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 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 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

Perhaps one of the most restrictive MLATs is the agreement with Switzerland. In addition to limiting the use of information obtained thereunder in tax cases, the MLAT generally excludes tax and other fiscal offenses from its scope, except in cases involving organized crime or “tax fraud,” narrowly defined under Swiss law as conduct involving forged or falsified documents or documents that have been falsely completed.14 As such, historically, no government has been able to obtain information about Swiss bank accounts when investigating tax crimes that do not require a showing of forged or false documents.

Aside from MLATs, in recent years, the United States has been making greater use of tax treaties and tax information exchange agreements (“TIEAs”) to obtain foreign evidence in tax investigations and prosecutions. TIEAs are agreements, created by statute, that specifically provide for mutual assistance in criminal and civil tax investigations and proceedings. See 26 U.S.C. §274(h)(6)(C). The United States has entered into more than sixty tax treaties with other countries, which includes more than twenty with known tax havens.15 However, the government has had problems obtaining information under TIEAs as well. For example, in 1996, after sixteen years of negotiation, the United States and Switzerland entered into a TIEA. Yet the amount of information shared between the date of signature and January 2003 was so insignificant that the TIEA was revised. The revisions provide that the United States and Switzerland “shall exchange such information as is necessary for the prevention of tax fraud or the like in relation to the taxes which are the subject of the Convention.”16 A Protocol agreed to in connection with the revised tax treaty re-defined “tax fraud or the like” as “fraudulent conduct that causes or is intended to cause an illegal and substantial reduction in the amount of tax paid to a Contracting State.”17 Yet, even after these revisions, criticisms remained regarding Swiss assistance in U.S. tax matters.18

Recent Developments Regarding Tax Havens

In the future, U.S. prosecutors may face less obstacles when seeking records located in bank secrecy jurisdictions. In recent months, increasing international pressure driven by the global economic crisis has resulted in what appears to be an erosion of the bank secrecy laws of tax haven jurisdictions. This is particularly evident from an examination of the actions of several jurisdictions labeled as “uncooperative tax havens” by the Organization for Economic Cooperation and Development (“OECD”). In 1998, the OECD published a report entitled “Harmful Tax Competition – An Emerging Global Issue,” in which it threatened “tax havens”19 with tax and nontax sanctions for failure to implement transparency and exchange of information rules.20 In June 2000, the OECD identified 35 jurisdictions who would have to make “commitments” to cooperate with the OECD in addressing issues relating to transparency and the effective exchange of information to avoid being labeled “uncooperative.”21 As of February 2009, three of 38 jurisdictions listed as tax havens, Andorra, Liechtenstein, and Monaco, were labeled “uncooperative.”22 In mid- March, however, in anticipation of the April 2, 2009, summit of the leaders of the Group of 20 countries (the “Summit”), the OECD prepared an updated summary of uncooperative tax havens, adding Switzerland, Luxembourg, Austria, Singapore and Hong Kong to the list. 23

Soon after the OECD updated its list, Andorra, Lichtenstein, Monaco, Austria, Luxembourg and Switzerland all made concessions with regard to their countries’ bank secrecy laws. Liechtenstein announced that it will comply with international standards for tax and data sharing established by the OECD and Andorra represented that it will relax its bank secrecy laws by November 2009 in the hopes of being removed from the OECD’s “blacklist.”24 Monaco also announced the adoption of international standards for banking openness and information sharing.25 Breaking with perhaps the most long-standing traditions, on March 13, 2009, Switzerland announced that it will relax bank secrecy laws to cooperate more fully with international tax investigations, as did Austria and Luxembourg.26 However, Switzerland’s President and Finance Minister specified that Switzerland will only share information when provided detailed requests related to individual cases and given “concrete” evidence of tax evasion.27 Swiss cooperation may soon increase in light of the recent announcement by the United States Treasury Department that the United States and Switzerland will renegotiate the 1996 TIEA in order to comply with international standards for the exchange of tax information.28

Not all jurisdictions initially made similar concessions to cooperate. The Philippines, Uruguay, Costa Rica and the Malaysian territory of Labuan were named by the OECD at the Summit as additional “uncooperative tax havens.” However, there was a consensus at the Summit to publicly identify and subject to sanctions, including the withdrawal of financing by the World Bank or the International Monetary Fund, tax havens that do not agree to share tax information with the authorities of other countries.29 Shortly thereafter, on April 7, 2009, the OECD announced that Uruguay, Costa Rica, the Philippines and the Malaysian territory of Labuan had agreed to cooperate.30

Recent Criminal Tax Prosecutions Involving the Use of Offshore Accounts in Tax Havens

