FATCA Follies

It seems the IRS is going global, a development that has some pundits up in arms about potential stock market impact. The Foreign Account Tax Compliance Act (FATCA) is what I’m referring to. Under FATCA, the IRS is moving toward taxing US citizens’ offshore financial activity, including money held in banks abroad—effectively eliminating “tax havens” for US citizens. US expatriates and foreign banks are up in arms. The law conflicts with local banking laws in other countries, and banks have responded by simply slashing access to banking services for Americans living abroad. But while it creates hassles, barring a big international regulatory blowback, the law doesn’t seem poised to create many ripples for stocks.

FATCA, now four years old, was conjured following a 2009 scandal, which revealed a major Swiss bank was helping well-to-do Americans dodge taxes. The backlash against the scandal peaked in 2010, when Congress passed FATCA as a provision of HR 2847, the Hiring Incentives to Restore Employment Act. An effort to boost US government tax revenue by broadening the base, FATCA also has some grassroots appeal as it carries the label of reducing tax dodging. FATCA was supposedly a means to get fatcats to pay their fair share. (My apologies for the pun.) Foreign banks were also not the most popular group in the immediate aftermath of the Global Financial Crisis.

Initially, FATCA seeks to provide the IRS information about US citizens’ and green card holders’ taxable accounts exceeding $50,000 in market value held at foreign financial institutions. International banks (Foreign Financial Institutions or FFIs) are required to ink a special deal with the IRS, under which they report all US taxpayers’ qualifying accounts and holdings. Account disclosure began January 1, 2014. After June 30, 2014, foreign banks will have to provide details regarding investment account holdings, and by January 1, 2015, FATCA’s full implementation will install a 30% withholding on US sourced income (salary/capital gains/interest/dividends).

While the IRS and politicians claim the banks were abetting tax dodging, foreign banks and US citizens abroad argue they were merely facilitating the free flow of capital by permitting US citizens abroad to access local banking services. Since FATCA passed, Americans abroad report having difficulty opening a new account and greatly reduced competition. These are problems for Americans living abroad, to be sure, and one potentially hindering Americans working or residing in foreign nations. However, it has limited real, immediate market fallout.

The rules have been a known quantity for banks and bankers since 2012. Most major, global banks have established their FFI agreement, and the costs to implementing necessary back office systems and reporting mechanisms are largely already sunk. Still, foreign banks with a US customer account base are likely to face increased ongoing compliance costs. Relationships with US clients have already been impacted, with no doubt many accounts being closed. From a supply side, the banks seem to have already adapted to the FATCA, mitigating any economic or market shock.

While the number of Americans rescinding their citizenship is up—and up sharply—last year’s 221% increase put the total number renouncing the USA at 2,999, that’s a minute figure compared to the estimated 7 million Americans who reside abroad. And there are severe headwinds to that number rising materially. Accounts held abroad that will be discontinued by banks aren’t being expropriated or vanishing, so the likelihood is high the funds will simply find their way back to US financial institutions.

One consideration our research staff is monitoring is the potential for unintended consequences. While it seems highly improbable today, there is the potential for a negative international reaction to FACTA. One can interpret FATCA as financial or tax revenue protectionism. The law comes into conflict with some foreign nations’ bank secrecy laws, like those in Switzerland and Austria, for example—and in that way, it might appear like the US government overreaching and stepping on the sovereignty of other nations. Should a trade dispute develop out of the situation, it is a potential negative for stocks, as it could cause fragmentation in the global financial system and inhibit the free flow of capital through the creation of severe tax barriers. This would discourage foreign investment and, in that way, would be a similar outcome to typical tariff wars or trade protectionism.

However, most nations are agreeing to waive bank secrecy laws to make way for FATCA. Most major nations globally have already signed agreements—including Switzerland, Germany, the UK, Bermuda, the Cayman Islands and more. (You can see the agreements yourself at the US Treasury’s website here.) Some remain, like Austria, which is close to an agreement but hasn’t inked one as of this writing. And a comparison may be the reaction to the USA Patriot Act, passed in the wake of the September 11, 2001 terror strikes. The Patriot Act, which added many restrictions and reporting requirements on foreigners and nonresident Americans holding financial accounts met with some squabbling from abroad, but little actual action.

HT: Todd Bliman, Christopher Wong.