STATE BAR OF CALIFORNIA TAXATION SECTION INTERNATIONAL COMMITTEE

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1 STATE BAR OF CALIFORNIA TAXATION SECTION INTERNATIONAL COMMITTEE PROPOSED EXPANSION OF CATEGORY OF REGISTERED DEEMED-COMPLIANT FFI: THE GOOD FAITH LOCAL FFI AND THE ACCIDENTAL AMERICAN This proposal was prepared by Patrick W. Martin 1 and, 2 members of the State Bar Taxation Section. 3 The authors wish to thank Ms. Laurie Hatten-Boyd of KPMG LLP and Mr. Andrés Fuentes, Tax Director of Banamex for their valuable insights and comments. 4 Contact Person: Patrick W. Martin Procopio, Cory, Hargreaves & Savitch LLP 525 B Street, Suite 2200 San Diego, CA (619) Patrick.martin@procopio.com 1 Mr. Martin is Past Chair of the International Committee and past Executive Committee member of the State Bar of California, Taxation Section and the tax partner in charge of the tax practice at Procopio, Cory, Hargreaves & Savitch LLP in San Diego, California. 2 Ms. Menzie is an attorney licensed to practice law in Mexico and the State of California and practices at Procopio, Cory, Hargreaves & Savitch LLP in San Diego, California. 3 The comments contained in this paper are the individual views of the authors who prepared them, and do not represent the position of the State Bar of California. 4 Although the participants on the projects might have clients affected by the rules applicable to the subject matter of this paper and have advised such clients on applicable law, no such participant has been engaged by a client to participate in this project. Patrick W. Martin

2 EXECUTIVE SUMMARY The enactment of the Foreign Account Tax Compliance Act ( FATCA ) is probably the most significant change in U.S. international tax law in decades. The implementing regulations of FATCA are crucial and the current proposed regulations introduce numerous valuable and practical concepts and solutions. This paper discusses one of those concepts regarding foreign financial institutions ( FFI or FFIs ). The provisions of FATCA will apply to the millions of U.S. citizens and lawful permanent residents ( LPRs ) residing outside the U.S. 5 Many of these individuals were born in the U.S. or acquired derivative citizenship based on a number of factors via one or both parents. However, other than their U.S. citizenship they typically have no other direct family, business or personal ties to the U.S. Many LPRs who worked in the U.S. for a few years or who acquired their green card through their U.S. parents have long ceased to live in the U.S., returning to their country of origin. The authors refer to each of these types of U.S. individuals as Accidental Americans. The Accidental American is subject to U.S. income tax on his or her worldwide income, 6 and to information reporting requirements the same as a U.S. citizen or LPR residing in the U.S. FATCA will add another layer of complexity to the Accidental American, who in some foreign countries is already experiencing difficulty maintaining or opening bank accounts in their country of residence. 7 There are two main parts to FATCA compliance and costs for FFIs. First, the due diligence portion of identifying and constant monitoring of accounts to identify U.S. Accounts. The second part is the information reporting, tax withholding and payment, and filing of U.S. tax returns. The due diligence portion does not represent such a large expense and burden to the FFI, since each FFI can largely use its existing internal KYC and AML procedures and policies to comply with many of the due diligence requirements of FATCA (generally with minor adjustments). FFIs consider 5 See statistics and comments in this paper for more detail on the estimated number of U.S. citizens and LPRs residing abroad. 6 See, IRC 61 and Treas. Reg (b) and 1.1-1(a)(1). 7 For example, in July 2011 HSBC Holdings PLC terminated its banking relationship with U.S. customers with banking operations in India. 2 Patrick W. Martin

3 this part of the compliance requirements manageable and not cost prohibitive. However, the information reporting, tax withholding and payment, and filing of U.S. tax returns will require each FFI to adopt completely new systems and hire new or retrain employees dedicated to these activities. In addition, each FFI will assume the risk that in the event there is a mistake (on the information reporting requirements and/or filing of U.S. tax returns) the FFI will be (i) directly liable for the 30% withholding tax imposed under FATCA (e.g., if failure to withhold on recalcitrant accounts/npffi 8 and/or (ii) failure to file proper information returns, and/or (iii) the IRS could revoke their status as a participating FFI ( PFFI ). Due to the high cost of complying with this second part of FATCA, many FFIs have an economic incentive to purge all Accidental American customers to avoid and minimize the high costs of the information reporting, withholding taxes and payment and filing of withholding tax returns under FATCA. Many FFIs will elect to comply with FATCA and carry out the account due diligence requests to identify U.S. Accounts ; while sending these Accidental American customers on their way. This will leave many Accidental Americans without accounts and no access to basic financial services in their country of residence. There are millions of U.S. citizens and LPRs residing abroad, so this will have a major impact on the lives of many U.S. individuals who are Accidental Americans. In addition, in most countries local law prohibits the disclosure of customer information that a FFI is required to provide under an FFI Agreement. Purging U.S. customers and U.S. Accounts is the easiest way for FFIs to comply with FATCA and their own countries laws. Customer information is typically confidential and can only be disclosed to specific local tax, administrative or judicial authorities, not to foreign authorities such as the IRS. Many or most local FFIs will be willing to comply with FATCA, by terminating all U.S. Accounts, including Accidental American accounts so they can avoid the most significant and risky conflicts of laws problems; i.e. since its employees and officers can be found to violate their country s civil (and even criminal) laws in many cases. 8 Non-participating FFI ( NPFFI ). 3 Patrick W. Martin

