Part 7: What God Hath Wrought – The #FATCA Inquisition (Review, Identify and Report on “U.S. Persons”) – Which country decides the nature of the “Entity”?

On May 13, 2014, Calgary lawyer Roy Berg appeared as a witness before the House Finance Committee in Ottawa. His testimony was in relation to Bill C – 31 AKA Canada’s FATCA implementation legislation which was called:

CANADA–UNITED STATES ENHANCED TAX INFORMATION EXCHANGE AGREEMENT IMPLEMENTATION ACT

This legislation was for the purpose of the Canadian Government complying with Canada’s FATCA obligations under the IGA. The text of the proposed laws is at the end of this post.*

I will let Mr. Berg’s testimony speak for itself. It is interesting in at least one significant respect. Mr. Berg’s testimony illuminates the problem when the U.S. and Canada define the same term in different ways. I remind you that under the Canada U.S. FATCA IGA, that each country is free to interpret the agreement. See for example S. 2 of Article I of the Canada U.S. IGA which reads as follows:

Any term not otherwise defined in this Agreement shall, unless the context otherwise requires or the Competent Authorities agree to a common meaning (as permitted by domestic law), have the meaning that it has at that time under the law of the Party applying this Agreement, any meaning under the applicable tax laws of that Party prevailing over a meaning given to the term under other laws of that Party.

FATCA-eng

Note the problems created by definitions.

Mr. Berg’s testimony included:

Good afternoon, Mr. Chairman and members of the committee.

My name is Roy Berg. I’m a U.S. tax lawyer with Moodys Gartner. I was born, raised, and educated in the U.S. I practised in the U.S. for 17 years in tax law before immigrating to Canada three years ago. Therefore, I think there are very few individuals who have more personally and professionally vested in this issue than I do.

On March 9, 2014 our office submitted extensive analysis and commentary to the Department of Finance regarding our concerns about the draft legislation, and on April 10 we submitted a brief on these concerns to the committee. I will be happy to elaborate on any of the materials we have submitted, as they’re quite detailed and quite specific.

Before I summarize our comments on the draft legislation, however, I want to emphasize that we do agree with the Minister of Finance that entering into the IGA with the U.S. was beneficial to Canada. Had Canada not entered into the IGA, Canadian financial institutions would have faced the unenviable dilemma of either complying with Canadian law and risking FATCA’s 30% withholding tax or complying with FATCA and risking violating Canadian law.

Unfortunately, as FATCA is drafted and the IGAs are designed, there is no middle ground. Those are simply the facts. Life under the IGA is better than life without the IGA. As Senator Patrick Moynihan of the U.S. said, “everyone is entitled to his own opinion, but not his own facts”.

The committee is likely going to be aware of rather jingoistic hyperbolic rhetoric admonishing Finance for ceding Canadian power, ceding sovereignty, and also encouraging Canada to stand up to FATCA. As the committee hears such comments, we encourage it to remember that FATCA is U.S. law, and the way it’s designed, it’s enforced not by the IRS, not by the Treasury, but by the markets themselves. In that, it is like a sales tax. The withholding obligation is on the person making the payments.

While the IGA is unquestionably beneficial to Canadians, the legislation before you requires refinement, specifically in the manner in which a financial institution is defined under the legislation. The definition is actually much more narrow in the legislation than in the IGA, the intergovernmental agreement.

The Department of Finance disagrees with that assertion. The Department of Finance believes that the definition of financial institution under the legislation is consistent with that in the IGA. However, in our briefs and in our submissions to Finance, we go through the legal analysis to support our position.

One thing I believe the Department of Finance does not disagree on is that the definition of financial institution is more narrow in the regulations and the implementing legislation of other FATCA partners. Therefore, the definition of financial institution for certain Canadian financial institutions will be different under Canadian domestic law from what it will be under U.S. domestic law, for example.

This difference will likely lead to unintended and unnecessary withholding of certain Canadian trusts that otherwise have no U.S. connections at all, for example, a spousal trust created at death, where the spouse, the beneficiaries, and the trustees have no U.S. connections whatsoever, and the only connection would be a U.S. bank account.

In that case, under Canadian domestic law, that trust would be defined as a non-financial foreign entity, whereas in the U.S., it will be defined as a foreign financial institution. Payments coming out of the U.S. to that Canadian trust will be subject to withholding, because under U.S. law, when there’s a discordance between the stated classification of the entity and the classification of the entity under U.S. law, there is mandatory withholding.

