Introducing this “guest post”
This guest post is written by Dominic Ferszt of Cape Town, South Africa. I first became aware of Mr. Ferszt when, in October of 2014, his post: “The Accidental Tax Invasion” was published in Forbes. I have discussed various aspects of “citizenship-based taxation” with him since. I am very pleased that he has accepted my invitation to write this “guest post” for publication at Citizenship Solutions. His post exposes an aspect of “citizenship taxation” and the S. 877A U.S. expatriation tax that has not (as far as I am aware) been discussed before. Those who did NOT acquire “dual citizenship” at birth because of discriminatory laws (example British and Canadian laws saying that citizenship could be passed down from the father but not from the mother) will find this post extremely interesting and relevant.
Without further adieu …
Apartheid and the Accidental Taxpayer
How the United States Congress has passed legislation which imposes a tax obligation in accordance with the discriminatory policies of foreign nations; and how this might offer a glimmer of hope to millions around the world who feel unjustly targeted by FATCA or the IRS.
By Dominic Ferszt, Cape Town
In 2010, the United States Congress passed FATCA, or the Foreign Account Tax Compliance Act. Since that time, anyone with a bank account outside the U.S. has suffered some consequence.
FATCA requires all financial institutions outside the USA, notably banks and insurance companies, to review their records to identify possible evidence that customers may be U.S. taxpayers. Once identified, the financial institutions are required to report certain financial information; ultimately to the IRS.
This seemingly simple task has proven to be a complex compliance exercise costing the banks billions of dollars every year; and such perpetual expenses inevitably reflect in our bank fees. Perhaps the more brazen face of FATCA has been the requirement, by millions around the world, to go into a bank and sign a form declaring to the U.S. government (under penalty of perjury) that they either are, or are not, a U.S. taxpayer.
However, there is one group of people, likely numbering in the millions, whose lives have been unexpectedly and disproportionately shattered by the passage of FATCA. Some call them ‘Accidental Americans’, but what they have in common is some formal connection with the United States which they long ago abandoned. Perhaps they were born in America to foreign parents or overseas to U.S. parents, perhaps they studied or worked there in their youth, perhaps they emigrated long ago. Many of them do not even speak English. The problem they all share is that they (unknowingly) carried with them a perpetual obligation to pay U.S. tax after they returned home; unless they had performed some obscure and punitive expatriation process known only to a few U.S. tax scholars in ‘white shoe’ law firms. These individuals continue to be U.S. taxpayers (regardless of where they live in the world) because they are U.S. citizens. In the case of ‘foreigners’ who, under U.S. law, inadvertently acquired citizenship at birth, their tax obligation is arguably discrimination based on “national or social origin” or “birth” as articulated in the Universal Declaration of Human Rights.
This style of perpetual taxation, not just of emigrant citizens, but also of former residents (Green Card Holders), is unique to the United States. There was little to no awareness among the ‘American diaspora’ of this tax obligation, there was no enforcement of it by the IRS, and compliance was close to nil. FATCA legislation was ostensibly enacted to identify Americans who were hiding money from taxation by using overseas banks. Perhaps one of its unintended consequences has been the financial duress that has been inflicted on Accidental Americans.
Recent efforts by the U.S. Treasury and State departments created an awareness among overseas Americans of their tax obligations, so many Accidentals entered an IRS disclosure program with the intention of bringing their affairs into order. Unfortunately the program had been designed for wealthy tax evaders (punitive penalties in exchange for amnesty from prosecution), so the Accidentals suffered unscrupulous treatment and disproportionate penalties under the program’s evolving terms and conditions.
As many around the world feel trapped by an uninvited bully, poised to extract its pound of flesh, there have been reactions from various groups which are seeking to confront the injustice. Notable among them has been American Citizens Abroad (ACA) who have been lobbying Congress to address the untenable circumstances. Unfortunately, such wheels turn very slowly; often without resolution. There has also been legal action against FATCA, in both Canada and the U.S., and for those who wish to educate themselves, or merely commiserate with fellow Accidentals, there are numerous websites and blogs; most notably The Isaac Brock Society.
