Jackie Bugnion is an American citizen who has lived in Switzerland for 45 years. She had two securities accounts in her adopted country but in the spring she was told that she should find another home for her money. This summer those accounts were moved into SEC-regulated subsidiaries. "I call them the 'American ghettos'," she says. These subsidiaries are subject to higher fees and higher minimum investments than normal accounts. "It makes you feel toxic when this happens to you after you have been the client of a bank for years," says Ms. Bugnion.

American expatriates are fast becoming the world's financial refugees. Onerous legislation from the U.S. government is making it too difficult – and too expensive – for banks to service U.S. citizens that live abroad. Expats are being left with a fast diminishing range of options. An increasing number are taking the most drastic step and renouncing their citizenship.

So far the latest rules have drawn little comment. US expats don't have much political influence as their votes are spread across their native country. And the law is popular domestically because it is seen as way of cracking down on tax-dodgers. Slowly, however, bankers, lawyers and accountants are waking up to the wider implications of the new rules. American expats, it seems, may only be the first to suffer.

 

Barack Obama signing a new law

The U.S. government – under a new law incorporated in the Hiring Incentives to Restore Employment Act signed by President Barack Obama on 18 March 2010 – is demanding that international financial institutions reveal which of their clients are U.S. citizens with accounts of more than $50,000. Foreign banks are, in effect, being asked to act as the international enforcement arms of the Internal Revenue Service. Those banks that don't comply will be subject to a 30% withholding tax on all payments made to them in the U.S. Many banks and wealth managers have decided it is far easier to politely show their U.S. clients the door.

Earlier this month, the law firm Withers conducted a survey of bankers, accountants, independent financial advisers, trust companies and other private client advisors to analyze the impact of the HIRE Act. Over half said they have seen instances where Americans were denied investment and banking services in the last two years. And 95% expect this to increase as a result of the HIRE Act.

David Treitel, a tax director, at U.S. Tax & Financial Services, said that at least 20% of the American customers serviced by his company's London and Swiss offices have had their bank accounts closed over the past year.

The Hire Act is only the latest in a raft of different laws aimed at American expats, American residents with off-shore accounts and the institutions that service both groups. Jay Krause, a partner at the law firm Withers, says: "The difficulties that American expats face predates the HIRE Act. But the new law will take it to a whole new level. I think that it is the most remarkable piece of tax legislation ever enacted."

The U.S. government already taxes expatriate citizens on their worldwide income regardless of where it is earned or where they live, making them the only people in the developed world who are taxed in both their country of citizenship and country of residence. Many expats complain that these rules are getting tougher and the penalties more draconian by the year.

 

Paul Hocking, chairman of Frank Hirth, an accountancy firm that specializes in the interaction between UK and U.S. tax regimes, says there has been an explosion in the time it takes us to keep U.S. expat clients compliant with the U.S. tax regime. He says that their bills have "at least doubled" in the past couple of years.

But the HIRE Act is a whole different ball game – the law effectively requires foreign banks to police their own customers. Mr. Hocking believes the genesis of new law lies in the issues the U.S. authorities uncovered in its long-running tax evasion fight with the Swiss bank UBS. Last year, UBS paid a $780 million settlement to the IRS and admitted to helping clients conceal their identities from U.S. tax authorities in order to hide money offshore.

"But that was mostly people living in the U.S.," says Mr. Hocking. "However, the people bearing the brunt of the new law are U.S. expats. They are the least appropriate targets as they are already paying tax in the country in which they are resident."

Provisions in the HIRE Act are meant to close loopholes in the 2001 Qualified Intermediaries agreement, which charged a withholding tax on "U.S. persons" unless they made full disclosure to the qualified intermediary. The difficulty for the banks was the lack of clarity on the definition of a "U.S. person".

"Sadly, it is entirely unclear who actually counts as a U.S. person and who does not," according to an investment commentary published by Wegelin & Co, a Swiss private bank, before the HIRE Act was signed.

