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Bank office towers in downtown Toronto. The United States has offered scant evidence that its the heavy-handed approach to tax cheats will result in significant unreported taxes. (Kevin Van Paassen/The Globe and Mail/Kevin Van Paassen/The Globe and Mail)
Bank office towers in downtown Toronto. The United States has offered scant evidence that its the heavy-handed approach to tax cheats will result in significant unreported taxes. (Kevin Van Paassen/The Globe and Mail/Kevin Van Paassen/The Globe and Mail)

Barrie McKenna

Why the IRS crackdown puts Canadian banks in a tight spot Add to ...

Americans living in Canada are getting some welcome relief from a U.S. hunt for tax cheats.

Still waiting for a reprieve are Canadian financial institutions, which will soon have to start tracking the citizenship of millions of account holders to identify their American customers.

The U.S. Internal Revenue Service warned last week that it will miss a year-end deadline to produce draft rules as it gears up for the controversial new tax regime, set to come into force in 2014.

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The IRS is facing a barrage of criticism from financial institutions in Canada and Europe. Canada has complained that implementing the new IRS regime, mandated by the 2010 Foreign Account Tax Compliance Act, will be hugely costly, dangerously extraterritorial and run afoul of privacy laws.

IRS commissioner Douglas Shulman acknowledged the international backlash in a speech last week, saying foreign financial institutions have “major concerns.” He vowed to “work through these tricky issues in a practical fashion.”

Concerns may be an understatement. European financial institutions are in full revolt. Several major banks, including HSBC, Deutsche Bank, Credit Suisse and Commerzbank, are already dropping U.S. customers, rather than comply with FATCA.

Canadian financial institutions, whose U.S. clients are typically dual citizens, remain justifiably uneasy. The law essentially enlists them as IRS spies, strong-arming them into joining the cause under threat of a punitive tax on their U.S. subsidiaries.

It’s not a coincidence the issue didn’t come up when Prime Minister Stephen Harper and U.S. President Barack Obama met earlier this month to unveil the Beyond the Border trade and security deal. FATCA isn’t the kind of information-sharing the leaders wanted to talk about.

The law could impede trade by making it more difficult for financial institutions to operate in both countries. Canadians and Americans working in each others’ countries will increasingly have trouble finding financial institutions willing to serve them.

The United States has offered scant evidence that its the heavy-handed approach will result in significant unreported taxes.

A global banking organization has estimated that complying with FATCA will cost nearly as much over the next decade as any extra taxes the U.S. collects in this sweep. Major financial institutions, such as Canada’s big banks, could each face bills of $100-million as they reprogram computer systems and introduce new paperwork to help the IRS track Americans.

Financial institutions are quietly frustrated that the delay in releasing draft rules isn’t giving them enough time to prepare.

The Canadian Bankers Association is already ramping up for FATCA, recently posting a Q&A on its website to help Canadians prepare for what’s coming. But even the CBA acknowledges the guidance could change at any time.

And there’s no indication Washington is backing down on the main thrust of the crackdown. The U.S. appears intent to create the world’s most leak-proof tax system by carefully matching what Americans declare to the IRS and the assets they actually have around the world.

The U.S. has long demanded that its citizens report their worldwide income to the IRS, regardless of where they live, work or pay taxes. And since 9/11, it has required Americans to annually disclose the contents of their foreign accounts in so-called Report of Foreign Bank and Financial Accounts, or FBARs. As far back as 2000, it has also badgered foreign financial institutions into signing so-called “qualified intermediary agreements” to withhold taxes owing to the United States on U.S. income.

FATCA goes one significant step further by threatening steep penalties unless institutions identify all their American-held accounts and share U.S. Social Security numbers with the IRS.

Canadian banks and other financial institutions will soon begin asking clients to sign special consent forms, granting them permission to share information with the IRS.

The consequences for individuals and institutions who don’t play ball are severe. If you’re an American in Canada, you may soon find that your bank or broker no longer wants you as a customer.

Financial institutions are also in a tight spot. They face a 30-per-cent tax on U.S. income and other transactions if they don’t co-operate. For major Canadian financial institutions – many of which have vital U.S. operations – that’s a potentially business-destroying prospect.

Complying will be problematic because banks often don’t know who among their millions of customers are Americans or dual citizens. And Canadian banking law doesn’t require them to ask.

But FATCA could also prove to be a marketing boon for Canadian financial institutions that don’t operate in the U.S., and an incentive for marginal players to exit the U.S. market.

Hardly trade-enhancing.

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