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*What follows is Part 5 of Canada’s Bill C-31The Canada–United States Enhanced Tax Information Exchange Agreement Implementation Act – the Bill which is the enabling legislation to implement the Canada U.S. FATCA IGA – signed by the Harper Government.

Note in particular S. 4 which makes it clear that All Canadian laws are now subject to FATCA. In other words: The U.S. “Congress has spoken” and Canada will obey. The Government of Stephen Harper – with the support of about 20% of those eligible to vote in Canada – has surrendered Canada’s sovereignty to the United States. I would like to believe that my interpretation of this is incorrect. Would somebody please comment, explaining to me, how Canada can remain a sovereign country when it has agreed that the validity of Canada’s laws, now depends on whether Canadian law is consistent with FATCA?

A group of Canadians will be commencing legal action, seeking a declaration that the FATCA IGA and Part 5 of Bill C-31, violate the Canadian Charter of Rights and Freedoms. After all, Canada’s Charter of Rights is the “supreme law of the land”. It is important to recognize that if this Charter challenge fails, the obvious conclusion is that:

FATCA will become the “Supreme law of the land” in Canada!

4. (1) Subject to subsection (2), in the event of any inconsistency between the (provisions of this Act or the Agreement) and the (provisions of any other law) (other than Part XVIII of the Income Tax Act), the provisions of this Act and the Agreement prevail to the extent of the inconsistency.

In other words, all Canadian laws are now subject to FATCA. The citizenship inquisition, or more specifically the question of:

“Are you or have you ever been a United States citizen?”

begins on Canada – July 1, 2014.

Those who are interested to understand how the FATCA inquisition will work, are invited to review Professor Allison Christian’s FATCA analysis.

Oh, and just in case, a mistake has been made, note S. 2 of the legislation which allows for the IGA to be amended from time to time.

2. In this Act, “Agreement” means the Agreement between the Government of Canada and the Government of the United States of America set out in the schedule, as amended from time to time.

And finally, never forget that it is the United States alone who defines who is a “U.S. person for the purposes of FATCA”. A surprisingly high number of Canadians, are defined by the U.S. as U.S. persons taxpayers.

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PART 5

CANADA–UNITED STATES ENHANCED TAX INFORMATION EXCHANGE AGREEMENT IMPLEMENTATION ACT

Enactment of Act
Enactment
99. The Canada–United States Enhanced Tax Information Exchange Agreement Implementation Act, whose text is as follows and whose schedule is set out in Schedule 3 to this Act, is enacted:
An Act to implement the Canada–United States Enhanced Tax Information Exchange Agreement
Short title
1. This Act may be cited as the Canada–United States Enhanced Tax Information Exchange Agreement Implementation Act.
Definition of “Agreement”
2. In this Act, “Agreement” means the Agreement between the Government of Canada and the Government of the United States of America set out in the schedule, as amended from time to time.
Agreement approved
3. The Agreement is approved and has the force of law in Canada during the period that the Agreement, by its terms, is in force.
Inconsistent laws — general rule
4. (1) Subject to subsection (2), in the event of any inconsistency between the provisions of this Act or the Agreement and the provisions of any other law (other than Part XVIII of the Income Tax Act), the provisions of this Act and the Agreement prevail to the extent of the inconsistency.
Inconsistent laws — exception
(2) In the event of any inconsistency between the provisions of the Agreement and the provisions of the Income Tax Conventions Interpretation Act, the provisions of that Act prevail to the extent of the inconsistency.
Regulations
5. The Minister of National Revenue may make any regulations that are necessary for carrying out the Agreement or for giving effect to any of its provisions.
Entry into force of Agreement
6. (1) The Minister of Finance must cause a notice of the day on which the Agreement enters into force to be published in the Canada Gazette within 60 days after that day.
Amending instrument
(2) The Minister of Finance must cause a notice of the day on which any instrument amending the Agreement enters into force to be published, together with a copy of the instrument, in the Canada Gazette within 60 days after that day.
Termination
(3) The Minister of Finance must cause a notice of the day on which the Agreement is terminated to be published in the Canada Gazette within 60 days after that day.

