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March 2009 |
Schiff Hardin Tax Alert By Robert E. Kolek and Thomas R. Wechter Fine chocolate, precision timepieces and bank secrecy are three things for which Switzerland has been noted. That changed significantly on February 18, 2009, when UBS AG, Switzerland's largest bank, entered into a Deferred Prosecution Agreement with the Department of Justice (DOJ) pursuant to which UBS agreed to pay $780 million to the United States and to disclose the names of between 250-300 of its U.S. clients that had maintained secret accounts at UBS. Historically, the reasons for the maintenance of foreign bank accounts have been varied. Frequently, accounts were established many years ago with tax-paid legal funds. In some instances, the accounts were associated with World War II and the Holocaust, as a remnant of the "Cold War," or because of deep distrust of the central government. In more extreme cases, the party establishing the account may have engaged in a complex tax avoidance scheme. In early 2008, an employee of a Swiss trust company provided authorities with a stolen list of customers of Swiss banks who were maintaining secret bank accounts. Shortly thereafter, a private banker who had been employed by UBS pleaded guilty to U.S. offenses and agreed to cooperate in a wide-ranging Justice Department investigation of U.S. taxpayers' use of secret foreign accounts. In furtherance of its investigation, in the spring of 2008, the IRS served a "John Doe" summons on UBS seeking production of records relating to U.S. citizens who were maintaining bank accounts at UBS. The management of UBS initially agreed to comply, and it was reported that the names of approximately 20,000 individuals would be released by UBS to the IRS.1 Then, in December of 2008, it was reported that the DOJ had expanded its investigation into offshore tax evasion to include Credit Suisse of Zurich and HSBC, Europe's largest bank. This occurred shortly after the DOJ unsealed an indictment charging a senior executive of UBS with conspiring to defraud the U.S. by aiding in the concealment of American clients' taxable assets. This issue has now been elevated to the highest level by Congress and the new administration.2 Pursuant to the Deferred Prosecution Agreement, UBS is required to pay to the U.S. $780 million to disgorge itself of profits from maintaining its U.S. cross-border business from 2001 through 2008, and for backup withholding tax required to be withheld by UBS with respect to disclosed accounts during that same period. More important, consistent with an order issued by the Swiss Financial Market Supervisory Authority, UBS is to provide to the U.S. the identities and account information of between 250 and 300 U.S. clients that had maintained secret accounts at UBS. A failure of UBS to comply with the Agreement could lead to criminal prosecution of UBS. Following on the heels of this Agreement, the DOJ has sued UBS in the U.S. District Court for the Southern District of Florida to enforce the John Doe summons served in early 2008. The DOJ is seeking to obtain access to what is described as an additional 52,000 accounts (involving over $14 billion in cash and securities) belonging to U.S. clients that the DOJ claims did not disclose their accounts, in violation of U.S. tax laws. Joined by the Swiss government, UBS is resisting the enforcement action claiming that further disclosures would violate Swiss banking secrecy laws and constitute violations of the treaty between the U.S. and Switzerland. With respect to the 250-300 names of U.S. taxpayers that were disclosed under the Deferred Prosecution Agreement, it is believed that many of the account holders have most likely already come forward in an effort to avoid prosecution. For those among the disclosed names that have not come forward, it may be too late in the process to attempt to "make a deal" with the IRS, now that the U.S. is armed with facts to prosecute them. In this uncertain environment, individuals who maintained an as-yet undisclosed Swiss or foreign account will be seeking advice on how they can cure failures to report in prior years before they are contacted by the IRS, the DOJ or some other U.S. agency. Whatever the reason for the use of a secret foreign account, the situation is ripe for being "cleansed" under the IRS' voluntary disclosure policy. It may even be possible for someone who engaged in tax fraud to avoid criminal sanctions by filing amended returns before the IRS (or another governmental entity) begins an investigation that leads to a discovery of the fraud. Because of the potential adverse consequences, however, such action must be taken with utmost care and only after full and complete analysis of the facts. The