4 The authors propose expanding the Local FFI concept, 9 and refer to it herein as the Good Faith Local FFI ( GFLFFI ), where the Accidental American would continue to have access to financial services and the banking system in their country of residence. As discussed in this paper, there is little room for tax abuse by the Accidental American with the GFLFFI, which is similar to the current deemed compliant Local FFI solution provided in the proposed Treasury regulations, yet adds the additional requirement that accounts in excess of US$1M be reported by the FFI to the IRS. 10 This concept is necessary, since the current deemed compliant Local FFI requirement of 98% of account holders must be resident in their own country is not feasible (e.g., throughout Latin American countries even small local banks and financial institutions will have a sizeable percentage of customers from neighboring countries; e.g., Central American and many South American countries are small and have strong commercial ties to neighboring countries). In addition, as explained throughout the paper, the GFLFFI would not be permitted to open (or maintain) accounts for U.S. resident persons. This approach will also provide a direct means by which Accidental Americans can be educated and informed about U.S. tax law via the GFLFFI. 9 A category of deemed-compliant FFIs that are deemed to comply with the requirements of IRC Section 1471(b). 10 The term regulations is used throughout to reference the Treasury Regulations under Title 26 of the U.S. Code. 4 Patrick W. Martin

5 DISCUSSION I. BACKGROUND: FOREIGN ACCOUNT TAX COMPLIANCE ACT On March 18, 2010, President Obama signed into law the Hiring Incentives to Restore Employment Act (the HIRE Act ). 11 The HIRE Act enacted the Foreign Account Tax Compliance Act ( FATCA ). These provisions impact mainly three areas: (i) increased reporting requirements for U.S. individuals with foreign assets; (ii) substantive changes in U.S. Federal income tax law regarding certain foreign trusts; and (iii) introduction of the foreign non-financial entity ( FNFE ) regime and a new reporting and withholding tax regime for FFIs. FATCA added a new Chapter 4 to Subtitle A of the Internal Revenue Code 12 (the Code ) titled Taxes to Enforce Reporting on Certain Foreign Accounts, Sections 1471 through This paper focuses on the provisions of Chapter 4 and the impact to the Accidental American and FFIs in their country of residence. The IRS issued preliminary guidance on FATCA through three Notices (the Notices ). 13 On February 8, 2011, the IRS released proposed regulations designed to assist financial institutions in implementing the reporting and withholding regime established by FATCA. 14 Comments on the proposed regulations are due by April 30. FATCA will dramatically impact all persons with accounts abroad, not only U.S. persons, and will subject FFIs to detailed administrative procedures. FFIs are incurring substantial costs to comply with and implement FATCA. This paper focuses on two main concepts. First, the U.S. citizens and lawful permanent residents ( LPRs ) who despite having U.S. citizenship or a green card have little to no ties to the U.S. because their connection to the U.S. was being born in the U.S. or having worked there for a few years. The authors refer to these U.S. individuals as the Accidental Americans. Second, the Accidental American will typically be related to the Local FFI, which is a category of deemedcompliant FFI that is deemed to comply with the requirements of Code 11 Pub.L. No Unless otherwise provided, all references to the IRC are references to the Internal Revenue Code of 1986, as amended, 26. U.S.C. 1 et. seq., as in effect during the relevant period, and references to sections are references to the IRC. 13 See Notices , and REG Patrick W. Martin

6 Section 1471(b). 15 The paper proposes to expand the Local FFI concept, to include what is referred to here as the Good Faith Local FFI ( GFLFFI ) which, among other objectives, would allow the Accidental American to have access to the financial and banking system in his or her country of residence. However, as explained in the paper, the GFLFFI would not allow U.S. individuals who reside in the U.S. to open (or maintain) accounts with the GFLFFI. As explained in part III of this paper, one of the proposed requirements of a GFLFFI is that the GFLFFI provide a general summary of the U.S. tax obligations of U.S. individuals to its Accidental American customers. This could be an educational opportunity for the benefit of the IRS, since the GFLFFI would be reaching out to its Accidental American customers to provide them general information about their U.S. tax obligations via local FFIs that satisfy the criteria of a GFLFFI. A. New withholding and reporting obligations of FFI Generally under FATCA, a withholding agent 16 must deduct and withhold a tax equal to 30% of the gross amount of any withholdable payment to an FFI who has not entered into an agreement with the U.S. Treasury where the FFI agrees to certain due diligence, reporting and withholding obligations. 17 FATCA generally applies to payments made after December 31, 2013 with a further phase in period through A withholdable payment is broadly defined as any payment of interest (including any original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income, if such payment is from sources within the U.S., and any gross proceeds from the sale or other disposition of any property of any type which can produce interest or dividends from sources within the U.S. 18 The U.S. Treasury and a FFI 19 can enter into an Agreement (an FFI Agreement ) where the FFI will be required to take various steps 15 Proposed Treas. Regs (f)(1)(i)(A). 16 IRC 1473(4). A withholding agent is any person, in whatever capacity acting, having the control, receipt, custody, disposal, or payment of any withholdable payment. 17 IRC 1471(a). 18 IRC 1473(1). 19 A FFI is any financial institution which is a foreign entity. A financial institution is any entity that (a) accepts deposits in the ordinary course of a banking or similar business, (b) holds financial assets for the account of others as a substantial portion of its business, or (c) is engaged, or holding itself out as being engaged, primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest in such. See IRC 1471(d)(4) and (5). 6 Patrick W. Martin