R.S., c. 1 (5th Supp.)
Amendments to the Income Tax Act
100. (1) The portion of subsection 162(6) of the Income Tax Act before paragraph (b) is replaced by the following:
Failure to provide identification number
(6) Every person or partnership who fails to provide on request their Social Insurance Number, their business number or their U.S. federal taxpayer identifying number to a person required under this Act or a regulation to make an information return requiring the number is liable to a penalty of $100 for each such failure, unless
(a) an application for the assignment of the number is made within 15 days (or, in the case of a U.S. federal taxpayer identifying number, 90 days) after the request was received; and
(2) Subsection (1) comes into force on the day on which the agreement set out in the schedule to the Canada–United States Enhanced Tax Information Exchange Agreement Implementation Act enters into force.
101. (1) The Act is amended by adding the following after Part XVII:
PART XVIII

ENHANCED INTERNATIONAL INFORMATION REPORTING
Definitions
263. (1) The following definitions apply in this Part.
“agreement”
« accord »
“agreement” has the same meaning as in section 2 of the Canada–United States Enhanced Tax Information Exchange Agreement Implementation Act.
“electronic filing”
« transmission électronique »
“electronic filing” means using electronic media in a manner specified by the Minister.
“listed financial institution”
« institution financière particulière »
“listed financial institution” means a financial institution that is
(a) an authorized foreign bank within the meaning of section 2 of the Bank Act in respect of its business in Canada, or a bank to which that Act applies;
(b) a cooperative credit society, a savings and credit union or a caisse populaire regulated by a provincial Act;
(c) an association regulated by the Cooperative Credit Associations Act;
(d) a central cooperative credit society, as defined in section 2 of the Cooperative Credit Associations Act, or a credit union central or a federation of credit unions or caisses populaires that is regulated by a provincial Act other than one enacted by the legislature of Quebec;
(e) a financial services cooperative regulated by An Act respecting financial services cooperatives, R.S.Q., c. C-67.3, or An Act respecting the Mouvement Desjardins, S.Q. 2000, c. 77;
(f) a life company or a foreign life company to which the Insurance Companies Act applies or a life insurance company regulated by a provincial Act;
(g) a company to which the Trust and Loan Companies Act applies;
(h) a trust company regulated by a provincial Act;
(i) a loan company regulated by a provincial Act;
(j) an entity authorized under provincial legislation to engage in the business of dealing in securities or any other financial instruments, or to provide portfolio management, investment advising, fund administration, or fund management, services;
(k) an entity that is represented or promoted to the public as a collective investment vehicle, mutual fund, exchange traded fund, private equity fund, hedge fund, venture capital fund, leveraged buyout fund or similar investment vehicle that is established to invest or trade in financial assets and that is managed by an entity referred to in paragraph (j);
(l) an entity that is a clearing house or clearing agency; or
(m) a department or an agent of Her Majesty in right of Canada or of a province that is engaged in the business of accepting deposit liabilities.
“non-reporting Canadian financial institution”
« institution financière canadienne non déclarante »
“non-reporting Canadian financial institution” means any Canadian financial institution or other entity resident in Canada that
(a) is described in any of paragraphs C, D and G to J of section III of Annex II to the agreement;
(b) makes a reasonable determination that it is described in any of paragraphs A, B, E and F of section III of Annex II to the agreement;
(c) qualifies as an exempt beneficial owner under relevant U.S. Treasury Regulations in effect on the date of signature of the agreement; or
(d) makes a reasonable determination that it qualifies as a deemed-compliant FFI under relevant U.S. Treasury Regulations in effect on the date of signature of the agreement.
“U.S. reportable account”
« compte déclarable américain »
“U.S. reportable account” means a financial account that, under the agreement, is to be treated as a U.S. reportable account.
Financial institution
(2) For the purposes of this Part, “Canadian financial institution” and “reporting Canadian financial institution” each have the meaning that would be assigned by the agreement, and the definition “non-reporting Canadian financial institution” in subsection (1) has the meaning that would be assigned by that subsection, if the definition “Financial Institution” in subparagraph 1(g) of Article 1 of the agreement were read as follows:
g) The term “Financial Institution” means any Entity that is a Custodial Institution, a Depository Institution, an Investment Entity or a Specified Insurance Company, and that is a listed financial institution within the meaning of Part XVIII of the Income Tax Act.
Financial account
(3) For the purposes of this Part, the agreement is to be read as if the definition “Financial Account” in subparagraph 1(s) of Article 1 of the agreement included the following subparagraph after subparagraph (1):
(1.1) an account that is a client name account maintained by a person or entity that is authorized under provincial legislation to engage in the business of dealing in securities or any other financial instruments, or to provide portfolio management or investment advising services.
Identification number
