Texas investors, Sam and Charles Wyly amassed vast wealth from various investments and business ventures including those in technology, restaurant and retail industries. The Wyly’s financial affairs had been under close scrutiny from the Inland Revenue Service (“IRS”) and the Securities Exchange Commission in the US for a number of years. These inquiries were brought to a head when Sam Wyly and the widow of the deceased Charles Wyly, Caroline “Dee” Wyly, filed for bankruptcy in 2014. Their bankruptcy came about as a result of an 2010 enforcement action for federal securities law violations and claims from the IRS for some $3.22 billion in taxes, penalties and interest (which was later reduced by the IRS to $1.43 billion from Sam Wyly and $834.2 million from Caroline Wyly) both arising from transactions involving some 16 offshore trusts and 38 offshore corporations.

In an opinion issued earlier this year, US bankruptcy judge, Barbara Houser found that the Wyly brothers had engaged in tax fraud (although she ruled that Caroline Wyly was innocent of wrongdoing under the so-called innocent spouse defense). Houser’s opinion is some 459 pages long and addresses many issues, inaccuracies and inconsistencies in the establishment and operation of the offshore structure and the Wyly’s own reporting in the US. Two key elements contributed to Houser’s finding that the brothers had committed tax fraud, which are of particular importance for offshore trustees:

1. The unnecessary complexity of the structure

The Court easily determined that the “heart of the Wyly offshore system had been established through deceptive and fraudulent actions”. Houser cited many examples of transactions involving the myriad of offshore structures which involved numerous unnecessary steps with no economic substance.

With “little legitimate business explanation” for the complexity of the offshore system, the Court inferred that the primary reason for this system was to make it impossible for anyone, including the court, to unravel and understand.

2. The use of the offshore system as a “personal piggy bank”

Houser commented that “no money or assets moved within that system without Sam Wyly’s knowledge and express direction.”

The Court found that the trustees unquestioningly adhered to the Wyly brother’s requests to purchase assets for the family’s personal use using “offshore money”. The Court found that this was a clear indicator that the Wyly family considered the “offshore system to be their personal piggy bank, through which they could purchase items using offshore money on a tax-free basis”.

What should trustees with US beneficiaries take away from this?

  • Structures should be kept as simple as possible avoiding any unnecessary complexity for which there is no legitimate business reason.
  • Trustees should ensure that they exercise their discretion independently and do not simply adhere to the wishes of beneficiaries or settlors without question.
  • It is highly likely that the IRS was able to put together a strong case against the Wyly brothers due to the financial information they had received from financial institutions in the Isle of Man under FATCA and IGAs in place between the US and various countries around the world. This judgment highlights the scope of the information disclosed to the US Government and the IRS’s powers to enforce historic tax liabilities with heavy interest and penalty payments attached.