THE CARROT & STICK APPROACH TO PARTICIPATION IN THE OVDI PROGRAM: IRS OFFSHORE COMPLIANCE AUDITS

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1 THE CARROT & STICK APPROACH TO PARTICIPATION IN THE OVDI PROGRAM: IRS OFFSHORE COMPLIANCE AUDITS By Richard J. Sapinski Sills Cummis & Gross P. C. Newark, NJ

2 Between February 2009 and early 2010, UBS provided initially 285 names of U.S. numbered account clients and ultimately an additional 4,450. In June 2011 IRS began audits of U.S. Taxpayers who had UBS accounts but did not come into the 2009 OVDI Many of these audits are STILL in progress In April 2011 IRS served a John Doe Summons on HSBC seeking the names of US Taxpayers with accounts at HSBC (India) IRS is reportedly now beginning audits on U.S. clients of Indian banks

3 Background In March 2009, IRS announced the 2009 Offshore Voluntary Disclosure Initiative ( 2009 OVDI ) through which U.S. customers of UBS or other foreign banks who had not been compliant could: 1. Avoid potential criminal prosecution and 2. Limit their civil exposure for unpaid taxes and penalties.

4 The 2009 OVDI Program Taxpayers who wished to participate in the 2009 OVDI had to: 1. Request pre-clearance from IRS-CI (to confirm the Taxpayer was not already under audit or investigation or known to IRS) 2. Provide a written submission (signed under penalties of perjury) to IRS-CI detailing the nature and extent of the Taxpayer s offshore activities.

5 3. Obtain IRS-CI Preliminary Acceptance of the case as a voluntary disclosure. 4. File 6 years of amended tax returns ( ) and 6 years of delinquent or amended FBARs ( ). 5. Fully pay the tax due on the Forms 1040X plus a 20% accuracy-related penalty on the tax plus interest. 6. Pay an FBAR-substitute penalty of 20% of the highest aggregate balance of the Taxpayer s foreign accounts (and/or other foreign assets) within the 6 year OVDI period.

6 Consequences of Non-Participation in 2009 OVDI IRS issued written guidance about the 2009 OVDI in which it warned Taxpayers that those who did not participate in the 2009 OVDI and either did nothing or attempted to do a quiet disclosure (file one or more years amended returns and FBARs without formally notifying IRS that the purpose was to correct offshore non-reporting) that IRS was actively attempting to identify them and, if caught, they would face possible criminal prosecution or, at best, would be subjected to intensive audit and face maximum civil penalties.

7 IRS Post 2009 OVDI Enforcement Efforts 2009 OVDI ended 10/15/09 with approximately 15,000 U.S. Taxpayers participating. IRS continued its offshore enforcement efforts in Switzerland and expanded them to other countries where it believes U.S. Taxpayers have maintained undisclosed accounts or assets in order to avoid or evade their U.S. tax obligations.

8 Subsequent IRS enforcement actions are known to have focused on accounts in: India Israel Lichtenstein Pacific Rim (Hong Kong, Singapore, etc.) IRS also has aggressively pursued small Swiss banks without U.S. offices which have been used by U.S. Taxpayers fleeing UBS or other major banks. Currently 14 foreign banks have either acknowledged being under investigate or have been identified in press reports as being under investigation.

9 IRS Reopens the OVDI Program IRS reopened the OVDI in 2011 for 8 months (2011 OVDI) and reopened it again indefinitely in January 2012 ( 2012 OVDI ) However, IRS reserved the right to close the 2012 OVDI to certain classes of U. S. Taxpayers without notice (including customers of certain banks or Taxpayers with accounts in certain countries) but to date has not done so.

10 Current OVDI Requirements The 2011 and 2012 OVDI Programs were more onerous than the original 2009 OVDI Program. 8 years of amended returns/fbars required (vs. 6 years in 2009 OVDI) FBAR-substitute penalty raised to 25% (2011) and then to 27-1/2% (2012) of highest value of offshore assets during the 8-year OVDI period (vs. 20% in 2009 OVDI). Nonetheless, an additional approximately 20,000 U. S. Taxpayers have participated in the 2011 and 2012 programs and the total collected by IRS to date through these programs exceeds $5 Billion.