(4) For the purposes of this Part, a reference in the agreement to “Canadian TIN” or “taxpayer identification number” is to be read as including a reference to Social Insurance Number.
Term defined in agreement
(5) In this Part, a term has the meaning that is defined in, or assigned by, the agreement unless the term is defined in this Part.
Amending instrument
(6) No person shall be liable for a failure to comply with a duty or obligation imposed by this Act that results from an amendment to the agreement unless at the date of the alleged failure,
(a) the text of the instrument that effected the amendment had been published in the Canada Gazette; or
(b) reasonable steps had been taken to bring the purport of the amendment to the notice of those persons likely to be affected by it.
Designation of account
264. (1) Subject to subsection (2), a reporting Canadian financial institution may designate a financial account to not be a U.S. reportable account for a calendar year if the account is
(a) a preexisting individual account described in paragraph A of section II of Annex I to the agreement;
(b) a new individual account described in paragraph A of section III of Annex I to the agreement;
(c) a preexisting entity account described in paragraph A of section IV of Annex I to the agreement; or
(d) a new entity account described in paragraph A of section V of Annex I to the agreement.
U.S. reportable account
(2) A reporting Canadian financial institution may not designate a financial account for a calendar year unless the account is part of a clearly identifiable group of accounts all of which are designated for the year.
Applicable rules
(3) The rules in paragraph C of section VI of Annex I to the agreement apply in determining whether a financial account is described in any of paragraphs (1)(a) to (d).
Identification obligation — financial accounts
265. (1) Every reporting Canadian financial institution shall establish, maintain and document the due diligence procedures set out in subsections (2) and (3).
Due diligence — general
(2) Every reporting Canadian financial institution shall have the following due diligence procedures:
(a) for preexisting individual accounts that are lower value accounts, other than accounts described in paragraph A of section II of Annex I to the agreement, the procedures described in paragraphs B and C of that section, subject to paragraph F of that section;
(b) for preexisting individual accounts that are high value accounts, other than accounts described in paragraph A of section II of Annex I to the agreement, the procedures described in paragraphs D and E of that section, subject to paragraph F of that section;
(c) for new individual accounts, other than accounts described in paragraph A of section III of Annex I to the agreement,
(i) the procedures described in paragraph B of section III of Annex I to the agreement, or
(ii) in respect of a clearly identifiable group of accounts, the procedures that would be applicable if the accounts were preexisting individual accounts that were lower value accounts, with such modifications as the circumstances require, including procedures to review any documentary evidence obtained by the institution in connection with the opening of the accounts for the U.S. indicia described in subparagraph B(1) of section II of Annex I to the agreement;
(d) for preexisting entity accounts, other than accounts described in paragraph A of section IV of Annex I to the agreement, the procedures described in paragraphs D and E of that section; and
(e) for new entity accounts, other than accounts described in paragraph A of section V of Annex I to the agreement, the procedures described in paragraphs B to E of that section.
Due diligence — no designation
(3) If a reporting Canadian financial institution does not designate a financial account under subsection 264(1) for a calendar year, the institution shall have the following due diligence procedures with respect to the account:
(a) if the account is a preexisting individual account described in paragraph A of section II of Annex I to the agreement, the procedures described in paragraphs B and C of that section, subject to paragraph F of that section;
(b) if the account is a new individual account described in paragraph A of section III of Annex I to the agreement,
(i) the procedures described in paragraph B of section III of Annex I to the agreement, or
(ii) in respect of an account that is part of a clearly identifiable group of accounts, the procedures that would be applicable if the account were a preexisting individual account that was a lower value account, with such modifications as the circumstances require, including procedures to review any documentary evidence obtained by the institution in connection with the opening of the account for the U.S. indicia described in subparagraph B(1) of section II of Annex I to the agreement;
(c) if the account is a preexisting entity account described in paragraph A of section IV of Annex I to the agreement, the procedures described in paragraphs D and E of that section; and
(d) if the account is a new entity account described in paragraph A of section V of Annex I to the agreement, the procedures described in paragraphs B to E of that section.
Rules and definitions
(4) For the purposes of subsections (2) and (3), subparagraphs B(1) to (3) of section I, and section VI, of Annex I to the agreement apply except that
(a) in applying paragraph C of that section VI, an account balance that has a negative value is deemed to be nil; and
(b) the definition “NFFE” in subparagraph B(2) of that section VI is to be read as follows:
2. NFFE
An “NFFE” means any Non-U.S. Entity that is not an FFI as defined in relevant U.S. Treasury Regulations or is an Entity described in subparagraph B(4)(j) of this section, and also includes any Non-U.S. Entity
