The introduction of FATCA has provided the US government with greater access to information about individual taxpayers on a global scale, adding to the information that the US has already gathered as a result of its voluntary disclosure programs for individuals. It means US individuals will increasingly be under the scrutiny of the IRS regardless of their residency. Here is an in-depth discussion on the issues of US tax compliance and legal implications for individuals and institutions

By Nan-Hie In and Kenny Lau

The possibility of an American trying to stash financial assets in a foreign bank account as a way to evade US tax liabilities is surely becoming a thing of the past. The enactment of the US Foreign Account Tax Compliance Act (FATCA) in 2010 was the beginning of a worldwide effort to crack down on US persons – citizens and permanent residents alike – who may be involved in the criminal act of tax evasion.

FATCA is a step towards greater financial and tax transparency as participating foreign (non-US) financial institutions (FFIs) are obliged to report information of their US clients and account holders to the US Internal Revenue Service (IRS). When FFIs fail to comply, they are subject to a penalty of a 30 percent withholding tax on all US income. Hong Kong as a jurisdiction has already signed an agreement with the US government for cooperation and compliance.

The implementation of FATCA, however, has created a number of unintended consequences: US citizens are reportedly having a hard time opening financial accounts with certain banks, and some are simply denied basic banking services – all because FFIs may be reluctant to do business with Americans.

“FFIs are absolutely petrified of the supposed 30 percent penalty that the IRS is going to assess on the grounds of noncompliance,” says Larry Lipsher, a US-certified public accountant who has been in Hong Kong for more than 20 years.

Under FATCA, foreign financial institutions with clients with US tax liabilities are required to file reports to the IRS, and they must do so under the Foreign Financial Institutions and Entities scheme and apply for a Global Intermediary Identification Number (GIIN) number, he points out. “This is a government number for FFIs under FATCA, which all banks must have.”In the current economic environment where institutions are likely more concerned about revenue than compliance, there is a possibility that FFIs may fall behind the schedule of coming into full compliance, Lipsher cautions, highlighting a potential problem.

“The risk is that the longer you wait, the lower the priority it may become in your organization,’ he says. “I’d recommend that organizations complete Form 8966, and electronically file it to the IRS on every account of each and every US client.”

Disclosure of information

FATCA is essentially a worldwide reporting regime for the purpose of enforcing US tax compliance by requiring all foreign banks and financial institutions to provide the IRS with information of their US clients and account holders. It has significantly expanded the IRS’s ability to find out more about individual US taxpayers – and it does not matter if they live and work in the US or in a foreign country.

Over the past few years, FFIs in every corner of the globe have been working to install a system to identify US account holders and report such findings to the IRS; otherwise, they could be found guilty of noncompliance for which a large portion of their US-sourced income would be withheld as a penalty.

From the perspective of individual Americans, it means the IRS will have more access to their financial information. Recent whistleblowing and cyber breaches have also provided tax authorities with a rather high-profile leads to financial data of US taxpayers, provoking tax authorities to take a deeper look into potential cases of noncompliance with US tax laws.

The recent leak of 11.5 million financial documents from a law firm in Panama is a case in point. Whether rightfully or not, it has exposed the undisclosed wealth of high-profile people and has prompted the US government to take further action against offshore tax cheats and shell companies.

“With so much information being gathered by the US tax authorities, people – US citizens and green card holders – are frankly mistaken if they think they are not going to be discovered,” says Seth G Cohen, a US tax expert and a partner of law firm Withers Bergman LLP, noting a growing number of legal tools and measures being made available to the IRS for tax compliance enforcement.

The IRS has been employing tactics far more aggressively in recent years than at any time in the past, including attempts to outdo bank secrecy laws of other countries or jurisdictions, even using the infrequently used “Bank of Nova Scotia summons” in February to get a branch of UBS in Miami to furnish financial records of a US citizen’s UBS account in Singapore.

It is highly likely that the IRS is acting on data and records of financial information about US bank account holders, provided by foreign banking institutions and other sources. In effect, it is a money trail that US tax authorities could follow from one offshore jurisdiction to another, including Hong Kong.

What does this mean for US individuals in Hong Kong? It is advisable for those with exposure to “come clean” before they are hunted down for noncompliance.

Legal consequences

15 (new)Individuals and institutions often overlook the wide-ranging effects of America’s worldwide taxation system. Americans, unlike their peers of other major developed economies, are taxed on their foreign-earned income, and they are required by law to file US tax returns annually and disclose their financial assets, even if they live and work overseas, Cohen points out.

