Tax Analysts Blog

FATCA Envy Spreads Across Hemisphere

Posted on Oct 24, 2014

Here in America, tax collectors know when you earn interest on your bank deposits. That's because U.S. banks are obliged to collect such information and report it to the IRS. This makes it impractical for would-be tax evaders to purposefully underreport their interest income for tax purposes. They'd be easily found out.

Now that we live in the age of the Foreign Account Tax Compliance Act, foreign banks face similar reporting requirements. When a U.S. taxpayer earns income from an overseas financial account, the relevant bank data will eventually make its way to the IRS. That income has always been taxable, of course, but before FATCA many people were tempted to omit it from their tax returns. They figured the IRS would never know about it. Those days are gone.

FATCA is not a new tax. It merely enhances taxpayer compliance by making offshore tax avoidance much riskier.

The South American nation of Colombia does not have its own version of FATCA, but its government wishes it did. That's evident from its current tussle with neighbor Panama. The root of the problem between the two nations is FATCA-style reporting of bank data, or the lack thereof. Colombia wants it badly; Panama wants nothing to do with it.

Here's a brief background:

Panama City boasts a thriving financial center, one of the largest in Latin America. Together with the Canal Zone it accounts for most of the country's GDP. One reason for the Panamanian banking sector's success is ring-fencing. This policy attracts capital flow from wealthy foreign investors all over the world. Banks in Panama don’t collect information on accounts held by nonresident depositors, so there is no information to share with tax collectors in other countries.[FATCA alters that policy, but only for U.S. accountholders.]

Colombian law requires taxpayers to fully disclose bank deposit income regardless of where it was earned. But If a Colombian taxpayer failed to report his or her income from a Panamanian bank, the tax authorities would be very unlikely to detect the omission because of Panama’s lack of reporting. For practical purposes, the offshore account would remain a secret known only to the bank and the accountholder. Taxable income is thus concealed from Colombia’s revenue body with minimal risk.

The result of all this is tax enforcement on the honor system, without the traditional backstops of withholding or reporting. Predictably, noncompliance in Colombia is a massive problem. Officials in Bogotá estimate the revenue loss from nondisclosure of offshore bank income at $2 billion to $7 billion annually. Those are large numbers for a country Colombia's size.

Recently, Colombian officials asked their Panamanian counterparts to sign a bilateral tax information exchange agreement, known as a TIEA. The TIEA would have been reciprocal in nature, meaning it would oblige each signatory nation to collect and share bank information about the other nation's residents. Panama said "no, thanks." It has little to gain from a TIEA with Colombia.

So long as the banking sector is thriving -- and it is -- Panama's government doesn't care whether residents of other countries cheat on their taxes. The banks' position is that all nonresident clientele are free to self-report their interest income and it's not their fault when a Colombian client violates her country's tax laws. Nobody puts a gun the accountholders' heads and forces them to dodge taxes, although Panama's de facto bank secrecy certainly enables that outcome.

This dialogue might sound familiar. If you substitute the words "U.S.A." for "Colombia" and "Switzerland" for "Panama," you recreate the dynamics of the UBS banking scandal from a few years ago. All that's missing is a whistleblower, stolen computer files, and congressional hearings. The political fallout from that scandal is precisely what inspired the U.S. Congress to enact FATCA.

Where do things currently stand?

Colombia was extremely upset with Panama's refusal to negotiate a TIEA. Their frustration was made more acute by the awareness that Panamanian banks have already begun gathering data on another group of nonresident depositors (namely, Americans).

Colombian Foreign Minister Maria Angela Holguin recently emphasized that her country was not asking Panama for anything "not already requested by other countries" -- a subtle reference to the fact Panama now sends bank data to the IRS as required by FATCA.

Colombia retaliated by threatening to tag its northern neighbor with a "tax haven" designation. That legal status would trigger punitive taxes on all money transfers into Panama. It would also inflict reputational damage on Panama's entire financial system, which could have a chilling effect on foreign investment.
Panama responded by threatening to deport Colombian workers, repatriate Colombian criminals from Panamanian jails, and impose travel restrictions on Colombians attempting to enter the country. It's also considering a 300 percent increase in tariffs on goods imported from Colombia. Panama might also cancel a cross-border electricity sharing agreement.

Tensions between the two nations are now easing. Colombia's finance ministry has announced a preliminary agreement to exchange tax information with Panama. No TIEA has been signed yet, but it appears Panama has finally warmed to the idea. In return, Colombia has removed Panama's tax haven designation. The pressure seems to have worked.

It's well known that tax laws have unintended consequences. Could one of FATCA's ripple effects be the inclination of other countries to mimic its outcome? What cash-strapped government wouldn't seek parallel treatment when its citizens put money offshore, particularly if banks have already implemented mechanisms to gather the relevant data? This may prove to be FATCA's true legacy. For better or worse, FATCA envy could be here to stay.

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