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Dismissal of FATCA Lawsuit Upheld

Sixth Circuit affirms that plaintiffs lacked standing to challenge foreign reporting requirements.

In Mark Crawford, et al., v. U.S. Department of the Treasury, et al., Case No. 16-3539 (Aug. 18, 2017), the U.S. Court of Appeals for the Sixth Circuit affirmed a district court’s decision dismissing a complaint that challenged the constitutionality of certain foreign reporting requirements. The plaintiffs sought to enjoin the enforcement of the Foreign Account Tax Compliance Act (FATCA), the foreign bank account reporting (FBAR) requirement under the Bank Secrecy Act, and the intergovernmental agreements (IGAs) designed to facilitate disclosure of foreign account information of individuals and foreign financial institutions (FFIs). Specifically, the plaintiffs challenged: (1) FATCA’s individual reporting requirements; (2) FATCA’s FFI penalty; (3) FATCA’s passthru penalty; (4) the IGAs; and (5) the FBAR willfulness penalty. The Sixth Circuit agreed with the lower court that the plaintiffs, who included Senator Rand Paul (R-Ky) and other individuals, lacked standing to challenge FATCA, the FBAR and the IGAs.

The Parties

Seven plaintiffs collectively brought suit against the Internal Revenue Service, the U.S. Treasury and the U.S. Financial Crimes Enforcement Network (FinCen). Each plaintiff alleged different injuries.

Mark Crawford is a U.S citizen living in Albania. He owns a brokerage firm located in Albania and is a partner of a bank in Copenhagen. Crawford alleged that he suffered injury when the Copenhagen bank wouldn’t permit his brokerage firm to accept U.S. citizen clients because it didn’t want to “assume the burdens that would be foisted on it by FATCA.” He also claimed that FATCA forced him to turn away business of prospective American clients living in Albania, noting that his brokerage firm even denied his own application for a brokerage account because he was a U.S. citizen.

Senator Paul claimed that he couldn’t exercise his constitutional right as a member of the U.S. Senate to vote against the IGAs because they weren’t submitted to the Senate or Congress for approval. Senator Paul didn’t challenge any other provision of FATCA and didn’t challenge the FBAR.

Roger Johnson, a U.S. citizen living in Czech Republic, is married to Katerina, a Czech citizen, with whom he previously shared joint financial accounts. He claimed that he was forced to separate their accounts to avoid subjecting Katerina’s account information to FATCA disclosure requirements.

Stephen J. Kish is a Canadian citizen living in Toronto and was a U.S. citizen at the time he filed the complaint. He had since renounced his U.S. citizenship. Kish and his Canadian wife share a joint bank account at a Canadian bank. He claimed that FATCA caused discord between him and his wife because she opposed disclosure of her personal financial information to the U.S. government.

Daniel Kuettel, a Swiss citizen and former U.S. citizen living in Switzerland, and his wife, a citizen of Switzerland and the Philippines, have a daughter who’s a citizen of the United States, the Philippines and Switzerland, and a son who’s a citizen of the Philippines and Switzerland. Kuettel claimed that he renounced his U.S. citizenship because of difficulties caused by FATCA, including his inability to refinance a mortgage with Swiss banks and transfer a college savings account to his daughter.

Donna-Lane Nelson is a Swiss citizen and former U.S. citizen living in Switzerland and France. She claimed that she renounced her U.S. citizenship when her Swiss bank notified her that because she was an American, she wouldn’t be able to open a new account if she ever closed her existing one. Nelson is also married to a U.S. citizen with whom she shares a joint bank account at a bank in France. She also claimed that she’s had private financial account information disclosed to the IRS and the U.S. Treasury Department, even though she’s not a U.S. citizen.

L. Marc Zell is a U.S. and Israeli citizen living in Israel. He claimed that because of FATCA, he and his law firm have been required by their Israeli banking institutions to complete IRS withholding forms prior to opening trust accounts for both U.S. and non-U.S. persons and entities. He alleged that he’s had to close certain trust accounts and has been prevented from opening trust accounts because of the FATCA requirements. He further claimed that banking officials have told him that the mere fact that a U.S. person or trustee or his law firm acts as a fiduciary is reason enough to require non-U.S.-person beneficiaries to report identities and assets to the United States. He claimed that as a result, he individually lost clients, and his firm has suffered financial loss.

The seven plaintiffs also sought to add three new plaintiffs to their complaint: Johnson’s wife, Katerina; Kuettel’s daughter, Lois; and Nelson’s husband, Richard.

FATCA Individual Reporting Requirement

Under FATCA, 26 U.S.C. Section 6038D(b)-(c), certain taxpayers who hold “specified foreign financial assets” that exceed $50,000 must file a report with their annual tax returns that reveals: (1) the name and address of any financial institution that holds each account; (2) the name and address of any issuers of specified stock or securities; and (3) information necessary to identify other specified instruments, contracts or interests and their issuers. Taxpayers must also identify the maximum value of each specified asset during the taxable year. The Secretary of the Treasury may prescribe higher dollar amounts for certain taxpayers depending on their marital status, maximum asset value during the tax year, and place of residence.

