Gonzales-final-requirement-2018.docx

State Obligation Initiated through a Non-Inclusive Treaty Process: Determining the Validity of Foreign Account Tax Compliance ActIntergovernmental Agreement (FATCA-IGA)

In Partial Fulfillment of the Requirements for Fundamentals of Thesis Writing II

Atty. Patricia Anne D. Sta. Maria

PREPARED BY: TRIXIE CARMELA J. GONZALES 15-024

SY 2017 – 2018

ATENEO DE MANILA UNIVERSITY SCHOOL OF LAW

TABLE OF CONTENTS

ABSTRACT

3

I. BACKGROUND OF THE STUDY A. OVERVIEW

4

B. BASIC STRUCTURE OF FATCA

10

C. PHILIPPINE LEGAL BASIS

12

D. TAX TREATY, FATCA-IGA PHILIPPINES, AND CAA: GENERAL OBLIGATIONS

13

II. STATEMENT

OF THE PROBLEM/THESIS STATEMENT

III. OBJECTIVES OF

THE S TUDY

14 15

IV. DEFINITION OF TERMS

15

V. RESEARCH METHODOLOGY

21

VI. SIGNIFICANCE OF

23

THE STUDY

VII. SCOPE AND LIMITATION

25

VIII. ORGANIZATION OF THESIS

26

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Abstract It is not clandestine that U.S. Investors choose to capitalize their money on offshore tax havens allowing tax savings on their part and industry growth of the beneficiary State. As such, this confidential arrangement proves to be beneficial for both parties. In present times, U.S. Investments remain to be a large part of the Philippine Foreign Direct Investment. These investments facilitate growth in various areas in the Philippine industries. However, there exists a danger of pulling out of investments due to the obligation imposed by Foreign Account Tax Compliance Act. According to the Foreign Account Tax Compliance Act – Intergovernmental Agreement of the Philippines, the obligation of the Philippines to comply with Foreign Account Tax Compliance Act provisions stems from the fact that such was envisioned in the Tax Treaty between U.S. and Philippines, known as Double Taxation Avoidance Agreement between Philippines and United States of America, which was completed last 1st of October, Nineteen Seventy-Six. Under the provision of the Nineteen Seventy-six Tax Treaty, reciprocity of disclosure requirements only covers the needed information relating to the Convention which is Double Taxation on Income Tax items. Yet, the Foreign Account Tax Compliance Act – Intergovernmental Agreement of the Philippines is guised as a supplement or enhancement of the previous treaty although it encompasses disclosure on foreign investments or assets. It is also worth emphasizing that the latter instrument is not a treaty which can impose a binding obligation. Consequently, no treaty process, with a chance for negotiation and reservation, was done on the matter. The question now remains: how can Foreign Account Tax Compliance Act – Intergovernmental Agreement of the Philippines stand as a legal basis in imposing Philippine obligation (e.g. disclosure of foreign investments and other asset items) when it is not one of the instruments recognized under Public International Law which can impose State obligation? Through collection and examination of relevant legal literature on matters relating to obligations imposed under Foreign Account Tax Compliance Act, study of Bureau of Internal Revenue advisories on the matter, and analysis of the legal literature and inquiry gathered, this study aims to prove that the Foreign Account Tax Compliance Act – Intergovernmental Agreement of the Philippines, under the guise of a supplement or enhancement of the Nineteen Seventy-six Tax Treaty, is not an instrument which can impose state obligation upon the Philippines. The entrance of Foreign Account Tax Compliance Act and ultimately the Foreign Account Tax Compliance Act – Intergovernmental Agreement in the Philippines will have disadvantageous impact on Philippine Financial Institutions. As U.S. Investors will be faced with an insignificant profitability through the elimination of tax savings, they will be left with the choice of pulling out their investments and choosing to place such in another offshore tax haven. 3

I. Background of the Study

A. Overview This thesis aims to prove that the Foreign Account Tax

Compliance Act –

Intergovernmental Agreement of the Philippines (“FATCA-IGA”) cannot stand as a legal basis in imposing State obligation upon the Philippines. In doing so, the this study will use and follow a particular flow in attaining such conclusion.

The study begins with presenting the general sources of state obligation1. Distinctively, the authors cited that there are three primary sources of international obligation which are Law of Nations or extranational law, Law over Nations or supranational law, and Law between Nations or international law. Briefly, Law of Nations is the interpretation and understanding by one State of the law of another State2. This is extremely useful in conflicts of law cases wherein the facts or the issues of the case crosses upon borders of different countries, states, political subdivision, or any region which has its own jurisdiction. Law over Nations is the set of laws which are used by international tribunals (e.g. International Court of Justice) in deciding international cases which involve at least two States3. This also consequently leads to the fact that all the States involved in the international cases adhere to such laws and considered such as binding upon them. Law between Nations is simply the Public International Law which comes in the form of

1 Lawrence

Evans, et al., The Primary Sources of International Obligations, 5 PROCEEDINGS OF THE AMERICAN 278 (1990).

