Thoughts on the "you first, no you first" provision in Norway's FATCA agreement with the US Treasury

Norway signed an IGA with the US Treasury on April 15.  I blacklined the Norway agreement against the Model 1 FATCA, (you can download the comparison here) and note that some of the regular features appear, including deemed-compliance status for pension funds and "local" banks* but want to address in this post what I'll call the "you first, no you first" provision in Article 4, paragraph 6.

Some FATCA watchers were surprised to see this paragraph, and I admit I had not noticed it before so I assumed it was new--until I blacklined it and found that no, that paragraph is in the Model 1 Agreement (however it is not in the IGAs with Mexico or the UK), and the Model language is identical to that in the Norway agreement.

In any event, having now read this Art. 4 paragraph 6 more closely, I notice there is actually a good bit of maneuvering going on here. Here is the language:

6. Coordination of Timing. 

Notwithstanding paragraphs 3 and 5 of Article 3:

a) Norway shall not be obligated to obtain and exchange information with respect to a calendar year that is prior to the calendar year with respect to which similar information is required to be reported to the IRS by participating FFIs pursuant to relevant U.S. Treasury regulations;
b) Norway shall not be obligated to begin exchanging information prior to the date by which participating FFIs are required to report similar information to the IRS under relevant U.S. Treasury regulations;
c) the United States shall not be obligated to obtain and exchange information with respect to a calendar year that is prior to the first calendar year with respect to which Norway is required to obtain and exchange information; and
d) the United States shall not be obligated to begin exchanging information prior to the date by which Norway is required to begin exchanging information.

This is actually not at all easy to read (on purpose? One always wonders).  But for sure this does not say, as some readers initially thought, that Norway can wait to give info to the IRS until the IRS begins to give info to Norway. In fact, it rather says quite the opposite. Nor, as I thought when I first read it, does it say that Norway need not exchange until Treasury begins to require equivalent information be reported on Norwegian account holders by US FIs to the IRS.

Instead, it says very simply that Norway need not exchange information with the IRS before the US Treasury regulations require FFIs to begin reporting to the IRS, and the IRS will not exchange info with Norway before Norway starts exchanging. All this use of negatives is confusing so let me try to put it in positive terms: it in effect says that Norway will start giving the IRS info once the IRS requires FFIs to begin reporting per the Treasury regs. Notice that Treasury makes no affirmative commitment on the part of the IRS to actually exchange thereafter--only that in any case it will not exchange before Norway does. It implies that it will be obligated to automatic exchange thereafter, but I am not sure even that is so clear.

The Mexico IGA--the only agreement that is technically in force right now--should provide ample proof that the Treasury has not committed to actual automatic exchange of information with its IGA partners (regardless of para. 6), and certainly that the Treasury is not going to go first. On the contrary, Treasury has only said that it will begin requiring US banks to provide the IRS with information on IGA-country account holders, which could be exchanged with such IGA partners if Treasury determines that such sharing would be appropriate. According to the Treasury, "Even when [an info exchange] agreement exists, the IRS is not compelled to exchange information… if there is concern regarding the use of the information or other factors exist that would make exchange inappropriate.”

No word on what those other factors might be, so read this as a broad grant of discretion to the Treasury, with no accountability required toward the IGA partner.

Mexico, it appears so far, has not yet been given the green light, so I can only assume that the status quo right now is Mexico dutifully turning over (on a monthly basis I believe) IGA-compliant information, while the IRS provides Mexico nothing in return. You might like to see what the American Banking Association thinks about this status quo. I think it is safe to say that the Florida and Texas Bankers Associations are determined to at minimum delay reciprocal automatic information exchange as long as possible, if they cannot eliminate it all together.

Now, if I have these facts incorrect and the IRS is actually exchanging information with Mexico under the IGA, I hope that someone will please correct me right away because this is tremendously important--as I have suggested before, the information Mexico could get from the IRS under such an arrangement could be explosive in terms of exposing the volume and direction of tax evasion as between these two countries (not that the public will get much or any information on these things--on the contrary we most likely will learn absolutely nothing, more's the pity).

