On August 11, two women filed a lawsuit against the federal government claiming that certain legislation enacted in response to the Foreign Account Tax Compliance Act (“FATCA”) is unconstitutional. The case has potentially far-reaching effects for the estimated one million American and dual U.S.-Canadian citizens who reside in Canada.

By way of background, FATCA was enacted in March 2010 and obligates U.S. payors to withhold 30% of payments made to foreign financial institutions (“FFIs”) unless the FFI discloses certain information regarding the recipient accountholder. This information can include the accountholder’s name, SSN or SIN, and residential address.

In February 2014, Canada entered into an intergovernmental agreement (the “IGA”) which alleviates certain of the more onerous aspects of FATCA. For example, the IGA provides that certain accounts are exempt from being reported on, recalcitrant accounts are not subject to immediate closure, and certain smaller FFIs are not subject to the reporting requirements at all. A previous blog piece – “Big Brother Gains a Powerful New Tool” (found here) – discusses the IGA in more detail.

By the lawsuit, the plaintiffs effectively argue that the IGA and the domestic legislation implementing it (the “Impugned Provisions”) are unconstitutional. The plaintiffs claim that the Impugned Provisions violate the Constitution Act, 1867, unwritten constitutional principles (including the principle of Canadian sovereignty), and the Charter of Rights and Freedoms (the “Charter”).

Whether the IGA is constitutional has been the subject of considerable debate recently. Indeed, in December 2012 Professor Peter Hogg (one of Canada’s leading constitutional experts) sent a letter to the Department of Finance alleging that the model intergovernmental agreements promulgated by the IRS at that time would (if implemented) unjustifiably violate the Charter. The IGA is based largely upon the Model 1 version analyzed by Professor Hogg.

The lawsuit essentially asks the Court to declare all of the Impugned Provisions unenforceable. The result of such a declaration, however, could have disastrous consequences. Without the IGA, the full force of FATCA could be felt, meaning that Canadian financial institutions would be required to report directly to the IRS or else be subject to the full 30% withholding tax. It could also mean, among other things, that more accounts (e.g., RRSPs and TFSAs) will become reportable accounts. In short, FATCA itself will continue to exist without or without the IGA.

If the plaintiffs are successful, there are several remedies available to the Court ranging from severing or reading down certain of the Impugned Provisions, to declaring the offending statutes invalid and issuing an injunction against the Canada Revenue Agency from complying with the IGA. Alternatively, the Court could side with the plaintiffs but delay the enforcement of its decision for a reasonable period of time to allow a new, more narrowly-drafted IGA to be signed with the U.S. It would not be surprising if the case eventually reaches the Supreme Court of Canada.

One of the plaintiffs’ claims is that by entering into the IGA, “Canada is forfeiting its sovereignty by facilitating the extra-territorial taxation of Canadian citizens by [the United States].” A serious allegation and one that goes to the core of the Canadian identity.