Preparing For The Intended And The Unintended Consequences Of The U.S. HIRE Act
March 7, 2011, Orlando, Florida: One unintended but critical consequence of the new U.S. HIRE Act will be significant capital flight from the United States in the next 23 months. The other will be for foreign financial institutions and foreign private-sector interests to stop conducting their business in dollars.
Dear Live and Invest Overseas Reader,
"Long the champion and beneficiary of free trade and the free flow of capital," writes international tax attorney Joel Nagel, "the United States last year enacted legislation that a growing number of commentators and professionals believe could be the start of capital controls in America.
"The provisions are found in a jobs' bill, H.R. 2847 (also known as the HIRE Act), which became law in March 2010. Title V of the law largely encompasses the Foreign Account Tax Compliance Act of 2009, or FATCA, also referred to as the 'Offset Provisions' of the bill.
"On their face, these provisions appear intended to force U.S. tax compliance with regard to foreign accounts and transactions between the United States and individuals in countries that are considered to be tax havens (meaning the banks and financial institutions in those countries do not share account information with U.S. authorities).
"Section 1474 refers to 'withholdable payments' to Foreign Financial Institutions that don't meet U.S. standards for information sharing. The law requires that any financial institution (U.S. or foreign) remitting any foreign payment to a bank in such a country withhold 30% of the amount of such payment and remit that percentage to the Internal Revenue Service (IRS) as a tax.
"A withholdable payment is defined as any payment of interest, dividends, rents, salaries, wages, premiums, annuities, compensation, enumerations, emoluments, and other fixed or determinable annual or periodical gains, profits and income, if such payment is from sources within the United States.
"On its surface, the withholdable payment is designed to ensure that pre-tax monies are not sent abroad without applicable U.S. federal taxes being paid. Looking a little deeper, however, the law does two things that go beyond the responsibility of each taxpayer to pay what he owes to the IRS.
"First, under Section 1474 of the bill, the law makes banks, as a third party, responsible for the enforcement of government tax policy. The banks are liable for the customer's tax obligation on transferred funds if they don't withhold the required 30% to cover any possible tax liability. The banks essentially become the tax police, working for the government as hammers to bring about individual compliance.
"Second, the same provision holds the banks harmless and indemnifies them if they improperly withhold the 30% tax when it is not due.
"So, if banks are third-party tax enforcers on the one hand, and completely indemnified from improper tax withholding on the other, it is clear what banks will do. It would be difficult in any case for banks to determine the difference between a pre-tax remittance versus a post-tax payment. They will be inclined, therefore, to withhold 30% tax on all foreign payments to banks and countries that do not have what are considered 'information-sharing agreements with the United States.
"The net effect of this provision will be to greatly discourage any financial transactions between U.S. banks and foreign banks not entering into information-sharing agreements with the U.S. government.
"To wire transfer US$100,000 to Panama, for example, to purchase a piece of real estate, one would have to agree to send US$142,000 so that a net US$100,000 would reach its destination. Who would be inclined or willing to pay 30% more in a global transaction to satisfy these requirements? Almost nobody.
"International payments beginning Jan. 1, 2013, will be subject to these new withholding requirements. The delay of more than two years is designed to force foreign governments (especially those in tax havens) to enter into agreements with the United States, as Panama is in the process of doing now.
"In addition, the law will put extreme pressure on individual foreign banks to enter into private-sector agreements with the IRS to disclose all U.S. account holders or risk having all U.S. transactions to or through their individual bank subject to 30% tax withholding.
"In addition to those intended effects, I believe the new law will have two unintended consequences, as well. First, both U.S. and non-U.S. persons fearing how the implementation of the new law will impact them after Jan. 1, 2013, may be inclined to move assets outside the United States before the effective date, meaning we could see significant capital flight from the United States in the next 23 months.
"Foreign financial institutions may drop U.S. clients as one way to avoid being subject to the 30% withholding requirement, as well as avoiding the U.S. regulatory compliance costs (again, probably an intended consequence of the law). These compliance costs to worldwide bankers have been estimated by the Swiss Banking Association to total nearly US$40 billion annually, while the measure is projected to generate only around US$8 billion to the U.S. Treasury in increased taxes.
"Additionally, foreign financial institutions and foreign private-sector interests may simply stop conducting their business in dollars. A dollar-denominated transaction will ultimately pass through a U.S. Federal Reserve Bank and potentially subject the transaction to the risk of a U.S. bank levying a 30% withholding tax on any payment.
"One method for foreigners to ensure that this would not happen would be to designate the contract in a currency other than U.S. dollars. So if a German businessman, for example, contracts with his Japanese counterpart to do a deal to sell equipment in China, the best way to ensure that the transaction would not be subject to U.S. withholding tax would be to designate the contract in euro, yen, won, or any other currency than dollars. Those currencies would not pass through a U.S. Federal Reserve Bank and therefore would not be subject to the backup tax regime.
"Russia and China announced at the end of last year that they would no longer be doing trade transactions in U.S. dollars but rather in their own currencies. The two countries indicated that there was too much risk in using the dollar for their trade.
"As more global transactions (especially oil, gold, and other commodities) are done in non-dollar currencies, the global demand for the U.S. dollar will decrease. If you follow this thinking through, you see how it is very likely that the U.S. dollar eventually, perhaps sooner than later, will no longer be the world's reserve currency. As demand decreases, the value of the dollar will surely fall as well. So while exchange and private capital controls may well have been envisioned in the HIRE Act, additional unintended consequences of immediate capital flight and long-term devaluing of our currency through simple supply-and-demand manipulations were probably less well-considered.
"It is unlikely that even a new President in January 2013 will undo the effects of this damaging legislation. For individuals, there exists just less than two years to plan for the new law and to take steps to avoid the consequences, both intended and unintended."
P.S. As Joel explained it to attendees at our Emergency Offshore Summit in Panama City last December, "If you can see the freight train coming from a few miles down the track, you should be able to save yourself from being run over."
This freight train is coming. That's why we're planning a second Emergency Offshore Summit, again in Panama City. We're in the process of adding this important program to our conference calendar for this year and will be in touch with further details as soon as they're finalized. Yes, Joel will be among the two-dozen-plus expert speakers participating.
Meantime, you can access the recordings of every presentation from the event we held three months ago here.
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Kathleen Peddicord is the founder of the Live and Invest Overseas publishing group. With more than 25 years experience covering this beat, Kathleen reports daily on current opportunities for living, retiring, and investing overseas in her free e-letter.
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