Analysis: Critics say new law makes them tax agents

The unusually broad regulation, known as FATCA, or the Foreign Account Tax Compliance Act, makes the world's financial institutions something of an extension of the tax-collecting Internal Revenue Service -- something no other country does for its tax regime.

Conceived as a way to enlist the world in a crackdown on wealthy Americans evading tax, it gives global financial institutions and investment entities a choice: either collect and turn over data on U.S. clients with accounts of at least $50,000, or withhold 30 percent of the interest, dividend and investment payments due those clients and send the money to the IRS.

Foreign institutions and entities that refuse, or fail, to do so face bills for the taxes due, a draconian penalty of 40 percent of the amount in question and heightened scrutiny by the IRS.

"FATCA is a blunt instrument for which foreign banks have no choice but to each spend tens of millions of dollars to help the U.S. enforce its own tax law," said Scott Michel, a tax lawyer at Caplin & Drysdale in Washington, D.C.

A senior American finance executive at the Hong Kong branch of a major investment house told Michel that FATCA was "America's most imperialist act since it invaded the Philippine Islands in 1899." The regulation, Michel said, was "engendering a profound and growing anti-American sentiment abroad."

Dean Marsan, a tax lawyer and former senior tax counsel at Lehman Brothers who has written extensively on FATCA, called the rule "a U.S.-centric law for the world."

The legislation that created FATCA was introduced in 2009 by four congressmen during a crackdown on UBS, the Swiss bank giant that sold tax evasion services. Signed into law by U.S. President Barack Obama in March 2010, FATCA goes into effect on January 1, 2014, for most types of transactions and a year later for other payments.

The phase-in, announced in April, already represents a backtracking by the U.S. Treasury Department amid criticism from foreign banks about FATCA's reach, costs and still-to-be-ironed-out points. It originally had planned a January 1, 2013, start date.

In June, the private banking arm of HSBC said it would stop offering services to U.S. residents outside the United States because of the cost of complying with the rule. That month, Michael Ambuehl, Switzerland's secretary of state for international tax and financial matters, told a conference in Zurich that FATCA showed that "Switzerland is becoming a target of intense international greediness." Even the European Commission has objected, and experts say other countries may create their own FATCA-style regimes for U.S. banks or withdraw from U.S. capital markets.

In a barrage of letters to the Treasury, IRS and Congress, opponents from Australia to Switzerland to Hong Kong assail FATCA's application to a broad swath of institutions and entities. Those affected include commercial, private and investment banks and shells and trusts; broker-dealers; insurers; mutual, hedge and private-equity funds; domiciliary companies; limited liability companies, partnerships; and other intermediaries and withholding agents. FATCA also covers affiliates of the entities.

Foreign banks object to the rule's applicability to financial instruments including bearer bonds and payments which "pass through" securitization pools, a component of syndicated loans.

In June, the European Banking Federation and the Institute of International Bankers, both trade groups, told the U.S. Treasury that forcing banks to track pass-through payments on syndicated loans, swaps, foreign currency trades and routine money transfers "will create stresses in the global financial system, with indeterminate consequences." Euroclear, the world's largest settlement company for bond, equity, derivatives and other transactions, echoed those thoughts.

Tax lawyers at the Swiss-American Chamber of Commerce in Zurich called FATCA "the neutron bomb of the global economic system" for what they argued would deter foreign investment in U.S. securities.

Marsan said the pass-through provision could also hit corporate America: U.S. companies that borrow money from foreign banks for strategic acquisitions.

Dozens of other trade groups and banks, including Credit Suisse and Barclays, have weighed in with concerns about bank secrecy laws and FATCA's requirement that private bankers sift through boxes of client data and compile electronic records from information they may not have.

A bank in Tajikistan which holds U.S. Treasuries in its portfolio and opens a savings account for a local camel herder must either verify and report to the IRS that the herder is not a U.S. citizen or withhold taxes and remit them to the IRS.

FATCA is supposed to raise a net $7.67 billion for the Treasury over 10 years. Treasury officials insist the program is an outgrowth of Washington's crackdown on tax evasion through Swiss banks, not a deficit-plugging move. But a senior U.S. official who declined to be identified said "we do not have a sense of the response rate from foreign banks on signing up with FATCA."

Treasury has promised to iron out gray areas in the rules, especially those governing pass-through payments.

In an interview, Manal Corwin, Treasury's deputy assistant secretary for International Tax Matters, acknowledged that "we need to provide additional guidance. It's going to define it and refine it."

While FATCA envisions institutions turning over client data to the IRS, Corwin said the Treasury was considering alternatives for countries with bank secrecy laws. "One possibility is having the foreign bank report to its government and the government turn it over to the IRS," she said.

Referring to talks with Treasury officials, Mario Tuor, a spokesman for Switzerland's Federal Department of Finance, said that "we explored the terms and conditions of simplified implementation of the FATCA with the U.S. authorities, in particular regarding deemed-compliant banks" which can prove to the Treasury that they do not have U.S. clients.

But an IRS spokesman said that FATCA "contemplates that the information will be provided directly by the financial institutions."

FATCA grants exceptions to government entities. But that raises questions about whether Swiss cantonal banks, most of which are owned by Swiss regional governments and some of which are under criminal scrutiny by the U.S. Justice Department for enabling tax evasion, could serve as evasion conduits. And because FATCA covers only U.S.-denominated investments, American tax cheats could open hidden offshore accounts holding foreign investments.

Tax experts also question how the IRS will handle the flood of data FATCA is expected to produce.

(Editing by Howard Goller and Richard Chang)