In other words, it is a legal requirement that all US individuals regardless of residency must report their salary, earnings and pay as well as their foreign bank accounts to the IRS.

“If you are an American who has a foreign bank account with an aggregate value of over US$10,000, you need to file a Foreign Bank and Financial Accounts Report (FBAR),” he notes. “The penalty for failing to do so can be as high as 50 percent of your undisclosed assets on a yearly basis.”

“For example, if you had US$1 million for the past six years in a foreign bank account which you’ve failed to disclose, the IRS could impose a fine of US$3 million,” he explains.

However, new guidelines were issued in 2015, partly because of the possibility that such penalty may be considered disproportionate in a US court of law and deemed a violation of the US Constitution as an “excessive fine.” Moreover, whether a noncompliant taxpayer is found to have committed a willful (or non-willful) violation is also part of the assessment.

“In the past, those who opened a foreign bank account with the intention of evading taxes and those who were simply unaware of the existing reporting requirements were treated the same way,” says Cohen. “The IRS has now determined that certain people are less culpable than others.”

“While the law says the authorities can impose up to six years of fines based upon the statutes of limitations, they generally will not,” he adds. “If it is a willful violation, under the new guidance, the IRS will generally only impose a 50 percent penalty in most cases and a maximum of two 50 percent penalties in more extreme cases.”


The penalty structure is as follows: for a willful violation, the fine is 50 percent of the aggregate balance of one’s foreign account(s); for a non-willful violation, the penalty is up to US$10,000 per year per account. But under the new guidance in most cases, the IRS would issue, depending on the circumstances, only a single US$10,000 penalty for all years to a non-willful violator.

Another recent development is the ability of the IRS to restrict international travel movements of US individuals found to be tax non-compliant, says Laurence Ho, a partner at Withers. In December last year, a new rule was established and signed into law, and it gave the US government the legal power to revoke passports of Americans who owe more than US$50,000 in taxes (including penalties and interest). The law went into effect in January 2016.

“They can deny your passport application for renewal or outright revoke it,” Ho points out, noting an IRS communication system with the Department of Homeland Security (US port entry) and Department of State (US passport issuance). “For Americans overseas, their US passport may be the only passport they possess; so it might cause a lot of difficulties in terms of travel and their work visa for which they depend on a valid passport.”

Voluntary disclosure

Various options are indeed available to encourage US taxpayers who had previously failed to fulfill their tax reporting obligations to, once again, become compliant. Eligibility for these programs depends on individual cases and circumstances. One of the criteria is whether noncompliance was intentional or not.

The Offshore Voluntary Disclosure Program (OVDP), launched in 2009 and based on an earlier model of voluntary disclosure, is one example. It is an IRS program which affords US taxpayers (those who have failed to report their foreign financial accounts) the opportunity to reconnect with the US tax system on a voluntary basis and to avoid criminal prosecution before they are pursued by the US tax authorities.

The OVDP program is not available to individuals once there is an IRS case against them. For those who are eligible, they may choose to participate and pay eight years of back taxes, plus interest and a penalty which may vary from 27.5 to 50 percent of all unreported offshore assets.

Those who did not willfully fail to meet their reporting obligations may consider the new Streamlined Offshore Domestic and Foreign Procedures, Cohen notes. “It gives you the opportunity to come forward and pay three years of taxes with interest. This applies to US individuals outside the US.” And there is no additional penalty. Conversely, domestic US taxpayers are subjected to a five percent penalty.

Under certain circumstances, one can elect the least onerous route: it is the Delinquent Foreign Bank Account Report (FBAR) and the International Informational Return Submission Procedures. Taxpayers who have unintentionally failed their reporting obligations and have owed no taxes on omitted income may make a filing and walk away, and there will unlikely be any further complication, Cohen notes.

It is advisable that banks and trust companies continue to assess whether any financial account holders are of US status, including those as signatory of non-US companies, he adds. “They will need to go through their documents and determine if the accounts were owned outright or owned through an entity, and, if there are problems, they will need to come forward with the information in order to avoid prosecution if they are investigated.”

In any case, those that are found to have deliberately supported structures designed to circumvent tax laws could be subject to criminal liability, Cohen stresses. “The IRS, Department of Justice (DOJ), and Congress have made it a lot easier to prosecute those who are not compliant. If a bank is investigated, at a minimum, the appearance of impropriety exists, and you start with a losing proposition with worries about the potential reputational damage from a criminal indictment.”