SOCIETY OF INTERNATIONAL LAW AT ITS ANNUAL MEETING 257, 2 Id. 3 Id.

4

treaties or conventions4. Simply stated, these laws are rules or responsibilities between or among two or more States, respectively. This general source of obligation is further broken down into two components, namely, custom and international agreements. Custom is a standard of conduct exercised by two states which, as a general rule, is not evidenced by any written instrument. International agreements comprise of consular conventions and treaties which recognize the sovereign authority of the party-State.

The common denominator in all the primary sources of international obligation is state consent5. The principle of state consent has two prerequisites which must both be present in order to uphold the validity of a state obligation and honor the state-party’s sovereignty. First, the States must identify and acknowledge the laws they consider binding upon themselves and special rules or laws which will govern their agreement6. Through this, the States are obliged to recognize a certain parameter which shall determine whether an act of the state-party is legal or not and which shall serve as point of legal reference among parties. Second, the States must have a mutual and uniform understanding in relation to issues of efficacy and implementation7. The consent in this factor equates to the willingness of both States to enforce the agreed norm8. Moreover, this includes agreements with regards to sanctions. When non-compliance imposes sanctions, consent requires that the sanction shall only be enforced when agreed upon by both 4 Id. 5 Daniel

Bodansky, et al., State Consent and the Sources of International Obligation, 86 PROCEEDINGS OF THE ANNUAL MEETING (AMERICAN SOCIETY OF INTERNATIONAL LAW) 108, 110 (1992). 6 Id. 7 Id. 8 Id.

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parties9. Consequently, the lack of state consent would translate to infringement of State Sovereignty.

It is through state consent that treaties are made effective. The legal framework of treaties is introduced by the Nineteen Sixty-Nine Vienna Convention on Law of Treaties. This convention became binding on the Philippines on its date of ratification which is November 15, 1972. As defined in the same instrument, a treaty is an international agreement between or among two or more states, respectively, which is contained in a single or two or more instruments10. According to the same instrument, there is a no particular form of a treaty for as long as there is an intention to be bound11. Among others, there are particular forms of treaty which have been deemed acceptable by international cases and which are considered binding between States. Consequently, these binding instruments pose valid obligation upon States which are signatories to it or which have ratified the same. The first form of binding instrument is a new treaty which has undergone the treaty process outlined in the Nineteen Sixty-Nine Vienna Convention on Law of Treaties. This means that the instrument went through proper negotiation as proposed by authorized representatives of both parties who posses full powers of the state. Next, both representatives must had an opportunity to present and interpose their reservations which has the objective of either excluding or modifying the legal effects of certain provisions under negotiation. Thereafter, each state which has the intention to be bound by the new treaty must adopt the same. In the Philippine setting, Section 2, Article VII of the 1987 Constitution 9 Id. 10 Vienna

Convention on the Law of Treaties, November 15, 1972, art. 1, 1155 U.N.T.S. 331 [hereinafter VCLOT].

11 Id.

6

requires that there must be a two-thirds vote of the Senate in order for a treaty to become effective in the Philippine jurisdiction. Most importantly, consent must be shown by any of the following acts: signature, exchange of instruments, ratification, acceptance, approval or accession, or by any other means if so agreed. It is this consent which is formally expressed through writing that shows the willingness of a state to be bound by a treaty12. The second form of binding instrument is a subsequent agreement which is treated as an extension of an existing treaty. It may either be an amendment or supplement of a treaty. In case of an amendment, the Nineteen Sixty-Nine Vienna Convention on Law of Treaties states that it must still follow the process of forming a new treaty. Hence, such amendment must undergo negotiation, reservation, and adoption with express consent13. On the other hand, the supplement of a treaty requires stricter rules. A supplement can only be had when the all the parties to the existing treaty are also the parties to its supplement, the earlier treaty is not terminated or suspended in operation, and the supplement provisions may only come into effect when they are compatible with the existing binding provisions14. Among others, the significance of a formed and binding treaty includes the regulation of commercial transactions, settlement of disputes, and assurance of investments.

One example of a valid and binding treaty which most importantly, regulates commercial transactions, settle disputes, and guarantee investments is the Nineteen Seventy-six Tax Treaty between the Republic of the Philippines and the United States of America. The same instrument is regarded as the “mother treaty” which serves as the anchor of the obligations contained in the 12 Id.

art. 11.

13 Id.

art. 39.

14 Id.

art 32.