 

A number of banks decided that the concept of U.S. citizenship was too nebulous for them to police. Darlene Hart, the chief executive of U.S. Tax & Financial Services says that when the rule came out in 2001 many of her U.S. clients received letters from their wealth managers telling them that their investment portfolios had been liquidated.

Now a second wave of banks – especially in Switzerland but increasingly in the UK and the Channel Islands – are closing their doors to Americans because of the added burden of the HIRE Act. James Sellon, co-founder of wealth manager Maseco Financial, which specializes in servicing American expatriates in Europe, says: "It's fair to say that most, if not all, medium-sized brokers in the UK are conducting a review of their U.S. client policy."

What then are U.S. expats to do if even more banks cut them adrift as a result of those reviews?

A small but growing number have decided that the best way to avoid the rules is to hand in their passports. According to U.S. government figures, twice as many Americans renounced their citizenship in the last quarter of 2009 than in the whole of 2008. The numbers are still only in the hundreds but are expected to rise now that the HIRE Act has been signed. Ms. Hart says the last time she checked it was not possible to get an appointment at the U.S. embassy in London to renounce citizenship until 2012. In Bern, you couldn't get an appointment until June next year.

Jeffrey Gould, associate director at Frank Hirth, says: "Renouncing citizenship is the nuclear option. But it is one that an increasing number of people are considering. Lots of people are coming to us and asking for advice on whether their children should renounce their citizenship. It is a very emotionally-charged decision."

Those that don't want to take such a drastic step can move their investments back to the U.S. However, this can be tricky without an address in the U.S. because of the Patriot Act, which tightened up the procedures by which banks verify their clients' identities. It also means that the investments will be tied to the dollar rather than the currency of the country in which the expatriate lives.

Mr. Krause says: "We're likely to see a scenario in which U.S. expats are encourage – or forced, depending on your point of view – to use U.S. banking affiliates abroad. They will have options but nowhere near the same range of options as everyone else."

Business Opportunity

Some boutique advisers have started to realize that if everyone else is shunning Americans it creates a business opportunity for them. Mr. Sellon says: "There are a few US-compliant entities like us springing up across Europe but they are few and far between. Many American expats don't want to be tied to the dollar and they don't think the international investment arms of U.S. wealth managers have a global enough approach."

For some, these issues may just sound like the complaints of rich Americans. Many will conclude that the U.S. authorities are entirely within their rights to ensure that all their country's citizens pay the full amount of tax for which they are liable.

But, although it is the U.S. expats that are suffering the most at the moment, the impact of the new law could eventually be felt far more widely. The banks that sign up to the new rules are likely to pay for the required upgrades to their systems by increasing the bank fees for their rest of their customers.

And eventually the reverberations from the HIRE Act may also be felt back in the U.S. The legislators have based the rules on the assumption that the withholding tax will be so onerous that all foreign financial institutions will be forced to comply. But implicit in that assumption is the belief that all foreign investors want to – and will always want to – invest in the U.S. But what if that proves to be a miscalculation?

Mr. Krause, who is American, says: "The law is reasonably well intentioned. But what do they say about the path to hell? This law is going to have significant unintended consequences. Yes, it is going to give U.S. expats problems. But it will also engender immense ill will towards the U.S. because it rides roughshod over existing tax treaties, it will cost hundreds of millions in compliance and it could well discourage investment into the U.S."

Nearly three-quarters of respondents to the Withers survey said they expected to see investment into the U.S. decrease in the coming years because of the HIRE Act. Wegelin & Co. is, for one, advising its clients to exit all direct investments in U.S. securities: "We do not deny that by doing this, we hope to significantly reduce the risk carried by our bank as an intermediary."

Ms. Bugnion, who sits on the executive committee of American Citizens Abroad, a Geneva-based lobby group of U.S. expatriates, says: "The US government is assuming that this is a big enough stick to force everyone to comply. But these banks don't have to trade in the U.S.; there are lots of other investment opportunities out there.

"It is a sign of total arrogance on the part of the U.S. to feel it can impose its rules on the rest of the world."

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