Potential high-risk SFCP participants enjoying the fruits (and vegetables) of their evil unpatriotic non-payment of U.S. taxes at a wet market in Shatin, a “new town” suburb of Hong Kong about an hour away from the central business district. Photo by Enoch Lau/Wikimedia Commons.
Yesterday, Roy Berg of Moodys wrote up a very helpful analysis (see also our discussion here) of the problems and uncertainties in the IRS’ new Streamlined Filing Compliance Procedures, also known here as Stealing From Canadian Pensioners. His comments are aimed primarily at Canadians, but are worth reading regardless of what country you live in. Below, I riff off several points of his in order to explore how the SFCP affects U.S. Persons in Hong Kong, and the likelihood that the IRS may classify you as a “high-risk” taxpayer for activities that everyone here would consider ordinary and innocent.
The IRS asks a series of 20 questions to determine whether a taxpayer is “low-risk” or “high-risk”. I’ve analysed the five most problematic ones below. Why does it fall to me, a random blogger, to do this analysis for Hong Kong? Why didn’t one of the copious numbers of cross-border tax consultancy firms here jump on the chance to point out these problems to the tens of thousands of U.S. Persons in this city? I suppose they don’t have any time to pay attention because they’re too busy shilling for data protection law amendments in order to dump all the costs and harms of FATCA compliance onto Hong Kong taxpayers. Anyway …
Question 5: Since January 1, 2006, have you had a financial interest in or signature or other authority over any financial accounts located outside your country of residence?
According to Hong Kong law — not to mention international reality — we live in the same country as mainland China and Macau, hence the famous “One Country, Two Systems” slogan. However, the IRS doesn’t see it that way:
Hong Kong has historically been treated as a separate country for purposes of the Internal Revenue Code and Income Tax Regulations, including subpart F of the Code. Consistent with the treatment of Hong Kong and China as separate countries under the Convention and the Shipping Agreement on and after July 1, 1997, the Service will continue to treat Hong Kong and China as separate countries on and after July 1, 1997, for purposes of the Code and regulations, including subpart F.
See United States-Hong Kong Policy Act of 1992, § 201, 22 U.S.C. § 5721 (1996) (providing that notwithstanding any change in the exercise of sovereignty over Hong Kong, the laws of the United States will continue to apply with respect to Hong Kong on and after July 1, 1997, in the same manner as before that date unless otherwise expressly provided by law or Executive Order).
From the perspective of taxing U.S.-based multinationals this may or may not make sense, but for U.S. Persons who actually live in Hong Kong this definition of “separate country” is pointlessly onerous. On my morning commute, if I catch the train on the left side of the platform instead of the right side, I can be in mainland China in about forty minutes. Tens of thousands of people here work cross-border two or three days a week at offices and factories in Dongguan. Hundreds of thousands of others take weekend trips to Shenzhen or Shanghai or Beijing.
As a result, it is perfectly ordinary for Hong Kong residents to maintain bank accounts in mainland China in order to keep “walking-around money”. And of course Hong Kong is not the only place where border-hopping is a simple fact of everyday life — just look at the European Union with its guarantees on freedom of movement for workers. Does having one account where you live and shop and another where you work put you at risk if you go into the SFCP?
Imagine if the U.S. decided that it was “high risk” for people from New Jersey to have bank accounts in New York? But of course, U.S. tax laws aim to make it impossible for U.S. Persons abroad to live like ordinary members of society in our countries of residence. (In the mean time, Congresscritters get very angry at immigrants who refuse to assimilate and live like “ordinary Americans”).
Incidentally, Beijing also claims a number of territories under the control of other governments — the Spratly Islands, Diaoyutai, Taiwan, and some parts of Northeast India. Someone who wanted to turn this “separate country” into a giant issue could just go open a bank account in Taipei, or if you’re looking for a more exotic destination, in Arunachal Pradesh on the other side of the McMahon Line.
Question 6: Since January 1, 2006, did you have a financial interest in any entities located outside your country of residence? If yes, do these entities control U.S. investments?
