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Why US Citizens Who Are Residents of Canada Should Take Note: The Supreme Court of Canada Has Dismissed the Constitutionality Challenge of US FATCA
In a decision dated July 13, 2023, Gwendolyn Louise Deegan v. Attorney General of Canada, et al., the Supreme Court of Canada has dismissed an application for leave to appeal filed by the appellant challenging the constitutionality of Part XVIII of the Canadian Income Tax Act.
The Foreign Account Tax Compliance Act (FATCA) is a 2010 US anti-tax-evasion federal law requiring non-US foreign financial institutions to enter into an agreement with the Internal Revenue Service (IRS) and disclose the identity of its customers who may be subject to US taxation (based on several indicia or connections to the US such as the customer’s place of birth, citizenship of parents etc.) to the US.
In a bid to assist the United States with implementing FACTA, in 2014, Canada enacted domestic legislation under new Part XVIII of the Income Tax Act. In addition, Canada and the US agreed to terms of a new tax and information exchange agreement (“TIEA”) which was enacted in Canada under the new Canada-United States Enhanced Tax Exchange Information Act (for purposes of this blog, we’ll refer to Part XVIII and the new TIEA collectively as “Part XVIII”). Collectively, new Part XVIII requires Canadian financial institutions to first disclose the information of customers suspected to be subject to US taxation to the Canada Revenue Agency, who will, in turn, then pass the information to the US via the IRS.
The Appellants, Gwendolyn Louise Deegan and Kazia Highton brought an action in the Canadian Federal Court challenging the constitutionality of Section XVIII. The appeal before the FCA considered one issue: whether the Federal Court erred when it concluded that Part XVIII contemplates an unreasonable search or seizure for purposes of s. 8 of the Canadian Charter. The Federal Court had held that although Part XVIII did constitute a seizure, it did not violate s. 8 of the Charter because the persons affected by the legislation had little privacy interest in the seized information, and Canada had an important objective in enacting Part XVIII.
On appeal to the Federal Court of Appeal (“FCA”), the Appellants submitted that: (1) the purpose of the Impugned Provisions was not driven by Canada’s interests; it simply was to facilitate the interests of the IRS; (2) the seized information may belong to persons with no real connections to the United States, or to persons who are not themselves subject to worldwide US taxation; and (3) the IRS may use the information for the enforcement of its tax laws, including for prosecution of tax evasion.
The FCA concluded that the Federal Court did not err in finding that Part XVIII did not violate the Charter as the contemplated seizure was reasonable for purposes of s. 8. The FCA agreed with the Federal Court’s view that while it was true the effect of Part XVIII assists the United States with administering its tax laws, it was enacted with a Canadian beneficial goal in mind, primarily to avoid the potentially catastrophic impact of FATCA on Canadian financial institutions, customers and the economy at large. The FCA further highlighted that the SCC has held that the relevant state interest to be considered under s. 8 of the Charter is “its rationality in furthering some valid government objective.”
Although the FCA further held that the seized information may be used for a criminal prosecution (of the reported party) for tax evasion in the United States, it concluded that the information shared was “regulatory in nature,” similar to information automatically provided to the CRA for regulatory purposes. The FCA also found that the automatic disclosure of information embodied in Part XVIII has gained widespread international support through the development of a common reporting standard. Accordingly, the FCA found that Part XVIII did not intrude significantly on the privacy interests of affected persons despite the fact that it may possibly be used for a criminal prosecution. Finally, the FCA held that the provisions of Part XVIII are not harsh or burdensome because they are an example of international cooperation in the administration of income tax laws widely accepted in recent years and were not more intrusive than was necessary to be effective.
Interestingly, in a parallel decision in Belgium – reached by the Belgian Data Protection Authority (“the DPA”) – it declared unlawful, and decided to prohibit, the transfers of personal data of Belgian “Accidental Americans” by the Belgian Federal Public Service Finance (FPS Finance) to the US tax authorities under the intergovernmental FATCA agreement. According to the Belgian DPA, the data processing carried out under this agreement did not comply with all the principles of the General Data Protection Regulation (“GDPR”), including the rules on data transfers outside the EU. It also asked the FPS Finance to alert the competent legislator of the shortcomings identified by the DPA.
So where does this all leave US citizens who are resident in Canada? The Supreme Court of Canada appears to have inherently legitimized Part XVIII and its overarching implications. US citizens with no real ties, history or assets in the US will continue to be uncovered by their financial institutions and have their information shared directly with the IRS without consent. Accordingly, the burden of dual tax compliance will be the norm for Canadian accidental Americans, and proper tax management advice will become increasingly important to avoid both criminal and civil sanctions by the IRS.
Many US citizens who are residents in Canada have been closely following these Court proceedings and have been holding onto hope that the Canadian Courts would find Part XVIII unlawful. Should the decision have been the opposite of what the Courts have found (in other words, should the Courts have found Part XVIII to have been unconstitutional), such people and advocates appear to have been ready to use such a decision to advance further arguments that the US would have no right to enforce its citizenship taxation rules on its expats living in Canada. This hope now appears dead in the water.
Accordingly, as stated above, US citizens who are residents of Canada will need to continue to be vigilant in filing US tax returns with proper disclosures. Such dual Canadian and US reportings, possible exposure to US estate tax on death, gift tax on lifetime transfers of properties and other complications can be very complex and expensive.
One viable alternative for many US citizens who are residents of Canada is to consider the pros vs cons of possibly renouncing one’s US citizenship. While complex, it may simplify such persons’ taxation matters significantly. Our firm has one of the largest – if not the largest – US renunciation practice groups in the world, led by Alexander Marino. Alex is constantly providing information to the public on renunciation matters via webinars, blogs and other information sources. Our firm has a microsite dedicated to providing information on this topic which can be viewed here.
Be careful out there!
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