One might say the USA won't similarly refuse to share information with Norway as such behavior smacks as bad faith, and countries have a positive duty to on the contrary act in good faith with respect to "international agreements". Moreover, it strains credulity to think that Treasury would start collecting information on Norwegian account holders from US banks, without actually planning to share it.

To that I would counter, presumably Norway knows exactly what it got in this deal: the same promises as have come before.

This is consistent with the rest of the IGA, which suffers from the same lack of reciprocity that in my view belies the character of these instruments as international agreements at all, even beyond their likely constitutional violation in the USA.  I recently wrote an article about the lack of reciprocity in the IGAs, why I think that is so problematic in terms of creating a perverse market advantage for the USA to facilitate tax evasion, and why there is not much reason for being optimistic that the necessary sea change will occur to make FATCA a viable multilateral regime with equal applicability to the world's largest destination for foreign capital. You can read that article here, and as alway I welcome feedback, especially to correct any of my misunderstandings.

To sum up, in my view the "you first, no you first" provision adds nothing in terms of greater reciprocity in the Norway IGA, while the same procedural and substantive defects we have already seen continue unabated.

* I also note a new conditionality to the local bank exception, in Annex I Part II.A.(e):

"provided thatNorway provides information on an automatic basis to the relevant Member State;"

This seems to mean that until Norway is actually exchanging info, its local banks will not be deemed compliant but will be withheld upon once the "you first" rule kicks in (i.e., once FFIs must begin reporting per Treasury regs).  

The local bank exception is a get-out-of-FATCA-free card for banks whose account holders--including US citizens--mostly live in the country. I've been told the provision is meant to help Americans living abroad whose local banks are dropping them in the (mistaken) hopes that this will relieve the FI of FATCA scrutiny. I have a lot of trouble with this local bank exception in terms of what the US appears to be trying to do with it, tempering citizenship-based taxation with an escape hatch that potentially encourages and even invited casual noncompliance, but that's a conversation for another day.

My intrigue with the new language in the Annex here is that I'm not sure why this condition applies only to local banks, and not other deemed compliant FIs. Those who think the FATCA regime is now deliberately aimed not at catching HNW Americans living in the USA and stashing cash offshore (few of whom hold large amounts of cash in accounts with their own names attached, as Lee Sheppard has repeatedly pointed out) but instead at imposing upon US citizens living abroad with their middle class wage earnings and their lack of effective representation in Washington, could have a field day with this provision. 

France ups the ante for EU tax evasion

Cahuzac's denials and ultimate admission about hiding money offshore while serving as the anti-evasion officer-in-chief is very embarrassing for France, and so it should be no surprise to see the rhetoric heat up as new allegations surface about his attempts to move the money around in an ultimately futile attempt at subterfuge. From AFP:

J'ai dit quoi?

France said Sunday [ed: France is a country and cannot speak. It is not so difficult to write "French leaders said", and it is ever so much less distracting.]  it was looking to tighten Europe-wide measures against tax evasion as it scrambles to contain a fraud scandal that has rocked President Francois Hollande's government.

...Finance Minister Pierre Moscovici announced that France would seek to reinforce the exchange of banking information throughout Europe, based on a US ruling in place since 2010 that seeks to fight offshore tax evasion.

Well, the "rule" may have been in place but let us recall that it is not in fact yet in force...three years later, we're still working out the kinks over here, and there are many, many kinks.

More:

"I propose that there be an automatic exchange of information, a European FATCA," Moscovici said on Europe 1 radio.

Hollande's government has been shaken by the scandal, which erupted Tuesday after Cahuzac -- once in charge of tackling tax evasion -- admitted to investigators that he had a foreign account containing some 600,000 euros ($770,000). 