This question doesn’t even make sense. Having a “financial interest” in an entity is an impossibly broad standard which catches everyone from 100% owners down to kids whose grandparents bought them one board lot of shares. And what does it mean for it to be “located outside your country of residence”? Place of incorporation? Place of business? Location of directors? And why does the entity’s control over U.S. investments matter — shouldn’t the point be whether the taxpayer controls it?
Over on the Stock Exchange of Hong Kong, you can buy stocks of Hong Kong-incorporated companies which do most of their business in mainland China, but also have U.S. operations. You can buy H-shares of mainland-incorporated companies which also have U.S. operations. You can buy index funds which track India’s Sensex (2836.HK), Malaysia’s KLCI (3029.HK), and South Korea’s KOSPI 200 (3090.HK). The exchange even allows listings from companies incorporated in twenty other jurisdictions. Which of those would count as “entities located outside of Hong Kong” or “control[ling] U.S. investments”?
In short, this is yet another question from the fantasy 1950s world that the U.S. government is stuck in, according to which the U.S. is the hub of everything and the only place where any legitimate cross-border activity occurs, while the rest of us are sitting in little self-contained units called “foreign countries” which only ever interact with the One Big Important Country.
To qualify for E-2 classification, the employee of a treaty investor must be the same nationality of the principal alien employer (who must have the nationality of the treaty country) … If the principal alien employer is not an individual, it must be an enterprise or organization at least 50% owned by persons in the United States who have the nationality of the treaty country. These owners must be maintaining nonimmigrant treaty investor status.
Are you a treaty investor in the U.S. who wants to sponsor employees of other nationalities than your own — even those from other countries having treaties of navigation and commerce with the U.S.? Too bad. Companies are expected to be of one nationality only.
Disqualification from the SFCP for accounts in the U.S.?
The flip side of that ridiculous attitude is that the IRS and Americans at large consider it “normal” for people from anywhere in the world — especially Americans abroad — to have bank accounts and investments in the United States. This is not merely a policy position (expressed, for example, in the non-reporting of bank interest, or the sweetheart 0% capital gains tax rate for “non-resident aliens”), but also a deeply-held unconscious bias of the IRS examiners who are going to be sorting SFCP participants into “low-risk” and “high-risk” buckets. You live in Hong Kong and you have an account 40 miles away in “Red China”? Sneaky and high-risk and anti-American to boot. You live in Hong Kong and you have an account 8,000 miles away in New York? That’s normal, we welcome you and your money to the Homeland!
Of course, this is just my gut feeling telling me that the IRS will not classify a taxpayer abroad with a U.S. account as “high risk”. My gut feeling is not professional advice. I’m not a lawyer, and even the actual lawyers on this site are not your lawyers. Which leads right back to Mr. Berg’s point:
If the procedure were properly tailored for these hapless minnows it would contain greater degree of certainty and not require the taxpayer to engage counsel to assess “risk level” before entering into the program.
Apparently the IRS believes it better that ten innocents pay thousands of dollars to tax attorneys than one guilty man go free.
Question 7: Do you have a retirement account located in your country of residence?
Pretty much every who works in Hong Kong is obligated to participate in an MPF or ORSO retirement plan, many of which allow the participants to allocate some of their savings into index funds and mutual funds. This is very helpful and convenient, unless you’re a U.S. Person abroad — in which case it would probably be lower risk and simpler for you to buy uranium and store it under your bed.
What if you were dutifully filing your 1040s, 1116s, and 2555s, but had no idea about the insane “information returns” for what the IRS calls “foreign trusts” and “passive foreign investment companies”? You’re not in a good position, because you’ll have to amend your past returns to include 3520s, 3520-As, and 8621s — the so-called “Streamlined Filing Compliance Procedures” don’t actually involve the IRS using its authority to streamline any filings for U.S. Persons abroad. As the IRS’ instructions state:
Amended returns submitted through this program will be treated as high risk returns and subject to examination, except for those filed for the sole purpose of submitting late-filed Forms 8891 to seek relief for failure to timely elect deferral of income from certain retirement or savings plans where deferral is permitted by relevant treaty.