Unlike lobbying, court cases do reach a conclusion; and come with a ruling. There are already two known lawsuits, but we badly need a third; and maybe you can help.
Here’s why and how:
FATCA is the reviled tool that has exposed and enabled the unfair taxation of Accidentals, and FATCA has a number of questionable provisions in the context of individual rights and sovereignty. It is natural to fight back against the weapon that is attacking you, but a victory against FATCA is a victory against the symptom, not the cause; which in this case is the United States’ assertion of a taxing jurisdiction over those without meaningful ties to the country.
Also, the anti-FATCA lawsuits might find themselves facing unanticipated political headwinds. At the time they were launched, FATCA stood alone as a requirement of banks to identify U.S. individuals and report their private information to a foreign agency. This raises obvious concerns regarding privacy and nationality based discrimination. However, over the past 18 months, the world has been introduced to CRS, or the “Common Reporting Standard”; to which the majority of the world’s nations have made some commitment. In short, under CRS, most banks will now be filing reports destined for every foreign account holder’s tax authority. This new global disclosure initiative might throw ‘cold water’ on objections that seemed valid when the anti-FATCA lawsuits were launched.
A major difference between CRS and FATCA is that, while CRS transfers financial information only to the taxpayer’s country of residence, FATCA is effectively an enforcement mechanism for the United States’ unique style of citizenship-based taxation (CBT). FATCA appears to subject Accidentals to double disclosure, the insane complexity of reconciling the U.S. tax code with a foreign one and, inevitably, some double taxation. But FATCA is merely the enforcement mechanism. Perhaps the answer is not a lawsuit against FATCA, but a lawsuit against the United States’ CBT.
What would a lawsuit against “citizenship-based taxation” involve?
There are those who wish to attack the entire system of U.S. CBT on constitutional grounds; while others have noted that CBT rests on a poorly reasoned U.S. Supreme Court ruling granted in 1924. But a lawsuit against CBT, as a general principle, offers little chance of success against the talented legal minds of the U.S. Treasury Department. There appears to be nothing overtly unconstitutional about the U.S. policy of CBT; while decades of congressional policy and related regulations have entrenched CBT into U.S. tax law. A broad challenge to CBT may be difficult.
On the other hand, CBT as a whole is merely the sum of its parts. The better approach may be to challenge a specific part of United States CBT.
If we could identify an appropriate provision of CBT, let’s call it a ‘chink in the armour’ of the U.S. tax code, we could start building a legal case around it. Ideally, if our case presented circumstances that were so patently an affront to the values enshrined in the U.S. constitution, then a judge might be forced to strike down the offending laws. Additionally, the whole issue of tax fairness with respect to Accidentals would start to receive judicial consideration; and maybe even policy debate in Congress.
So, is there chink in CBT’s armour?
Any computer hacker will tell you that the more complex a system is, the more likely it will contain vulnerabilities. There are few pieces of legislation that are more complex than the U.S. tax code. In this regard, I’d like to introduce you to Section 877A of the Internal Revenue Code.
Internal Revenue Code – S. 877A – America’s Exit Tax
Section 877A of the U.S. tax code is commonly referred to as the exit tax. An exit tax includes a tax on any unrealised gains that you may be holding at the time you leave a country’s tax jurisdiction. In some circumstances it’s a legitimate tax claim. In the case of Accidentals subject to CBT, it is resoundingly unfair.
A legitimate exit tax:
Take the extreme example of Warren Buffett, who started a company many decades ago, and whose shares are now worth around $50 billion. Buffett is famous for never having sold any of his shares, so without an exit tax he could expatriate and sell his stock, depriving the U.S. government of tax revenues it would receive if Buffet were a U.S. citizen at the time of sale. Buffett would, I’m sure, never do such a thing, but countless wealthy Americans have engaged in such expatriation for the purposes of tax planning. Congress has been making efforts since the 1960s to prevent it, culminating in the 2008 enactment of Section 877A.
