Finance Minister Jim Flaherty and National Revenue Minister Kerry-Lynne Findley have signed the agreement to implement the U.S. Foreign Account Tax Compliance Act.
Introduced in the U.S. in 2010, the law is meant to track down U.S. tax cheats living abroad. But it has also caught up an unknown number of people who didn’t realize the U.S. is only one of two countries in the world that requires its citizens to file taxes no matter where they are living.
Catches 'accidental Americans'
It has also caught “accidental Americans,” people who didn’t realize becoming a citizen of another country doesn’t supersede their U.S. citizenship, or that the U.S. automatically confers citizenship on anyone with at least one U.S. parent.
It is estimated one million U.S. citizens live in Canada. The rules affect each of them, their children and anyone with whom they may hold a joint account or co-own a business or property.
Canada is the last G7 country to sign an agreement with the U.S. to implement FATCA, in part because government officials say they spent a long time negotiating exemptions for Canada.
Although the most contentious aspects of the law remain intact — the requirement for financial institutions to flag the account information of “U.S. persons” for the U.S. Internal Revenue Service to then verify if all taxes have been paid — the agreement allows the Canadian banks to provide the information the Canada Revenue Agency instead of the IRS directly.
Using the CRA as a "go-between" allows a mechanism for Canadians who feel they have been wrongly flagged to appeal, and also avoid an almost certain breach of Canada’s privacy act had banks been sending customer information to a foreign government.
RDSPs, RESPs exempted
Canada also successfully negotiated exemptions for most of the registered accounts held by Canadians.
Until now, the IRS did not recognize accounts such as RDSPs and RESPs, and treated them as “off-shore trusts” — and taxed them accordingly.
The special tax-exempt status of TFSAs will also be recognized.
While banks say they will still be left on the hook for the enormous compliance costs of tracking and reporting all this additional information on a some of their clients, this agreement spares them the penalties the U.S. was threatening for non-compliance; a 30 per cent withholding tax on all of their U.S. transactions.
The Canadian government has raised objections to FATCA from the beginning, saying the existing Canada-U.S. tax treaty allowed the U.S. to do all it needed to.
The protests, however, fell on deaf ears, which left Canadian financial institutions in a tough spot: forced either to pass along customer information to the IRS and likely face court cases for violating privacy, or get hit with the withholding tax — something the Canadian government warned could have a “negative impact” on the whole of the Canadian economy.