7

FATCA-IGA of the Philippines. The precedent instrument states its purpose as - avoidance of double taxation and prevention of fiscal evasion. In the long run, the treaty is set up to effectuate the reduction of taxes incurred as a result of the income from investments on both ends15. The taxes covered in the treaty are only limited to the taxes covered in the National Internal Revenue Code of the Philippines.16 This means that the taxes are confined to income items only. The treaty further states that the only persons covered are individuals who have residential or habitual abode or economic relations in the Philippines and partnerships and corporations which are considered to have permanent establishment in the Philippines17. Most importantly, this treaty provides in its Article 26 that both parties, Republic of the Philippines and United States of America, are obligated to provide an exchange of information with regard to information necessary to carry into effect the purpose of the treaty and information regarding the taxes covered in relation to the persons mentioned in the treaty18. This emphasizes that information necessary to be divulged is only with regard to taxes on income items in order to avoid double taxation in relation the persons covered under the treaty.

The same Article 26 of the Nineteen Seventy-six Tax Treaty is mentioned in the whereas clauses of the FATCA-IGA. The whereas clauses of the later instrument state that the Philippines

15 Double

Taxation Avoidance Agreement between Philippines and United States of America, October 1, 1976, [hereinafter TAX TREATY]. 16 Id.

art. 1.

17 Id.

art. 2.

18 Id.

art. 26.

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is obligated to exchange information by virtue of the mandate reflected in the treaty19. As stated in the latter instrument, its purpose is to outline the guide for reporting the information needed under FATCA with the ultimate motive of getting to know the true net worth of U.S. Citizen and U.S. Entities. In contrast with the treaty, FATCA-IGA covers investment assets such as insurance cash value, deposits, bonds or value of shares, currency or commodity transactions, futures contracts, hedge funds, options contracts, and credit swap20. A further contrast in the FATCAIGA involves the persons covered21. The latter instrument particularly states that the persons covered are both natural and juridical persons whether or not they have economic relations or permanent establishments in the Philippines. The FATCA-IGA also states the procedure for reporting the aforementioned information, as prepared by the U.S. Department of Treasury without the concurrence of any Philippine government official or authorized person, is outlined.

The next portion of the study provides an anlaysis through outlining the differences between the Nineteen Seventy-six Tax Treaty and the FATCA-IGA and through revealing that the latter is not a binding instrument at it falls short of the requirements of a new treaty and amendment or supplement of an existing treaty. The FATCA-IGA is not a new treaty because it is not negotiated by an authorized representative from the Philippines as it was unilaterally issued by the U.S. Department of Treasury. By the unilateral promulgation, the Philippines was not afforded its right to reservation on some of the provisions. Most importantly, the Senate of the 19 Agreement

between the Government of the United States of America and the Government of the Republic of the Philippines to Improve International Tax Compliance and to Implement FATCA, July 13, 2015, [hereinafter FATCAIGA Philippines]. 20 Id.

art. 2.

21 Id.

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Philippines has neither adopted nor ratified such which leads to non-consent of the Philippines. The FATCA-IGA is not an amendment of the Nineteen Seventy-six Tax Treaty because the steps in making an amendment was non-availing in this unilateral imposition of State obligation. The FATCA-IGA is also not a supplement of the Nineteen Seventy-six Tax Treaty as incompatibility exists in terms of the taxes covered and the persons covered. Therefore, the FATCA-IGA does not impose a valid obligation upon the Philippines because it is neither a treaty nor an amendment or supplement of an existing treaty. This also implies that there is a breach of sovereignty since the United States of America is unilaterally imposing a state obligation upon the Philippines without the latter’s consent.

The last portion of the study tackles the practical effects and economic impact of pushing through with the FATCA-IGA compliance.

B. Basic Structure of Foreign Account Tax Compliance Act Last 25th of August, two thousand and ten, an act shortly titled Hiring Incentives to Restore Employment (“HIRE”) Act22 was passed into law by former United States President Barack Obama. Title V, Subtitle A of the same act is titled Foreign account tax compliance.23 Such small part of a bigger law was developed into an act itself now known as Foreign Account Tax Compliance Act (“FATCA”). FATCA basically requires two things. First, it requires that foreign financial institutions and certain non-financial foreign entities report on the foreign assets

22 Hiring

Incentives to Restore Employment Act [HIRE Act], 26 U.S.C (2010).

23 Id.

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held by their U.S. account holders.24 Second, it also requires its own citizens, U.S. persons, to report, depending on the value, their own foreign financial accounts and foreign assets.25 As punishment for non-compliance, the foreign financial institution or the U.S. Account Holder will be liable for the payment of thirty percent (30%) withholding tax. Furthermore, it is also mandated that when the foreign law prohibits the disclosure required despite an appeal for waiver, the account of such holder must be closed within a reasonable period of time.

To further strengthen FATCA and to to provide the reportorial structure and system, the U.S. Department of the Treasury single-handedly formulated the FATCA-IGAs. These FATCAIGAs basically afford the foreign financial institution two models which outline the process by which the same institutions shall use in reporting the needed information. The first model, Model 1 IGA, involves the reporting of information to the FATCA Partner Government followed by a government-to-government exchange of information.26 The second mode, Model 2 IGA, involves the direct reporting of information by the foreign financial institution to the U.S. Internal Revenue Service (“IRS”).27

24 Foreign

Account Tax Compliance Act, available at https://www.irs.gov/businesses/corporations/foreign-accounttax-compliance-act-fatca (last accessed January 3, 2018). 25 Id. 26 FATCA:

Where are we now?, available at http://www.bworldonline.com/content.php? section=Economy&title=fatca-where-are-we-now&id=115621 (last accessed January 3, 2018). 27 Id.