...Critics have been quick to round on Hollande and his ministers, accusing them of either trying to cover up the scandal or of mismanagement for having believed Cahuzac's denials.

...Hollande has tried to contain the fall-out from the scandal, saying he was unaware of the account and announcing Wednesday that a new law would be submitted within weeks that will establish greater control over ministers' wealth. 

The law would also ban any elected representative found guilty of tax fraud or corruption from holding any form of public office.

Query whether there would be enough people left to run the world if every country made this same pledge.

Hearings on tax evasion & tax havens in the Canadian parliament tomorrow

Meeting of the Standing Committee on Finance beginning at 8:45 in Room 7-52, 131 Queen Street, featuring a fascinating line-up:

Tax Evasion and the Use of Tax Havens		Fraude fiscale et le recours aux paradis fiscaux
Witnesses		Témoins
Canadian Bankers Association		Association des banquiers canadiens
Marion Wrobel, Vice-President Policy and Operations		Marion Wrobel, vice-président Politiques et opérations
Darren Hannah, Director Banking Operations		Darren Hannah, directeur Opérations bancaires
Canadians for Tax Fairness		Canadiens pour une fiscalité équitable
Dennis Howlett, Executive Director		Dennis Howlett, directeur exécutif
Videoconference - Cambridge, United Kingdom		Vidéoconférence - Cambridge, Royaume-Uni
Tax Justice Network		Tax Justice Network
Richard Murphy, Director		Richard Murphy, directeur
Videoconference - Austin, Texas		Vidéoconférence - Austin, Texas
As an individual		À titre personnel
Arthur Cockfield, Professor Faculty of Law, Queen's University, Fulbright Visiting Chair in Policy Studies, University of Texas

Germany rejects Swiss Rubik deal...again

Also from Tax Analysts [again, gated]:

The upper house of the German parliament (Bundesrat) has again voted to reject the agreement with Switzerland aimed at taxing the undeclared assets of German taxpayers. 

This was the Rubik deal: basically, Switzerland won't share any information on individual accounts but will collect withholding taxes and pay them over. Here's a short explanation with a horrid graphic. I haven't discussed the deals much here, but it's had lots of play over on TJN [shorter and more to the point here]--it's a pretty wacky deal, really. I mean, how do you keep anyone honest in terms of withholding and paying over the "right amount" of tax if you can't pry any info from them?  From Tax Analysts:

The agreement was similar to one reached between Switzerland and the United Kingdom. It called for a one-time charge on all undeclared assets held in Switzerland as well as an ongoing withholding tax on income earned in undeclared accounts. The agreement also would have allowed German tax authorities to make a limited number of information requests that would not require the level of detail expected for standard treaty requests. 

Social Democratic Party lawmakers have long objected to the agreement, saying it was too lenient and that tax evaders should not be allowed to remain anonymous.

I take it that the deal was little more than an end run around the European Savings Directive. Certainly with Switzerland talking FATCA with the US it's hard to imagine any country in Europe settling for Rubik's weak tea.

Obama admin taking the high road on FATCA reciprocity?

I have predicted that real FATCA reciprocity would not fly in the US once people began to understand what the details entailed, but I would like to be wrong about that, and I have argued that the best course forward for FATCA is real reciprocity coupled with adherence to residence-based taxation. Here's a sign from the Chicago Tribune that I could get at least one of my wishes:

Foreigners' accounts in U.S. banks eyed in tax crackdown

The Obama administration may soon ask Congress for the power to require more disclosure by U.S. banks of information about foreign clients' accounts to those clients' home governments, as part of a crackdown on tax evasion, sources said on Monday. 

In a move facing resistance from some in the U.S. banking industry, two tax industry sources said the administration was considering asking Congress in an upcoming White House budget proposal for the authority to require more disclosure from U.S. banks. 

...At the heart of FATCA is a law requiring more disclosure by non-U.S. banks of information about Americans' accounts to the Internal Revenue Service, with the goal of exposing Americans' efforts to dodge U.S. taxes through secret offshore accounts. 