Perhaps the largest criminal tax investigation by the U.S government involving the use of offshore accounts in tax havens is the one involving Union Bank of Switzerland AG (“UBS” or “the Bank”). Over the past year and a half, the U.S. Department of Justice (“Department of Justice”) secured guilty pleas from two individuals and entered into a Deferred Prosecution Agreement (“DPA”) with UBS,31 in connection with its investigation into the assistance provided by the Bank to certain U.S. clients with regard to maintaining undisclosed accounts in Switzerland and other foreign countries. Two other individuals, who are currently fugitives, have also been indicted in connection with their role in the scheme, and on April 3, 2009, the first U.S. client of UBS whose name was disclosed pursuant to the DPA was charged with filing a false tax return. Given that the U.S. government is seeking to compel UBS to disclose the identifies of the holders of 52,000 other offshore accounts, it is likely that more prosecutions of U.S. taxpayers will follow.

The Deferred Prosecution Agreement with UBS

On February 19, 2009, UBS entered into a DPA with the Department of Justice Tax Division and the U.S. Attorney’s Office for the Southern District of Florida, in which it admitted that, from 2000 through 2007, through certain private bankers and managers in its U.S. cross-border business, it assisted U.S. individual taxpayers in setting up accounts at UBS which concealed the U.S. taxpayers’ ownership interest in these accounts.32 As described in the DPA, the private bankers and managers, among other things, helped U.S. taxpayers to create accounts in the names of offshore companies, which enabled them to evade reporting requirements and conceal from the IRS both the active trading of securities and the transfer of assets to and from the accounts. The DPA further states that UBS accepted IRS Forms W-8BEN from the directors of the offshore companies, which represented, under penalty of perjury, that these offshore companies were the beneficial owners of the assets in the UBS accounts, when in fact, the true owners were the U.S. taxpayers who directed and controlled the management and disposition of the assets.

Under the terms of the DPA, UBS agreed to pay a total of $780 million, which included: (1) $380 million in disgorgement of profits ($200 million of which was to be paid to the U.S. Securities and Exchange Commission (“SEC”) to settle a related case); and (2) $400 million for federal backup withholding taxes, interest and penalties, and restitution for unpaid taxes (and interest) of U.S. taxpayers whom UBS bankers allegedly assisted and facilitated. The government agreed to recommend dismissal of a criminal Information charging UBS with conspiracy to defraud the United States after a period of eighteen months, in return for UBS’s commitment to: (a) accept responsibility for its conduct; (b) cooperate with the government; (c) comply with the criminal laws of the United States and any directives issued by the Federal Reserve Board of Governors (which is UBS’s primary bank regulator); and (d) comply with the terms of the DPA.

Some of the more significant of these terms included an agreement to reveal the names and account information of reportedly 300 U.S. clients who are suspected by the U.S. government of having committed tax crimes.33 In addition, UBS also agreed to “exit” its U.S. cross-border business and to provide banking or securities services to U.S. resident private clients (including companies) solely through SEC-registered subsidiaries or affiliates which require fully executed IRS Form-W9s.34 Pursuant to its exit program, UBS agreed to send a letter to clients of the crossborder business informing them that (1) their accounts had to be closed and, if the funds were to be transferred to another UBS account, that a Form W-9 for the account had to be provided;35 (2) the IRS has a voluntary disclosure practice “to encourage U.S. taxpayers to bring themselves voluntarily into full compliance with the U.S. tax laws, and, in exchange, the IRS may provide for substantial relief from otherwise applicable penalties and fines”; and (3) the advantages of the IRS voluntary disclosure practice will be unavailable for those whose information is first obtained by the Department of Justice or the IRS from UBS’s ongoing cooperation with the investigation or as a result of a civil “John Doe” summons served upon UBS.36

The above-referenced “John Doe” summons seeks information about U.S. clients other than those whose information had to be turned over by UBS as part of the DPA. On July 1, 2008, the U.S. District Court for the Southern District of Florida granted authority to the IRS to serve the summons on UBS seeking the records of U.S. persons who maintained accounts at UBS in Switzerland from 2002-2007 for whom UBS did not file the mandatory W-9 forms with the IRS. On February 19, 2009, the Department of Justice filed a petition in the Southern District of Florida to enforce this summons. The Court set a July 13, 2009 hearing date to determine whether to order UBS to disclose what are allegedly 52,000 names of U.S. clients to the government.37

Prosecutions of Individuals

In late 2007, Igor Olenicoff, a billionaire California real estate developer, pleaded guilty to filing a false 2002 income tax return in connection with funds held in an offshore UBS account. According to the statement of facts in the plea agreement, Olenicoff falsely responded, “No” to the question on his tax return which asked whether he had “an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account.”38 Olenicoff avoided jail time but paid $52 million in back taxes, interest and civil fraud penalties.39