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C. Philippine Legal Basis Imposition of the provisions of FATCA-IGAs applies to Philippine financial institutions. Authorities have assigned the treaty between U.S. and Philippines, known as Double Taxation Avoidance Agreement between Philippines and United States of America, as the legal basis in complying with duties enforced in FATCA-IGAs. Article twenty-six (26) of the same treaty provides the exchange of information between U.S. and Philippines.28 It allows the exchange of information between the two aforementioned states in aid of the requesting state for the latter’s own use.

To date, the Bureau of Internal Revenue (“BIR”) has already issued four (4) advisories on the matter. In Advisory No. 2 dated last 10th of May, two thousand and sixteen, it is categorically stated that the Philippines will utilize Model 1 IGA in data reporting following the FATCA-IGA Philippines issued on 13th of July, two thousand and fifteen. Such model entails that the Philippine financial institutions shall collect and report the needed data which shall be transmitted to the BIR. Consequently, the BIR shall communicate the same to the IRS. The agreed upon process between BIR and IRS, as Competent Authorities, was finalized and embodied in the Competent Authority Arrangement (“CAA”) signed last 24th of March, two thousand and sixteen.29

28 TAX

TREATY, supra note 15, art. 26.

29 FATCA ADVISORY,

available at https://www.bir.gov.ph/index.php/international-tax-matters/fatca.html (last accessed January 3, 2018).

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D. Tax Treaty, FATCA-IGA Philippines, and CAA: General Obligations Article 26 (1) of the Tax Treaty between U.S. and Philippines states: The competent authorities shall exchange such information as is necessary for carrying out the provisions of this Convention or for the prevention of fraud or for the administration of statutory provisions concerning taxes to which this Convention applies provided the information is of a class that can be obtained under the laws and administrative practices of each Contracting State with respect to its own taxes.30

The phrase “for carrying out the provisions of this Convention or for the prevention of fraud or for the administration of statutory provisions concerning taxes to which this Convention applies”31 merely refers to the avoidance of double taxation between U.S. and the Philippines. Having been completed on 1st of October, nineteen seventy-six, no reference can be made to the present provisions of FATCA and FATCA-IGAs.

However, the whereas clauses of FATCA-IGA Philippines refer to the same convention to strengthen the position of U.S. that the Philippines has an existing obligation to the former to provide necessary information for its own use. To outline the preliminary steps that a Philippine Financial Institution shall take, the FATCA-IGA Philippines included Annex I which requires the Republic of the Philippines to obligate the Philippine Financial Institutions to apply due diligence procedures for identifying and reporting U.S. reportable accounts.32 To ensure compliance and convenient monitoring, Paragraph 2 of CAA requires the registration of Philippine Financial Institutions for the issuance of Global Intermediary Identification Number (“GIIN”) which serves as the control number of IRS. 30 Id. 31 Id. 32 FATCA-IGA

Philippines, supra note 19, art. 2.

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Reportorial requirements include the name, address, and U.S. TIN of each Specified U.S. Person that is an Account Holder of such account.33 Time and manner of exchange of information mandates that the Philippine Financial Institutions should automatically report the required data within nine (9) months after the end of the calendar year to which the information relates.34 Moreover, the arrangement outlines the format and the transmission method to be utilized by the competent authorities of the both States. The same arrangement also provides the remediation procedures in case of non-compliance which entails added costs for the noncomplying Philippine Financial Institution or U.S. account holder.

II. Statement of the Problem/Thesis Statement Given the supposed Philippine legal basis in the form of the Nineteen Seventy-six Tax Treaty at one hand and the further obligations imposed in FATCA-IGA Philippines at another, this thesis theorizes that: the FATCA-IGA, under the guise of a supplement or enhancement of the Nineteen Seventy-six Tax Treaty, is neither a treaty nor a supplement or amendment of an existing treaty. Hence, it cannot impose a valid state obligation and which consequently defeats the principle of state consent under the Public International Law.

33 Id. 34 Competent

Authority Arrangement Between the Competent Authorities of the United States of America and the Republic of the Philippines, March 24, 2016, [hereinafter CAA].

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III. Objectives of the Study First, to gather and identify the various legal justification for compliance with the provisions of FATCA and obligations outlined in FATCA-IGA Philippines and CAA. Second, to examine the extent of processes required to be done by the Philippine Financial Institutions and incurrence of additional costs due to strict compliance. Third, to inspect the possible damages or pecuniary estimation of the penalties to be paid by Philippine Financial Institutions in case of lapse in reportorial requirements. Fourth, to assess the sufficiency of the legal obligation provided in the Tax Treaty to enforce the overall processes of collecting data required and penalties for the lapse under FATCA. Fifth, to provide the overall impact of compliance with FATCA provisions on the Philippine economy. Lastly, to study the possible legal consequences in breaching through our State consent.

