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The Internal Revenue Service office in New York.Lucas Jackson

Ottawa is in talks with the Obama administration to temper a sweeping law that requires Canadian financial institutions to report their American customers directly to U.S. tax authorities.

Financial institutions want the federal government to collect the data itself and deal with the U.S. Internal Revenue Service, using the information-sharing provisions of its existing bilateral tax treaty with the U.S.

Ottawa now says it's open to a government-to-government deal – a bid to allay concerns about the extraterritorial reach of the U.S. law and possible violations of Canadian privacy laws.

Several European countries worked out a similar compromise in February.

"The framework that the U.S. has developed with certain European countries appears to demonstrate an interest in greater joint government collaboration to address [Canadian]concerns," Finance Department spokesman Jack Aubry said.

Finance officials are now working with U.S. officials to "minimize the red-tape burden, minimize conflicts with privacy and other laws, and improve collaboration between governments," Mr. Aubry added.

The U.S. Foreign Account Tax Compliance Act, or FATCA, has provoked a storm of protest in Canada, home to roughly one million Americans.

Earlier this year, the IRS responded to foreign complaints by delaying the law's income-reporting requirements by two years to 2016 and softening other provisions.

But the law remains deeply unpopular with non-U.S. banks, brokers, insurers, mutual fund companies and other financial institutions, which complain it will be a logistical and administrative nightmare.

Terry Campbell, president of the Canadian Bankers Association, applauded Ottawa's efforts to work out a compromise that lessens the burden on financial institutions.

"The way FATCA is written now, institutions have to deal one-on-one with the IRS. That's extremely onerous," Mr. Campbell argued. "It just strikes us … that it's much more streamlined if you can do it tax authority to tax authority."

Mr. Campbell said "everyone understands" the United States wants to make its tax system as leak-proof as possible, but the devil is in the details.

"This is a hellishly complicated piece of legislation," he said. "You must be able to get the details right or it's not going to work for the U.S. tax authorities and it certainly won't work for us."

It is not clear how a FATCA compromise will make life any easier for the many Americans and dual citizens in Canada – many of whom don't regularly file U.S. taxes, as required.

Peter Dunn of Toronto, a dual Canadian-American citizen, isn't sure how having the Canada Revenue Agency share his financial information with the IRS would improve things.

"The idea that any of our financial information would be given to the IRS is an abomination," said Mr. Dunn, 48, who is in the process of giving up his U.S. citizenship and filing back taxes to end his obligations to the IRS.

FATCA requires that foreign financial institutions identify U.S. customers with accounts valued at more than $50,000, including registered retirement savings plans. Institutions, and customers, that don't comply would be hit with a 30-per-cent withholding tax on any U.S.-source income and transactions.

Financial institutions would have to verify the identity of all their account holders and keep photocopies of customers' passports or drivers licences on file. And then they would have to do it all over again each time those documents expire. FATCA also requires institutions to deny service to customers who refuse to allow account information to be sent to the IRS.

In a 54-page submission last week, the CBA, Investment Funds Institute of Canada, Investment Industry Association of Canada and Canadian Life and Health Insurance Association urged the IRS to make numerous changes to the FATCA implementation regulations.