FATCA agreement: Some Canadians identified as U.S. persons confused and angry to learn of tax filing obligations with IRS

By Susan Yellin | May 08 2015 09:00AM

Clients with almost any known connection with the U.S. are getting letters from their Canadian banks as the financial institutions try to identify those considered a “U.S. person” under the Foreign Account Tax Compliance Act (FATCA), the U.S. legislation aimed at helping identify taxpayers who live outside the U.S.chang_veronika Countries like Canada have entered into an intergovernmental agreement (IGA) with the U.S. to help the exchange of tax information required by FATCA. Specifically, Canadian financial institutions must report on their U.S. clients to Canada Revenue Agency (CRA), which then sends that information to its U.S. counterpart, the Internal Revenue Service (IRS).

Anger and confusion is the reaction coming from some Canadians with so-called U.S. indications, or “indicia,” who blame any potential taxes resulting from the IGA on Canada and the FATCA agreement. But in reality, says Veronika Chang, a U.S. tax lawyer with Morris Kepes Winters LLP in Toronto, many of these people should have been paying U.S. taxes all along – while others shouldn’t worry because they don’t fall into the “U.S.-person” category.

This all comes in the midst of a constitutional challenge that was launched in September. Virginia Hillis and Gwendolyn Deegan, who are dual Canada-U.S. citizens, are suing the federal Canadian government for complying with FATCA. The two claim FATCA violates their rights under the Canadian Charter of Rights and Freedoms. They say it allows their financial information to be seized without a warrant and discriminates against U.S. persons. It is expected the case will take some time to resolve.

Chang says she has received a number of queries from people who were born in the U.S. but are now Canadian citizens who have never been aware of their tax-filing obligations.

“They think FATCA is making them file their U.S. tax return, which is not true. What FATCA is doing is making them aware that they always needed to file one.”

– Veronika Chang

Flagging bank customers

As part of FATCA, Canadian financial institutions are doing their due diligence to find out who is truly a U.S. person. They are flagging certain bank customers with accounts over specific dollar thresholds who have indicated they have some connection to the U.S. This includes those who have stated they have a U.S. passport, or were born in the U.S. (even though they are now Canadian citizens), worked at one time in the States or had a U.S. phone number.

Clients who fit into this category need to fill out an online form indicated in their bank letters. Many people have nothing to worry about, says Chang, but others who haven’t been filing U.S. income tax as they should, will now be identified by CRA, and ultimately, the IRS. All registered products, such as RRSPs, RESPs and TFSAs are exempt from FATCA.

A win for advisors

In the meantime, the Investment Funds Institute of Canada (IFIC) has gained a win for advisors in the latest FATCA iteration of its guidance for financial services, negotiating provisions with CRA to allow advisors to keep complete control over their relationships with investors who have client name accounts.

James Carman, senior policy advisor, taxation, at IFIC, said that under the IGA, the mutual fund manufacturer and the dealer/advisor have joint responsibility with regards to FATCA reporting. IFIC was concerned that manufacturers would be put in a position where they had to contact the client directly, especially if the manufacturer had information on the U.S.-reportable status of an account holder that was different than the information provided by the dealer.

IFIC negotiated a split of the FATCA responsibilities with CRA so that the dealer/advisor is now responsible for documenting the account and determining whether the account is U.S.-reportable. The manufacturer is responsible for reporting the required information to CRA.

Carman said the recent update has made the process in client name reporting more administratively efficient, while ensuring that the industry is compliant with FATCA requirements.

Investor-client relationship

In the end, it puts control over reporting on FATCA on advisors and maintains the investor-client relationship.

“Advisors are [now] the ones who collect all the paperwork and making sure the account classification as U.S. person is correct or not,” said Carman. “At no point is the fund coming in and going directly to the client to ask for additional information and clarification. The business relationship that was in place before FATCA remains there, which was what the dealers and advisors wanted and was also what the mutual fund manufacturers wanted.”

He said IFIC wanted the model to be set up the way Canadian tax reporting and compliance reporting works now. “So right now – if you ignored FATCA – and you looked at who is responsible for Anti-Money Laundering Legislation and Know Your Client rules when the dealer opens the account, it’s the dealer and the advisor. And who does the government reporting for client name accounts? It’s the fund company. So we wanted CRA to basically use the same standards for FATCA reporting.”

A major advantage of this is that physical files won’t have to move from advisors to dealers to fund companies to verify the account status.

Carman said as this is the first year of the reporting season, there are issues that haven’t been identified. He said IFIC will be in touch with its members first to look at the subjects and then provide recommendations and suggestions for change to the CRA by late spring If anything significant comes out of this reporting season, there could yet be revised CRA guidance sometime in the late summer or fall, said Carman.