IV. Definition of Terms For understanding of the scope of the terms herein included, the following definitions shall be used as the strict reference:

1. Partner Jurisdiction means a jurisdiction that has in effect an agreement with the United States to facilitate the implementation of FATCA.35

35 FATCA-IGA

Philippines, supra note 19, art. 1.

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2. Philippine Financial Institutions means (i) any Financial Institution organized under the laws of the Republic of the Philippines, but excluding any branch of such Financial Institution that is located outside the Republic of the Philippines, and (ii) any branch of a Financial Institution not organized under the laws of the Republic of the Philippines, if such branch is located in the Republic of the Philippines. Such include Custodial Institutions, Depositary Institution, Investment Entity, or Specified Insurance Company. For easy reference, this term applies to institutions which: (A) accepts deposits in the ordinary course of a banking or similar business; (B) as a substantial portion of its business, holds financial assets for the account of others; or (C) is engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities.36

3. Custodial Institution means any Entity that holds, as a substantial portion of its business, financial assets for the account of others. An entity holds financial assets for the account of others as a substantial portion of its business if the entity’s gross income attributable to the holding of financial assets and related financial services equals or exceeds 20 percent of the entity’s gross income during the shorter of: (i) the three - year period that ends on December 31 (or the final day of a non - calendar year accounting period) prior to the year in which the determination is being made; or (ii) the period during which the entity has been in existence.37

36 HIRE

Act, §1473.

37 FATCA-IGA

Philippines, supra note 19, art. 1.

16

4. Depository Account includes any commercial, checking, savings, time, or thrift account, or an account that is evidenced by a certificate of deposit, thrift certificate, investment certificate, certificate of indebtedness, or other similar instrument maintained by a Financial Institution in the ordinary course of a banking or similar business. A Depository Account also includes an amount held by an insurance company pursuant to a guaranteed investment contract or similar agreement to pay or credit interest thereon.38

5. Financial Account means an account maintained by a Financial Institution, and includes: (1)

in the case of an Entity that is a Financial Institution solely because it is an

Investment Entity, any equity or debt interest (other than interests that are regularly traded on an established securities market) in the Financial Institution;

(2)

in the case of a Financial Institution not described in subparagraph 1(s)(1) of this

Article, any equity or debt interest in the Financial Institution (other than interests that are regularly traded on an established securities market), if (i) the value of the debt or equity interest is determined, directly or indirectly, primarily by reference to assets that give rise to U.S. Source Withholdable Payments, and (ii) the class of interests was established with a purpose of avoiding reporting in accordance with this Agreement; and

38 Id.

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(3) any Cash Value Insurance Contract and any Annuity Contract issued or maintained by a Financial Institution, other than a noninvestment-linked, nontransferable immediate life annuity that is issued to an individual and monetizes a pension or disability benefit provided under an account that is excluded from the definition of Financial Account in Annex II.

Notwithstanding the foregoing, the term “Financial Account” does not include any account that is excluded from the definition of Financial Account in Annex II. For purposes of this Agreement, interests are “regularly traded” if there is a meaningful volume of trading with respect to the interests on an ongoing basis, and an “established securities market” means an exchange that is officially recognized and supervised by a governmental authority in which the market is located and that has a meaningful annual value of shares traded on the exchange. For purposes of this subparagraph 1(s), an interest in a Financial Institution is not “regularly traded” and shall be treated as a Financial Account if the holder of the interest (other than a Financial Institution acting as an intermediary) is registered on the books of such Financial Institution. The preceding sentence will not apply to interests first registered on the books of such Financial Institution prior to July 1, 2014, and with respect to interests first registered on the books of such Financial Institution on or after July 1, 2014, a Financial Institution is not required to apply the preceding sentence prior to January 1, 201639.

39 Id.

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6. U.S. Person includes U.S. citizen or resident individual, a partnership or corporation organized in the United States or under the laws of the United States or any State thereof, a trust if (i) a court within the United States would have authority under applicable law to render orders or judgments concerning substantially all issues regarding administration of the trust, and (ii) one or more U.S. persons have the authority to control all substantial decisions of the trust, or an estate of a decedent that is a citizen or resident of the United States.40 This term already includes Specified U.S. Person41.