In April 2008, a federal grand jury in the Southern District of Florida returned an indictment against two individuals, Bradley Birkenfeld and Mario Staggl, for allegedly assisting Olenicoff in evading taxes on income earned on $200 million in assets maintained in secret bank accounts in Switzerland and Lichtenstein. 40 Birkenfeld pleaded guilty and Staggl is currently a fugitive.41 According to the indictment,42 Staggl, a resident of Lichtenstein who owned and operated a trust company, allegedly devised, marketed and implemented schemes designed to assist U.S clients evade their taxes by utilizing Liechtenstein banks and nominee entities, and Danish shell companies. Birkenfeld, a U.S. citizen, was a director in the private banking division of UBS from 2001 through 2006.43 According to the statement of facts filed with his plea agreement, Birkenfeld, along with other bankers and managers, assisted U.S. clients in concealing their ownership of assets held in UBS accounts by helping these clients set up nominee and sham entities which were falsely listed on paper as the owners of these accounts. Lichtenstein and Swiss businessmen, including Staggl, allegedly helped set up the sham and nominee entities and also posed as their directors or owners. Birkenfeld further admitted that false paperwork was generated in connection with the accounts, including IRS Forms W-8BEN, which listed the nominee and sham entities as the beneficial account owners. As part of his plea agreement, Birkenfeld agreed to cooperate with the government - and the IRS utilized information he provided to obtain the “John Doe” summons.

In November 2008, a federal grand jury in the Southern District of Florida returned an indictment charging Raoul Weil, the former Chief Executive Officer of a division that oversaw UBS’s crossborder business (and the former head of UBS’s wealth management business), with conspiracy to defraud the United States.44 According to the indictment, UBS’s cross-border business provided private banking services to approximately 20,000 U.S. clients, of which 17,000 concealed their identities and the existence of their UBS accounts from the IRS. The indictment further alleges that many of these clients willfully failed to pay tax to the IRS on income earned on their Swiss bank accounts.45

Finally, the first U.S. client whose information was turned over to the Department of Justice pursuant to the DPA – Stephen Rubinstein - was charged in a criminal complaint dated April 1, 2009 with filing a false income tax return.46 According to the complaint, Rubinstein was the beneficial owner of an account at UBS which was held under the name of a nominee entity incorporated in the British Virgin Islands.47 From 2001 through 2008, Rubinstein allegedly failed to report income earned in his UBS bank accounts and also failed to disclose that he had an interest in or signature or other authority over a bank account in Switzerland.

Options Available for Taxpayers Holding Offshore Accounts

The prosecution of Rubenstein, and aggressive pursuit of additional names of Americans with undeclared offshore accounts is clearly meant to send a message to U.S. taxpayers that the government is going to aggressively pursue those who have used tax havens as a vehicle to commit tax crimes. Moreover, although the initial focus of the UBS matter appears to have been on U.S. clients who set up their offshore accounts under false names,48 a U.S. taxpayer with an offshore bank account in their own name which has not been declared and reported, also may face prosecution.

For example, a U.S. citizen or resident who has an offshore account with a value exceeding $10,000 is legally required to acknowledge this on Schedule B of their Form 1040 and, separately, to annually file a Form TDF 90-22.1 reporting the account with the Treasury Department (Foreign Bank Account Report (“FBAR”)). FBARs must be filed on or before June 30 of the calendar year following the year in which the taxpayer had the account. In the past, the Treasury Department has not made a concerted effort to enforce these requirements. However, failure to file an FBAR can be a felony criminal offense and failure to acknowledge the offshore account on the Form 1040 can form the basis of a criminal prosecution for filing a false income tax return. The civil penalty for failing to file an FBAR is $10,000 for each year of nonfiling and in the case of a willful failure to file, the penalty is increased to the greater of $100,000 or 50 percent of the account balance for each year and each account.

The good news is that, for those who want to regularize their tax situation, there are options aside from waiting to be prosecuted. One option is the IRS’s longstanding Voluntary Disclosure Practice (Internal Revenue Manual Section 9.5.3.1.2.1) (the “VDP”).49 Under the VDP, the IRS generally will not seek criminal prosecution of anyone who comes forward voluntarily and satisfies certain criteria more fully described below. However, the VDP does specify that it cannot provide full immunity and highlights the fact that it does not create substantive or procedural rights for taxpayers.