IRS has in place a voluntary disclosure policy that is available to taxpayers who have legal sources of income and want to clear their legal obligations with the government. Under the policy, voluntary disclosure is considered along with other factors in determining whether a criminal prosecution will be recommended. And although voluntary disclosure creates no substantive or procedural right for taxpayers, because the IRS has limited resources and seeks to encourage taxpayers to voluntarily comply, it would be rare for the government to criminally prosecute a taxpayer who otherwise meets the requirements of the policy. In addition to the requirement that the taxpayer has a legal source of income, the policy requires that the disclosure be truthful, timely and complete, and that the taxpayer exhibits a willingness to cooperate with the IRS in determining the taxpayer's correct tax liability and makes good faith arrangements to pay the amount of tax, interest and penalties due. In addition to filing amended tax returns, every person making a voluntary disclosure with respect to an offshore account will have to file a foreign bank account report (FBAR) for each of the open years with respect to those accounts. The FBAR requires U.S. taxpayers with a financial interest or authority over a foreign account that exceeds $10,000 at some time during the calendar year to submit an information report for the year. Failure to file the FBAR is a criminal offense, with civil penalties up to 50% of the account balance for each year that a report was not filed. Thus, failure to file the FBAR for more than a year will result in penalties equal to the entire balance of the account. If a holder of a foreign account was required to file FBARs for earlier years but did not, the delinquent FBARs should be filed with the voluntary disclosure and a statement attached explaining why the reports were filed late. No penalty will be assessed if the IRS determines that the late filings were due to reasonable cause. When deciding whether to make a voluntary disclosure, the taxpayer will have to consider the economic consequences of the FBAR penalty, since it could exceed the account balance. At present, the IRS has not announced any initiatives to encourage voluntary disclosures with respect to offshore accounts. The making of a voluntary disclosure is a matter of judgment. It is not a guarantee, but a practice that creates no substantive or procedural rights. It is merely a mitigating circumstance in the IRS' determination as to whether to recommend prosecution or not. A voluntary disclosure should be made only after it is determined that the taxpayer is not already the subject of an investigation. Given the speed at which events dealing with UBS, Credit Suisse, HSBC and other foreign banks are developing, and since a taxpayer's name may be discovered by the enforcement of the John Doe summons against UBS or in the Congressional hearings, it would be prudent for affected taxpayers to begin the process of determining whether the voluntary disclosure policy is available and appropriate for their particular circumstances. As IRS Commissioner Shulman forewarned, "having the IRS find you could mean a much heavier price than coming forward on your own." If you have questions regarding the current IRS/DOJ investigation into secret foreign bank accounts and whether the voluntary disclosure policy could be of benefit, please contact Robert E. Kolek at 312.258.5755 or Thomas R. Wechter at 312.258.5756. ABOUT SCHIFF HARDIN LLP Schiff Hardin's tax attorneys handle all manner of federal, state and local tax controversies, at the audit and administrative appeals levels and in tax litigation, as well as advising clients in connection with disclosure and tax penalty mitigation. We also represent taxpayers in connection with actual or potential criminal tax investigations. Our tax attorneys also advise clients on the federal, state, local and foreign tax aspects of their business and investment activities including the structuring of complex business transactions, business combinations, financing transactions, joint ventures, private equity and investment funds. We also assist in the implementation of affirmative tax planning opportunities such as the award of equity-based compensation, tax-deferred exchanges and maximizing the use of foreign tax credits. We also counsel businesses in connection with FIN 48 tax disclosure issues. For more information, please feel free to contact us. 1 UBS has since changed its position and, as indicated later, is now engaged in litigation over the disclosure of the list of names. 2 See Report of the United States Senate, Permanent Subcommittee on Investigation "Tax Havens and U.S. Tax Compliance," July 17, 2008. |