11 IRS Efforts to Identify Non- Participating Taxpayers To validate the 2009, 2011 and 2012 OVDI Programs, IRS has aggressively sought to identify U. S. Taxpayers who should have participated but did not do so. o Once identified, the IRS has either opened a Criminal investigation of the U. S. Taxpayer (either in conjunction with the Dept. of Justice Tax Division or separately as an Administrative Investigation) or sent out audit notices to U. S. Taxpayers who IRS believes have not reported their foreign accounts or income.

12 The IRS has assigned both agents from the International Individual Compliance (IIC) Unit of the Large Business & International (LB&I) Division and specially detailed Revenue Agents from its regular Small Business/Self- Employed (SB/SE) Division to conduct audits of these U. S. Taxpayers

13 Sources of Information for IRS About Non-Participating Taxpayers Information Provided by Foreign Banks Pursuant Non-Prosecution or Deferred Prosecution Agreements Negotiated with the Tax Division of the Dept. of Justice (UBS) John Doe Summonses issued to either U.S. branches of foreign banks or their U.S. correspondent banks. (HSBC, Wegelin, Bank Frey, Zuricher Kantonal) Information Stolen by bank employees and sold to U.S. or other governments (LGT)

14 Information Provided by Foreign Bankers or Investment Advisors Negotiating Their own deals with the Justice Dept. (Credit Suisse) Suspicious Activity Reports filed by U.S. banks on unusual account activity by their Customers (foreign wire transfers, cash deposits being made to repatriate the money outside of OVDI)

15 How Do I Tell If The Audit Is Offshore-Related o o Audit letter appears routine and does not notify the Taxpayer of the nature/origin of the examination. However, the Initial IDR request is unusually detailed and asks that copies of all bank accounts for the year under audit as well as any financial statements or loan applications, AND the Taxpayer him/herself be at the first meeting.

16 TELLTALE INDICATIONS OF REAL ORIGIN OF THE AUDIT The IRS agent who sent the audit letter is from the IRS LB&I Division and the Taxpayer is not otherwise an LB&I Taxpayer (not a business with assets over $10,000,000). The agent is located outside New Jersey (California, Texas or Florida) but refuses to transfer the audit to New Jersey or explain why not. If a New Jersey SB/SE agent is assigned, the agent may be located in either Paramus or Fairfield, New Jersey but is auditing a Taxpayer elsewhere in the state. IRS Agent will insist on meeting and interviewing the Taxpayer and be willing to travel even from out of state to do so.

17 IRS will Summons the Taxpayer if the request for interview is not granted. IRS will request information for and examine years outside of the year stated in the audit letter. IRS agent will not (usually) explain why he/she must interview the Taxpayer, disclose the questions in advance, provide copies of what information IRS has nor even disclose (in most cases) that it has any information. o ask your client, he/she knows what he/she why he is being audited and knows what has or doesn t have that is responsive."

18 PUNITIVE PENALTY ASSERTIONS In many cases, IRS will assert civil fraud (75% of tax) penalties and maximum FBAR penalties (50%/year on that year s highest balance) based on the Taxpayer either admitting to having undisclosed foreign accounts or lying and denying having them ( damned if you do/damned if you don t).

19 Other Risks/Unique Features Possible criminal referral from auditor to IRS-CI. Required Records Doctrine being used by the Dept. of Justice to compel Taxpayers to produce foreign account records despite the obvious Fifth Amendment implications of doing so. IRS Rigid Attitude to Resolving the Audit in an Expeditious Way (Short of full Taxpayer concession of wrongdoing). IRS Counsel attorney working with the auditor in developing the case. Preparer Obligations and Potential Issues

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