7 associated with U.S. Accounts mainly in two stages: (i) due diligence of identifying (and subsequent monitoring) of accounts, and (ii) information reporting, tax withholding and payment, and filing of U.S. tax returns. The FFI Agreement will dramatically impact all persons with accounts abroad, including the Accidental American, since a FFI must do certain due diligence regarding each customer and obtain information to determine whether the account is a U.S. Account. The term U.S. Account is broadly defined as any financial account which is held by one or more specified United States persons 20 or United States owned foreign entities B. Terms of FFI Agreement If a FFI enters into a FFI Agreement to avoid the 30% withholding on any withholdable payment, the FFI must agree to: 23 (i) (ii) Obtain certain information from each account holder maintained by the FFI as necessary to determine which accounts are U.S. Accounts; Comply with verification and due diligence procedures as the Secretary requires with respect to the identification of U.S. Accounts; (iii) Report annually certain information with respect to any U.S. Account maintained by such FFI 24 ; 20 IRC 7701(a)(30). 21 IRC 1471(d)(1). 22 On the same day that the IRS released the proposed FATCA regulations, the IRS issued a joint statement with the governments of France, Germany, Italy, Spain and the United Kingdom summarizing a possible alternative approach to implement FACTA, where the U.S. would enter into automatic exchange of information Agreements ( EIAs ) with these countries. No similar statements have been released by the IRS and any Latin American countries as of the date the authors prepare this paper. Under an automatic EIA, the foreign contracting country would agree to collect the information required by FATCA and provide the information through its own tax authority, and the FFIs would not have to enter into FFI Agreements with the IRS. If adopted, the EIAs will simplify the FATCA regime as applied to FFIs of the countries that are a party to EIAs. Although the 30% withholding regime would not apply if there is an EIA in place, FFIs will still need to comply with the law. See proposed Treas. Regs (b)(1). 23 Proposed Treas. Regs (a). 24 See IRC 1471(c). The name, address and taxpayer identification ( TIN ) number of each U.S. person account holder; the name, address and TIN of each substantial U.S. owner (generally more than 10% owner) of any account holder that is a U.S. owned foreign entity; the account number; the account balance as of the time prescribed by the IRS; and the gross receipts and gross withdrawals from the account as determined by the IRS. 7 Patrick W. Martin

8 (iv) (v) (vi) Deduct and withhold a 30% tax with respect to a recalcitrant account holder or other FFIs that to not satisfy these requirements; Comply with requests by the Secretary for additional information with respect to any U.S. Account maintained by such institution (which is an open ended requirement, since the FFIs do not know what additional information the U.S. Treasury will request); and Attempt to obtain a waiver in any case in which any foreign law would (but for a waiver) prevent reporting of information required by the provision with respect to any U.S. Account maintained by such FFI, and if a waiver is not obtained, to close the account. 25 Paragraphs (i) and (ii) above are the due diligence portion of FATCA where the FFI must identify U.S. Accounts. Paragraphs (iii) through (vi) involves a much greater cost and higher risk to the FFI, since it must collect detailed information about assets, income, deposits and account activity for information reporting, tax withholding and payment, and filing of U.S. tax returns regarding U.S. Accounts. These obligations are the ones that involve a high cost to the FFI, since the FFI will most likely need to introduce completely new systems and hire new employees dedicated to comply with these requirements of FATCA and invest time and resources to train existing employees. These costs can be avoided, yet still allow the FFI to be a PFFI, if the FFI simply purges all Accidental America accounts (i.e., close accounts defined as U.S. Accounts owned by persons residing in the FFI s home country). In addition to the high cost of complying with this second part of FATCA, FFIs will also take on the risk and liability for the correct withholding, remittance and calculation of any withholding tax due under FATCA. FFIs will also have uncertainty regarding the additional requests for information that the IRS may make regarding U.S. Accounts in the future, since the terms of the FFI Agreement are expected to be very broad and the FFI will agree to comply with requests by the IRS for additional information. Hence, FFIs will have a powerful economic incentive to terminate all Accidental American customers to avoid the high costs of information reporting (which will be extensive pursuant to the proposed 25 IRC 1471(b). 8 Patrick W. Martin