7. U.S. Person Account Holder means the person listed or identified as the holder of a Financial Account by the Financial Institution that maintains the account. A person, other than a Financial Institution, holding a Financial Account for the benefit or account of another person as agent, custodian, nominee, signatory, investment advisor, or intermediary, is not treated as holding the account for purposes of this Agreement, and such other person is treated as holding the account. In the case of a Cash Value Insurance Contract or an Annuity Contract, the Account Holder is any person entitled to access the Cash Value or change the beneficiary of the contract. If no person can access the Cash Value or change the beneficiary, the Account Holder is any person named as the owner in the contract and any person with a vested entitlement to payment under the terms of the contract.42

40 Id. 41 Id. 42 Id.

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8. Specified U.S. Person means a U.S. Person, other than: (i) a corporation the stock of which is regularly traded on one or more established securities markets; (ii) any corporation that is a member of the same expanded affiliated group, as defined in section 1471(e)(2) of the U.S. Internal Revenue Code, as a corporation described in clause (i); (iii) the United States or any wholly owned agency or instrumentality thereof; (iv) any State of the United States, any U.S. Territory, any political subdivision of any of the foregoing, or any wholly owned agency or instrumentality of any one or more of the foregoing; (v) any organization exempt from taxation under section 501(a) of the U.S. Internal Revenue Code or an individual retirement plan as defined in section 7701(a)(37) of the U.S. Internal Revenue Code; (vi) any bank as defined in section 581 of the U.S. Internal Revenue Code; (vii) any real estate investment trust as defined in section 856 of the U.S. Internal Revenue Code; (viii) any regulated investment company as defined in section 851 of the U.S. Internal Revenue Code or any entity registered with the U.S. Securities and Exchange Commission under the Investment Company Act of 1940 (15 U.S.C. 80a-64); (ix) any common trust fund as defined in section 584(a) of the U.S. Internal Revenue Code; (x) any trust that is exempt from tax under section 664(c) of the U.S. Internal Revenue Code or that is described in section 4947(a)(1) of the U.S. Internal Revenue Code; (xi) a dealer in securities, commodities, or derivative financial instruments (including notional principal contracts, futures, forwards, and options) that is registered as such under the laws of the United States or any State; (xii) a broker as defined in section 6045(c) of the U.S. Internal Revenue Code; or (xiii) any tax-exempt trust under a plan that is described in section 403(b) or section 457(g) of the U.S. Internal Revenue Code43.

43 Id.

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9. Reportable Account means a Financial Account maintained by a Reporting Philippine Financial Institution and held by one or more Specified U.S. Persons or by a Non - U.S. Entity with one or more Controlling Persons that is a Specified U.S. Person. Notwithstanding the foregoing, an account shall not be treated as a U.S. Reportable Account if such account is not identified as a U.S. Reportable Account after application of the due diligence procedures in Annex I.44

10. Recalcitrant Account Holder means any account holder which fails to comply with reasonable requests for the information or fails to provide waiver on the foreign law which prohibits disclosure upon request.45

11. Principle of State Consent is the foundation of international law. The principle that law is binding on a State only by its consent remains an axiom of the political system, an implication of State autonomy.46

V. Research Methodology This study employs three methods of research. First, collection and examination of relevant treaties, laws, agreements, and legal literature on matters relating to obligations imposed under FATCA. Second, study of BIR advisories and inquiry with the BIR International Tax 44 Id. 45 HIRE 46 IAN

Act, §1473.

BROWNLIE, PRINCIPLE OF PUBLIC INTERNATIONAL LAW, 4 (6th ed. 1995).

21

Affairs Division regarding the Philippine progress on the matter. Lastly, assessment and analysis of the legal literature and inquiry gathered.

First, as already laid down in the preceding sections, pertinent provisions of Tax Treaty between U.S. and Philippines regarding primarily the avoidance of Double Taxation completed on the year nineteen seventy-six and agreements and arrangements laid down in FATCA-IGA Philippines and CAA shall be examined and gathered for further research and interpretation.

Second, advisories and opinions issued by BIR shall also be regarded as a relevant literature to assess the extend of processes to be fulfilled by the affected Philippine Financial Institutions. Further inquiry with the BIR International Tax Affairs Division regarding the same matter shall be done. This inquiry mainly consists of the further agreement signed by incumbent President Rodrigo Duterte which was later passed on to the Senate for possible concurrence.

Third, the same Tax Treaty between U.S. and Philippines shall be regarded as the primary authority in providing a gateway for obligating the Philippines to comply with FATCA. Such provisions will be related to the obligations imposed under FATCA-IGA Philippines and CAA, together with the further agreements signed by the present Philippine President. As such, all relevant legal literature will be assessed together to determine the sufficiency or insufficiency of the Tax Treaty provisions as a legal basis in obligating the Philippines, as well as the Philippine Financial Institutions, to comply with a U.S. domestic law known as FATCA. Finally, with the

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use of gathered literature, possible consequences for the breach of our State consent may be drawn.

