What are the Effects of FATCA?

In 2009 UBS admitted to facilitating tax evasion by U.S. citizens. In response Congress passed the Foreign Account Tax Compliance Act (“FATCA“) to help the IRS improve collections of foreign income. As the IRS has issued new rules and forms derived from the act, many foreign financial institutions have told U.S. investors that their money is no longer wanted. At the same time record numbers of American citizens have renounced their citizenship. Could it be the U.S. has extended their reach too far?

that’s a complicated way of saying: New rules are being written which will extend the ability of the IRS to track investments made overseas. In anticipation of these rules going into effect foreign banks and hedge funds are divesting themselves of U.S. investors. They complain that these rules are too complex and onerous because they require them to also monitor the companies they do business with. If a business partner is non-compliant with FATCA the foreign financial institution will be required to withhold more profits than usual from their clients and report all income to the IRS. Rather than develop compliance measures these financial institutions have opted to cut ties with Americans. They would rather forego the wealth of the world’s richest country than have to comply with FATCA’s rules. This trend is troubling for American investors because it means they have fewer options and less access to foreign markets.

One response American investors with large holdings have opted for is renunciation of their American citizenship. Most recently, it was revealed that Facebook co-founder, Eduardo Saverin gave up his citizenship in favor of becoming a resident of Singapore. Speculators believe this decision was motivated primarily to avoid taxes on his Facebook stock. But he is also an active investor with holdings in Europe and Asia which would make him, and the firms, subject to the new law. It is not much of a stretch to think this did not factor into his mind. And there are reports (linked above) suggesting that more U.S. citizens are leaving so they can continue to stay invested overseas and avoid any impending tax increases.

Consequences for America: With investment opportunities being closed off to Americans it will be more difficult for them to gain access to global markets and diversify their positions. Over time this may lead to lower returns and, therefore, lower tax revenues. Further, because our dollars are not as able to flow into emerging economies, it will be harder for us to wield influence as they grow larger. If the recent trend of citizen renunciation continues the U.S. will be losing access to many successful, sharp minds and their investment savvy. Not only do they leave, but they generate great animosity and probably feel like they will not be welcomed back.

There is Opportunity: If there are banks out there refusing to service American investors because the compliance costs are too high, perhaps there are also banks who are already compliant and willing to move to Singapore or Hong Kong and fill the void. They may not have the immediate expertise to create financial products that match the quality of local branches, but there is reason to be hopeful that with time they will match our foreign counterparts. Growth opportunities for American banks are not readily apparent these days so this news could be welcomed by them and shareholders. A second offshoot is that U.S. citizen investors may look harder for good investment opportunities within. Perhaps the next facebook is already invented but just needs somebody to provide the funding for them to make the leap to greatness. FATCA creates many headaches and red tape for those investors with assets overseas. But it also encourages them to bring their business home and work on improving America.