An unfair exit tax:
Imagine a typical Accidental: somebody who was born in the United States to parents who were living temporarily in the United States. This person moved from the United States as a child. He grew up residing in another country. He was educated in that other country. His career was in that other country. He has not lived in the United States, does not carry a U.S. passport and has not utilised (indeed he may be unaware of) his U.S. citizenship. Let’s imagine that he founded a successful company in his home country where he has lived and paid taxes. Should he be subject to a U.S. exit tax payable on (1) savings that were earned while the person was NOT resident in the U.S. and (2) assets that never benefitted from the exceptional economic infrastructure of the U.S. ? Many would regard the application of an exit tax payable in these circumstances as being absurd.
But, absurd as it may be:
Section 877A seeks to levy a tax on all U.S. citizens who expatriate. The exit tax is levied on the unrealised gains in your assets, including an obligation to pay tax today on pension benefits which may not pay out for decades. If you have Apple shares which you purchased some time ago for $10K, and they’re now worth $100K, you must pay tax to Uncle Sam on the $90K profit; even though you haven’t sold the shares. Perhaps most inequitable is the taxing of Accidentals’ home equity. Imagine a retiree who bought a home for $100K back in the 1960s, and it’s now worth $2M. An Accidental would have to pay around $300K in tax in respect of this home. Who has $300K to pay the U.S. for the right to expatriate? So while the exit tax is fair in the ‘Buffett Scenario’, it is patently unjust in the case of Accidentals.
Many will suggest that the exit tax only applies to the wealthy; those with assets in excess of $2M, but this is simply not true. Elderly homeowners in cities like Toronto, London or Hong Kong may have $2M locked into the value of their homes without being considered wealthy. Moreover, the exit tax also applies to those who expatriate without being in full IRS compliance for a number of prior years. Given the complexity of the U.S. tax code, foreign asset disclosures and foreign tax adjustments it’s likely that IRS compliance for Accidentals will cost anything from $2K to $10K+ per annum; or around $10K to $50K+ in total. Most Accidentals simply can’t afford that. By my estimation, there is a small demographic of moderately wealthy middle class Accidentals who can realistically comply with Section 877A without triggering the exit tax. And this is important: the exit tax is likely to apply to most Accidentals who formally expatriate.
Introducing the ‘Dual Citizen’ exemption from the exit tax:
Section 877A does attempt to carve out an exemption for those without meaningful ties to the U.S., but it is flawed; and it is in this provision that Congress has enacted legislation which might form the basis of a worthwhile lawsuit. The Dual Citizen exemption to the exit tax is available if:
“The individual became at birth a citizen of the United States and a citizen of another country and, as of the expatriation date, continues to be a citizen of, and is taxed as a resident of, such other country”
This quote is part of the actual wording in Section 877A (there is also a residency requirement), and it is here that the U.S. tax code has lent itself to some rather curious interpretation. In order to qualify as exempt from the exit tax, one would at least have to have acquired dual nationality at birth. Whether one acquires dual nationality at birth depends on the nationality laws of other countries; and this can serve up some spectacular discrimination.
How is citizenship acquired?
As a broad principle, countries confer citizenship at birth to individuals based on one of two principles: jus soli or jus sanguinis:
Jus soli is the right of citizenship to anyone born in the territory. This concept applies largely to the entire western hemisphere (North, Central & South America) as well as to the UK, France, Iran, Pakistan, South Africa, Australia, NZ and others.
Jus sanguinis is the right to citizenship acquired through your parents or more distant ancestors. Notable countries include Germany, Greece, India, Ireland, Israel, Italy and Poland.
Of course these two concepts have become somewhat blurred and made more complex by modern nationality statutes that have evolved alongside globalization. Many are unaware that they acquired a second citizenship at birth, while some countries are providing citizenship with retroactive effect to address unjust nationality laws from an earlier period. So, many Accidentals may be unregistered or potentially retroactive dual citizens. Perhaps it’s time to revisit the family tree. Italy and Ireland in particular confer citizenship down multiple generations.
All things considered, there are two ways you can become “at birth a citizen of the United States and a citizen of another country”: birth in the USA to ‘jus sanguinis citizen parents’; or birth in a ‘jus soli country’ to U.S. citizens. (The U.S. also recognises citizenship by descent, subject to certain conditions).
