FATCA

Despite the prosperity it has enjoyed under a free market, the United States in 2009 enacted legislation that many people view as the start of capital controls in America.

That legislation is found hidden in a jobs’ bill, H.R. 2847 (also known as the HIRE Act), which became law in March 2010. Title V of the law largely encompasses the Foreign Account Tax Compliance Act of 2009, or FATCA.

On their face, these provisions appear intended to force U.S. tax compliance on with regard to foreign accounts and transactions between the United States and individuals in countries that are considered to be tax havens (meaning the banks and financial institutions in those countries do not share account information with U.S. authorities).

Section 1474 refers to “withholdable payments” to foreign financial institutions that don’t meet U.S. standards for information sharing. The law requires that any financial institution (U.S. or foreign) remitting any foreign payment to a bank in such a country withhold 30% of the amount of such payment and remit that percentage to the IRS as a tax.

A withholdable payment is defined as any payment of interest, dividends, rents, salaries, wages, premiums, annuities, compensation, enumerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income, if such payment is from sources within the United States.

On its surface, the withholdable payment is designed to ensure that pretax monies are not sent abroad without applicable U.S. federal taxes being paid. Looking a little deeper, however, the law does two things that go beyond the responsibility of each taxpayer to pay what he owes to the IRS…

First, under Section 1474 of the bill, the law makes banks, as a third party, responsible for the enforcement of government tax policy. The banks are liable for the customer’s tax obligation on transferred funds if they don’t withhold the required 30% to cover any possible tax liability. The banks essentially become the tax police, working for the government as hammers to bring about individual compliance.

Second, the same provision holds the banks harmless and indemnifies them if they improperly withhold the 30% tax when it is not due.

So, if banks are third-party tax enforcers on the one hand and completely indemnified from improper tax withholding on the other, it is clear what banks will do. It would be difficult in any case for banks to determine the difference between a pretax remittance versus a post-tax payment. They will be inclined, therefore, to withhold 30% tax on all foreign payments to banks and countries that do not have what are considered “information-sharing agreements” with the United States.

The net effect of this provision will be to greatly discourage any financial transactions between U.S. banks and foreign banks not entering into information-sharing agreements with the U.S. government.

Example: To wire transfer US$100,000 to Panama, for example, to purchase a piece of real estate, one would have to agree to send US$142,000 so that a net US$100,000 would reach its destination. Who would be inclined or willing to pay 30% more in a global transaction to satisfy these requirements? Almost nobody.

International payments are now subject to these new withholding requirements. You can go here to see if your bank of choice is FATCA compliant.

FATCA has placed extreme pressure on individual foreign banks to enter into private-sector agreements with the IRS to disclose all U.S. account holders or risk having all U.S. transactions to or through their individual bank subject to 30% tax withholding.

In addition to those intended effects, FATCA is having other consequences.

For one, many foreign financial institutions have dropped their U.S. clients and are refusing new ones as a way to avoid being subject to the 30% withholding requirement as well as avoiding the U.S. regulatory compliance costs. (These compliance costs to worldwide bankers have been estimated by the Swiss Banking Association to total nearly US$40 billion annually, while the measure is projected to generate only around US$8 billion to the U.S. Treasury in increased taxes.)

Additionally, foreign financial institutions and foreign private-sector interests may simply stop conducting their business in dollars. A dollar-denominated transaction will ultimately pass through a U.S. Federal Reserve Bank and potentially subject the transaction to the risk of a U.S. bank levying a 30% withholding tax on any payment.

One method for foreigners to ensure that this would not happen would be to designate the contract in a currency other than U.S. dollars. So if a German businessman, for example, contracts with his Japanese counterpart to do a deal to sell equipment in China, the best way to ensure that the transaction would not be subject to U.S. withholding tax would be to designate the contract in euros, yen, or any other currency than dollars. Those currencies would not pass through a U.S. Federal Reserve Bank and therefore would not be subject to the backup tax regime.

Russia and China have already conducted massive transactions in their own currencies, and it’s only the start.

As more global transactions (especially oil, gold, and other commodities) are done in nondollar currencies, the global demand for the U.S. dollar will decrease. If you follow this thinking through, you see how it is very likely that the U.S. dollar eventually, perhaps sooner than later, will no longer be the world’s reserve currency. As demand decreases, the value of the dollar will surely fall as well. So, while exchange and private capital controls may well have been envisioned in the HIRE Act, additional unintended consequences of immediate capital flight and long-term devaluing of our currency through simple supply-and-demand manipulations were probably less well-considered.

The U.S. government’s expanding and extraterritorial efforts to intrude into the private affairs of its lawabiding citizens are a cause of great concern to us. But we’re pragmatists by nature and not fools. We’re not going to waste time fighting a battle that can’t possibly be won.

We don’t care what happens to the U.S. dollar, or the euro either.

That isn’t very helpful to you, we understand. However, allow us to explain why we can comfortably say those things…

Once you have worked steadily and steadfastly to organize your life and your financial affairs, it really doesn’t matter. This is the key. So that no matter what happens with any currency or any government or any economy, you’ll be OK.

Even if you hold only a small fraction of your cash outside your home country, it means you have options should something tragic occur at home…economically or politically. And you can accomplish that by simply opening a bank account offshore.

Sure you can hold another currency in an account you already have in the United States, but that account would still be in the United States, subject to U.S. rules. Open an account in another country, transfer some dollars, and convert them to whatever currency you are most comfortable with. That is the easiest first step to internationalizing your life…and one you’ll be happy you made no matter what happens at home.

Indeed, international diversification is the surprisingly simple answer to the sometimes seemingly impossible-to-process question:

Spread yourself around so that you’re not at the mercy of any one of them, so that no particular down is fatal for you. It is the only sensible course of action, elegant in its simplicity but intimidating, too, when you’re standing at the starting line.

You’ve read about this idea before, perhaps. It’s often referred to as the “Five Flags” strategy. In fact, it can translate as six or seven flags or maybe only two or three.

We couldn’t tell you what level of diversification you require. That depends on your circumstances and your agendas. Big picture, the objective is to disperse your assets, your investments, your business, and your lifestyle across borders so that they’re all as insulated as possible from outside threats. How far and wide should you spread? That depends on how much you’ve got and what you ultimately want to do with it.