As Treasury has implemented FATCA, some countries - possibly including France, Germany and China - were said to be driving a hard bargain. They have been saying that if their banks have to tell the IRS about Americans' secret accounts, then U.S. banks should have to reciprocate by disclosing more information about the U.S. accounts of French, German and Chinese nationals. 

...China has been publicly dismissive of FATCA, but it is talking with U.S. officials behind the scenes, sources said.

...France and Germany "have been asking for something more like full reciprocity," said Jonathan Jackel, a lawyer with the law firm of Burt Staples & Maner LLP in Washington, D.C. 

The story says that "The IRS this year started disclosing to some foreign governments information about bank interest payments earned by their citizens with U.S. bank accounts."--but I am not sure that that is true, given that the only country currently on the list for automatic info sharing on portfolio interest is Canada-and Canada was already on that list anyway.


The story quotes Itai Grinberg, who has to be the foremost expert on the legislation and really ought to be listened to on the underlying principles:

"The United States should be moving toward full reciprocity," said Georgetown Law School Professor Itai Grinberg, a former Treasury official, adding it would be "deeply hypocritical" of the United States to ask for U.S. taxpayer information "without offering some kind of reciprocity."

Progress, perhaps. But this is America, so here comes a lawsuit:

The Texas Bankers Association is considering a lawsuit against the government to stop accountholder information sharing with Mexico, said Eric Sandberg, the group's president.

Why, what s the problem?  Well, you see, it's financial privacy.

"We are concerned with Latin American countries like Mexico," said Fran Mordi, senior tax counsel at the American Bankers Association. "In the past, U.S. banks didn't report interest payments to non-resident aliens ... IRS is now saying you have to report that."

Translate how you will. I think it's a clear illustration of the state at war with itself over how to gain the maximum advantage from a combination of cooperation and competition with other states on taxation. Information sharing is going to benefit the US more in terms of dollars in the economy if it is one-way street that catches US shirkers but doesn't prevent taking advantage of other countries' ignorance about the location of their own taxpayers' resources. I think the mercenary state will prevail in the end--cooperate in principle, defect in practice--but I am very much hoping to be wrong.

Manx tax strategy

Interesting: Isle of Man announces it will keep its 0/10 corporate tax rate and pretty much the rest of its tax system as is, but wil cooperate with the US on FATCA and the EU on its codes of conduct, and might join the mutual administrative assistance in tax matters agreement, and even "consider working with other countries and multilateral organisations on the development of co-operation systems similar to FATCA." I think that last one is in regards to the UK, but it could be broader in scope.

At the same time, the Isle of Man will

"maintain competitive  personal income tax rates  as one of the features making the Island an attractive place to live and work; and

maintain a competitive business tax system in the Isle of Man to support economic development;"

among other aspirations. I think they are in a tough spot, with the US and the UK focused on chasing individual tax cheats and corporate tax avoiders (respectively, perhaps) through their banks. By way of background, the tax strategy says:

The Isle of Man‟s taxation policies have played an important part in our economic success. 

...The key principles of fiscal sovereignty, economic stability and adherence to international standards which underpinned the original taxation strategy remain just as relevant today. 

I'm not sure what anyone means by fiscal sovereignty anymore. Then again, I never really did think it was a real thing.

FATCA will/will not work: discuss

TJN ran two stories recently on FATCA's impact on tax competition. Which is right?

Story #1 says Austria and Luxembourg "may be forced to abandon banking secrecy because, in agreeing to implement FATCA with the US:

"EU member states could impose [automatic information exchange] on these two recalcitrant jurisdictions by invoking the 'most favoured nation' clause, explains Pascal Saint-Amans of the OECD."

 EU Directive 2011/16/EU contains a most favoured nation clause: if a Member State provides wider cooperation to a third country than that provided for under the directive it may not refuse such wider cooperation to another Member State that requests it on its own behalf."