The 5th and 14th amendments to the U.S. Constitution collectively enshrine the due process of law which, most notably in this case, prohibit all levels of government from enacting legislation that would arbitrarily deprive Americans of life, liberty or property. I struggle to imagine any law having more arbitrary or capricious application than one which defers its interpretation to the vagaries and complexities of the evolving nationality laws of the nations of the world.
How your liability of the exit tax depends on the laws of other countries
Now let’s look at some potential real world examples where the results are dependent on the citizenship laws of other countries.
Example 1: U.S. citizenship acquired by birth in the United States:
Two babies are born next to each other in an American hospital: one to Argentinian parents, the other to Italian parents. Both families return back to their homelands. Thirty years later, the children choose to expatriate: the Argentinian (because he did NOT acquire Argentinian citizenship at birth) must pay the exit tax, while the Italian (because he DID acquire Italian citizenship at birth) is exempt from the exit tax.
Example 2: U.S. citizenship acquired by birth outside the United States to U.S. citizen parent(s):
Two American families emigrate; one to Australia the other to Greece. Shortly after arrival they have children. 30 years later, the children expatriate: the Australian pays no exit tax (the child was born an Australian citizen) , while the Greek citizen must pay the exit tax (the child was NOT born a Greek citizen).
Example 3: Dual citizenship denied on account of apartheid
This is my favourite hypothetical: two U.S. couples, one white and one black, emigrate to South Africa in the 1970s and start families. The babies are U.S. citizens at birth. Yet, under South African apartheid, blacks were denied citizenship of South Africa. In such circumstances, the black U.S. citizen would be required to pay the exit tax; while the white one wouldn’t.
And there you have it. South African apartheid policies wholly imported into the U.S. tax code.
It’s not hard to imagine that, with the appropriate individual(s), a compelling case could be presented to a U.S. court and an important victory might result. The difficulty is finding individuals whose circumstances could form the solid basis for such a case.
To be fair, there weren’t many Americans emigrating to South Africa in the time of apartheid; in particular not many African Americans. On the other hand, Barak Obama is living testimony to the fact that Americans of (recent) African descent do exist. Ultimately, this apartheid case study is only the most egregious example of the discriminatory application of Section 877A.
Another good example which has occurred in countless countries is gender discrimination. Until recently, many countries only conferred patrilineal citizenship, i.e. a father could transmit his citizenship to his children, but not a mother. By way of example, the United Kingdom only updated its legislation in 1981 to allow either British parent to be able to transmit British citizenship. Prior to 1977 only a father could transmit Canadian citizenship to a child born in the United States. Similar situations might arise among Accidentals from countries which observe Sharia Law.
So here we have a lot of potential: there must be thousands of Accidentals (British, Canadian, Muslim or otherwise) who would be subject to discriminatory treatment under the Dual Citizenship exemption without even being aware of the injustice they are suffering. It is important that we raise awareness of this issue among ‘foreigners with U.S. citizenship’ so that they have the opportunity to self-identify, and then become part of a bigger campaign if they so wish. So please spread the word.
For the purposes of this exercise, I have drawn on my limited knowledge of a few countries’ nationality laws. Surely, when one considers the vast array of evolving nationality legislations to which millions of Accidentals were subject at the time of their birth, many more such instances are likely to exist. But you can’t bring a case into a U.S. court on the basis that it might be discriminatory in some circumstances. You need to expose the actual discrimination before a judge.
Accidentals are a very disparate group. They’re scattered around the world with nothing to unite them; not even a U.S. accent in most cases. Identifying them is hard for banks; next to impossible for individuals.
Are you facing the legal and compliance quagmire of expatriating from the USA? Are you a foreign-born U.S. citizen who did not acquire citizenship of the country in which you were born? Did you fail to acquire the citizenship of your home country on account of your birth in the U.S.?
Alternatively, are you exempt from the exit tax because you did acquire dual nationality at birth? Does, or did, the nationality law of your home country contain some provisions that might seem offensive in the present climate of human rights and anti-discrimination?
If you think these circumstances might apply to you or anyone you know, please get in touch.