Relevant excerpts from the decision (citation omitted):
The Florida and Texas Bankers Associations now challenge those reporting requirements, alleging that the regulations violate the Administrative Procedure Act and the Regulatory Flexibility Act. The Bankers Associations contend … that the IRS got the economics of its decision wrong and that the requirements will cause far more harm to banks than anticipated. Because the Service reasonably concluded that the regulations will improve U.S tax compliance, deter foreign and domestic tax evasion, impose a minimal reporting burden on banks, and not cause any rational actor – other than a tax evader – to withdraw his funds from U.S. accounts, the Court upholds the regulations …
The IRS is on a constant quest to bridge the so-called “tax gap” – that is, the $450 billion gap between what taxpayers owe the government and what they actually pay. Part of this gap is caused by a lack of taxpayer candor regarding assets retained in off-shore accounts. While U.S. citizens and residents owe taxes on the interest meted out by foreign banks, much of those off-shore earnings go unreported and undetected.
Honesty, however, may not be every American taxpayer’s greatest virtue. As a result, the Government also relies on third-party reporting, matching, and verification to confirm the correct amount of taxpayer liability and to encourage accurate self-reporting.
As a result, the United States has entered into treaties with at least 70 foreign governments to provide for the exchange of tax information upon request.
Reciprocity is the key to success in such treaties. If the United States does not gather and report tax information for foreign accountholders, then other countries have little incentive to provide us with similar information.
In the IRS’s 2011 Notice of Proposed Rulemaking, the Agency put forward regulations that would require U.S. banks to report the interest paid to all non-resident aliens. The Agency claimed that such regulations were warranted as a result of the “growing global consensus” that “cooperative [tax] information exchange[s]” were necessary to apprehend tax cheats. “[R]outine reporting” of non-resident tax information would, it said, “strengthen the United States exchange of information program” and thus “help to improve voluntary compliance” with existing tax laws by U.S. taxpayers.
The Financial Accountability and Corporate Transparency Coalition, for example, noted that “America should not be a haven for international tax evaders.”
While the United States has exchange agreements with only 70 countries, the proposed amendments required reporting for all 196 countries worldwide.
Commenters also worried about the confidentiality of the information collected and the potential risk of “capital flight” – that is, non-residents’ closing their accounts and withdrawing their money due to the new regulations.
The final rule, which was issued in 2012, responded to these comments by preserving the core of the amendment while somewhat narrowing and clarifying the regulations. 77 Fed. Reg. 23,391. Pursuant to the final rule, effective January 1, 2013, banks are now required to report interest payments to non-resident aliens, but only for aliens from countries with which the United States has an exchange agreement. The reports utilize the same forms already employed to report Canadian non-resident income, Forms 1042 and 1042-S.
In addition, the IRS responded to the various concerns raised in the comments it received. As noted, the rule narrowed the reporting requirement to countries with which the United States has an exchange agreement. The Service also addressed confidentiality questions by noting that “all of the information exchange agreements to which the United States is a party require that the information exchanged under the agreement be treated and protected as secret by the foreign government.” Id. In terms of capital flight, the IRS reasoned that “these regulations should not significantly impact the investment and savings decisions of the vast majority of non-residents who are aware of and understand these safeguards and existing law and practice.” Their information, after all, would remain confidential and could only detrimentally affect them if they were evading their countries’ tax laws.
While the IRS conceded that the regulations would affect many small banks, it determined that they would not have a “significant economic impact” because banks have already “developed the systems to perform . . . withholding and reporting” for U.S. citizens, residents, and Canadian citizens. “U.S. financial institutions can,” therefore, “use their existing W-8 information” – which contains data on residency and citizenship for all accountholders – “to produce Form 1042-S disclosures for the relevant nonresident alien individual account holders. Nearly all U.S. banks and other financial institutions have automated systems to produce” those forms.
