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Aug. 19 — Tax authorities and practitioners around the world are awaiting a Canadian court's ruling on the legality of Canada's legislation to comply with the Foreign Account Tax Compliance Act.
The Federal Court of Canada is due to issue by Sept. 30 a ruling on the validity of the intergovernmental agreement on FATCA between Canada and the U.S., which mirrors more than 100 IGAs the U.S. has reached with other jurisdictions.
The ruling will address the preliminary issue, addressed in oral arguments Aug. 4-5, of whether information exchanges authorized by Canadian legislation to implement the IGA are consistent with the Canada-U.S. Income Tax Convention. The court will rule later on the constitutional validity of Canada's legislation to implement the IGA, which is the lawsuit's main thrust.
If the court finds in favor of the plaintiffs, the Canadian government will undoubtedly file an appeal with the Federal Court of Appeal, but in the interim, the ruling will “throw the brakes” on FATCA's application in Canada, Roy Berg, director of U.S. tax law with Moodys Gartner Tax Law LLP, told Bloomberg BNA in an Aug. 18 interview.
The court could also find the IGA partially inconsistent with the tax treaty, leaving the door open to appeals by both sides. Even if the court supports the government's position, an appeal is likely, Berg said.
In addition, the court has indicated it will likely issue only a bare order, with reasons to follow later, leaving uncertainty over the details of its finding, and regardless of this ruling, the constitutional challenge will remain to be heard, he said.
The Canadian challenge is being watched carefully in the other jurisdictions with IGAs in place, and success by the Canadian plaintiffs could lead to a string of challenges, particularly as the treaty-based arguments would apply in a number of jurisdictions, he said.
Additionally, Berg said that if the Canadian lawsuit is successful, it could put at risk Canada's ability to participate fully in the Organization for Economic Cooperation and Development's common reporting standard. The Canadian government committed in its budget for fiscal 2015-2016 to implementing the OECD standard in July 2017, with draft legislation to be introduced during 2015.
“Potentially, the storm is coming,” Berg said.
Alexander Demner, a partner in the Toronto office of Thorsteinssons LLP, agreed Aug. 19 that a ruling in favor of the plaintiffs would be “extremely significant,” effectively striking down the IGA and forcing Canadian financial institutions to choose between reporting directly to the IRS and paying the full 30 percent withholding tax on payments received from U.S. payors.
That would also mean that Canadian taxpayers' other accounts, including registered retirement savings plan accounts and tax-free savings accounts, would lose the exemptions provided in the IGA and would be reportable to the IRS, Demner told Bloomberg BNA in an e-mail.
“The result could potentially be disastrous,” he said. “Canadian banks could find themselves in an untenable position, and one which could have serious economic repercussions.”
Roanne C. Bratz, a partner in the Montreal office of Stikeman Elliott LLP, agreed Aug. 19 that a ruling in the plaintiffs' favor could be seen as support for similar legal challenges in other jurisdictions. “Of course, the basis for the Canadian judgment would be key in determining the extent of such jurisprudential support,” Bratz told Bloomberg BNA in an e-mail.
In any event, there will be significant uncertainty regardless of the outcome of this first ruling in the Canadian lawsuit, she said. “Whichever side is victorious at first instance, it is certain that appeals will be filed, so a realistic final determination is not imminent,” she said.
Bratz also noted the lawsuit in the U.S. filed by Republican presidential candidate Sen. Rand Paul (Ky.) that challenges the validity of FATCA-related IGAs signed by the U.S. with Canada, the Czech Republic, Israel and Switzerland.
Veronika Chang, head of the U.S. law practice group with Toronto law firm Morris Kepes Winters LLP, suggested Aug. 19 that while a ruling in the plaintiffs' favor would invalidate Canada's IGA, it would not affect the underlying requirements imposed by FATCA.
The ruling could inconvenience Canadian financial institutions and potentially spur similar court challenges in other jurisdictions, but that won't help Canadian taxpayers, Chang told Bloomberg BNA in a telephone interview. “At the end of the day, I don't see it changing much,” she said.
The first portion of the lawsuit addresses the arguments by plaintiffs Virginia Hillis and Gwendolyn Deegan, dual citizens who were born in the United States, that the requirements in the IGA for provision of account holder information to the IRS is more extensive than permitted by Articles XXVI-A, XXVII and XXV of the bilateral income tax treaty.
They argued that only a tiny subset of the information collected by the Canada Revenue Agency from Canadian financial institutions would be legally disclosable under the treaty and that the information would not provide any benefit to the IRS, demonstrating that coverage of Canada under FATCA was unnecessary.
It is impossible to guess on which side of the case the ruling will land, but there is a reasonable chance that the court could “bite” on the plaintiffs' arguments, Berg said.
“Taken at face value, the plaintiff's position would greatly limit the exchange of information contemplated by FATCA, which the defendants argued could not reasonably be what Canada and the U.S. intended when they entered into the IGA. The defendants proffered the counter-argument that under Canadian law interpreting a tax treaty is different than interpreting a statute,” Berg said.
The main portion of the lawsuit argues that the Canada-U.S. IGA, signed Feb. 5, 2014, violates basic freedoms guaranteed by Canada's Charter of Rights and Freedoms and the unwritten constitutional principle against forfeiting sovereignty to a foreign state.
Federal lawyers countered that the IGA's provisions are constitutional because they don't cede sovereignty, and if they do violate Charter rights, the infringements are justified to relieve Canadian financial institutions and their clients from the “crippling” consequences of non-compliance with FATCA.
Canada's Model 1 IGA relieves Canadian financial institutions from having to file reports directly to the IRS, instead reporting to the CRA, which would then provide the information to its U.S. counterpart. That eliminates concerns about compliance with Canadian privacy laws and protecting the exchanged information under Article XXVII of the bilateral tax treaty.
The IGA also clarifies that Canadian institutions aren't required to report on certain classes of accounts, exempts smaller deposit-taking institutions from FATCA reporting requirements, exempts Canadian institutions from mandating closure of client accounts and provides simpler rules than those in FATCA.
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