9 regulations), withholding taxes and payments and filing of withholding tax returns under FATCA; even though they will be PFFIs This will leave many Accidental Americans without accounts and no access to basic financial services in their country of residence. Throughout Latin America, several FFIs are currently identifying Accidental American accounts doing just this; i.e., purging all such customer accounts resident in their country. Finally, FFIs face the risk that the U.S. Treasury may terminate any FFI Agreement if the U.S. Treasury determines that the PFFI is not in compliance with the FFI Agreement. 26 C. Reporting Obligations on U.S. Accounts by FFIs In General If a FFI has a FFI Agreement in place, each year the FFI will be required to report detailed information to the IRS with respect accounts held by specified U.S. persons, which will include accounts held by Accidental Americans. As discussed in part B above, many FFIs can avoid the cost of reporting this information by purging all Accidental American customers and any other accounts of U.S. persons, since complying will involve significant costs in implementing new systems, hiring new personnel, etc: 27 The information reporting and risks that can be avoided by the FFI are the following: (i) (ii) The name, address and taxpayer identification number of each account holder that is a specified U.S. person; If the account holder is a U.S.-owned foreign entity, the name, address, and taxpayer identification number of each substantial U.S. owner of such entity; (iii) The account number; (iv) (v) The account balance or value; The payments with respect to the account (the aggregate gross amount of interest and dividends, proceeds from sales or 26 IRC 1471(b)(1). 27 See IRC 1473(3), 1471(c) and proposed Treas. Regs (d)(3). The proposed regulations provide reporting requirements for accounts of specified U.S. persons, U.S. owned foreign entities and branches. 9 Patrick W. Martin

10 redemption of property and any other income paid or credited to the account; and (vi) Such other information as may be required to be provided under the instructions to the IRS form to be issued by the IRS to comply with these annual reporting obligations. As discussed in part B above, FFIs will also take on the uncertainty of having to provide any other information regarding U.S. Accounts that may be requested by the IRS to comply with the PFFI s reporting obligation regarding its Accidental American accounts. This is another incentive for FFIs to purge their Accidental American customer accounts. D. Deemed-compliant FFIs Code Section 1471(b)(2) provides that an FFI may be deemed to comply with the requirements of Section 1471(b) if it meets certain requirements. IRS Notice provided initial guidance on certain categories of FFIs that will be deemed to comply with the requirements of Section 1471(b). The proposed regulations expand the categories of deemed-compliant FFIs, with the intent of reducing or eliminating the burden on certain local entities where entering into a FFI Agreement is not necessary to carry out the purposes of Chapter Certain local banks and investment funds conducting business predominantly with local customers and other entities that represent a low risk of tax evasion are exempted from Chapter 4 if they comply with certain requirements. 29 These exceptions are important since a deemed-compliant FFI may avoid withholding under Chapter 4 without entering into a FFI Agreement, but rather complying with other criteria that are lest costly and burdensome. The proposed regulations provide for two types of deemedcompliant FFIs: registered and certified. 30 A registered deemed-compliant FFI must register with the IRS and declare its status as deemed compliant, and certify to the IRS that it satisfies certain procedural requirements. This paper only discusses Local FFIs, which are a type of registered deemedcompliant FFI. 28 See Executive Summary of explanation of provisions of proposed FATCA regulations, pg See Summary of Obligations of FFIs, explanation of provisions of proposed FATCA regulations, pg Proposed Treas. Regs (f)(1) and (2). 10 Patrick W. Martin

11 These Local FFIs must satisfy the following requirements: 31 (i) (ii) Be licensed and regulated under the laws of its country of organization as a bank or similar organization authorized to accept deposits in the ordinary course of its business, a securities broker or dealer, or a financial planner or investment advisor (but must not qualify as a FFI merely because it is an investment institution; Must have no fixed place of business outside its country of incorporation or organization; (iii) Must not solicit account holders outside its country of incorporation or organization; (iv) (v) (vi) Must be required under the local tax laws where it is incorporated or organized to carry out information reporting or tax withholding regarding accounts held by residents; At least 98% of the accounts maintained by the FFI must be held by residents (including entities) of the country where the FFI is organized; Implement policies and procedures to ensure that it does not open or maintain accounts for any specified U.S. person who is not a resident of the country in which the FFI is organized [emphasis added]; and (vii) Review the accounts of individuals who are not residents of the country in which the FFI is organized pursuant to certain procedures provided under the proposed regulations, and certify to the IRS that it has closed such accounts or agree to withhold and report on such accounts as if a FFI Agreement were in place. This is a sound concept that helps the IRS administer the law while minimizing the risk of tax evasion or other abuses by U.S. persons. These deemed compliant local FFIs will not be required to enter into an FFI Agreement. They will need to certify their compliance. 31 Proposed Treas. Regs (f)(1)(i)(A). 11 Patrick W. Martin

