Volume 36 - Issue 6 Fordham International Law Journal

Buying FATCA Compliance: Overcoming Holdout Incentives to Prevent International Tax Arbitrage

The United States is at war with tax evaders.  A 2008 Congressional Report estimated that the United States loses close to US$100 billion in tax revenues annually due to offshore tax evasion.  Policy makers often blame tax havens for this “staggering” statistic, pointing to the legal systems of tax haven countries that provide tax evaders with the means to avoid detection by US authorities.  According to the Organization for Economic Cooperation and Development (“OECD”), globalization has opened up new channels for individuals and businesses to minimize and avoid taxes.  Tax havens, generally nations that lower tax liabilities, can take advantage of this phenomenon by developing tax policies aimed primarily at attracting “geographically mobile capital.”  The reduction of non-tax trade barriers, an element of globalization, has further exacerbated the effect that domestic tax policies can have on international economies.  Consequently, tax havens hold nearly US$1.5 trillion in US assets.  As the enormous tax gap suggests, the United States has thus far found itself on the losing side of this war.

More recently, the 2008 financial crisis put pressure on increasingly indebted governments to refocus their attention on the harmful effects that tax havens and tax evasion have on their national treasuries.  The United States, like many other nations, relies on personal income and consumption taxes as a major source of its tax revenues.  As a result, the most recent financial crisis substantially decreased US tax revenues because both earnings and consumption dropped.  Further, the Troubled Asset Relief Program (“TARP”) and other federal government bailouts created additional spending commitments that further widened the disparity between government spending and revenue.

In response to this revenue shortcoming, and drawing upon the lessons from the 2008 UBS AG tax evasion scandal, in which UBS admitted to fraud and conspiracy in exchange for a US$780 million fine, Congress enacted the Foreign Account Tax Compliance Act (“FATCA”), as part of the comprehensive Hiring Incentives to Restore Employment (“HIRE”) Act.  President Obama signed the bill into law on March 18, 2010, as a potentially forceful solution to the type of offshore tax evasion brought to light by the UBS scandal.  FATCA’s stated purpose is to detect and deter offshore tax evasion by requiring all Foreign Financial Institutions (“FFIs”), non-US trusts, and non-US corporations to identify and annually report information to the Internal Revenue Service (“IRS”) about their US accountholders.  The overseas entities that do not comply with FATCA’s provisions face a thirty percent withholding tax on all US-sourced withholdable payments (i.e., certain types of payments generally fixed or determinable, annual or periodical (“FDAP”)) to a non-US person or business entity.  As US Senator Carl Levin pointed out, some financial institutions might choose to forego all US investments rather than enter into a FATCA compliance agreement.  Institutions that do not forego their US investments, though, will be subject to FATCA’s new, and more complicated, disclosure requirements.

Recently the IRS announced that it would modify its proposed regulations and extend the implementation of FATCA to January 1, 2014, to “reduce administrative burden.”  Although this extension was certainly a welcome reprieve, FATCA raises a number of concerns in its critical purpose of attempting to enforce US tax laws and solve offshore tax evasion.  According to some financial analysts and commentators, compliance with FATCA’s due diligence requirements poses an immense administrative burden upon compliant FFIs.  This burden could be so great as to potentially drive future investment away from the United States, which would then likely fail to generate the revenue anticipated.

This Comment examines the harmful consequences that the implementation of FATCA might have, particularly as this legislation could affect the ability of the United States to induce tax haven compliance in the future. Tax evasion thrives on information asymmetry, and the current bilateral and multilateral exchange agreements have proven generally incapable of overcoming this problem.  Part I provides background information on tax havens and the relevant international agreements that the United States has used to curb illicit tax practices. Part II explores the conflict created by the UBS scandal and Congress’ legislative reaction to the overwhelmingly large federal tax gap through the enactment of FATCA. It further analyzes the effect that FATCA might have on future tax treaties between the United States and other countries. Part III concludes by arguing that, because bilateral treaties incentivize holdouts by non-signatory nations, FATCA encourages tax arbitrage and capital flight towards these non-signatory nations. It concludes that the United States can overcome this holdout incentive through the use of tax flight bounty sharing treaties that would induce tax haven participation in international information exchange, increase taxpayer voluntary compliance, and minimize tax arbitrage.


Full Comment Available in:
Fordham International Law Journal
Volume 36, Number 6


Suggested Citation:
Marc D. Shepsman, Comment, Buying FATCA Compliance: Overcoming Holdout Incentives to Prevent International Tax Arbitrage, 36 Fordham Int’l L.J. 1769 (2013)

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