a) that is resident in Canada and is not a listed financial institution within the meaning of Part XVIII of the Income Tax Act; or
b) that is resident in a Partner Jurisdiction other than Canada and is not a Financial Institution.
U.S. indicia
(5) For the purposes of paragraphs (2)(a) and (b), subparagraph (2)(c)(ii), paragraph (3)(a) and subparagraph (3)(b)(ii), subparagraph B(3) of section II of Annex I to the agreement is to be read as follows:
3. If any of the U.S indicia listed in subparagraph B(1) of this section are discovered in the electronic search, or if there is a change in circumstances that results in one or more U.S. indicia being associated with the account, then the Reporting Canadian Financial Institution must seek to obtain or review the information described in the portion of subparagraph B(4) of this section that is relevant in the circumstances and must treat the account as a U.S. Reportable Account unless one of the exceptions in subparagraph B(4) applies with respect to that account.
Financial institution
(6) For the purpose of applying the procedures referred to in paragraphs (2)(d) and (e) and (3)(c) and (d) to a financial account of an account holder that is resident in Canada, the definition “Financial Institution” in subparagraph 1(g) of Article 1 of the agreement is to be read as follows:
g) The term “Financial Institution” means any Entity that is a Custodial Institution, a Depository Institution, an Investment Entity or a Specified Insurance Company, and that is a listed financial institution within the meaning of Part XVIII of the Income Tax Act.
Dealer accounts
(7) Subsection (8) applies to a reporting Canadian financial institution in respect of a client name account maintained by the institution if
(a) property recorded in the account is also recorded in a financial account (in this subsection and subsection (8) referred to as the “related account”) maintained by a financial institution (in this subsection and subsection (8) referred to as the “dealer”) that is authorized under provincial legislation to engage in the business of dealing in securities or any other financial instrument, or to provide portfolio management or investment advising services; and
(b) the dealer has advised the institution whether the related account is a U.S. reportable account.
However, subsection (8) does not apply if it can reasonably be concluded by the institution that the dealer has failed to comply with its obligations under this section.
Dealer accounts
(8) If this subsection applies to a reporting Canadian financial institution in respect of a client name account,
(a) subsections (1) to (4) do not apply to the institution in respect of the account; and
(b) the institution shall rely on the determination of the dealer in respect of the related account in determining whether the account is a U.S. reportable account.
Reporting — U.S. reportable accounts
266. (1) Every reporting Canadian financial institution shall file with the Minister, before May 2 of each calendar year, an information return in prescribed form relating to each U.S. reportable account maintained by the institution at any time during the immediately preceding calendar year and after June 29, 2014.
Reporting — nonparticipating financial institutions
(2) Every reporting Canadian financial institution shall file with the Minister, before May 2 of each calendar year, an information return in prescribed form relating to payments, to a nonparticipating financial institution that is the holder of a financial account maintained by the reporting Canadian financial institution, during the immediately preceding calendar year if the immediately preceding year is 2015 or 2016.
Filing of return
(3) An information return required under subsection (1) or (2) shall be filed by way of electronic filing.
Record keeping
267. (1) Every reporting Canadian financial institution shall keep, at the institution’s place of business or at such other place as may be designated by the Minister, records that the institution obtains or creates for the purpose of complying with this Part, including self-certifications and records of documentary evidence.
Form of records
(2) Every reporting Canadian financial institution required by this Part to keep records that does so electronically shall retain them in an electronically readable format for the retention period referred to in subsection (3).
Retention of records
(3) Every reporting Canadian financial institution that is required to keep, obtain, or create records under this Part shall retain those records for a period of at least six years following
(a) in the case of a self-certification, the last day on which a related financial account is open; and
(b) in any other case, the end of the last calendar year in respect of which the record is relevant.
Anti-avoidance
268. If a person enters into an arrangement or engages in a practice, the primary purpose of which can reasonably be considered to be to avoid an obligation under this Part, the person is subject to the obligation as if the person had not entered into the arrangement or engaged in the practice.
Deemed-compliant FFI
269. If a Canadian financial institution makes a reasonable determination that it is to be treated as a deemed-compliant FFI under Annex II to the agreement, this Part applies to the institution, with such modifications as the circumstances require, to the extent that the agreement imposes due diligence and reporting obligations on the institution.
(2) Subsection (1) comes into force on the day on which the agreement set out in the schedule to the Canada–United States Enhanced Tax Information Exchange Agreement Implementation Act enters into force.