FATCA, CRS, and the Wrong Choice of Who to Regulate

Abstract

FATCA and CRS have a major flaw that enables tax evaders to avoid reporting of their offshore financial assets. This noncompliance opportunity stems from the fact that many private entities are classified under FATCA and CRS as “financial institutions” (“FIs”), and as such these entities are required to report their beneficial owners. Where a tax evader holds financial assets through a private entity that he or she owns and manages, it is unlikely that this entity will report its owner to the tax authorities. At the same time, banks and other FIs that maintain the financial accounts of such entities are not required to report these entities’ beneficial owners. Therefore, to avoid reporting, tax evaders can simply hold financial assets through private entities that are classified as FIs.

This noncompliance opportunity is a result of a wrong choice of who to regulate. The drafters of FATCA and CRS decided to impose obligations on many private entities to report their beneficial owners, instead of imposing these obligations on banks and other FIs that maintain the financial assets of such entities. This policy also results in higher compliance costs for compliant taxpayers, and larger distortions and deadweight loss. Thus, it benefits tax evaders and harms compliant taxpayers. This Article proposes solutions that the U.S. Treasury and the OECD should consider.

Building on this analysis, this Article explores a general question of regulatory design: how to choose which group of agents should be required to satisfy a regulatory obligation where that obligation can be imposed on one of two or more alternative groups of agents. When making this decision, the designers of the regulation should consider the cost-effectiveness of compliance, the potential distortions, and the likelihood of noncompliance for each of the alternative groups.

Keywords: CRS, FATCA, Financial Institutions, Regulation, Tax Evasion

JEL Classification: G28, H26, K34