The Internal Revenue Service building in Washington. Fatca requires foreign financial institutions to report directly to the IRS information about financial accounts held by US taxpayers, or by foreign entities in which US taxpayers hold a substantial ownership interest. Image Credit: Bloomberg

Dubai: American expatriates in the UAE are being urged to seek specialist tax advice as the US government clamps down on people cheating the system.

A piece of legislation known as the Foreign Account Tax Compliance Act, or Fatca, is causing great concern among Americans living overseas as they face up to new filing demands that critics say are excessive and overblown.

Some UAE-based Americans with dual-citizenship are even looking to renounce their US passports in a bid to avoid complying with the new regulations.

"Expats who have fallen out of compliance with the US tax rules or who are unsure if they have been filing correctly should speak to a US tax attorney, not an accountant, in order to receive attorney client privilege," said Virginia La Torre Jeker, J.D., a Dubai-based tax specialist.

"As for trying to fix up past mistakes, proper advice must be sought. It is too risky to fill in the FBAR (report of foreign bank and financial accounts) on your own, at least initially.

"The pace has really picked up; people have been reading about convictions for criminal tax evasion and they are getting scared, especially those close to retirement age. They know when they return to the US and are drawing on social security, it can be taken away if the IRS comes calling. People are scared and, in fact, they should be scared," she added.

Fatca is a piece of government legislation that requires certain US taxpayers holding foreign financial assets with an aggregate value exceeding $50,000 to report certain information about those assets on a new form (Form 8938), which must be attached to the taxpayer's annual tax return.

Wilful blindness

According to Jeker, claiming ignorance of US tax obligations will not be deemed a sufficient excuse to avoid penalties as Fatca has been well publicised in recent months. "The IRS has a concept of "wilful blindness" and if the IRS can demonstrate a taxpayer evidenced wilful blindness in not meeting his tax obligations, this can lead to severe penalties," she said. Reporting applies for assets held in taxable years beginning after March 18, 2010. For most taxpayers this will be the 2011 tax return they file during the 2012 tax filing season. According to the IRS, failure to report foreign financial assets on Form 8938 will result in a penalty of $10,000, and a penalty up to $50,000 for continued failure after further notification.

"The initial feedback from US expatriates and businesses is not positive," said Asim Shaikh, partner at Ernst & Young, Middle East and North Africa. "Most US expatriates believe in the importance of paying taxes and are supportive of any effort made by their government to prevent tax evasion. However, they believe Fatca is too far-reaching and may have a significant impact on investments in the US from the Middle East and other growing economies," he added.

Fatca also requires foreign financial institutions (FFIs) to report directly to the IRS certain information about financial accounts held by US taxpayers, or by foreign entities in which US taxpayers hold a substantial ownership interest. To properly comply with these new reporting requirements, an FFI will have to enter into a special agreement with the IRS by June 30, 2013. "The important thing to understand is that Fatca is primarily designed to deal with foreign financial institutions such as banks, pension funds and mutual funds," said Dean Rolfe, tax partner at PricewaterhouseCoopers.

Awareness

"People have been aware of Fatca for a number of years, but it has been difficult for businesses to decide what they needed to do; they have to be up to speed by 2014, however, or they will be subject to withholding taxes," he added.

Rolfe says individuals will also be impacted by Fatca as the IRS will join the dots further down the line. But he also stressed there was always an opportunity to set the record straight and for American expatriates to come back into compliance with the system. "As far as individuals are concerned, they may be asked to provide information to banks/funds where they have money located if those institutions sign up to the Fatca agreement," he said.

"The US system involves taxing Americans working in the Middle East; they are subject to file tax returns. There are an awful lot of people, either deliberately or by mistake, who have not done so in the past but Fatca has concentrated their attitude on the matter; they know they have to be compliant and up-to-date with their taxes," he added.

However, some American expatriates are already seeking drastic action to avoid complying with the new regulations including renouncing their US passports and green cards.

About 1,780 expatriates gave up their nationality at US embassies last year, up from 235 in 2008, according to Geneva's Overseas American Academy. Jeker says she has recently spoken to many American expatriates in the UAE who have considered renouncing their citizenship or green cards.

"Many people do not fully understand what they have to do to formally relinquish their US tax status. Many simply disappear underground. But in the eyes of the US tax law they are still US citizens, or in the case of certain green card holders they are still US tax residents; both are liable to tax on their worldwide income," she said.

"There are many steps to consider and one of them is certifying under the penalties of perjury you have met all your US tax obligations for the past five years. You cannot get rid of what is perceived by many as a "curse", without getting back into compliance with the US tax system. It is causing sleepless nights for a lot of people."