Local banks have little choice but to comply with a controversial law that requires financial institutions around the world to hand over information about American citizens that will be passed on to the US tax department, the New Zealand Bankers' Association says.

The US Foreign Account Tax Compliance Act (FATCA), which will be phased in from July 1, aims to crack down on tax avoidance by US citizens who have financial accounts outside the United States.

The association said an amendment of this country's Tax Administration Act, passed yesterday, meant New Zealand financial institutions were now required to collect information to determine whether a client was a US citizen and if so disclose information on that customer to the Inland Revenue Department (IRD), which would in turn be passed on to the US Internal Revenue Service (IRS).

"Our banks and New Zealand have little choice but to comply with FATCA," said Bankers' Association chief executive Kirk Hope. "Not complying could see banks penalised by a 30 per cent withholding tax on principal and income from investments in the United States. US capital markets provide much of the funding most banks need to lend to New Zealand households and businesses. So there would be a huge impact on our economy if we didn't comply."


He said complying with FATCA also meant local banks could continue to provide services to US citizens and residents who have New Zealand bank accounts.

"We commend the Government for its efforts in negotiating an IGA [inter-governmental agreement] that secures a number of New Zealand-specific exemptions and does its best to protect New Zealanders' interests."

FATCA, unsurprisingly, is unpopular with many US ex-pats, with critics labelling the act a violation of constitutional protections and a form of punishment for Americans working abroad.

The US and Eritrea - a tiny nation in the Horn of Africa - are the only countries that tax their citizens' world-wide income, no matter where they live, according to the Wall Street Journal.

The law is also reciprocal, meaning information about Kiwis' financial affairs in the US could be handed over to New Zealand's IRD.

Critics of FATCA say this could threaten America's economy by scaring off foreigners who may have otherwise invested in the US.