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FATCA: The U.S. Flexes Its Waning Economic Muscle Abroad

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The Foreign Account Tax Compliance Act (FATCA). Typical of the taxman's inimitable use of the English language worldwide, the title doesn't exactly sound particularly menacing. However, the shockwaves from this recent piece of legislation from the U.S. Internal Revenue Service (IRS) are being felt around the financial world.

FATCA is aimed at targeting tax avoidance by U.S. citizens and entities abroad. Unlike most countries, American expatriates are still expected to pay tax at home on their income earned abroad. The IRS feels that many Americans are not taking this responsibility seriously enough. Their plan is simple: bring in tough new legislation to force foreign financial institutions to give up details about their U.S. citizen clients, leaving potential tax evaders with nowhere to hide.

FATCA is one of the few economic issues that has received little coverage during Barack Obama and Mitt Romney's tussles over the state of America's finances. So while FATCA has remained a non-entity in the build-up to the U.S. election, reaction to it abroad has been far from lukewarm.

Reports have surfaced that some Swiss banks are shunning their American customers in fear of onerous demands from the IRS on foreign private banks. Alarming news for a few, but the effects of FATCA have far greater implications than the difficulties of wealthy American citizens abroad.

The sheer cost of becoming FATCA compliant has put many international financial institutions between a rock and a hard place. Global banks could face a bill of as much as USD 100 million to become compliant, while harsh penalties are planned for those who do not toe the line. Meanwhile, the IRS is yet to even clarify the small print on FATCA, with pages and pages of legislation still to be finalized.

Firms could simply sidestep these costs by removing their presence from the U.S. in the future, but for almost every major firm in the industry, the thought of simply writing off the huge U.S. financial services market is more frightening than even FATCA itself.

So where does FATCA's looming presence leave the U.K. in particular? The U.S. and U.K. governments recently announced an intergovernmental agreement (or IGA) on FATCA. It includes a "most-favoured-nation clause", whereby the structure of the U.K.'s IGA will automatically revert to any future improvements made on the model in future agreements with other countries. This will undoubtedly give British firms a head start in their preparations for FATCA, but the U.K.'s willingness to jump into bed with the IRS has set a dangerous precedent for the rest of the world.

In Asia, there has been widespread anger and confusion over perceived American bullying tactics. However, over time, and with the U.K. dutifully falling into line with the IRS, the signs are that countries in Asia and elsewhere will start to countenance IGAs of their own. The cold-blooded world of international finance doesn't leave much room for sentiment, and governments and financial institutions worldwide are starting to realize that the IRS cares little for moral debate on the issue.

The hard truth for many financial institutions with interests in the U.S. is that FATCA is simply not going to go away. Whoever comes out on top in the nail-biting U.S. election will not want to be associated with an attempt to repeal legislation that makes rich Americans abroad pay more tax. With the U.K.'s IGA already in place, and more agreements in the pipeline, in many respects the FATCA train has already left the station.

However, that won't stop many financial commentators from turning their critical eyes on the IRS's relentless pursuit of U.S. tax evaders abroad, whatever the cost. In the end, the damage already done by their bullying tactics could one day have far greater significance than the revenue they manage to claw back into their coffers.