A taxpayer who fails to report is penalized up to $10,000 per violation, plus 40 percent of the amount of any underpaid tax “attributable to” the assets for which disclosure was required. There’s an exception to the penalty if failure to report is due to reasonable cause and not due to willful neglect.

In the instant case, the plaintiffs sought to enjoin the reporting requirements and the regulations underlying the reporting requirements.

FATCA FFI Penalty and Passthru Penalty

In addition to the individual reporting requirement, FATCA also imposes a reporting requirement on FFIs.  FFIs can satisfy this requirement by: (1) entering into an agreement with the Treasury to take certain actions, including deducting and withholding a 30 percent tax on any passthru payment that is made by such FFI to a recalcitrant account holder or another FFI that doesn’t meet certain requirements (the passthru penalty); (2) having the Treasury deem the FFI compliant, by virtue of the FFI’s country of jurisdiction signing an IGA with the Treasury; or (3) electing to withhold a tax from payments sent to the FFI from “accounts held by recalcitrant account holders or foreign financial institutions which do not meet the requirements of this subsection.”

An FFI that fails to meet the FATCA institutional reporting requirement in one of the three ways will be subject to an FFI penalty—a tax equal to 30 percent deducted and withheld from all withholdable payments sent to the FFI. This FFI penalty applies to both U.S.-sourced income payable to the FFI and foreign-sourced income payable to the FFI.

IGAs

To facilitate the implementation of FATCA, the United States reached agreements with many foreign governments—known as Model 1 IGAs and Model 2 IGAs. Under a Model 1 IGA, a foreign government directly reports to the IRS financial information that FATCA would otherwise require FFI to report. So long as the foreign government complies with its obligations under the IGA, any FFI in that government’s jurisdiction that also complies with its own obligations under the IGA is treated as complying with FATCA and is exempt from FATCA reporting, penalties and withholding. At the time the complaint in the instant case was filed, the United States either signed Model 1 IGAs with Canada, France, Czech Republic, Denmark and Israel, or signed later Model 1 IGAs that were treated as if they were in effect at the time the complaint was filed.

Under a Model 2 IGA, a foreign government agrees to modify its laws to enable its FFIs to report their U.S. account information directly to the IRS. The United States and Switzerland signed a Model 2 IGA in which the Swiss government agreed to direct all Swiss financial institutions to register with the IRS and comply with FATCA.

In the instant case, the plaintiffs sought to invalidate the IGAs with Canada, Czech Republic, Israel, France, Denmark and Switzerland.

FBAR Willfulness Penalty

Unrelated to FATCA or IGAs, the Bank Secrecy Act imposes a requirement on any U.S. person with “a financial interest in or signature authority over at least one financial account located outside of the United States.” Such person is required to file an FBAR (FinCEN Form 114) with Treasury annually if “the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year reported.” 

In the instant case, the plaintiffs challenge the willfulness penalty, which provides that Treasury may impose a penalty equal to the greater of $100,000 or half the value in the reportable account(s) at the time of the violation. The plaintiffs also seek to enjoin the requirement to complete FinCEN Form 114.

Plaintiffs’ Complaint

Both the original and the amended complaint contained eight counts against the defendants:

  1. The IGAs exceeded the scope of the president’s constitutional powers.
  2. The IGAs are inconsistent with congressional legislation in the exercise of its constitutional authority in that FATCA allows FFIs to report to their national governments rather than to the IRS.
  3. FATCA, IGA and the FBAR reporting requirements violate the equal-protection clause.
  4. The FFI penalty is unconstitutionally excessive in that it’s grossly disproportional to the gravity of the offense it seeks to punish.
  5. The passthru penalty is unconstitutionally excessive.
  6. The FBAR willfulness penalty is unconstitutionally excessive.
  7. FATCA institutional reporting requirements violate plaintiffs’ Fourth Amendment right to privacy in that they constitute a warrantless search.
  8. The IGAs violate plaintiffs’ Fourth Amendment right to privacy in that they require that FFIs to report account data either to their governments or to the United States. 

District Court Decision

In 2015, the plaintiffs filed their original complaint and moved for a preliminary injunction in the U.S. District Court for the Southern District of Ohio. The district court denied their motion, holding that they weren’t likely to succeed on the merits because they lacked standing and, alternatively, because they’d brought allegations that failed as a matter of law. Later that year, the plaintiffs moved for leave to amend their complaint.

