First published in Canadian Tax Highlights (23:9), September 2015
On August 4 and 5, 2015, the FC heard oral arguments in a lawsuit – commenced on August 11, 2014 by two Canada-US citizens – that challenges the law implementing the Canada-US intergovernmental agreement (IGA) relating to FATCA (Virginia Hillis et al. v. The Attorney General of Canada et al., court file no. T-1736-14). I attended the hearing. Surprisingly, the court said that it would rule on the plaintiffs’ motion by September 30, 2015, which is the deadline for the first transfer of information from Canada to the United States under the IGA. the FC decision may profoundly affect FATCA’s application and Canada’s ability to implement the OECD’s common reporting standard for the automatic exchange of information. The FC decision on the substantive issues will mark the first time that a court in an IGA-partner jurisdiction has decided the domestic legality of an IGA’s implementing legislation: the 115 IGA-partner jurisdictions await both the FC decision and the US treasury comments if the court decision is favourable to the plaintiffs.
In its 2015 budget, the federal government announced a commitment to implement the OECD’s common reporting standards starting in July 2017 and reaffirmed Canada’s commitment to introduce draft legislation in 2015. The reporting obligations and the mechanics of the information exchange are based largely on the architecture of FATCA and the IGAs; the court order may therefore also affect Canada’s ability to fully participate in the common reporting standards.
The plaintiffs’ motion seeks an order to “permanently enjoin the Minister of National Revenue from disclosing to the United States government… the private banking information of us persons resident in Canada who are Canadian citizens or residents when such disclosure is contrary to the Canada-US treaty.” Thus, if the court finds that the information intended to be exchanged is outside the scope of the Canada-US income tax treaty, the plaintiffs’ objective of precluding Canada from complying with the FATCA information exchange will be achieved (provided that the decision is not overturned on appeal).
The 2014 pleadings primarily address Canadian Constitutional law, and the 2015 motion’s pleadings largely reserve those arguments for the full trial. The motion focuses on the limits applicable to the collection and exchange of information in the Canada-US treaty.
In essence, the plaintiffs argue that the accountholder information to be exchanged under the IGA is more extensive than any information that is permitted to be exchanged by Canadian domestic law and treaty articles XXVI A (Assistance in Collection), XXVII (Exchange of Information), and xxv (Non-Discrimination).
The plaintiffs summarize their general treaty positions as follows:
It is the plaintiffs’ position that only a tiny subset of the information collected by Canada from Canadian financial institutions might be disclosable and if the united states is made aware of the severe limitations on what Canada will disclose, it likely will not even care to have that information. this will simply demonstrate that Canada was caught by the US FATCA worldwide net without any good reason.
If the plaintiffs’ position is upheld, the exchange of information contemplated by FATCA is greatly limited; the defendants argue that this cannot reasonably be what Canada and the United States intended when they entered into the IGA. The defendants say that under Canadian law, treaty interpretation differs from statutory interpretation, and “[a] literal or legalistic interpretation should be avoided if it might defeat or frustrate the intentions of the parties.” The following discussion sets out (1) the treaty articles that deal with information disclosure and (2) the plaintiffs’ and defendants’ positions on those articles.
Article XXVI A (Assistance in Collection). The plaintiffs note that treaty article XXVI A(8) precludes Canada from assisting the United States in the collection of tax from an individual who is also a Canadian citizen when the United States makes a revenue claim. The plaintiffs argue that providing accountholder information includes everything needed for the IRS to assess and collect taxes and is thus equivalent to assisting the United States to collect its taxes.
This argument suffers because the IRS’s authority to assess tax and penalties is typically subject to the deficiency procedures found in code sections 6211-6215. Those procedures generally assure the taxpayer access to administrative review (namely, IRS Appeals) and a pre-payment judicial forum (namely, the US Tax Court) for the review of disputed additions to tax and penalties. However, there is an exception to this rule – the IRS assessment of assessable penalties in code section 6679(b), which are not eligible for the safeguards of the deficiency procedures and can be assessed almost immediately by the IRS. Neither party raised the issue of assessable penalties in its submissions, which may have assisted the plaintiffs’ argument that disclosure of accountholder information is the equivalent of providing assistance in collection.
For example, the failure-to-file penalties imposed by Code chapter 61 are assessable penalties, are not eligible for the deficiency procedures, and may be assessed without giving the taxpayer access to administrative review and a pre-payment judicial forum. The IRS may assess these penalties by simply providing the taxpayer with notice and demand for payment, and the IRS may commence collection action if payment is not made within 10 days. Assessable penalties arise frequently: the most common instances are the assessable penalties that are imposed on a US citizen residing abroad for failure to file the many common information returns such as forms 926, 5471, 5472, 8865, and 8938. Providing accountholder information may thus be tantamount to assisting in collection, at least as it relates to assessable penalties.