But don’t be too jealous of the Canadians (the only people who qualify for Form 8891). Most of them won’t qualify as “low risk” either, because they have other kinds of plans which aren’t covered by their treaty with the U.S. — TFSAs, RDSPs, RESPs, and the like. This is also why you shouldn’t put any faith whatsoever in the idea that U.S. government is going to relieve you of your paperwork burdens. The evidence is quite clear: in seven decades of tax treaties, the U.S. government still hasn’t managed to work out the problems that their tax system causes for their next door neighbour and closest ally in which as many as a million of their citizens may be living. What do you think is the chance that any future U.S. policy or agreement with Hong Kong is going to fix all these miserable issues for a mere sixty thousand of us living halfway around the world?
Question 10: During the above-listed tax years for this submission, have you declared all of your income in your country of residence?
As Mr. Berg points out:
In Canada, for example, certain items are excluded from gross income (e.g., capital dividends, lottery winnings, life insurance proceeds, income accrued inside a TFSA, etc.) and are never reported on the taxpayer’s TI (Canada’s general income tax return), even though such items may be taxable in the US. So if a taxpayer does not report income on a T1 that isn’t required to be reported, has he “declared” all of his income to Canada?
The larger problem pointed to by this question is that “income” has very different definitions in different countries. Hong Kong does not have an “income” tax and so we do not “declare income” at all. We have a salaries tax for people who are paid by employers, a profits tax for individuals carrying on business, property tax for people who own flats, and stamp duty for people who bought or sold certain Hong Kong assets (primarily stocks).
The U.S. thinks that gains inside non-U.S. ETFs are “income”. The Hong Kong government does not care at all if your MPF holds some 2800.HK. It’s none of their concern if you went to Macau one weekend and won some money at blackjack. Does your failure to “declare” something in which your local government has absolutely no interest disqualify you from the SFCP? Did anyone at the IRS think about this before they put out these vague and confusing guidelines?
Question 20: Are you claiming a refund on any returns you are submitting through this program?
This question is particularly troubling for Hong Kong because U.S Persons who did not know about their U.S. tax filing requirements may have invested in U.S. stocks through brokers who treated them as foreigners (perhaps due to confusion between the securities law and tax law definitions of “U.S. Person”). If they earned dividends, those would have had tax withheld on dividends at the 30% non-treaty rate, and thus — unlike people living in treaty countries, who get withholding at a lower tax rate — they would be entitled to refunds. The total of hundreds of thousands of U.S. Persons in Brazil, Taiwan, Argentina, and the various countries of the Persian Gulf — none of which have U.S. tax treaties either — will face a similar situation.
One small mercy of Hong Kong’s currency being pegged to the U.S. dollar is that we do not have to worry about U.S.-monetary-policy-driven “phantom gains” messing with our tax returns. That means that the vast majority of Hong Kong-resident U.S. Person investors in U.S. stocks are likely to have investment income well under the personal exemption and standard deduction for the years in question. With their dividends having been mistakenly taxed at 30%, they’re owed a complete refund of the tax paid. Even those over the threshold are owed a refund of half of the tax paid if they held the stocks long enough for those to become “qualified dividends”. And even if the dividends were ordinary income instead of qualified dividends, as long as their income was under US$171,550 they’d be in the 28% bracket or lower and thus are still entitled to enough of a refund to buy some beer.
The only possible reason for this provision of the SFCP is to intimidate people into not trying to claim a refund to which they are legally entitled. But of course, the IRS’ goal is not to make sure that people are paying the legally correct amount of tax (let alone the morally correct amount). The IRS’ goal is to use the ridiculous fines attached to all of these garbage “foreign information returns” to scare U.S. Persons abroad into giving the IRS money which does not belong to it — whether that be an unclaimed refund of a few hundred dollars, or an OVDI penalty of tens of thousands against a three-digit tax deficiency.