So if these countries provide automatic information exchange to the U.S., then they are not allowed to refuse it to other E.U. member states.

TJN says thanks to FATCA, "the all-important amendments to the EU Savings Tax Directive are therefore likely to be passed this year, and Swiss efforts to torpedo this transparency initiative will have failed." Conclusion: FATCA will turn into its ultimately goal, a global tracing system under which no one can hide behind bank secrecy to evade their taxes, what some like to call GATCA.

Story #2 says Hong Kong is set to grab all the tax haven business:

Hong Kong just became an even better place for company directors who value secrecy. The Chinese territory, already ranked fourth in a list of 71 "secrecy jurisdictions" by the Tax Justice Network, has proposed new laws making it harder to identify the directors of non-public companies.

TJN says in response: "Tax havens. As we have said - this is where real power in the world increasingly lies. And the race to the bottom on secrecy continues apace."

If FATCA will shut Austria and Luxembourg as tax havens, why not Hong Kong?

The IGAs don't, I think, really explain things: in the absence of IGAs, FATCA is supposed to apply directly to all foreign financial institutions.  So it is the IGAs that would change the scene on the EU directive.  These agreements, let's be fair, really don't have a single thing to do with the FATCA statute from a legal perspective.  In other words, no one in the world needs FATCA to order into an agreement on automatic information exchange, countries could have (and in some cases have already--US, Canada) agreed on automatic info exchange years, decades, and even a century ago (which in fact they also did, see some of US early agreements).  FATCA is just a very big stick that is forcing Luxembourg and Austria to so agree, thus apparently opening themselves up to similar agreements throughout the EU.  Score one for dreams of multilateralism, but only among rich countries.

But Hong Kong, poised to take over, shows why FATCA can't get us to GATCA, i.e., there will be no worldwide information exchange, and the world is still safe for tax cheats. The reason for this lies in s S. 1471(f), which reads:

Subsection (a) shall not apply to any payment to the extent that the beneficial owner of such payment is—

(1) any foreign government, any political subdivision of a foreign government, or any wholly owned agency or instrumentality of any one or more of the foregoing...

(3) any foreign central bank of issue...

Translation seems to be: no big stick on payments that go to state-owned financial institutions.  That, I take it, describes China's entire financial system, including Hong Kong and Singapore.  Tell me if I am wrong about this, because I truly want to know.  If I am right, then FATCA moves tax havens around on the board but doesn't actually end the gravy train for tax cheats.

If that in turn is true, then the application of onerous compliance and filing issues on americans living in high tax countries to try to hunt down tax cheats who will not even be there seems particularly troublesome.

Cost to poor countries of illicit Cash flow: $859B

TJN posts this report from Global Financial Integrity, showing that

Crime, corruption, and tax evasion cost the developing world $858.8 billion in 2010

... the biggest exporters of illicit financial flows over the decade are:

• China,  $274 billion average ($2.74 trillion cumulative)
• Mexico, $47.6 billion avg. ($476 billion cum.)
• Malaysia, $28.5 billion avg. ($285 billion cum.)
• Saudi Arabia, $21.0 billion avg.  ($210 billion cum.)
• Russia, $15.2 billion avg. ($152 billion cum.)

Table 2 of the report's appendix has a complete list. This demonstrates why information gathering and exchange has got to be global and, contrary to how it's going right now, should probably start with the world's wealthiest countries imposing their gathering, reporting, and sharing regime on their own financial institutions vis a vis the rest of the world, rather than working to protect their own bases first and foremost.  This is a time for leadership by example.

Deutsche Bank offices raided in tax evasion inquiry | World news | The Guardian

"Tax officials clutching backpacks and suitcases were seen leaving the bank's twin-tower headquarters in Frankfurt."

Come on now. 

