Two countries in the world tax their non-resident citizens on their worldwide income. One is Eritrea. The other is The United States of America. And Eritrea taxes it’s non-residents at a much lower rate.
While violence, including conflicts with Ethiopia, and weather that is apparently beyond hot, might encourage you to flee Eritrea, American citizens, or permanent residents are also turning their backs on the considerable benefits of their American citizenship. The reason, of course, is precisely the USA’s tax laws that follow them around the world. In the last few years the number of American citizens renouncing their citizenship, or expatriating as it is called, has shot way up, from 235 in 2008 to 2,999 in 2013 to 5,411 in 2016.
Clearly, increased taxation levels to cope with the 2008 financial crisis and the huge debt burden left over from the financial bailout have spurned the increase. But more than that, the increased vigilance by the Treasury and the IRS of US expat’s financial assets held in foreign banks is another key factor. The annual foreign bank account report, or FBAR, is one that is causing banks in places like Switzerland as well as in much of the rest of the world to now fall all over themselves to do their due diligence and beyond on accounts held by foreign nationals at their institutions. This is after UBS AG, a major Swiss bank, was fined US$ 780 million in 2009 for aiding and abetting tax evaders under US law. That ruling focused minds around the world, and FACTA – the Foreign Account Tax Compliance Act – which came into effect this July 1st after being created in 2010 by the US Congress, requires foreign banks to report directly to the IRS on their bank accounts held by US nationals. For countries whose banks do not comply with FACTA, US financial institutions are obligated to impose a 30% withholding tax on all payments made to those foreign banks. Needless to say, banks around the world are complying. US tax laws are notoriously complex, and the fear of non-compliance is real. It does not hold water with the IRS to say, “Sorry I didn’t really understand paragraph 6, section 4, sub-heading 1a. My bad.” Or, as is usually the case, for your tax lawyer to tell them that. Either you comply as they see it, or you pay the penalties, or go to jail, or try to put your accounts in order and then renounce your citizenship, or just renounce and hope the IRS leaves you alone.
There are about 6 million US expats around the world, so tens of thousands of US citizens or permanent residents giving up their citizenship or permanent resident status between 2009 and 2016 is not a very large number. The fact is that, aside from those in Canada, those renouncing US citizenship tend to be wealthier individuals and the sums involved can be considerable. Since 2009, more than $6 billion has been collected by the IRS on taxes owed as well as penalties and interest on more than 40,000 expat US taxpayers, according to some accounts.
In Canada, as a result of the tax treaty with the USA, Canadian banks, in compliance with FACTA, are now obligated to divulge details of any account holders who have US citizenship. Many US citizens in Canada are dual citizens who have lived a great part of their lives in Canada, some from childhood on, and may have one parent who is Canadian. Since FACTA went into effect on July 1 of 2014, they have been lining up at the US Consulate in Toronto, for example, to renounce their citizenship. According to some tax consultants, it’s the complexity of US tax law and the paperwork making them renounce, rather than the fact that they might owe Uncle Sam loads of money, which is more the case with Swiss bank account holders.
The line-up to make an appointment at the US Consulate in Toronto was pretty long once FACT came into effect. This was because to renounce your US Citizenship you must go in person to an embassy or consulate outside the US and sign an oath, affirming your intention to renounce your citizenship. You must demonstrate in at least one, and perhaps two, interviews with a consular official that your renunciation is voluntary and intentional. Your formal confirmation comes a few months later when you receive your Certificate of Loss of Nationality. The process was free until 2010, when a fee of USD$450 was applied and that fee has since been raised to USD$2,350 as of September 12 of 2014. In part, it is to cover the paperwork that is very involved and that takes a lot of time out of a busy consular official’s schedule, and in part to discourage future renunciations.
By some estimates, there are close to 1 million US citizens living in Canada, of which many may be dual citizens, who under US law, should have been filing taxes every year with the IRS, as well as reporting their bank accounts held in Canada to the Financial Crimes Enforcement Network, a branch of the US Treasury Department. Most have not bothered to, but now given the tax treaty between Canada and the US, Canada has essentially taken on at least part of the burden of enforcement of a citizenship-based tax system. This is a tricky proposition at best, seeing it depends on the voluntary compliance of those affected, unlike a residence-based tax system that almost all other countries use.
Of course, you can scare up compliance by threatening substantial penalties, like denying people re-entry into the US. The IRS and Treasury Department may be considering this as well, but can they really ask Canada to arrest and deport hundreds of thousands of expats who may not have filed taxes since leaving the US for Canada? It will be interesting to see how they proceed on both sides of the border, and it may be they will come down hard on certain individual cases to try and ensure more compliance. Whether that encourages more expats to start filing their US taxes or whether the line ups at US consulates around the world will get even longer is a good question, even if by some estimates it will cost US expats in Canada over CAD$10,000 to renounce and put their last tax payment to the IRS in good order. Not only that, you have to prove to the IRS that you have filed taxes according to IRS rules for the past five years. If not, you get to pay an exit tax which is equivalent to a capital gains tax. If your net worth exceeds USD$2 million, you will have to pay an exit tax regardless.
One wonders if Washington DC will ever decide to simplify their tax code; a remote possibility nowadays given that tax lawyers and tax consultants, and accountants at large, make a great living interpreting the byzantine rules and regulations issued by the IRS. And they certainly lobby to keep it that way. Imagine, if you will, the USA with a tax system similar to Canada’s current tax system. One suspects it might win the approval of more than a few American taxpayers, and not only the ones lining up in Toronto at their country’s consulate.