Article XXVII (Exchange of information) and the “may be relevant” standard. the plaintiffs note that treaty article XXVII(1) requires the competent authorities to exchange “such information as may be relevant for carrying out the provisions of this convention or of the domestic laws of the Contracting States concerning taxes to which this convention applies insofar as the taxation thereunder is not contrary to this convention.” the plaintiffs argue that the accountholder information to be exchanged is not relevant to taxes covered by the convention.
First, the plaintiffs note that a large majority of US citizens resident in Canada do not owe us tax because of the treaty and the double-tax-mitigating provisions of US domestic tax law (such as the foreign tax credit and the foreign earned income exclusion). Thus, accountholder information is relevant only to us persons who, for various reasons, may owe us tax. The defendants counter that the plaintiffs’ position is unreasonable because it will require the CRA to determine an affected individual’s US tax liability before providing accountholder information related to the taxpayer: “The CRA could not be expected to interpret and apply the different domestic tax laws of all 92 of its treaty partners. This interpretation of the Convention leads to absurd results.”
Second, the plaintiffs note that the information to be exchanged under article XXVII is limited to taxes to which the treaty applies – that is, taxes on income and capital. Furthermore, the tax information reporting requirements of us tax law (which attract failure-to-file penalties but for which no tax is calculated) are not relevant to the taxes on income and capital to which the treaty applies and thus are not subject to the information-sharing provision of article XXVII. The defendants counter that account information is relevant under article XXVII because it assists in the administration of us tax law by “encouraging, enforcing and verifying compliance with those laws by u.s. taxpayers.” The US tax information reporting requirements are similar to those imposed by Canada, which do not require that the information relate to any income or tax liability: section 233.3 of the Act requires certain Canadian taxpayers to report specified foreign property with a cost basis of more than $100,000, including capital held by foreign financial institutions. The report required of a Canadian resident by section 233.3 assists the Canadian government in the administration of its tax system, and thus a treaty request for information that may be relevant to the enforcement of section 233.3 is within the purview of article XXVII.
Third, the plaintiffs argue that article XXVII limits the information to be exchanged to what may be relevant to taxes covered by the treaty, but that it is not meant to apply to blanket disclosures of bank account information. In support, the plaintiffs cite the US technical explanation to the fifth treaty protocol:
However, the language “may be [relevant]” would not support a request in which a Contracting State simply asked for information regarding all bank accounts maintained by residents of that contracting state in the other contracting state, or even all accounts maintained by its residents with respect to a particular bank.
The plaintiffs say that IGA and the IGA were designed to require what the technical explanation says article XXVII precludes: the blanket exchange of bank account information. Furthermore, the OECD commentary on the model Agreement on Exchange of Information on Tax Matters provides that the “Contracting Parties are not at liberty to engage in fishing expeditions or to request information that is unlikely to be relevant to the tax affairs of a given taxpayer.”
In spite of the clear language of the US technical explanation, the defendants offer two counter-arguments. First, they say that the technical explanation eschews blanket exchanges of account information only if one state (say, the United States) requests bank account information from the other state (say, Canada) related to US residents who have financial accounts in Canada. the plaintiffs are not US residents, and thus the reference in the technical explanation does not preclude the exchange of their account information. Second, the defendants say that the technical explanation is not binding in interpreting the treaty, and the technical explanation should be read in light of the time when it was written (2007), which was three years before FATCA became US law. Moreover, the information that is the subject of exchange under the IGA is similar to the information excluded from exchange under the technical explanation: it is unreasonable to interpret the treaty so as to exclude that type of information.
Article XXV (Non-Discrimination). The plaintiffs note that under treaty article XXV, Canada cannot subject US nationals who are Canadian residents to taxation or other connected requirements that are more burdensome than what Canadian-resident nationals are or may be subject to. The Canadian implementing legislation (SC 2014, c. 20) requires the CRA to deliver to the IRS accountholder information for US nationals even though Canadian nationals are not subject to that requirement: “US persons are accordingly subject to a burden to which other Canadians are not: the burden of having their financial information turned over to a foreign government.”
The defendants counter that the plaintiffs’ reliance on article XXV is misplaced for three reasons. First, the IGA and Canadian domestic law do not impose more burdensome requirements on US nationals: the obligations apply only to financial institutions. Second, the direct burden of disclosing the plaintiffs’ banking information is imposed by US law and only indirectly by Canadian law. Third, a US national who is a Canadian resident is exposed to the same burdens as a Canadian national who has US indicia or who is a US person.
Counsel for both the plaintiffs and the defendants cite compelling arguments to support their positions and to rebut their opponents’ positions, and their efforts are impressive given the complexity of FATCA and international law. Even more impressive is the court’s commitment to render a decision on complex issues within a short time. The stakes are high for the individual plaintiffs, and the order’s potential effect on FATCA in Canada (and all IGA-partner jurisdictions) and on common reporting standards is massive: many practitioners are eagerly awaiting the court’s decision.