Activists seek Canada Tax Gap Estimate

There is a movement afoot to get Canada to get on the "Tax Gap" bandwagon, and make an estimate about how much is lost in tax revenues to tax evasion. As far as I know only the US and the UK even try to estimate this, and the UK's estimate has been criticised as laughably low, while the US estimate is hampered by shoddy data. Still, it's an exercise worth undertaking I think. If the government won't do it, do we have some enterprising accountants or economists willing to give it a go in Canada?

Canada's tax evasion problem in need of resources & leadership

Senator Percy Downe has issued a call to the Harper government to put some money and some effort into curbing Canadians hiding their assets overseas to escape taxation:

Sen. Percy Downe said the vacancy [at the head of the CRA] gives Prime Minister Stephen Harper the opportunity to elevate the job to the “importance it deserves” — to provide the resources to crack down on Canadians who stash money in havens to avoid paying taxes. 

...“It’s either a resource problem or a leadership problem and this is an opportunity for the prime minister to identify it as a problem and correct it,” said Downe. “I don’t want to see someone parked there to manage the status quo …. It’s time to shake up the status quo.” 

Former CRA commissioner Michel Dorais said it's a question of resources:

“CRA is a big collection machine and the money collected is directly proportional to the money invested. The determination of where to put the effort is a combination of ministerial direction, priorities of its clients, direction from the board of management and management decisions of the CEO/commissioner. If one of those three components is weak, the whole thing can breakdown rapidly.”

But the Senator says it is a question of will, not resources, becuase more resources put in will yield more revenues out.  The story quotes a "former CRA executive" who said “wherever you look you’ll find money.” Info on offshore accounts not being fully pursued by the CRA is a case in point:

In 2007, the government was given a list of 106 Canadians with secret accounts worth more than $100 million in a bank in Liechtenstein. They were among a longer list of clients taken from the bank by a former employee and later acquired by the German government, which shared the information with countries whose citizens were on the list. 

By April, Downe said CRA had assessed only $16.5 million owing in back taxes, interest and penalties on the money hidden in Liechtenstein. Of that, they collected only about $5 million and “not one penny has been assessed in fines.” 

“By its own admission, since CRA received this information five and a half years ago, not one of these Canadians who have hidden their money abroad to avoid paying taxes in Canada has stood before a judge,” said Downe.

More at the link.

Underground Economy in Canada, 1992-2009

Interesting stats, suggesting that the underground economy is not currently growing in Canada.  The CRA is careful to say that the UE is not an estimate of the tax gap, but CRA will look at these stats in light of the need to ensure everyone is "paying a fair share."  I'm only aware of an official statement of a "tax gap" by the U.S. and U.K.   

How to go offshore and disappear for a mere $400k

Richard Murphy got an email advertising an investment opportunity in St Kitts & Nevis:

A US$400,000 investment in the new Park Hyatt St Kitts development entitles the buyer to:

• An investment in shares of a globally recognized brand

• Annual income estimated between 2%-5%

• St Kitts Citizenship benefits (with passport)

• Security with an international developer and globally recognized brand

• Complimentary enrollment in the Hyatt Gold Passport Diamond Level, the highest tier of Hyatt's guest loyalty programme.

As one of the oldest of its kind in the world, the St Kitts & Nevis Citizenship by Investment Programme provides the following prime benefits:

• Fast processing of passport within four months

• visa-free travel to more than 130 countries including Schengen Zone

• No tax on worldwide income

For more information please click here

Murphy responds:

So, buy your holiday apartment and get a passport thrown in for free with no worldwide taxation. Now why would that appeal to anyone? 

As an example of a secrecy jurisdiction literally putting itself and its regulation - right down to citizenship – up for sale this one takes some beating. At the same time it shows just how tax haven activity is designed to undermine the very notion of the state whilst exploiting the power of the states that tax haven abuse captures to do so. The paradox and hypocrisy is all too apparent. 

Have no doubt that when I and others suggest tax haven abuse is meant to challenge democracy, our way of life and the states that support it we mean it. Reducing the state and its processes to a commodity is part of the process of destroying it.

