IRS Offers to Ease Penalties for Taxpayers Who Disclose Their Overseas Accounts in the Wake of the Department of Justice’s Continuing Crackdown on the Use of Tax Havens1 April 14, 2009 Introduction Between the bailout and the economic stimulus, one thing is for certain - the U.S. government needs to re-fill its coffers and there is no better source of revenue than taxes. While an increase in tax rates is one of the more obvious ways the government is attempting to generate revenue, more recently, we have also seen a crackdown on tax evasion and the use of offshore “tax havens,” and an assault on countries with “financial secrecy” that “impose little or no tax on income from sources outside their jurisdiction.”2 The United States Senate Permanent Subcommittee on Investigations recently produced a staff report on “Tax Haven Banks and U.S. Tax Compliance” in which it estimated that the United States loses approximately $100 billion in tax revenues due to offshore tax abuses.3 Tax Justice Network, a non-profit group, estimates that the global tax revenue lost as a result of the use of offshore tax havens is over $250 billion.4 Thus, it is not surprising that in these difficult financial times, the United States and other governments are escalating criminal tax prosecutions and putting increasing pressure on tax havens to relax their secrecy laws and cooperate with investigations. This memorandum provides an overview of historical limitations on criminal tax prosecutions involving the use of offshore accounts in tax havens and recent 1 This memorandum was authored by Stephanie Meltzer, Patrick Pericak and Shelly Goldklang. Before joining Cadwalader, both Mr. Pericak and Ms. Goldklang were trial attorneys with the Department of Justice Tax Division Criminal Enforcement Section. 2 See Abusive Tax Avoidance Schemes - Talking Points, April 3, 2009, http://www.irs.gov/business/small/article/0,,id=106568,00.html. Tax havens developed in the late 19th century after several jurisdictions were granted economic governance independence from Britain. See Matt Woolsey and Elisabeth Eaves, Tax Havens of the World, March 16, 2007, http://www.forbes.com/2007/03/15/havens-international-tax-forbeslife- cx_mw_ee_0315taxhavens.htm. 3 See United States Senate Permanent Subcommittee on Investigations, Staff Report, Tax Haven Banks and U.S. Tax Compliance, July 17, 2008, http://hsgac.senate.gov/public/_files/071708PSIReport.pdf, noting that the estimate is derived from studies conducted by a variety of tax experts. 4 See Tax Havens Cause Poverty, December 2007, http://www.taxjustice.net/cms/front_content.php?idcat=2. This memorandum has been prepared by Cadwalader, Wickersham & Taft LLP for informational purposes only and does not constitute advertising or solicitation and should not be used or taken as legal advice for specific situations, which depend on the evaluation of precise factual circumstances. Those seeking legal advice should contact a member of the Firm or legal counsel licensed in their state. Transmission of this information is not intended to create, and receipt does not constitute, an attorney-client relationship. Confidential information should not be sent to Cadwalader, Wickersham & Taft LLP without first communicating directly with a member of the Firm about establishing an attorney-client relationship. developments that may ease some of the prior obstacles faced by the U.S. government. It then discusses the ramifications of some of the recent criminal tax prosecutions involving the use of offshore accounts as well as current initiatives underway to provide benefits to those individuals seeking to voluntarily regularize their tax situation. Historical Limitations on Tax Prosecutions Involving the Use of Offshore Accounts in Tax Havens Criminal Tax Charges The government has a wide range of charges at its disposal to prosecute tax crimes. Tax evasion is one of the more serious offenses commonly charged. A person is guilty of tax evasion if he or she willfully attempts to evade or defeat any tax or the payment thereof.5 See 26 U.S.C. § 7201. The offense is a felony punishable by up to five years in prison and $250,000 in fines.6 There are also civil penalties that can be imposed.7 Prosecutors often charge tax evasion when they can show that a taxpayer has either under reported or failed to report income and, as a result, substantially understated the amount of tax due and owing to the Internal Revenue Service (“IRS”). The government may also charge an individual with filing false tax returns under 26 U.S.C. § 7206(1), which only requires proof that the taxpayer intentionally falsified an item on the tax return. If more than one individual is involved in committing a tax crime, prosecutors will sometimes charge a taxpayer with conspiring to defraud the United States under 18 U.S.C. § 371.8 Finally, prosecutors can also charge a taxpayer with endeavoring to obstruct the IRS, under 26 U.S.C. § 7212(a),9 or 5 Tax evasion is to be distinguished from tax avoidance, or using lawful measures, such as deductions, to reduce tax liability. 