The criteria that must be met by the taxpayer to render the VDP effective are fairly straightforward. First, the funds at issue must come from a legal source as the VDP does not apply to funds derived from an illegal source. Second, the disclosure must be truthful, timely and complete. A disclosure is only timely if it is received by the IRS before it has initiated, or has notified the taxpayer that it intends to initiate, a civil examination or criminal investigation. The IRS cannot have already received information from a third party alerting it to the taxpayer’s noncompliance, nor can it have acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action, such as a subpoena. Finally, the taxpayer must show a willingness to cooperate with the IRS and a good faith arrangement to pay the IRS in full for any past taxes owed, plus interest.

Although the above criteria are relatively basic, every taxpayer’s case is different and the particular facts and circumstances should be reviewed fully and thoroughly when considering whether to make a voluntary disclosure. Furthermore, if a taxpayer decides to make a disclosure, there are a number of factors that must be addressed to ensure that it is effective. For example, because a key requirement of the VDP is completeness, one issue that must be resolved is how many years the taxpayer must correct. The most prudent course of action is to go back six years, as that is the statute of limitations for criminal tax prosecutions in the United States. However, in certain situations, such as where the taxpayer believes that he or she has not intentionally failed to report income, a taxpayer may choose to argue that he or she should only have to correct filings for fewer years. Another factor to consider is the level of cooperation with the IRS. While a taxpayer in many districts may have the option of contacting the IRS anonymously in order to determine how to bring his or her tax situation into compliance, in order for the disclosure to be effective, the identity of the taxpayer will ultimately need to be revealed. The manner and means of the voluntary disclosure may also impact the taxpayer’s satisfaction of the VDP’s “timeliness” requirement. For example, if a taxpayer chooses to make a disclosure by filing complete and accurate amended returns and paying the tax due and owing in full, if the IRS starts an examination or investigation of the taxpayer or receives adverse information about the taxpayer prior to receiving the return, the VDP will not be effective. In addition, the amended returns may constitute an admission that the correct income and tax were not reported.50

One thing that should be noted is that the VDP has not traditionally protected individuals against civil penalties, which can be considerable, especially where foreign corporations and trusts are involved. However, the IRS is often more lenient when the taxpayer has shown good faith in coming forward and making a timely, truthful and complete disclosure. Furthermore, where a taxpayer faces criminal exposure, a voluntary disclosure can be a substantial benefit, even if large civil penalties are imposed, because the payment of large penalties may be worth the benefit of avoiding criminal prosecution.

Finally, although the IRS has not traditionally reduced civil penalties for those who make voluntary disclosures, it recently announced a plan, effective as of March 23, 2009, to ease penalties related to offshore bank accounts for individuals who make such disclosures.51 Under the plan, for those taxpayers who make a voluntary disclosure of legal source income, the IRS will not only generally decline to seek prosecution but also will lower the penalty for failing to file an FBAR from 50 to 20 percent and, in cases where the account was inherited and contained only funds that were initially properly taxed, five percent. In addition, the IRS will only levy the FBAR penalty once on the highest account balance over the last six years. Taxpayers will, however, need to pay taxes and interest owed over the entire six year period and the IRS will assess a standard 20 or 25 percent penalty on the underpayment of tax for filing late returns. Taxpayers in the program must also file amended returns for the last six years.

The above-described plan is only open to taxpayers who make voluntary disclosures by September 23, 2009, and excludes those individuals who are already under investigation.52 Given the limited timeframe and the considerable incentives that the IRS is offering, taxpayers should consider hiring competent counsel and taking advantage of this new program to regularize their tax situations. Indeed, the IRS has warned that for “taxpayers who continue to hide their head in the sand, the situation will only become more dire.”53

Conclusion

To-date, the Department of Justice has obtained information regarding the identities of only a small fraction of the holders of undeclared offshore bank accounts. However, in the near future, it is likely that it will learn the identities of thousands more – either through the John Doe summons enforcement proceeding or through information obtained from various sources, including cooperators, during the course of its ongoing criminal investigation. There is also no doubt that the Department of Justice Tax Division and U.S. Attorney’s Offices throughout the country will continue to focus their attention and resources on prosecuting tax evaders. As John A. DiCicco, Acting Assistant Attorney General for the Justice Department’s Tax Division stated after Rubenstein was charged, “[w]e expect that this prosecution is just the first of the prosecutions that will be brought, as we continue to review the information we have received from all sources.”54

Once a taxpayer’s identity is disclosed, the available options are limited. Moreover, although the spotlight may now be on Switzerland and Swiss accounts, there are already large investigations underway involving banks in Lichtenstein and other tax haven locations. Given the global pressure to crackdown on bank secrecy laws in these countries, it remains to be seen whether there will soon be any locations where undeclared accounts are protected. Thus, for those taxpayers holding such accounts, it is likely time to start considering the available options, before it is too late.