The IRS admits that it does not know exactly how much money non-resident aliens have deposited in U.S. banks. It notes, however, that gathering that information is one critical point of the regulations – to figure out how much money foreign residents hold in U.S. accounts and how much interest they are earning. As the Government highlights, it makes little sense to require an agency to possess the data it wishes to collect before enacting new data-collecting requirements.
Instead of using exact data, the IRS estimated, based on a mountain of existing information from the Treasury Department, that non-resident alien deposits in U.S. banks amounted to no more than $400 billion. Plaintiffs argue that such an estimate does not comport with the APA. But nothing in the APA forbids a government agency from estimating.
In addition – as explained more extensively below – the IRS’s estimate of how much money could be affected was not central to its decision to proceed with these regulations. The estimate was not even published in the Federal Register; it appears only in the administrative record. The IRS was unconcerned because it had determined that very little of this money would be affected – namely, because these regulations would not deter any rational actor other than a tax fraud from using U.S. banks.
No one with a passport would gainsay that the 70 covered countries diverge significantly in, inter alia, their populations, forms of government, and financial systems. For all their differences, however, those countries have one very important similarity to Canada: each has entered into an exchange treaty with the United States
4. Capital Flight
At the heart of the Bankers Associations’ argument – albeit buried somewhat in their brief – is the contention that the regulations should not have been issued given the negative impact they may have on banks. Plaintiffs claim that the IRS “disregarded” a flood of comments arguing that the new regulations would cause non-residents to withdraw their deposits en masse and thereby trigger substantial and harmful capital flight. The IRS, however, did not ignore those comments; indeed, it dedicated a majority of the preamble to addressing concerns about capital flight.
Many of the comments on this topic related to the privacy of customers’ tax information. In its preamble, the IRS noted that some comments “expressed concerns that the information required to be reported under th[e] regulations might be misused” or disclosed to rogue governments. Those privacy concerns, commenters worried, might trigger an exodus of foreign funds. To address those fears, the IRS described in great detail the privacy protections that were in place to safeguard account information, including the fact that “all of the information exchange agreements to which the United States is a party require that the information exchanged under the agreement be treated and protected as secret by the foreign government” as well as by the IRS. As a result of those protections, the Government concluded that the “regulations should not significantly impact the investment and savings decisions of the vast majority of non-residents.”
Plaintiffs raise one additional, related issue: They claim that the IRS ignored the massive capital flight that took place after the Canadian reporting requirements became effective in January 2000. The IRS, by contrast, contends that the alleged Canadian capital flight is a fiction: While the amount of Canadian interest-bearing deposits may have dipped after the reporting requirements were issued, they climbed back up shortly after that.
Commentary update: The Texas Bankers Association has reported that $500 million of foreign deposits has expatriated from Texas banks, and the Texas Bankers Association will file an Appeal to this decision.
LexisNexis FATCA Compliance Manual
Fifty contributing authors from the professional and financial industry provide 600 pages of expert analysis within the LexisNexis® Guide to FATCA Compliance (2nd Edition): many perspectives – one voice crafted by the primary author William Byrnes.
The LexisNexis® Guide to FATCA Compliance (2nd Edition) comprises 34 Chapters grouped in three parts: compliance program (Chapters 1–4), analysis of FATCA regulations (Chapters 5–16) and analysis of FATCA’s application for certain trading partners of the U.S. (Chapters 17–34), including intergovernmental agreements as well as the OECD’s TRACE initiative for global automatic information exchange protocols and systems. The 34 chapters include many practical examples to assist a compliance officer contextualize the regulations, IGA provisions, and national rules enacted pursuant to an IGA. Chapters include by example an in-depth analysis of the categorization of trusts pursuant to the Regulations and IGAs, operational specificity of the mechanisms of information capture, management and exchange by firms and between countries, insights as to the application of FATCA and the IGAs within new BRIC and European country chapters.
William Byrnes' Tax, Wealth, and Risk Intelligence 