Africa's US/UK offshore problem

Complicity with global tax evasion by the US and UK continues to be a big problem for Africa:

When we say offshore centers, when we say secrecy jurisdictions, when we talk about banking secrecy, people may think that these are alien lands, in no-man lands, but actually you will be surprised to know, if you didn’t know—I’m sure you know, but for those who didn’t know, they will be surprised to hear that the biggest offshore centers are in countries like the U.K., in London, the U.S., in New York, Paris in France. These are the biggest offshore centers where you find banks colluding with corrupt leaders, corrupt private investors, in hiding and not disclosing their investments and their bank accounts, because some of it was acquired illegally, was transferred illegally, is held illegally in the sense that it’s not reported to the government.

From RNN via NC.

Unbelizable: How to go offshore and disappear

Here is yet another story on how easy it is to set up offshore (especially if you are trying to do so in the USA), accompanied by an infographic:

This is from Planet Money and Adam Davidson has a related column.  Notice that "It's all legal," so this is not about evasion. Really!  It's about protecting your assets from a greedy spouse or undeserving creditors (or is it the other way around).  Of course it's not about evasion.  It's about the ability to say of your investments, "I don't manage them. I don't even know where they are." 

From the story:

Right now, the team here at Planet Money are the proud owners of two companies. Unbelizable Inc., in Belize City, and Delawho?, right here in the United States. We have a packet of incorporation documents and a lot of questions about what exactly people do with these kind of companies. Our plan is to find out.

Adam Davidson tries to pin the blame for offshore on overly complex regulations:

One often-overlooked lesson of the financial crisis is that shenanigans don’t happen in the absence of regulation; they happen when regulations are exceedingly complex and involve confusing, overlapping regulatory authorities. 

That is completely disingenuous.  Cheating is not about not overly complex regulations.  It is purely and simply about a desire and willingness to cheat plus an ability to get away with it.  Once again, I have to quote Charlie Kingson: When a large corporation says it wants simplicity, it wants money."  The Great American Jobs Act Caper, 58 Tax Law Rev. 327 (2005).

Tim W-thanks for the link.

Greek islands tax evasion rates: 60-100%

This story reports that in resorts on a number of the Greek islands including Crete, the rate of tax evasion is 100% or nearly so.  I'm not sure it's properly called evasion if there is apparently zero enforcement.  That's not a bug, that's the system?

FATCA, again

Peter Spiro points us to last week's NY Times story on FATCA and asks: "How many tax stories get this kind of play? NYT must have some reader traction on this.  Remember: the US is the only country other than Eritrea that taxes its external citizens."  Maybe things are not so crystal clear on Eritrea.  Peter thinks FATCA "[m]ight even violate international law, insofar as states can't arbitrarily obstruct expatriation."  From the NYT:

"new U.S. regulations — and much tougher enforcement — are catching some Americans in legal nets designed to snare terrorists, money-launderers or wealthy tax-evaders. Many Americans overseas — not just the rich — have had to pay thousands of dollars in fees for tax accountants or Internal Revenue Service fines.

...A growing number of Americans living abroad are renouncing once-valued U.S. passports. Some 1,780 people gave up U.S. nationality last year, eight times the 2008 level and the largest number in more than a decade."

Correlation ⇏ Causation, but it's a provocative statistic.   It's also bad when your taxpayer advocate says things like this:

"Nina E. Olson criticized the agency for not explaining the laws better to international payers; for issuing regulations so complex that compliance can be arduous and costly; and for issuing “potentially devastating penalties for even inadvertent noncompliance.”

$$ in Tax Havens: Same as it ever was

$2.7 trillion in 1997, and $2.7 trillion in 2011, just as if nobody did anything at all.  The Guardian.