12 II. RELEVANCE OF PROPOSED EXPANSION OF THE LOCAL FFI EXCEPTION: THE GOOD FAITH LOCAL FFI A. The Accidental American There are millions of U.S. citizens and LPRs residing abroad. No one seems to know exactly how many U.S. citizens reside overseas. The National Taxpayer Advocate Report to Congress estimated the number at 7 million (not including U.S. military personnel). 32 This does not include LPRs. To compound the lack of information, the U.S. census data does not try to effectively track U.S. citizens residing overseas. 33 In the mid- 1990s, The State Department estimated that there were approximately 3 million U.S. citizens living abroad, although thousands of these individuals may not even know that they are U.S. citizens. 34 More current (yet dated) estimates from the State Department are 4.1 million living outside the U.S. as of Mexico is the country where more U.S. citizens reside, according to the State Department, and Canada is number two on the list. Approximately one-quarter (1 million) of these people lived in Mexico, while 687,000 were in Canada. Other countries with large numbers of Americans included the United Kingdom (224,000), Germany (211,000), Israel (184,000), Italy (169,000), Philippines (105,000), Australia (103,000), France (102,000), and Spain (95,000). According to State Department data, these ten countries contain about 70% of all U.S. citizens living abroad. 36 In addition to U.S. citizens living overseas, there are numerous LPRs. There are currently approximately 12.5 million LPRs and more than 32 See, Patrick W. Martin and Cesar Luna, [unpublished], U.S. International Taxation and Immigration Law of Individuals, 1st Edition. 33 See, Estimation Of Emigration From The United States by Jason P. Schachter, Ph.D, page See, Joint Committee on Taxation Report, J.C.S : General Explanation of Tax Legislation Enacted in The 104th Congress (Expatriation Tax Provisions (Secs )). 35 See, Estimation Of Emigration From The United States by Jason P. Schachter, Ph.D, page 6, referencing the State Department estimates. 36 See, presentation of Jason P. Schachter. Senior Statistician, Bureau of Statistics, ILO Geneva at the United Nations Expert Group Meeting on Migration Statistics, New York, NY, December 4-7, Patrick W. Martin

13 7 million are eligible for naturalization. 37 No one seems to know or report on how many of these LPRs are principally residing outside the U.S. Of course, the citizenship status of an individual and whether one is a LPR is a crucial and threshold U.S. tax consideration. U.S. citizens are taxed on their worldwide income, regardless of where they might physically live. 38 It does not matter if they live in a country with a U.S. income tax treaty or if they have one or more nationalities in addition to U.S. citizenship. LPRs are also typically taxed on a worldwide basis. The U.S. tax consequences of worldwide income and U.S. information reporting can oftentimes come as a big surprise to many Accidental Americans. As discussed above, no one seems to know how many U.S. citizens actually live overseas for several reasons. First, many people are simply not aware they are U.S. citizens. The 14th Amendment automatically grants citizenship to anyone born in the U.S. and many foreign families give birth to children in the U.S. before returning to their home country. Second, many foreign born persons are automatically (or can become) U.S. citizens under a complex web of immigration laws that grants derivative citizenship depending upon a number of factors (e.g., date of birth, nationality of one or both parents and the number of days one or more parent spent in the U.S. or a U.S. territory) Distinction between the Accidental American vs. U.S. taxpayers hiding assets overseas The IRS has increased its international tax enforcement efforts in the past few years and has accomplished much in this regard. However, it is important to distinguish between the ordinary taxpayer residing overseas with foreign assets and those who take steps to hide assets and evade taxes; particularly U.S. resident taxpayers in the latter category. The message issued by the IRS Commissioner has been that the IRS is tracking down U.S. individual taxpayers with foreign assets, but does not distinguish between the Accidental American residing abroad who is trying to learn and 37 See, Rytina, Nancy; Estimates of the Legal Permanent Resident Population in 2009, Office of Immigration Statistics (Nov. 2010). 38 See, IRC 61 and Treas. Reg (b) and 1.1-1(a)(1). 39 Therefore, although many individuals residing abroad are U.S. citizens, they have little to no family, business or personal ties to the U.S. other than having been born in the U.S., and the authors refer to these U.S. individuals as the Accidental Americans. 13 Patrick W. Martin

14 comply with U.S. reporting obligations and Joe Smith living in the U.S. and hiding unreported investments and income in a foreign bank. Some comments by the Commissioner, for example on December 15, 2011 to the IRS/GWU 24th Annual Institute on Current Issues in International Taxation, seem to include both scenarios: Before I get to our overall strategic approach to international issues, let me begin with our multi-pronged and integrated approach to combating individual offshore noncompliance and how we re turning up the pressure on those not paying taxes on overseas assets. Our approach to offshore tax evasion follows a natural course cleaning up the abuses of the past and then mining and leveraging the data we receive to mount a greater attack on the abuse..... People who may consider hiding money offshore should also take note of ours and the Department of Justice s success record when it comes to criminal prosecutions. People hiding assets offshore have received jail sentences running from months to years, and they have been ordered to pay hundreds of thousands and even millions of dollars. I think it s fair to say that we are well on our way to deterring the next generation of taxpayers from using hidden bank accounts to cheat on their taxes. Through our ongoing efforts, we are demonstrating that the world has become a smaller place that we will eventually find you if you are hiding assets overseas. It seems there should be a clear distinction between the types of U.S. taxpayers (i) referred to in the Commissioner s above remarks and (ii) those millions of individuals residing outside the U.S. (e.g., the Accidental Americans) who necessarily have foreign banking relationships, 40 See, Prepared Remarks of Douglas H. Shulman, Commissioner of Internal Revenue, Before the IRS/George Washington University 24th Annual Institute on Current Issues in International Taxation, Washington, DC, Dec. 15, Patrick W. Martin

