the payment. The 30 percent FATCA withholding tax can also be levied in respect of a compliant financial institution, on individual accountholders that fail to provide documentation as to whether they are U.S. residents or U.S. citizens, and on passive entities (i.e., entities whose business purpose is to generate passive income) that fail to identify their substantial U.S. owners, if any. In some circumstances, FATCA could require financial institutions to close the accounts of certain clients.
What would be the consequences for Canadians and financial institutions had the intergovernmental agreement (IGA) not been signed?
FATCA has raised a number of concerns in Canada – among both dual Canada-U.S. citizens and Canadian financial institutions. One concern is whether the FATCA reporting requirements, which would compel financial institutions to report information on accountholders that are U.S. residents and U.S. citizens directly to the IRS, would be consistent with Canada’s privacy laws. Another concern is the possibility that, under FATCA, financial institutions would be required to deny services to certain clients in certain situations.
Absent an IGA, obligations for Canadian financial institutions to comply with FATCA would be unilaterally and automatically imposed on them by the U.S. as of July 1, 2014. These obligations would force Canadian financial institutions to choose between:
- entering into an agreement with the IRS that would require them to report directly to the IRS on accounts held by U.S. residents and U.S. citizens, which would raise concerns about consistency with Canadian privacy laws; or
- being subject to the 30 percent FATCA withholding tax on certain U.S.-source payments for not complying with FATCA.
Clients at Canadian financial institutions could also be subject to the 30 percent FATCA withholding tax or could have their accounts closed by their financial institution under the rules of FATCA for failing to comply with certain requirements that FATCA imposes on them.
Why is the U.S. interested in signing IGAs?
The intention of FATCA is to combat the use of offshore accounts to evade U.S. taxes by eliciting the transmission of information from non-U.S. financial institutions to the IRS. The U.S. has stated that it does not intend to raise revenues using the 30 percent FATCA withholding tax; this tax is intended solely as a means to induce non-U.S. financial institutions and their clients to comply. However, potential conflicts with the privacy rules in Canada, and a number of other leading economies, may prevent most major non-U.S. financial institutions from complying with FATCA in its original form. This raised the risk that FATCA would fail to achieve its main objective, and would create disruptive effects on financial markets through the imposition of the 30 percent FATCA withholding tax.
The Government of Canada advanced the principle that, in seeking to meet the objectives of FATCA, greater reliance should be placed on the exchange of information provisions that already exist in agreements such as the Canada-U.S. tax treaty. The Government is pleased that the U.S. accepted this principle, which led to the development of the IGA approach and its application worldwide as an alternative to FATCA. This approach fulfills the U.S. objective of enhanced information collection, without entailing the risk that a unilateral U.S. approach could conflict with foreign laws.
What are the benefits to Canada of the IGA?
Under the IGA:
- Canadian financial institutions will not report any information directly to the IRS. Rather, accountholder information on U.S. residents and U.S. citizens will be reported to the Canada Revenue Agency (CRA). The CRA will transfer the information to the IRS under the authority of the existing provisions of, and protected by the confidentiality safeguards under, the Canada-U.S. tax treaty.
- The 30 percent FATCA withholding tax will not apply to clients of Canadian financial institutions, and can apply to a Canadian financial institution only if the financial institution is in significant and long-term non-compliance with its obligations under the IGA.
- The FATCA requirement that Canadian financial institutions be required to close accounts or refuse to offer services to clients in certain circumstances will be eliminated.
- A number of accounts will be exempt from FATCA reporting, including Registered Retirement Savings Plans, Registered Retirement Income Funds, Registered Disability Savings Plans, and Tax-Free Savings Accounts.
- Smaller deposit-taking institutions, such as credit unions, with assets of less than $175 million will be exempt from reporting.
- The IRS will provide the CRA with enhanced and increased information on certain accounts of Canadian residents held at U.S. financial institutions.
Does the IGA mean that Canada will be enforcing U.S. tax laws?
