A federal court has ruled that U.S. banks must report to foreign governments on the holdings of nonresident alien account holders under the intergovernmental agreements that the Treasury Department has signed with other countries’ tax authorities in an effort to implement the Foreign Account Tax Compliance Act.

FATCA, which was included as part of the HIRE Act of 2010, requires foreign financial institutions to report on the holdings of U.S. citizens and residents to the Internal Revenue Service or else face stiff penalties, to combat offshore tax evasion. To overcome the objections of foreign countries and banks to the law, the Treasury has been negotiating a series of intergovernmental agreements with officials from abroad to provide reciprocity of reporting, so U.S. banks would report on the holdings of foreign citizens and residents to their respective tax authorities. As part of that effort, the IRS issued regulations in 2012 requiring U.S. banks to report the amount of interest earned by accountholders residing in foreign countries.

The Florida Bankers Association and the Texas Bankers Association challenged those reporting requirements in a lawsuit last year against the Treasury Department, alleging that the regulations violated the Administrative Procedure Act and the Regulatory Flexibility Act. They argued that the IRS regulations would cause far more harm to the banks than anticipated, leading to “capital flight” by nonresident aliens from U.S. banks to banks abroad.

In a decision Monday, Judge James E. Boasberg of the U.S. District Court for the District of Columbia—the same judge who ruled last year that the IRS had exceeded its statutory authority in imposing testing and continuing education requirements on tax preparers—in this case ruled in favor of the Treasury and the IRS.

“Because the Service reasonably concluded that the regulations will improve U.S tax compliance, deter foreign and domestic tax evasion, impose a minimal reporting burden on banks, and not cause any rational actor—other than a tax evader—to withdraw his funds from U.S. accounts, the Court upholds the regulations and grants the government’s cross-motion for summary judgment,” he wrote.

Boasberg noted that “reciprocity is the key to success” in tax treaties. “If the United States does not gather and report tax information for foreign accountholders, then other countries have little incentive to provide us with similar information,” he wrote.

He pointed out that long before the IRS issued the 2012 regulations, it had required banks to report the interest earned by at least some nonresident aliens, specifically Canadian citizens. The government proposed to extend the reporting requirements to nonresident aliens from all countries in 2001, but the proposal was never enacted.

The judge dismissed the arguments of the bankers associations, claiming that there was no evidence to support the notion that banks have systems in place to report on earned income.

“Because reporting requirements for U.S. and Canadian residents have been on the books for years, however, it was reasonable for the IRS to conclude that banks do have systems in place that allow them to comply with those requirements—especially since many are required to file their forms electronically.”

The bankers associations also argued that the IRS had overestimated the number of banks affected, but Boasberg did not find that argument convincing either. “Of course, the IRS’s decision did not rest on the number of banks implicated, which it acknowledged was substantial,” he wrote. “Even if the IRS were wrong, though, a smaller number of banks affected would only bolster the conclusion that an RFA analysis was not required here. The 2012 reporting requirements therefore complied with the RFA.”

He also dismissed the argument that the IRS had failed to take capital flight into account when promulgating the rules.

“To begin with, it is not even clear that capital flight is the sort of impact the IRS is required to analyze under the RFA [Regulatory Flexibility Act],” he wrote. “In general, the RFA calls for agencies to scrutinize only the regulations’ direct impact, such as ‘reporting, recordkeeping and other compliance requirements’—not indirect impacts caused by the actions of third parties like capital flight.”

In addition, the judge rejected the banks’ arguments that the regulations did not comply with the Administrative Procedure Act and would lead to capital flight as accountholders withdrew their funds en masse from U.S. banks. “Of course, there is another potential driver of capital flight,” he wrote. “If some of the banks’ customers are tax evaders, they would clearly have an incentive to withdraw their funds as a result of the new regulations,” he wrote. “Leaving the undisclosed funds in American banks might have unfortunate consequences in their homelands for those accountholders.”

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