15 foreign business or professional lives and foreign family members. How many in the latter category should fall into the category referred to by the Commissioner? In the authors view, there should be a distinction between those U.S. individuals residing in the U.S. who have unreported income and investments in foreign accounts who are purposefully hiding income and accounts abroad, and the Accidental American who is also a U.S. taxpayer but is unaware of his or her U.S. tax obligations, or has recently learned about them and is making efforts to comply. The latter category is not fraught with tax evasion due to Code Sections 901 et. seq. and 911. B. Benefits of GFLFFI - Encourage direct participation of FFIs with FATCA The GFLFFI would also encourage the direct participation of these FFIs with FATCA, since each GFLFFI would register with the Treasury, declare its status as deemed compliant and certify that it satisfies the procedural requirements provided under the proposed regulations. The GFLFFI would be required to implement policies and procedures to comply. GFLFFIs would also comply with the requirement to maintain internal records and monitor the accounts of its customers to ensure the GFLFFI complies with its category of registered deemed-compliant FFI. C. GFLFFI will enable the Accidental American to have access to local banking and financial system in home country The 30% withholding tax on withholdable payments has not come into effect yet. However, several banks abroad have already begun to close accounts (or have stopped opening new accounts) of Accidental Americans. 41 For the Accidental Americans, FATCA creates a risk that they may not have access to the local banking and financial system of their country of residence. Many individuals may not be able to open a bank account nor conduct basic banking activities if banks in their country of residence refuse to maintain or open accounts for Accidental American customers. Given the large number of Accidental Americans, this scenario is a significant concern that will impact millions of individuals. 41 See Wall Street Journal article, July 20, 2011 at 15 Patrick W. Martin

16 The authors have had discussions with officers and representatives of foreign banks and international banking organizations, such as the Federación Latinoamericana de Bancos - Banking Federation of Latin America or FELABAN - and it seems that most regional FFIs plan on taking the measures described above, i.e., purge all U.S. account holders, specifically Accidental American accounts. This will enable them to maintain U.S. based investments for their customer base (which consists principally of non-u.s. persons). For instance, a regional bank in Panama or Costa Rica can make sure its customers have access to U.S. based investments (e.g., U.S. treasuries, U.S. publicly traded bonds, publicly trades U.S. shares, etc.) by purging all U.S. Accounts, specifically including accounts of Accidental Americans. D. Little to No Loss of U.S. Taxes as a Result Of Proposed GFLFFI If the GFLFFI exception proposed in this paper is adopted, it should not cause a loss of revenue and U.S. taxes because of (i) the foreign earned income exclusion ( FEIE ) of Code Section 911 and (ii) the foreign tax credit ( FTC ) of Sections 901 et seq. To qualify for the FEIE, a U.S. citizen or LPR must have their tax home (bona fide residence test) located in the foreign country, or be physically present in the foreign country for at least 330 days during a period of 12 consecutive months. 42 The Accidental American would satisfy these requirements and would be able to claim the FEIE if they have earned income. Some U.S. individuals residing abroad are already filing U.S. income tax returns. However, the number of filings could and should be increased through the education and awareness benefits of the GFLFFI (i.e., mandatory requests that GFLFFI provide information regarding U.S. tax law and compliance requirements to their Accidental American customers). The proposed local GFLFFI exception could contribute to increase the number of U.S. returns that are filed each year by taxpayers residing abroad by bringing Accidental Americans into the U.S. taxing system. For instance, the IRS reports that in 2006, there were only 30,067 Canadian origin U.S. federal income tax returns filed claiming the FEIE. Even fewer Mexican origin returns in this category were filed; 42 See, IRC 911(d)(1) and Treas. Reg (a)(1) 16 Patrick W. Martin

17 6, A total of only 334,851 U.S. federal tax returns were filed for this category for that year, yet the total estimates of U.S. citizens residing overseas is several million (e.g., 7 million per U.S. Taxpayer s Advocate Report). Presumably, the number of taxpayers who are intentionally not filing U.S. tax returns is relatively small; maybe due to ignorance of the law? No one seems to know. These taxpayers residing overseas must be aware of their U.S. tax obligations and the consequences of the U.S. tax law, which the proposed local FFI exception, GFLFFI, will help promote. E. Minimization of Potential Tax Abuses By The Accidental American And U.S. Individuals Residing In The U.S. As discussed in Section III of this paper, one of the requirements of the GFLFFI is that the GFLFFI must provide a general summary of U.S. tax obligations of U.S. individuals to the Accidental American customer, such as filing U.S. tax returns, filing Form TD F Report of Foreign Bank and Financial Accounts or FBAR, information returns such as IRS Forms 3520 and 3520-A, 5471, 8865, etc. This would minimize the potential for any tax abuses by Accidental Americans, and should increase the number of U.S. tax returns that are filed every year by Accidental American taxpayers (see data and comments of Section C above). These taxpayers will have been put on notice of the law and these requirements. The proposed GFLFFI would also minimize the potential tax abuses by U.S. individuals who reside in the U.S. As explained in Section III of the paper, the GFLFFI would be prohibited from allowing U.S. individuals who reside in the U.S. to open (or maintain) accounts with the GFLFFI. Therefore, U.S. individuals with unreported income and accounts in foreign countries would not be able to maintain such accounts through a GFLFFI. 43 See, IRS SOI Tax Stats Individual Foreign Earned Income. Table 2. Individual Income Tax Returns With Form 2555: Foreign-Earned Income Exclusion, Housing Exclusion, and Housing Deduction, by Country or Region, Tax Year See other sample return data: return data: Country or region Number of returns Country or region Number of returns Africa, total - 9,697 Australia - 6,420 Asia, total - 138,795 Hong Kong - 10, Patrick W. Martin

