Asher Rubinstein’s article, “The IRS Offensive Against Offshore Accounts: New Attacks and New Relief” published in Tax Notes International, Vol. 62, number 4
by Asher Rubinstein

Reprinted from Tax Notes Int’l, April 25, 2011, p. 293

In 2009 U.S. prosecutors achieved a staggering victory against UBS, forcing the largest Swiss bank to settle criminal and civil charges that it aided and abetted tax fraud by assisting Americans to hide funds from U.S. taxation. UBS also was compelled to disclose to the IRS the identities of thousands of Americans with formerly secret Swiss accounts. This was a stunning breach of hitherto ironclad Swiss bank secrecy. Yet since then, the IRS has criminally prosecuted only 30 Americans for hiding offshore accounts to escape taxation.

Contrary to the perception of calm since the UBS settlement, recent events make clear that the IRS is still very active in ferreting out undisclosed offshore assets. The IRS is investigating additional banks and other jurisdictions, and it is prosecuting more Americans with undeclared foreign funds. The IRS’s continuing efforts are buttressed by further erosions of bank secrecy by tax information exchange agreements between the U.S. and former tax haven jurisdictions, and by disclosures of offshore bank clients made by disgruntled bank employees. Also, the new Foreign Account Tax Compliance Act (FATCA) creates new reporting requirements for U.S. taxpayers and foreign financial institutions, which will provide more information to IRS investigators.

However, notwithstanding this continuing offensive against noncompliant offshore banking, the IRS has offered a new opportunity for Americans to bring their foreign accounts into tax compliance via the 2011 offshore voluntary disclosure initiative (OVDI).

Additional IRS Targets
In early April 2011, the DOJ asked a federal court in California to issue a John Doe summons against HSBC that asks for the names of U.S. taxpayers with accounts at HSBC in India. The John Doe summons is how the government began its attack against UBS, which led to UBS disclosing account holders’ identities to the IRS and ultimately the erosion of Swiss bank secrecy. In the summer of 2010, the DOJ sent letters to HSBC foreign account holders, advising them that they are the subjects of criminal investigations relating to unreported accounts in India and Singapore. The DOJ has prosecuted a Virginia surgeon and two Miami Beach real estate developers for undeclared foreign accounts with HSBC.

In early February 2011, the real estate developers, father Mauricio Cohen Assor and his son Leon Cohen-Levy, were each sentenced to 10 years’ imprisonment for utilizing undeclared foreign HSBC accounts and foreign entities such as corporations in Panama and the Bahamas to avoid U.S. taxation. While most of the earlier offshore tax fraud prosecutions resulted in plea bargains for more lenient punishment such as probation and home detention, the Cohens’ 10-year sentences resulted from the first court trial of the recent offshore account prosecutions. The use of intermediary entities (such as foreign corporations, trusts, or foundations) to obscure the true beneficial ownership of the underlying foreign bank account seems to draw the ire of the IRS even more than a foreign account held personally, although both types of noncompliant foreign accounts could give rise to criminal tax fraud charges.

There are also reports that HSBC is implicated in the recent criminal prosecution of Vaibhav Dahake, an Indian-American with undeclared accounts in India and the British Virgin Islands. While the criminal indictment against Dahake does not mention HSBC by name, it alleges that an ‘‘unidentified bank’’ operated a division called NRI Services that specifically marketed foreign banking services to Americans of Indian descent. According to the allegations in the indictment, the bank advised that accounts be opened in India because they paid higher interest rates; no U.S. tax forms or Social Security numbers would be required; and the accounts would not be taxed in India. Interestingly, the indictment details transactions with a total value of less than $200,000. This suggests that the government is sending a message that all noncompliant foreign accounts, large and small alike, are vulnerable to investigation and prosecution.

Other banks besides HSBC are also targets. In February 2011 the DOJ charged multiple bankers at Credit Suisse with enabling tax fraud via noncompliant offshore accounts. In December 2010 Deutsche Bank paid $553 million to settle tax fraud charges brought by the U.S. government. The charges related to tax shelters set up from 1996 through 2002 that were ultimately determined by the courts to be shams. Accounting firm KPMG was previously prosecuted for promoting these tax shelters. While sham tax shelters differ from unreported offshore bank accounts, the government’s efforts against Deutsche Bank indicate its growing initiative against banks that facilitate tax fraud.

