Canada and the United States announced on February 5, 2014, that they had signed a long-awaited intergovernmental agreement (Canada–U.S. IGA) that dramatically expands the sharing of tax-related information between the countries. The agreement modifies the U.S. tax reporting and withholding provisions commonly referred to as the “Foreign Account Tax Compliance Act” (FATCA) as these provisions apply to Canadian financial intermediaries. The Canada–U.S. IGA must be ratified by Canada to come into force. Canada also released draft legislation on February 5 that would ratify and implement the Canada–U.S. IGA. Comments on this legislation are being accepted until March 10, 2014.
FATCA was enacted in 2010 to reduce perceived offshore tax evasion by U.S. citizens and residents holding assets through non-U.S. financial intermediaries. Absent an intergovernmental agreement, FATCA would have required Canadian banks and other “foreign financial institutions” (FFIs) to enter into an agreement (FFI Agreement) with the IRS to identify U.S. accounts and report information on those accounts to the IRS (such an FFI is a Participating FFI). FFIs and certain other foreign entities are also required to provide information regarding their beneficial owners to U.S. withholding agents, including Participating FFIs. Failure to enter into an FFI Agreement or provide required beneficial owner information would generally have resulted in the imposition of a 30% withholding tax on “withholdable payments”1 made to such non-compliant payees. FATCA withholding with respect to certain withholdable payments is scheduled to commence on July 1, 2014, and would become applicable to a broader class of payments beginning in 2017.
FATCA raised a number of concerns in Canada, such as whether Canadian FFIs could be compelled to report information directly to the IRS while complying with Canadian privacy laws. The Canada–U.S. IGA attempts to address those concerns by allowing Canadian FFIs to provide information on U.S. accounts to the Canada Revenue Agency (CRA), which will make the information available to U.S. tax authorities under the exchange of information article of the Canada–United States Income Tax Convention. In addition, under the Canada–U.S. IGA, the United States commits to provide the CRA with certain information about accounts held by Canadian residents in U.S. financial institutions. The Canada–U.S. IGA and the related annexes conform closely to the Reciprocal Model 1 intergovernmental agreement (IGA) that has served as the basis for the IGAs that the United States has signed with 18 other countries. Like these other IGAs, the Canada–U.S. IGA is intended to streamline FATCA information reporting, reduce FATCA compliance burdens for financial institutions and allow for compliance with FATCA in a manner that is consistent with applicable privacy and other laws.
Once in force, the draft legislation to implement the Canada–U.S. IGA will ratify the agreement (including its requirement for Canadian FFIs to implement due diligence procedures to identify U.S. accounts), and will require Canadian FFIs to electronically report specified information on those accounts to the CRA. Information reporting by Canadian FFIs to the CRA and exchanges of information under the Canada–U.S. IGA will begin in 2015. This information will be provided automatically by the CRA to the IRS. A Canadian FFI that complies with the requisite due diligence and reporting requirements and registers with the IRS in accordance with the Canada–U.S. IGA generally will be eligible to be treated as a registered deemed-compliant FFI for FATCA purposes and will not have to enter into an agreement directly with the IRS. The Canada–U.S. IGA also relieves Canadian FFIs of certain obligations that would otherwise be imposed under FATCA, including the obligation to withhold on payments to, or to close accounts of, recalcitrant account holders (that is, account holders who do not provide requested information to establish their identity), if the U.S. Competent Authority receives specified information with respect to such accounts.
Like the Model 1 IGA, the Canada–U.S. IGA contains an annex (Annex II) that exempts specified entities and financial products with a low potential for U.S. tax avoidance from FATCA’s reporting and withholding regime. Very generally, Annex II establishes that, among other entities, the Bank of Canada, certain international organizations operating in Canada and certain pension and retirement funds will be treated as “exempt beneficial owners” for FATCA purposes, and therefore will not be subject to FATCA withholding. In addition, smaller deposit-taking institutions, such as credit unions, with assets of less than $175 million will be exempt. FATCA withholding will also not apply to certain entities that Annex II treats as “deemed-compliant FFIs,” including Canadian financial institutions that provide financial services only within Canada to Canadian residents, certain Canadian non-profit organizations and certain entities formed by non-profits and pension plans. Compliance with the due diligence and reporting requirements under FATCA will also not be required of these entities.
The Annex also excludes from the definition of “financial account” certain accounts and products, including registered retirement savings plans, registered retirement income funds, pooled registered pension plans, registered pension plans, tax-free savings accounts, registered disability savings plans, registered education savings plans and deferred profit-sharing plans. The effect of this exclusion is that such accounts will not be subject to the due diligence and reporting requirements imposed by FATCA.
The Canada-U.S. IGA ensures that Canada will receive the benefit of any more favorable terms afforded to any other country that signs an IGA with the United States, provided that such other country commits to the same obligations undertaken by Canada.
Under the Canada–U.S. IGA, the United States has committed to providing the CRA with information on accounts of Canadian residents held through U.S. financial institutions. The commitments to provide the CRA information include the obligation to provide information with respect to bank deposit accounts and interest-bearing accounts at insurance companies held at U.S. financial institutions by individual Canadian residents and certain other “financial accounts” held by individuals and entities resident in Canada. The scope of this obligation is narrower than the obligation imposed on Canadian FFIs with respect to U.S. accounts, both with regard to the accounts on which information is to be provided (e.g., Canadian FFIs are required to provide information on bank deposit accounts of U.S. entities, not just accounts of individual U.S. residents) and the types of such information (e.g., Canadian FFIs are required to provide information, in the case of custodial accounts, on the gross interest, dividends and other income generated in the account, whereas U.S. FFIs will only be required to provide information on U.S.-source dividends and certain other U.S. source income that is already being collected under U.S. domestic law). The United States does agree, under the Canada-U.S. IGA, to pursue “the adoption of regulations and advocating and supporting relevant legislation” to achieve “equivalent levels of reciprocal automatic information exchange.”
The Canada–U.S. IGA takes effect when Canada has notified the United States that it has completed the necessary internal procedures to carry out its obligations under the IGA. However, for purposes of applying FATCA, the United States will deem the Canada–U.S. IGA to be in effect and Canadian financial institutions are now generally eligible to register on the FATCA registration website as deemed-compliant FFIs.
Canada noted that the IGA is consistent with Canada’s support for the G-20’s 2013 commitment to begin exchanging information automatically on tax matters by the end of 2015. Canada is working with the OECD on developing a global model to achieve that objective.
1 “Withholdable payments” include U.S. source interest, dividends, rents, salaries, wages, premiums, annuities and compensation, as well as the gross proceeds from the sale or disposition of property that can produce U.S. source interest or dividends.