Why Foreign Banks Will Shun American Business

Americans who travel extensively or live abroad and companies that do business overseas often need to maintain accounts at foreign financial institutions. Soon, however, foreign banks may start closing their doors to American depositors, thanks to an overreaching U.S. law.

Slipped into the Hiring Incentives to Restore Employment (HIRE) Act, passed in 2010, was a piece of tax legislation that may drastically change the way foreign financial institutions interact with the U.S. and its citizens. The law, the Foreign Account Tax Compliance Act (FATCA) will essentially require all foreign banks with U.S. accountholders to report annually to the Internal Revenue Service about their American customers’ activities. Institutions will also be required to collect a 30 percent withholding tax on U.S. income from any American customers unwilling to have their doings reported back to the IRS. Institutions that refuse to agree to these terms will be deemed noncompliant and will be hit with a 30 percent withholding tax of their own on “U.S. source income,” including the sale of U.S. securities. The law is scheduled to come into effect in 2014.

The goal is to track down tax cheats who squirrel away funds in offshore accounts. However, rather than making an effort to find these individuals itself, the IRS proposes to farm the task out to foreign financial institutions, forcing them to do the legwork of identifying American account holders and tracking their holdings.

FATCA has drawn intense criticism both from foreign financial institutions and governments and from American expatriates. Given the administrative demands created by the new law, its implementation has already been pushed back one year, but it is still unlikely that all those affected will be ready in time. Canada’s TD Bank has estimated that it would need to spend $100 million on new software and technology to comply with the law. Meanwhile, Canadian Finance Minister Jim Flaherty has called the individual reporting requirements “a frightening prospect that is causing unnecessary stress and fear among law-abiding hardworking dual citizens.”

While some financial institutions certainly will choose to pay the price of acting as de facto IRS agents in order to keep their American customers, it’s likely that others will not, opting instead to sever ties with American citizens and firms.

A few years ago, I opened an account with an offshore unit of an international bank to buy some euros in anticipation of a long personal trip to Europe. The trip was postponed indefinitely, but I have kept the account to avoid the costs of converting my euros back to dollars and then to euros again. I report the account every year to the U.S. Treasury, and I pay taxes on the interest, which comes to less than $2 a month. If I tried to open such an account now, however, it’s possible HSBC wouldn’t let me. The compliance burden per U.S. customer under FATCA is simply too high to make low-balance accounts worthwhile. If American customers come escorted by American tax collectors, banks will close their doors.

Perhaps even more importantly, FATCA encourages foreign financial institutions to limit their exposure to U.S. assets. In a joint letter to the Treasury and the IRS, the European Banking Federation and the Institute of International Bankers, which together represent most of the non-U.S. banks and securities firms that would be affected by FATCA, warned that “many [foreign financial institutions], particularly smaller ones or those with minimal U.S. investments or U.S. customers, will opt out of U.S. securities rather than enter into a direct contractual agreement with a foreign tax authority (the IRS) that imposes substantial new obligations and the significant reputational, regulatory, and financial risks of potentially failing those obligations.” A widespread divestment of U.S. securities by institutions seeking to avoid the burdens of FATCA could have real and harmful effects on the U.S. economy, though perhaps not effects as calamitous as some FATCA critics have warned.

All of this is designed to bring in an estimated $9 billion in tax revenue over a 10-year period, according to the IRS. For a country with a $3.8 trillion annual budget, that’s small change. The thinking, however, seems to be that even a small amount of income is worthwhile – so long as someone else is paying all the costs.

In many ways, FATCA is similar to the ill-fated Form 1099 scheme that was smuggled in through the health care reform bill. That law, allegedly intended to offset the costs of the health care initiative, would have introduced a flood of new paperwork by requiring companies to issue 1099 tax forms to all individuals or corporations that they pay more than $600 for goods or services each tax year. By making businesses effectively document each other’s revenue streams, the IRS hoped to cut down on unreported income. Congress apparently saw no problem with making business owners do the IRS’ work.

Once business owners got wise, however, they were quick to voice their displeasure, and the measure was repealed before it ever went into effect. Unfortunately, since the first blows will fall on foreign companies, which tend to have far less leverage with American lawmakers, repeal may not be so easy with FATCA. Americans may need to see the law’s effects first-hand before they understand how it will ripple through to them.

Going after tax cheats is important and appropriate, but trying to bully foreign companies into paying the bill is the wrong way to do it. If FATCA isn’t repealed before 2014, that will become all too apparent.

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About Larry M. Elkin 564 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

Visit: Palisades Hudson

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