The government moved to dismiss and opposed plaintiffs’ motion for leave to amend. In 2016, the district court granted the government’s motion to dismiss for lack of standing; declined to reach the government’s motion to dismiss for failure to state a claim; and denied plaintiffs’ motion for leave to amend. The Sixth Circuit agreed with the district court, holding that “the district court rightly held that none of the plaintiffs had standing to sue, and that granting leave to amend would not cure the defect in standing.”

Standing: Injury

Citing the U.S. Supreme Court case of Lujan v. Defenders of Wildlife, 504 U.S. 555 (1992), the Sixth Circuit began its analysis with the constitutional minimum that in each claim, a plaintiff must allege an actual or imminent injury that’s traceable to the defendant and redressable by a court. The injury must be an “injury in fact,” that is, an invasion of a legally protected interest, which is: (1) concrete and particularized, and (2) actual or imminent, not conjectural or hypothetical. There’s no “legally protected interest” in maintaining the privacy of one’s bank records from government access, stated the Sixth Circuit. As to the “concrete” component, the injury needn’t be tangible; however, it must not be abstract. As to the “particularized” component, a plaintiff raising only a generally available grievance about government isn’t enough. And, said the court, “the general rule that individual legislators lack standing to sue in their official capacity as congressman or senator follows from the requirement that an injury must be concrete and particularized.”

However, standing can derive from an imminent, rather than an actual, injury, but only when “the threatened injury is real, immediate, and direct.” Citing to Supreme Court precedent, the Sixth Circuit noted that for there to be standing to bring a pre-enforcement challenge to a federal statute, “there must be a substantial probability that the plaintiff actually will engage in conduct that is arguably affected with a constitutional interest, and there must be a certain threat of prosecution if the plaintiff does indeed engage in that conduct.” Moreover, said the court, “a plaintiff in most instances must assert his own legal rights and interests, not the rights and interests of third parties.”

Standing: Causation/Redressability

Even if a plaintiff alleges an imminent or actual injury that’s concrete and particularized, he or she must show that an injury is fairly traceable to the defendant’s allegedly unlawful conduct. In the instant case, the plaintiffs claim they’ve suffered “indirect” harm. Indirect harm is an injury caused to a plaintiff when a defendant’s unlawful conduct harms a third party who in turn causes the plaintiff’s harm. However, unlike in third-party standing cases, noted the Sixth Circuit, a plaintiff claiming indirect harm is seeking to vindicate the plaintiff’s own rights and not a third party’s. In this case, the plaintiffs relied on Roe v. Wade, 410 U.S. 113, 124 (1973), claiming that the law challenged in Roe directly harmed abortionists, not women seeking abortions, but that the indirect harm to women seeking abortions was nevertheless fairly traceable to the law. In their complaint, the plaintiffs argued that in Roe, the doctors had only two options (provide abortions and thus break the law, or comply with the law by declining to provide abortions). Similarly, FFIs have only two options: disregard FATCA and thus become subject to the 30 percent FFI penalty, or comply with FATCA by refusing to do business with certain U.S. persons.

The court rejected the plaintiffs’ Roe analogy. It stated that the plaintiffs’ analogy overlooked a third option available not available in Roe: FFIs may comply with FATCA and do business with U.S. persons—without imposing additional requirements on their clients beyond what FATCA and the IGAs themselves require.

The Sixth Circuit also noted that a plaintiff must also plead facts sufficient to establish that the court is capable of providing relief that would redress the alleged injury. 

Burden of Proof

The Sixth Circuit emphasized how the Supreme Court “always insisted on strict compliance with this jurisdictional standing requirement,” and the “inquiry into whether plaintiffs have standing is ‘especially rigorous’ where, as here, ‘reaching the merits of the dispute would force [a court] to decide whether an action taken by one of the other two branches of the Federal Government was unconstitutional’” (citing Raines v. Byrd, 521 U.S. 811 (1997) and Clapper v. Amnesty Int’l USA, 133 S.Ct. 1138 (2013)). It thus reviewed de novo the district court’s dismissal for lack of standing, accepted as true all the material allegations in the plaintiffs’ complaint, and construed plaintiffs’ complaint in their favor.

No Standing to Challenge FATCA

According to the Sixth Circuit, no plaintiff had standing to challenge FATCA’s individual reporting requirements or the passthru penalty because no plaintiff (or proposed plaintiff) alleged either an actual injury that was fairly traceable to FATCA or an imminent threat of prosecution from noncompliance with FATCA.

First, said the court, no plaintiff alleged any actual enforcement of FATCA such as a demand for compliance with the individual reporting requirement, the imposition of a penalty for noncompliance or an FFI’s deduction of the passthru penalty from a payment to or from a foreign account.