VI. Significance of the Study It is not clandestine that U.S. Investments remain to be a large part of the Philippine Foreign Direct Investment (“FDI”). These investments facilitate growth in various areas in the Philippine industries. In 2016, FDI inflows in the Philippines hit USD 8 billion, a multi-decade high. Japan and the US are the main investors, while inflows are concentrated in the manufacturing and the finance industry.47 This practice stems from the fact that U.S. investors prefer to put their money on offshore tax havens48 making it possible for them to profit while saving on taxes. Consequently, the same foreign investors trust that their transactions remain confidential. In an economic point of view, such confidential arrangement proves to be profitable and advantageous to both parties. The investors profit in terms of growth and tax savings. On the other hand, the beneficiary State utilizes gathered investments for improvements of different industries. Being applicable to the Philippines, it can be said that the same confidential structure is beneficial for both our State and the U.S. Person.

The entrance of FATCA, on the other hand, will have a direct and profound impact on foreign financial institutions that have U.S. proprietary investments, U.S. account holders, or 47 Philippines

(The): Foreign Investment, available at https://en.portal.santandertrade.com/establish-overseas/ philippines/foreign-investment (last accessed January 3, 2018). 48 The

impact of FATCA in the Philippines, available at http://bworldonline.com/content.php? section=Economy&title=the-impact-of-fatca-in-the-philippines&id=112793 (last accessed January 3, 2018).

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U.S. financial dealings.49 Unfortunately, being a State mandated by the U.S., the Philippine Financial Institutions will greatly suffer the impact of FATCA. Consequently, this will definitely take a toll on our economy leading to a probable demise of our industries. Since there will be no more significant incentive for U.S. investors to capitalize in our State, they might pull out their money leaving the Philippine economy to our demise.

Not only does FATCA-IGA endanger the economy of the Philippine Financial Institutions but the Philippine Banking System as well. One article provided: “Accordingly, legal reforms in the financial sector are anchored on the premise that any danger to the banking industry will also threaten the stability of the nation. Thus, in crafting the character of the country’s central monetary authority, the Congress took into account that ‘banks are the main arteries in the bloodstream of the economy. Indeed, a sound and stable banking system is unquestionably a vital ingredient for economic development.”50 Being the keeper of most investments, banks are reposed with utmost degree of trust and confidence in relation to its fiduciary relations to the investors. Through the FATCA-IGA compliance, banks, as mandated by the unilateral instrument, are obliged to disclose the amount of the covered persons’ investments to the BIR. The natural effect of such report is also outlined in the same article: “There are reports that the growing anxiety over FATCA compliance resulted to foreign banks ‘denying U.S. persons banking services, closing long-held accounts, and refusing to open new accounts, including run-of-the-mill accounts used to receive salary, pay bills, service mortgages, write checks, service debit/ credit cards, and more.’ The possibility that target accountholders may divest themselves of their U.S. securities also causes fear on the U.S. economy. American citizens living and working abroad are threatened of being put into serious financial jeopardy in terms of financial services such as pension funds, investment instruments, and other financial vehicles that are essential to the financial security of middle-income Americans.

49 The

Foreign Account Tax Compliance Act, available at http://files.dlapiper.com/files/Uploads/Documents/ FATCA-Alert.pdf (last accessed January 3, 2018). Soriano-Dionisio, FATCA and It’s Impact on Institutions Regulated and Supervised by BSP, 58 ATENEO LAW JOURNAL 81, 83 (2013). 50 Rowena

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Foreign banks and financial institutions have, in great numbers, warned the U.S. that compliance with FATCA obligations will be impracticable, if not impossible; ruinous for some banks; illegal in some countries due to privacy laws; and counterproductive because of the risk of divestment in U.S. Securities.”51

A very alarming situation is at hand. We might be obligated due to our recognized reciprocity with the U.S. This time, a sworn allegiance forged at the fact that there will be mutual help between both our States will bring about an advantage to the U.S. while leaving the disadvantageous effects to us.

Furthermore, if our State would extend such tremendous amount of help, clearly then, it would be allowing the U.S. to extend its sovereignty in our jurisdiction – a form of breach of our State consent. The most prominent danger in complying the provisions of FATCA-IGA is setting a precedent that the Philippines allow the imposition of an obligation even without complying with the Nineteen Sixty-Nine Vienna Convention on Law of Treaties. This might send idea to other States that Philippines allows unilateral imposition of State obligation. Hence, other States might follow suit.

VII. Scope and Limitation The main issue tackled in this discourse is the validity of FATCA-IGA Philippines in relation to the obligations imposed by the same. Consequently, this study shall not take into consideration the possible conflict of FATCA-IGA Philippines against our preexisting domestic laws.

51 Soriano-Dionisio,

supra note 33, at 96.

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In order to justify the compliance with provisions enacted in FATCA-IGA Philippines, the articles in the 1976 Tax Treaty, particularly Article 26, shall be examined. Hence, no other legal basis for the imposition of the obligation to comply shall be examined.

The discourse analysis will only include the obligations under FATCA-IGA Philippines and by extension and clarification, the CAA and further agreements signed by the sitting President. Hence, no other international legal documents will be examined to ascertain the sufficiency or insufficiency of the 1976 Tax Treaty.

