US banks’ challenge to tax info exchange fails

Judge: Reciprocity needed to fight offshore tax evasion

A U.S. District Court has rejected challenges by the Florida and Texas Bankers Associations to Internal Revenue Service rules that require American banks to report the interest income of bank account holders who reside abroad.

The banking associations which collectively represent more than 800 banks, many of which are small businesses, claimed the regulations would be too burdensome and cause harmful capital flight.  

The IRS rule, which became effective Jan. 1, 2013, forces U.S. banks to report interest payments to non-resident foreigners from countries with which the U.S. has concluded tax information exchange agreements.  

Judge James. E. Boasberg supported the IRS argument that because the U.S. government relied on foreign banks to report the interest income that U.S. taxpayers receive on their foreign accounts, U.S. banks have to provide similar information to ensure compliance with the 70 tax information exchange agreements that the U.S. government has entered into. 

“Reciprocity is the key to success in such treaties,” the judge said. “If the United States does not gather and report tax information for foreign account holders, then other countries have little incentive to provide us with similar information.” 

The reciprocity would also aid overseas compliance with the Foreign Account Tax Compliance Act, which “requires overseas financial institutions to identify U.S. accounts and report information, including interest payments, about those accounts to the IRS,” the judge said. 

In its deposition, the IRS disagreed with the view that the regulation was too burdensome for banks by pointing to the already existing banking systems used to perform withholding and reporting for U.S. citizens, residents and Canadian citizens. Meanwhile, the reporting of interest income utilizes the same forms that were employed by banks to report Canadian non-resident income for more than 10 years.  

The judge also rejected the bankers associations’ claim that the IRS had failed to explain why routine reporting was preferable to issuing summonses on a case-by-case basis, stating that it is appropriate and preferable to have the information readily available when a treaty partner requests it. It would also be a prerequisite to exchanging information “automatically – as opposed to slowly and manually.” 

The associations’ core argument was the regulation would cause foreign account holders to withdraw their deposits en masse and trigger a harmful capital flight.  

The plaintiffs referred mainly to privacy concerns, for example that information reported under the regulations could be misused or disclosed to rogue governments. 

The judge held that the IRS in response sufficiently outlined the privacy protections that are in place as part of the agreements to safeguard account information.  

Judge Boasberg also addressed tax evasion by foreign bank account holders as the true driver of potential capital flight, even though it was not a claim explicitly made the bankers associations. “To the extent that plaintiffs imply that any regulation that harms banks – including one that causes tax evaders to flee – should fail …, they cannot pass the blush test.” 

The government does not need to issue a disclaimer stating, “no banks will lose deposits as the United States helps to apprehend tax evaders,” nor is the IRS required “to pass only regulations that are good for banks,” he added. 

“If a small minority of investors chooses to withdraw its funds to continue evading taxes, the Executive was willing to take the tradeoff, and the tradeoff is the Executive’s to make,” he said. 

The judgment on the whole concurred with the IRS argument that the regulations were essential to the U.S. government’s efforts to combat offshore tax evasion. Moreover, the rules support U.S. tax compliance by making it more difficult for U.S. taxpayers with U.S. deposits to falsely claim to be non-residents in order to avoid U.S. taxation, the IRS said.  

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