4.5 Years & $274k for Canadian Tax Protestor

Russ Porisky and Elaine Gould, the "magic words" tax protestors, were sentenced today:

Porisky received 18 months in jail for the income tax and GST evasion and another three years for the fraudulent counselling of the students, to be served consecutively. The accused, who must also pay a $274,000 fine, had little reaction as he sat in the prisoner’s dock. Gould received a six month conditional sentence and a fine of $27,000. “I have no job,” she told the judge. “How am I going to pay the fine?” The judge told her that she had a year to pay off the fine. “If you can’t do it, you’ll have to come before me to explain why you can’t and tell me what efforts you’ve made to do it . . . You should make what efforts to pay what you can.” The couple kissed one another before Porisky was taken into custody by sheriffs. 

Read more here.

The Impossibility of Accurate Basis Reporting

The new cost basis reporting rules came into effect for stock brokers in 2011 and will come into effect for mutual funds and ETFs in 2012.  Bloomberg ran an article a few weeks ago outlining outlined a series of the major issues; yesterday Steven Rosenthal wrote on the many compliance headaches to expect, and concluded that although he thinks that on balance basis reporting is appropriate and necessary, "the transition will be painful."

I sent the article to David Nangle, a student of mine who has been interested and vocal on the importance of keeping track of basis given the taxpayer's propensity to prevaricate with impunity in the absence of a third party backstop.   He has extensive experience with corporate information management and worked with a software platform that automatically sent trade information and pricing data (including basis and valuation information) to prime brokers and fund administrations for hedge funds including funds of funds.   His response is that enforcement is not just difficult and painful, in fact it is impossible [edited & posted with his permission]:

"Whenever migrating existing a new fund onto our software, I always needed to know how they wanted their basis calculated similar to what the article discusses in #1.  FIFO was among the most popular used by funds, yet not uniform. HIFO - highest in, first out - was equally widespread, and in the case of arbitrage funds (who do thousands of trades a day) they frequently used our 'Min Tax' option or another exotic and rarely used scheme. Obviously heavy trade volume in a particular security clouds the cost basis of your overall position, so it was essential to be able to track different trade tax lots to see which ones were closing off against each other and keep all the different parties involves on the same page. It would be a massive headache for a couple weeks if one institution's internal accounting of the fund's changing portfolio positions was off and we needed to figure out why, though generally speaking after a couple weeks these issues would fade. 

Having seen firsthand the complex nature of this cost basis problem, I have absolutely no faith that regulators could ever successfully track the different tax lots of each trade and ensure that funds are doing it 'right'. There is just no way that the IRS will be able to track every funds' trade activity, along with pricing information, and conclude that particular funds are dodging tax liabilities. Its possible that they could find mistakes if they happened to know which fund or position to investigate, but this would be enormously difficult to look into without a tip that something is amiss in the first place. 

The problem becomes much more complex when the overall structure of hedge funds, mutual funds and fund of funds is considered.  When a fund uses a master feeder structure, or a 'block' fund, it buys a huge chunk of a particular security and then allocates the chunk of securities across multiple funds or investment pools.  This clouds the reporting discussed in the article even more, because technically the brokerage houses are not using the individual fund account numbers to make the purchases, merely the 'block' account.  The fund itself is allocating the shares to different strategies or sub accounts. Eventually, fund admins and brokerages learn the allocations after reconciliation, but that is not captured in the initial trade itself. Allocations can go to sub accounts that might have an existing position in that security, thus distorting the cost basis by either closing out or adding to the position, while other allocations are the first of that security's kind to be allocated to that sub account. 

Therefore it is the fund's internal decision making which will ultimately be reporting this information anyway, and even if the IRS forces a brokerage unit to report on a client funds' trade activity the block account will shield the allocations until the fund has decided the best way to report out their sub portfolios' positions.

I have to agree that the task sounds impossible.  Yet overstating basis is a major problem for the IRS, one made even more challenging by last week's Home Concrete decision [pdf], which tightens the IRS' time to review and investigate even in egregious cases.  Rock: hard place.