Finally, the study only involves the probable legal consequences for breaching through our State consent. Hence, this will not cover other States’ probable breach of consent and possible ramifications which should be done by U.S. for amendments with other States, if any.

VIII. Organization of Thesis To effectively discuss the full extent of this study, this thesis contains eight (8) chapters including this chapter. This chapter introduces the history of the enactment of FATCA and its developments. Moreover, discussion also includes the pertinent provisions to be considered in attaining the result or conclusion of this study.

The second chapter presents an extensive discussion on the General Sources of State Obligations and the Principle of State Consent. This explains in detail the law of nations, law 26

over nations, and law between nations as well as forms of customs and other international agreements in relation thereto. As a common denominator of the aforementioned laws, the Principle of State Consent shall also be discussed and its relation to the point of reciprocity. In comparison, the infringement of state sovereignty through lack of consent shall also be presented.

The third chapter provides the legal framework of treaties as introduced in the Nineteen Sixty-Nine Vienna Convention on Law of Treaties. This provides the definition of treaties and its forms under the same Conventions. It also maps out the binding instruments which validly impose state obligation. Most importantly, it makes available the significance of formed and binding treaties.

The fourth chapter introduces the “Mother Treaty” which is the Nineteen Seventy-six Tax Treaty between the Republic of the Philippines and the United States of America. Major points to be discussed are the purpose of the treaty, the taxes covered for avoidance of double taxation, the persons covered under the treaty’s protection, the mutual procedure in case of disagreements on doubtful interpretation, and the exchange of information as mapped out by Article 26 of the same treaty.

The fifth chapter introduces the FATCA-IGA which the primary instrument used in imposing the obligation of disclosing information upon the Philippines. For an orderly discussion of the analysis, the major points to be discussed in this chapter include the source and process of 27

the instrument’s perfection, its purpose, the investments covered, the persons covered, and the procedure of reporting.

The sixth chapter presents the analysis which would answer the legal issue of whether or not the FATCA-IGA can impose a valid state obligation upon the Philippines. First, this chapter presents the reasons why the the same instrument cannot be considered as a binding treaty. Second, this chapter provides the reason why the same instrument cannot be considered as an amendment to the Nineteen Seventy-six Tax Treaty. Third, this chapter makes available the reasons why the same instrument cannot be considered as a supplement of the Nineteen Seventysix Tax Treaty. Finally, this chapter concludes that the FATCA-IGA cannot impose a state obligation upon the Philippines.

The seventh chapter provides the practical and economic impact of pushing through with FATCA-IGA compliance. This chapter mainly expands the discussion on the significance of the study which is briefly discussed in the first chapter. This encompasses the study of the effect on the Philippine Financial Institutions, the Philippine Banking System, and the investments thereto. The eighth chapter is mainly about the recommendation. The proponent shall present several points that may be discussed in case another proponent may be interested in taking on the study and expanding its scope and limitations.

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PRELIMINARY BIBLIOGRAPHY

Primary Authorities

International Documents Agreement between the Government of the United States of America and the Government of the Republic of the Philippines to Improve International Tax Compliance and to Implement FATCA, July 13, 2015.

Competent Authority Arrangement Between the Competent Authorities of the United States of America and the Republic of the Philippines, March 24, 2016.

Treaty Double Taxation Avoidance Agreement between Philippines and United States of America, October 1, 1976.

Vienna Convention on the Law of Treaties, November 15, 1972.

United States Code Hiring Incentives to Restore Employment Act [HIRE Act], 26 U.S.C (2010).

Secondary Authorities Book Brownlie, Ian. Principle of Public International Law. Oxford: University Press, 1995.

Bodansky, Daniel. State Consent and the Sources of International Obligation. Cambridge: University Press, 1992.

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Evans, Lawrence. The Primary Sources of International Obligations. Cambridge: University Press, 1990.

Journal Soriano-Dionisio, Rowena. FATCA and It’s Impact on Institutions Regulated and Supervised by BSP. Ateneo Law Journal, 2013.

Internet Sources “Foreign Account Tax Compliance Act. Accessed January 3, 2018. https://www.irs.gov/businesses/corporations/foreign-account-tax-compliance-act-fatca.

“FATCA: Where are we now?.” Accessed January 3, 2018. http://www.bworldonline.com/content.php?section=Economy&title=fatca-where-are-wenow&id=115621.

“FATCA ADVISORY.” Accessed January 3, 2018. https://www.bir.gov.ph/index.php/international-tax-matters/fatca.html.

“Philippines (The): Foreign Investment.” Accessed January 3, 2018. https://en.portal.santandertrade.com/establish-overseas/philippines/foreign-investment.

“The impact of FATCA in the Philippines.” Accessed January 3, 2018. http://bworldonline.com/content.php?section=Economy&title=the-impact-of-fatca-inthe-philippines&id=112793.

“The Foreign Account Tax Compliance Act.” Accessed January 3, 2018. http://files.dlapiper.com/files/Uploads/Documents/FATCA-Alert.pdf.

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