18 F. Fewer Violations Of Local Laws Disclosure Of Confidential Customer Information In addition, FFIs would have a strong interest in satisfying the requirements of a GFLFFI because it would help them avoid violations under local law. Most all countries, including the U.S., have laws that restrict or prohibit financial institutions from taking customer information and supplying it to third parties without (i) the consent of the customer and/or (ii) an approved legal procedure in that country. Therefore, foreign employees, officers and banks will come under increased scrutiny and can be found to violate their countries civil (and even criminal) laws in many cases. Therefore, many conflicts of law issues arise with FFI Agreements if the FFI discloses information regarding U.S. account holders. Herein lays the incentive for FFIs to purge all accounts of Accidental Americans. For example, in Mexico, 44 employees and officers of a Mexican lending institution who violate the confidentiality provisions of the Ley de Instituciones de Crédito or Lending Institutions Act ( LIC ) can be subject to several sanctions, and the financial institution is subject to damages. 45 For example, an employee who discloses confidential information of an account holder under a scenario that is not expressly provided by the LIC (e.g., to an authorized Mexican tax or judicial authority) could be subject to thirty to two hundred days of community service for disclosing information without the consent of the account holder, which was obtained as a result of his or her employment or position. 46 In addition, the employee could be sentenced to six to twelve years in prison for revealing, disclosing or any improper use with prejudice to another; information or images obtained by participating in a private communication. 47 These two provisions are criminal Sections of Mexico s Federal Penal Code. They fall the law entitled Revelation of Secrets which apply broadly to all professional secrets and the banking secrecy provisions of the LIC. Although there are many conflicts of laws issues regarding FATCA and compliance with FFI Agreements, the GFLFFI should be a good practical solution to address these issues. 44 Ms. Menzie is an attorney licensed to practice law in Mexico and the State of California. 45 Article 117, fifth paragraph, of the Ley de Instituciones de Credito or LIC. 46 Article 210 of the Federal Penal Code. 47 Article 211Bis of the Federal Penal Code. 18 Patrick W. Martin

19 III. PROPOSED EXPANSION OF THE LOCAL FFI: THE GOOD FAITH LOCAL FFI This paper proposes an expansion of the concept of the existing registered deemed-compliant FFI, the Local FFI, which is referred to as the GFLFFI. The authors suggest that a GFLFFI satisfy the following requirements: (i) Meet the requirements of a Local FFI, 48 except that: It will not be prohibited from soliciting customers or account holders residing outside the country of organization or incorporation of the GFLFFI, which would only include non- U.S. customers for non-u.s. Accounts (except it will be prohibited from soliciting customers who reside in the U.S.); 49 and It will not have to satisfy the requirement of having at least 98% of the accounts maintained by the GFLFFI being held by residents (including entities) of the country where the GFLFFI is organized. 50 (ii) Will be prohibited from accepting individual customers who reside in the U.S.; (iii) Will be prohibited from accepting as customers any U.S. citizen or LPR who does not reside in the country of organization or incorporation of the GFLFFI (e.g., a citizen and resident of Peru who is also an Accidental American cannot open an account in Uruguay, or the FFI in Uruguay will not qualify as a GFLFFI; (iv) Review the accounts of individuals who are not residents of the country in which the FFI is organized pursuant to certain procedures provided under the proposed Regulations, and certify to the IRS that it has closed all Accidental American accounts (if the balance or value is greater than $1 Million) or agree to withhold and report on such accounts as if a FFI Agreement were in place; 48 Proposed Treas. Regs (f)(1)(i)(A). 49 Except it will be prohibited from soliciting customers who reside in the U.S. 50 This is due to the international nature of cross border banking operations. 19 Patrick W. Martin

20 (v) (vi) Must collect information of new customers or account holders such as place of residence, place of birth, and documentation confirming residency status and place of birth, such as passports and immigration or naturalization documents; and Agree to provide a general summary of the U.S. tax obligations of U.S. individuals to its Accidental American customers, such as filing U.S. tax returns, filing Form TD F Report of Foreign Bank and Financial Accounts or FBAR, information returns such as IRS Forms 3520 and 3520-A, 5471, 8865, etc., which must be signed and acknowledged by the Accidental American (see Exhibit A attached to this paper for a proposed example of this general summary). This concept provides a practical solution much along the same theme as the deemed compliant Local FFI, with additional requirements regarding providing information by the GFLFFI to educate their Accidental American customers and closing or reporting and withholding tax on any Accidental American account in excess of US$1 million. However, the GFLFFI rules proposed in this paper are more realistic to the real world commercial relationships of banking and financial institutions of its global customer base. Latin America, as a prime example, has a high concentration of U.S. citizens residing in various countries pursuant to the State Department data, in some cases representing a large percentage of the population (e.g., nearly one half of a percent -0.4%- of the total population of the Americas consisted of U.S. citizen i.e., most of whom are presumably Accidental Americans). In addition, the local FFIs who service their customer base, commonly have clients from a range of neighboring countries. The following map of Central America quickly demonstrates how 9 countries are located within a geographical region much smaller than the size of Texas (e.g., 202,000 square miles for Central America and Texas with 268,580 square miles). However, the population of Central America is estimated at about 42 million compared to Texas of 26 million, which simply means that there is a high concentration of people living beside and adjacent to a geographical region much smaller than a single State within the United States (or roughly the geographical size of the states of Kentucky, Indiana, Maine, South Carolina, West Virginia, Maryland, Hawaii, Massachusetts and Vermont). 20 Patrick W. Martin

