After much discussion and commentary echoing for months from both sides of the border, the United States and Canada executed, on February 5, 2014, an intergovernmental agreement (IGA) to implement the Foreign Account Tax Compliance Act. The Canada-United States IGA entered into is based on the Treasury’s Model 1 reciprocal exchange of information provisions.
Under FACTA, which was enacted into law by the 2010 HIRE Act, §501(a), foreign financial institutions must cooperate with U.S. tax administrators by supplying information with respect to U.S. reportable account holders in order to avoid 30% withholding on certain payments. The withholding is triggered if a withholdable payment doesn’t meet the requirements under §1471(b) as to reporting and other requirements. Withholdable payments will, in general, be treated as U.S. source fixed or determinable annual or periodical (FDAP) income and gross proceeds from the disposition of property that generates interest and dividends.
Under §1471(b), a foreign financial institution will meet the requirements, and therefore avoid FACTA withholding, if an agreement is in effect between the FFI and the IRS under which the financial institution agrees: (i) to obtain information for each holder of each account maintained by the financial institution in determining which accounts are U.S. accounts; (ii) to meet verification and due diligence procedures for identifying U.S. accounts; (iii) for any U.S. account maintained by the institution, to report annually certain information required under §1471(c); (iv) to deduct and withhold a 30% tax on any “passthru payment” made by the institution to a “recalcitrant account holder” or to another FFI which does not meet the §1471(b) requirements; and so much of any passthru payment made by the financial institution to another FFI that has a §1471(b)(3) election in effect for the payment, as is allocable to accounts held by recalcitrant holders or FFIs that do not meet the §1471(b) requirements; (v) to comply with IRS requests for additional information on any U.S. account; and (vi) where foreign law would prevent disclosure of the required information, to attempt to obtain a waiver of such law and make the required disclosure.
Due to issues related to bank secrecy laws in many foreign jurisdictions, the Treasury adopted an alternative approach to achieving transparency for foreign financial accounts owned by U.S. persons. This was achieved through the process of negotiating intergovernmental agreements (IGAs) with foreign countries to “soften” to some extent the breadth and depth of the FACTA rules. The Model 1 IGA has two species, reciprocal (Model 1A) and non-reciprocal (Model 1B). There is one main type of Model 2 IGA which has two versions, based on countries which the United States have and does not have an existing exchange-of-information agreement.
Canada’s Reaction to FACTA
Following passage of FATCA in 2010, Canadian financial institutions and wealthy individuals and their advisors had expressed reservations about the nature of the FATCA legislation and its heavy handed approach reflected by the U.S. law’s crossing-over jurisdictional boundaries to compel foreign financial institutions and non-financial foreign companies to foreign financial information and non-foreign financial entity information involving U.S. persons. The 2012 development of the IGA framework by the Treasury, admittedly designed to reduce financial institutions’ compliance costs and resolve local law conflicts, did not immediately assuage the rumblings heard from north of the border. It did not appear that Canada did not like IGAs as well.
In December, the Canadian Department of Finance acknowledged that it had received comments from a leading constitutional law expert in which he stated that an IGA negotiated under the terms of the model IGA would violate Canada’s Charter of Rights and Freedoms. When this development was reported by the tax press, it was suggested that perhaps Canada would resist falling in line with other foreign countries in agreement to enter into an IGA. Well, the issue has been put to rest by both governments entering into the IGA.
Under Article 4 of the Canada-U.S. IGA, each reporting Canadian Financial Institution will be treated as complying with §1471 (26 U.S.C.) if Canada complies with certain other portions of the IGA (Articles 2 and 3) and the Reporting Canadian Financial Institution: (i) identifies U.S. Reportable Accounts and timely reports annually to the Canadian Competent Authority the information required under Article 2, subparagraph 2(a); (ii) for 2015 and for 2016, reports annually to the Canadian Competent Authority the name of each Nonparticipating Financial Institution to which it has made payments and the aggregate amount of such payments; (iv) meets registration requirements on the IRS FATCA registration website, and meets other requirements, including making the required withholding on any U.S. Source Withhodable Payment payable to any Nonparticipating Financial Institution.
Another recent Model 1 mutual exchange of information IGA was entered into with Hungary on February 4. Including Canada and Hungary, the United States has entered into 22 IGAs.