Second, none of the plaintiffs can satisfy the test for standing to bring a pre-enforcement challenge to FATCA because no plaintiff claimed to hold enough foreign assets to be subject to the individual reporting requirement. Thus, no plaintiff can claim that there’s a “credible threat” of either prosecution for failing to comply with FATCA or imposition of a passthru penalty by an FFI. In fact, said the court, every plaintiff except Johnson and Zell either failed to state the value of their foreign assets altogether or alleged only that they have foreign accounts with an aggregate value “greater than $10,000.” FATCA’s individual reporting requirement applies only to individuals with at least $50,000 worth of assets held in foreign accounts, and Johnson, who lived outside of the United States, would have to have held foreign accounts with an aggregate value in excess of $200,000 to be subject to the individual reporting requirement. At the time Johnson filed the complaint, he wasn’t subject to FATCA. 

With regards to Zell, he had signatory authority over accounts over $200,000, which could subject him to FATCA individual reporting. However, FATCA doesn’t require reporting where trust accounts are held entirely for the benefit of non-U.S. persons. Also, the Israel IGA wasn’t in force when the complaint was filed, and Zell couldn’t have been subject to the individual reporting requirement because his own account had only an aggregate value exceeding $10,000.

Moreover, all the plaintiffs lacked standing to challenge FATCA’s FFI penalty because only the FFIs could bring suit to raise such a challenge

Fairly Traceable Injuries Test Not Satisfied

Some plaintiffs alleged harms arising from FATCA other than the individual reporting requirement or passthru penalty. However, stated the court, none of those alleged harms were injuries fairly traceable to FATCA. For example, even if Crawford’s allegation that the bank’s decision not to allow him or his brokerage firm to accept U.S. clients rises to the level of “injury,” it’s not fairly traceable to FATCA but rather to other independent actions. Similarly, the Johnsons’ decision to separate their own assets to avoid disclosing Katerina’s financial affairs to the U.S. government, absent any allegation that FATCA had actually compelled any such disclosure, is traceable to the Johnsons’ own independent actions, not to FATCA.

Regarding Nelson, although she claimed that her private financial information was disclosed to the IRS and Treasury, she stated no facts indicating that her financial information was disclosed because of FATCA. As such, any injury resulting from this disclosure couldn’t fairly be traced to FATCA.

Adams and Zell alleged that they had problems obtaining banking services from foreign banks. Zell stated that he was advised to move securities out of an Israeli bank and was told that his non-U.S. clients must complete IRS forms at the request of Israeli banks. However, a foreign bank’s choice whether to do business with Adams or Zell, or require non-U.S. clients to make disclosures, is a choice voluntarily made by the bank and isn’t fairly traceable to FATCA.

Similarly, Kuettel, who alleged he couldn’t refinance his mortgage until he renounced his U.S citizenship, isn’t enough to satisfy the standing requirements because at best, it’s a “past injury that is insufficient to warrant injunctive relief … and, in any event, it is traceable only to the foreign banks and not to FATCA because nothing in FATCA prevented the foreign banks from refinancing Kuettel’s mortgage.”

The court went on to examine other allegations by some plaintiffs regarding their purported injuries. For example, Kish claimed there was discord between him and his wife. The court rejected this claim as “not the sort of concrete injury that can give rise to standing. Neither is Crawford or Johnson’s discomfort with FATCA’s reporting requirements or Nelson’s ‘resent[ment]’ at having to prove to European banks that she is no longer a United States citizen in order to obtain banking services.”

“In sum,” said the Sixth Circuit, “no Plaintiff has standing to challenge FATCA’s individual-reporting requirements, the Passthru Penalty, or the FFI Penalty, because no Plaintiff has suffered direct harm that is fairly traceable to any of these challenged provisions, and because no Plaintiff has alleged sufficient facts to show a credible threat of prosecution for noncompliance with any of these challenged provisions.”

No Standing to Challenge IGAs

Only Senator Paul challenged the constitutionality of the IGAs and alleged injury arising out of not being able to vote against the IGAs. The court found that he had no standing to bring such a claim, in that any incursion on Senator Paul’s political power wasn’t a concrete injury like the loss of a private right. Moreover, any diminution in the Senate’s lawmaking power isn’t particularized but rather is a generalized grievance.

No Standing to Challenge the FBAR

Even though most plaintiffs alleged foreign account balances over $10,000 (and thus subject to the FBAR), none of them alleged both intent to violate the FBAR requirement and a credible threat of the imposition of a failure-to-file penalty, which is required to bring a pre-enforcement claim. Also, even Zell failed to allege facts that would show a credible threat of enforcement against him. Moreover, no plaintiff alleged any actual injury arising from the FBAR other than Lois Kuettel, who claimed she wanted to have a college-savings account placed in her name, but Daniel, her father, didn’t want to transfer the account to her for fear that it would trigger an FBAR requirement for her. That injury, however, is traceable to Daniel’s personal choice not to transfer the account, not to the FBAR. Thus, stated the court, “none of the plaintiffs have standing to sue, and the district court was correct to dismiss their suit.”

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