Legislation to give effect to the provisions of the IGA will be proposed to Parliament in order to ensure that financial institutions can rely on Canadian law when implementing their procedures for complying with the IGA. The CRA, rather than the U.S., will be responsible for administering the IGA. Canadian financial institutions will report information to the CRA.
Will Canada be signing similar agreements with other countries?
The IGA is consistent with the Government’s support for recent G-8 and G-20 commitments to multilateral automatic exchange of information for tax purposes. In September 2013, G-20 Leaders committed to automatic exchange of information as the new global standard and endorsed an OECD proposal to develop a global model for automatic exchange of information. The model being developed is based on due diligence and reporting procedures similar to those in the Canada-U.S. IGA.
Canada is actively participating in the work of the OECD to develop the new multilateral standard.
What are the next steps?
The IGA must be ratified by Canada in order to come into force. In order to ratify the IGA, Canada must first proceed with the implementation of the IGA into Canadian law, which will be carried out through implementing legislation that will be introduced in Parliament in the coming months.
Additional guidance on the implementation of the IGA will be available in the near future, including through the release of draft implementing legislation, which will be issued for comment, and publication by the CRA of detailed guidance for Canadian financial institutions and their clients.
Under the IGA, Canadian financial institutions will be required to begin due diligence procedures starting July 1, 2014, and to report information to the CRA beginning in 2015. The first exchange of information between the CRA and the IRS will be in 2015.
Does the IGA respect the privacy rights of Canadians?
FATCA has raised a number of concerns in Canada – among both dual Canada-U.S. citizens and Canadian financial institutions. One key concern was that the reporting requirements would force financial institutions to report accountholder information directly to the IRS, which would raise concerns about consistency with Canadian privacy laws.
Under the IGA, financial institutions in Canada will not report any information directly to the IRS. Rather, relevant information on U.S. residents and U.S. citizens will be reported to the CRA, similar to existing tax reporting by financial institutions to the CRA on their clients. The exchange of tax information between Canada and the U.S., including on an automatic basis, is already a longstanding practice, is authorized under Article XXVII of the Canada-U.S. tax treaty, and includes safeguards with respect to the use of the exchanged information. The information on U.S. accountholders obtained by the CRA will be exchanged with the IRS through these existing provisions, an approach that is consistent with Canadian privacy laws.
I am a U.S. citizen living in Canada and was not aware that the U.S. wants me to file tax returns. Will the IGA mean that I now have to pay U.S. taxes?
The IGA is strictly an information sharing agreement and does not involve the imposition by the U.S. of any new or higher taxes.
Unlike Canada, the U.S. taxes its citizens who reside in other countries on their worldwide income. The U.S. citizenship-based taxation regime has been in place since 1913, and is not altered by the enactment of FATCA, or the signing of any IGAs. For U.S. citizens resident in Canada, their U.S. tax obligations exist independently of their awareness of these obligations.
Canada respects the sovereign right of the U.S. to use citizenship as a basis for taxation. At the same time, citizenship-based taxation is a departure from the residence-based approach generally followed by Canada and most of the rest of the world, and creates unique challenges for U.S. citizens who reside in other countries. U.S. taxation of its non-resident citizens on their worldwide income, when these individuals are also subject to taxation on their worldwide income by their country of residence, can result in significant compliance burden on these individuals, even when they owe no U.S. tax.
What is the Government doing to protect dual citizens living in Canada against claims by the IRS?
While the Canada-U.S. tax treaty contains a provision that allows a country to collect the taxes imposed by the other country, the treaty does not apply to penalties under laws that impose only a reporting requirement. For example, the CRA will not assist in the collection of U.S. penalties associated with the Report on Foreign Bank and Financial Accounts (commonly known as the FBAR), which is a non-tax form required by the U.S. Treasury under the U.S. Bank Secrecy Act that requires the person filing the form to provide details of assets held at non-U.S. financial institutions.
Furthermore, the CRA will not collect the U.S. tax liability of a Canadian citizen if the individual was a Canadian citizen at the time the liability arose (whether or not the individual was also a U.S. citizen at that time).