Until recently, many of us seldom heard of Tax enforcement arrests and the failure of reporting obligations by well-known transnational companies and high net worth individual tax payers. Ever wondered why this has become a hot topic these days? Does this have anything to do with the economy, the recession, the US budget deficits or the humongous debt? Absolutely! Internal Revenue Service is aiming at decreasing the tax gap, which is the difference between what tax payers owe the government and what is actually collected. Currently it is estimated that the tax gap is at $345 billion or more and if this gap is reduced, it will contribute to reducing the projected $1.6 trillion deficit. Internal Revenue Service has requested $13.3 billion in the FY 2012 budget and is expected $6 billion will go towards enforcement activities. Tax analysts agree that for every dollar invested in enforcement, the Treasury nets by about four to five dollars in additional revenue.
As we are aware, different Countries or jurisdictions have different tax rates. Tax payers in countries with a higher tax-bracket – like the United States, often look upon lower tax rate countries as what is come to be referred to as a ‘Tax Haven’. Making the headlines for such shoring of tax dollars, are among others – the Cayman Islands, Jersey, British Virgin Islands, Isle of Man, Mauritius, Liechtenstein and others. From a study conducted by the U.S. Government Accountability Office in 2008, to help Congress better understand the nature of U.S. persons’ business activities in Cayman Islands, it was gleaned that one four storied building had 18,857 registered entities. Very few of these had actual physical presence in the Cayman Islands. These arrangements and similar evasive techniques left undetected or unchecked, have contributed to the huge tax gap and in turn, a need for higher enforcement.
In February 2011, the Internal Revenue Service announced the Offshore Voluntary Disclosure Initiative (OVDI) – similar to the 2009 Offshore Voluntary disclosure Program (OVDP). The penalties are 25% on OVDI as compared to the 20% under the OVDP. These penalties are less than the 50% penalty that the IRS otherwise imposes, beside criminal tax fraud prosecutions. The OVDI is the second opportunity that the IRS has offered Taxpayers with foreign accounts. Clearly, the IRS is moving beyond UBS and Switzerland to other banks in other countries. India appears to be a focus.
There has been an increased effort towards international transparency with the protocols to the income tax treaties, Tax Information Exchange Agreements (TIEA), Mutual Legal Assistance Treaty (MLAT) etc. For Example, Liechtenstein has shown its initiative by signing multiple tax treaties with other countries including United States. Some treaties or agreements signed may have a retrospective effect. For example, Appendix 8 of the TIEA signed between Liechtenstein and United States, states “Although the Agreement allows only for requests for information with regard to tax years beginning on or after January 1, 2009, the Agreement provides for exchange of documents or information created in or derived from a date preceding January 1, 2009, that are foreseeable relevant to a request relating to tax years beginning on or after January 1, 2009. Such information may be used only if there is an ongoing investigation or examination with respect to a tax year that begins on or after January 1, 2009. For example, if assistance is requested with respect to a taxpayer’s bank transactions occurring after December 31, 2008, and documents such as, but not limited to, a signature card for the account in question were executed prior to January 1, 2009, the parties would exchange the documents.” With this, if the United States were to obtain a signature card of the account holder who had opened an account many years ago, it may have enough evidence to proceed with further investigation.
The Foreign Account Tax Compliance Act (FATCA), enacted in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act, is an important development in U.S. efforts to combat tax evasion by U.S. persons holding investments in offshore accounts. Under FATCA, U.S. taxpayers holding financial assets outside the United States will report those assets to the IRS. In addition, FATCA will require foreign financial institutions to report directly to the IRS certain information about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest.
It is evident that the US government is sending a message to the taxpayers that every effort is being taken to investigate and prosecute noncompliant taxpayers liable to tax in US. In 2009, Internal Revenue Service prosecuted Swiss Bank UBS; followed by HSBC in 2010, which has been a target for criminal fraud investigation by the Department of Justice. The substantial presence of these major banks in US makes them vulnerable to investigation. In February 2011, four Credit Suisse bankers were indicted in the US for assisting US taxpayers to hide income from the IRS. Further, the information received from the LGT bank in Liechtenstein led to many prosecutions of Germans for tax fraud. This information is expected to have been exchanged with India, United States and other Countries.
Among the reporting obligation as stated in the table below, Report of Foreign Bank and Financial Accounts (FBAR) is being most talked about. So who must file an FBAR?
United States persons are required to file an FBAR if:
- The United States person had a financial interest in or signature authority over at least one financial account located outside of the United States; and
- The aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year to be reported.
United States person means United States citizens; United States residents; entities, including but not limited to, Corporations, Partnerships, or Limited Liability companies created or organized in the United States or under the laws of the United States; and trusts or estates formed under the laws of the United States.
FBAR filing now applies to foreign annuity policies and foreign life insurance policies that are owned by US taxpayers and to some beneficiaries along with US Grantors of foreign trusts. FBAR is due by June 30th of the year for previous calendar year.
Some of the filing requirement and the associated penalties are listed below:
| Filing requirement | Penalty | |
| 1 | A penalty for failing to file the Form TD
F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR”) |
$100,000 or 50% of the total balance of
the foreign account per violation |
| 2 | A penalty for failing to file Form 3520,
(Annual Return to report transactions with foreign trusts and receipt of certain foreign gifts) |
35% of the gross reportable amount |
| 3 | A penalty for failing to file Form 3520-A
(Information return of foreign trust with a US owner) |
5% of the gross value of trust assets |
| 4 | A penalty for failing to file Form 5471,
(Information Return of U.S. Persons with Respect to Certain Foreign Corporations) |
$10,000, with an additional $10,000
added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return |
| 5 | Penalty for failing to file Form 5472 (Information
return of a 25% foreign-owned US corporation or a foreign corporation engaged in a US trade or business) |
$10,000, with an additional $10,000
added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency |
| 6 | A penalty for failing to file Form 926
(Return by a US transferor of property to a foreign corporation) |
10% of the value of the property transferred,
up to a maximum of $100,000 per return |
| 7 | Possible criminal charges related to tax
Returns include tax evasion (26 U.S.C. 7201), filing a false return (26 U.S.C. 7206(1)) and failure to file an income tax Return (26 U.S.C. 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. 5322 |
A person convicted of tax evasion is
subject to a prison term of up to five Years and a fine of up to $250,000. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000 |
| Source: Internal Revenue Service |
Conclusion:
So, is it illegal to own a foreign bank account, foreign trust or foreign corporation?
It really boils down to tax avoidance vs. tax evasion. It’s not illegal to have a foreign investment or structuring a transaction to mitigate tax impact. This could be achieved by effective tax planning. Many major corporations like Google, Microsoft, Pfizer, Lilly, Oracle and Facebook save billions of dollars in taxes by having structured their businesses in a multitude of countries. These have been approved by IRS and these corporations have legitimately minimized their tax liability. These corporations are required to follow regulations, disclose information, and file returns as required by law. They have been successful in their effort to avoid taxes. However, what we have seen with the recent investigations in UBS, HSBC, Credit Suisse is that tax evasion is apparent by not reporting the transactions that may have been subject to tax. With the increased transparency, decreased bank secrecy and higher enforcement, it’s important to be proactive with the reporting obligation and emphasize on tax risk management.
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