The U.S. Government enacted the U.S. Foreign Account Tax Compliance Act (“FATCA”) in 2010 to combat offshore tax evasion, introducing detailed reporting requirements which affect some Canadian individuals with U.S. connections and Canadian financial institutions. But did you know these requirements could also affect some Canadian trusts and that trustees of these trusts may need to take compliance steps before January 1, 2014? In this blog we review some requirements of FATCA, and how they may affect Canadian residents.
Requirements For U.S. Persons
U.S. citizens wherever resident as well as people considered “U.S. Persons” for income tax purposes, are subject to U.S. income tax. It has been estimated that over 1 million U.S. citizens live in Canada.
Under FATCA, as of the 2011 tax year, U.S. citizens and U.S. Persons are now generally required to file a Form 8938, “Statement of Foreign Financial Assets” with their tax returns. The form includes information about financial accounts with financial institutions outside the U.S., stock or securities having a non-U.S. issuer, and interests in non-U.S. entities. Penalties for non-compliance begin at $10,000.00 per year. Form 8938 is in addition to the existing Report of Foreign Bank and Financial Accounts (“FBAR”), an annual report used by U.S. tax filers to disclose information about their financial accounts located outside the U.S.
Requirements For Foreign Financial Institutions
Foreign financial institutions (“FFIs”) are broadly defined to include any foreign entity which accepts deposits in the ordinary course of a banking business, holds financial assets for others as a substantial portion of its business, or is engaged primarily in the business of investing or securities trading. So Canadian banks and certain other financial institutions are “FFIs” and fall under FATCA.
The compliance requirements for FFIs under FATCA are extensive, and the consequences of non-participation can be onerous. For example, in respect of private bank accounts, FFIs participating in FATCA reporting must provide to the IRS information about any account holder who is a U.S. citizen or who has certain U.S. connections, including identifying information and information about the values of their accounts and gross transaction amounts. Non-participating FFIs are subject to a withholding of 30% on U.S. source payments to the financial institution and its clients. Given the reality of frequent cross-border financial transactions between the U.S. and Canada, such withholding has been characterized as punitive. FFIs must register by January 1, 2014, and begin reporting by March 31, 2015. Requirements under FATCA will be phased in generally between 2013 and 2017.
Impact on Trusts
At this point, it is unclear exactly what obligations trusts with Canadian resident trustees will have under FATCA. It seems clear that a trust may be considered an FFI if its primary business is investment or securities trading. However, certain trusts may qualify for reduced compliance requirements including if they hold accounts with a participating FFI (or U.S. financial institution), and are an “owner-documented FFI”, which generally includes an FFI if its primary business is investment or securities trading but not certain other kinds of FFIs. These trusts are required to provide information to the participating FFI, including annual statements and documentation regarding who has an interest in the trust, and the participating FFI carries out reporting obligations on behalf of the trust. Another possibility is that a trust may be treated as a passive “non-financial foreign entity” (NFFE) which requires it report information about its U.S. interest holders or that it has no substantial U.S. owners. Finally, it is understood that assets in certain revocable living trusts, known as “grantor trusts”, are considered to be owned by the settlor.
FATCA is U.S. domestic law and has not been implemented in Canadian domestic law. However the U.S. Treasury has begun negotiations with over 50 countries, including Canada, of intergovernmental agreements (“IGAs”). The IGAs follow one of two models: either permitting FFIs to report information to the local taxing authority, which is automatically transmitted to the U.S. authorities; or requiring the FFIs to report certain information directly to the IRS, which can then request additional information from the local taxing authority.
In the absence of an applicable IGA or treaty, questions have been raised about the enforceability of FATCA under private international law and Canadian constitutional law. But in practice, banks and other financial institutions may be faced with the choice of leaving the U.S. investments market or complying with FATCA, and will likely choose the latter.
FATCA imposes an added level of U.S. tax compliance on U.S. citizens, U.S. Persons and Canadian financial institutions. As well, it raises compliance concerns for many Canadians. For individuals, when opening an account at a bank in Canada, you can expect to be asked about your connections to the U.S., and if you don’t provide this information, a portion of certain payments may be withheld from your account. You may also be asked to waive Canadian privacy laws so that the bank can report information about your accounts under FATCA. At the same time, U.S. citizens and other “U.S. persons” must report information about their Canadian financial accounts on Form 8938, filed with their U.S. taxes. For trustees of Canadian trusts, any duties arising under FATCA should be considered well in advance of the January 1, 2014, implementation deadline and professional advice should be obtained if appropriate.
Don’t miss our next blog on the European Succession Regulation–what it is and why it may affect you.
The comments offered in this article are meant to be general in nature, are limited to the law of Ontario, Canada, and are not intended to provide legal or tax advice on any individual situation. In particular, they are not intended to provide U.S. legal or tax advice. Before taking any action involving your individual situation, you should seek legal advice to ensure it is appropriate to your personal circumstances.