21 Accordingly, individuals and businesses in these regions need to conduct regional business activities and have access to regional financial services in these regions. This is an example familiar to the authors, but there are many other regions throughout the world with the same concentration of local populations nearby multiple countries (e.g., most of South America, excluding the geographically large countries of Brazil, Argentina and Colombia; much of Southeast Asia, etc.). Since the State Department has identified such a large population of Accidental Americans living throughout the Americas (nearly ½ of a percent of the entire population), the GFLFFI deemed compliant proposal provides a more realistic approach in its application compared to the existing Local FFI exception, which will largely prohibit all Local FFIs from being able to fall within such an exception due to the requirement that 98% of account holders must be resident in their own country, which is not feasible, given the geographical proximity of multiple countries in these regions. IV. CONCLUSION FATCA is a key tool in the Government s noble efforts to fight tax evasion by U.S. taxpayers, particularly those living in the U.S. with unreported income and assets abroad and/or undisclosed foreign bank accounts. In pursuing this goal, the Accidental American can face a number of unintended problems as a result of FATCA. For example, the most problematic is the lack of access to basic banking and financial services in his or her country of residence (and in many cases maybe most - country of dual citizenship). 21 Patrick W. Martin

22 The proposed GFLFFI could be another tool available to the Government against tax evasion and promoting compliance with U.S. tax laws. The proposed GFLFFI is a practical solution that will require the collection of information of the GFLFFI s customers, classifying and categorizing customers based on their place of residency and complying with the complex FATCA provisions, without imposing costs prohibitive compliance measures where little tax abuse or evasion should be occurring. In addition, the GFLFFI could at the same time be a tool to provide education and outreach regarding U.S. income tax obligations to the Accidental American, who would become better informed about his or her U.S. tax obligations for compliance with such laws. 22 Patrick W. Martin

23 EXHIBIT A General summary of U.S. tax obligations of U.S. individuals to be provided by GFLFFI to Accidental American customers U.S. citizens and lawful permanent residents ( LPRs e.g., green card holders ) are subject to U.S. income tax on their worldwide income, regardless of their place of residence and the source of the income. This rule applies to U.S. citizens who were born in the U.S. or acquired derivative citizenship from one or two parents, and to LPRs who may have worked in the U.S. for a few years or who acquired their green cards through their U.S. parents, regardless of the time they lived in the U.S. or having returned to their country of origin. If you are a U.S. citizen or LPR, you must file Internal Revenue Service ( IRS ) Form 1040 ( U.S. Individual Income Tax Return ) for any tax year in which your gross income is equal to or greater than the applicable exemption and standard deduction for that year. U.S. citizens and LPR living outside the U.S. must file Form 1040 by June 15. You may also be required to file Form TD F ( Report of Foreign Bank and Financial Accounts or FBAR ) if during a calendar year you had a financial interest or signature authority over foreign financial accounts, if the aggregate value of the foreign financial accounts exceeds US $10,000 at any time during the calendar year. As of 2012, you may also be required to report to the IRS certain foreign financial assets with an aggregate value greater than $50,000. If you are subject to this reporting requirement, you must complete and attach IRS Form 8938 ( Statement of Foreign Financial Assets ) to your Form For more information, please go to click on Individuals, then International Taxpayers. You can also search the IRS website for phrases such as obligations citizens residing abroad. Advice from a U.S. tax return preparer or U.S. tax attorney is strongly suggested. There are many other information returns that may apply to you based on your personal circumstances. Penalties and interest may be imposed for failure to file Form 1040 and other applicable information returns. 23 Patrick W. Martin

24 TABLE OF CONTENTS Page EXECUTIVE SUMMARY... 2 DISCUSSION... 5 I. BACKGROUND: FOREIGN ACCOUNT TAX COMPLIANCE ACT... 5 A. New withholding and reporting obligations of FFI... 6 B. Terms of FFI Agreement... 7 C. Reporting Obligations on U.S. Accounts by FFIs In General... 9 D. Deemed-compliant FFIs II. RELEVANCE OF PROPOSED EXPANSION OF THE LOCAL FFI EXCEPTION: THE GOOD FAITH LOCAL FFI A. The Accidental American Distinction between the Accidental American vs. U.S. taxpayers hiding assets overseas B. Benefits of GFLFFI - Encourage direct participation of FFIs with FATCA C. GFLFFI will enable the Accidental American to have access to local banking and financial system in home country D. Little to No Loss of U.S. Taxes as a Result Of Proposed GFLFFI E. Minimization of Potential Tax Abuses By The Accidental American And U.S. Individuals Residing In The U.S F. Fewer Violations Of Local Laws Disclosure Of Confidential Customer Information III. PROPOSED EXPANSION OF THE LOCAL FFI: THE GOOD FAITH LOCAL FFI IV. CONCLUSION EXHIBIT A Patrick W. Martin