6 Tax evasion is not currently an underlying predicate offense for money laundering charges in the United States, which are punishable by up to 20 years in prison. However, in March 2009, Senators Patrick Leahy and Chuck Grassley introduced a bill to expand the list of predicate offenses for money laundering to include all crimes punishable by more than one year in prison. See Fraud Enforcement and Recovery Act of 2009, S. 386, 111th Cong. (2009). 7 Under the Internal Revenue Code § 6663(d), if any part of an underpayment of tax is due to fraud, a penalty equal to 75% of the portion of the underpayment can be imposed. Under the Internal Revenue Code § 6662(b)(1)-(5)), an accuracy-related penalty of 20% can be assessed on the portion of the underpayment of the tax. 8 Each member of the conspiracy can be fined or imprisoned for up to five years or both. If the offense that is the subject of the conspiracy is a misdemeanor only, the punishment for such a conspiracy shall not exceed the maximum punishment provided for such a misdemeanor. Under 18 U.S.C. § 3571, the maximum fine is at least $250,000 for individuals and $500,000 for corporations. Alternatively, if any person derives pecuniary gain from the offense, or if the offense results in a pecuniary loss to another person, the defendant may be fined not more than the greater of twice the gross gain or twice the gross loss. 9 The offense established by both 26 U.S.C. § 7206(1) and 26 U.S.C. §7212(a) are felonies punishable by up to three years in prison, or fines, or both. Under 18 U.S.C. § 3571, the maximum fine is at least $250,000 for individuals and $500,000 for corporations. Alternatively, if any person derives pecuniary gain from the offense, or if the offense results in a pecuniary loss to another person, the defendant may be fined not more than the greater of twice the gross gain or twice the gross loss. Cadwalader, Wickersham & Taft LLP 2 willfully failing to file, supply information required, or pay any estimated tax, which is a misdemeanor offense under 26 U.S.C. § 7203.10 Historical Limitations on Prosecution Although prosecutors have many tools available to charge individuals with tax crimes, historically, criminal tax prosecutions involving the use of offshore accounts in tax havens have been difficult for the U.S. government to pursue, primarily because the funds and evidence are located overseas in jurisdictions with strict bank secrecy laws. While there are various means available to U.S. law enforcement to obtain foreign evidence and international assistance in criminal tax cases, in the past, these means have been restricted. For example, one of the more common ways to gather foreign evidence is through requests made pursuant to Mutual Legal Assistance Treaties (“MLATs”). An MLAT is basically an agreement between two countries for the purpose of gathering and exchanging information in an effort to enforce criminal laws. As of August 1, 2008, the United States had MLATs with over fifty countries and more are pending.11 However, while many of the MLATs cover all criminal tax felonies, several MLATs contain restrictions regarding assistance for tax offenses, especially MLATs which the United States has entered into with tax havens. As a result, the information that the United States can request and obtain in criminal tax cases is sometimes limited because of the way certain countries define tax crimes. For example, Liechtenstein entered into an MLAT with the United States in 2002 in which it agreed to participate in tax information exchanges in criminal investigations and proceedings. However, the investigations in which Liechtenstein will provide information are limited because it has defined tax evasion as the “intentional use of false, falsified or incorrect business records or other records, provided that the tax due . is substantial.”12 The Cayman Islands and Bahamas similarly limit the information that they will provide as the MLATs that they have entered into generally contemplate information exchanges only in tax matters arising from unlawful activities otherwise covered by the MLATs. In addition, their MLATs contain specific limitations which prohibit evidence that has been obtained under the MLATs in connection with other specified offenses from being used in tax cases.13 10 The penalties include a fine or imprisonment of up to one year or both. The maximum permissible fine is at least $100,000 for individuals and at least $200,000 for organizations. 11 See United States Department of Justice Criminal Tax Manual, http://www.usdoj.gov/tax/readingroom/2008ctm/TaxManual2008.htm 12 See United States Senate Permanent Subcommittee on Investigations, Staff Report, Tax Havens and U.S.