There have also been reports that some clients of Swiss banks, when faced with the prospect of U.S. prosecution, disclosed to the IRS a portion of their funds at UBS, but moved other, undisclosed funds to smaller banks that were supposedly off the radar. The recent criminal prosecution of UBS banker Renzo Gadola, accused of advising and assisting Americans to evade taxes, now places those smaller cantonal (regional) Swiss banks firmly on the radar. The allegations are that Gadola utilized a small bank, Basler Kantonalbank, rather than UBS, in order to avoid detection. We can now add Basler Kantonalbank (and presumably other regional Swiss banks such as Zurich Kantonalbank) to the list of banks being investigated. Banks large and small and accounts of all sizes are vulnerable. Taxpayers should not believe that an account under a certain size is safe from discovery, nor is any bank, regardless of its size, off the radar.

Note that the cantonal banks do not have a U.S. presence. It was the substantial U.S. presence of UBS, and now HSBC, that made such banks vulnerable to U.S. prosecution. With U.S. banking licenses, multiple branches within the U.S., thousands of employees in the U.S., and billions of dollars in assets in the U.S., these banks are clearly within the jurisdiction of a U.S. court and susceptible to an adverse court judgment or order. UBS had to settle the tax fraud charges against it because the alternatives — seizure of its U.S. assets and revocation of its lucrative U.S. banking license — would have been catastrophic.

While the smaller cantonal banks do not have a U.S. presence, they are still subject to Swiss law, which now requires cooperation with the IRS. Following generations of Swiss bank secrecy, in 2010 Switzerland’s parliament changed long-standing Swiss bank secrecy laws to allow for cooperation and exchange of information with the IRS in both criminal and civil tax investigations. In 2009, Switzerland and the U.S. signed a new TIEA, which further eroded Swiss bank secrecy. The new agreement allows the U.S. greater access to Swiss banking records of American taxpayers, including records at the smaller cantonal banks.

Whistleblowers, Snitches, and Thieves
Bank employees handing over supposedly ‘‘secret’’ bank data is not new. In 1999 John Mathewson, the owner of Guardian Bank and Trust, a now-defunct Cayman Islands bank, was charged in the U.S. with money laundering. When Mathewson was arrested, he gave federal investigators bank records that contained information about American depositors at the bank who had evaded U.S. tax obligations. Mathewson gave up the bank data in return for leniency in his criminal sentencing.

In 2008 a renegade employee of LGT Bank in Liechtenstein stole data about client accounts and sold it to the German intelligence service in return for millions of euros. With that data, the German government prosecuted many prominent Germans for tax fraud. The German government also shared the data with other governments around the world. In 2009 an employee of HSBC provided bank account data to the French government. In 2010 Germany again purchased bank data, stolen by an employee of a Swiss bank. The DOJ was able to successfully prosecute UBS, and then UBS clients, because of information that had been disclosed by UBS banker Bradley Birkenfeld to the U.S. government.

Further Erosion of Banking Secrecy
The next bank to face DOJ action may be Julius Baer. It has been reported that this disclosure will be made via WikiLeaks. The banking data to be revealed comes, like the Guardian, LGT, UBS, and HSBC cases mentioned above, from internal bank sources — specifically, a disgruntled former employee of Julius Baer.

Irrespective of WikiLeaks, Julius Baer is already on the radar because many Americans accepted into the IRS voluntary disclosure program have disclosed their Julius Baer accounts. These account holders are now being interviewed by IRS investigators, presumably to build a case against Julius Baer, like UBS and HSBC. For Americans who did not disclose their Julius Baer accounts, immediate disclosure is strongly advised. Once the IRS gets the name of an account holder — from WikiLeaks or any other source (audit, whistleblower, investigation, or otherwise) — a voluntary disclosure is too late and criminal prosecution is likely.

Targets Beyond Switzerland
There are reports that IRS and DOJ investigators are also focusing on banks in Asia and the Middle East. Following the erosion of Swiss bank secrecy, large amounts of funds were reported to have been moved from Switzerland to Singapore. However, Singapore has taken steps to be removed from the OECD gray list of foreign tax havens and has discussed entering into an income tax treaty with the U.S. and other countries. In order to preserve its status as a major financial hub, Singapore has taken steps toward greater financial transparency. Also, as the HSBC investigation noted above illustrates, Singapore is very much under the watch of the IRS.

Following its success against UBS, the IRS has expanded beyond undeclared Swiss accounts to undeclared funds in other foreign jurisdictions. The IRS has opened or will soon open field offices in Panama, Australia, and China. TIEAs have been signed by all the former tax havens, including Liechtenstein and Monaco. While the IRS is intensifying its presence and its available tools around the world, it appears to be particularly concentrating on India and Israel.

New IRS Target: India
As noted above, HSBC is accused of having specifically targeted Indian-American clients and offered offshore banking services in India and Singapore. The John Doe summons against HSBC demonstrates that DOJ and IRS have moved beyond Switzerland, and India is now firmly a target for noncompliant offshore accounts. While UBS advised American clients that their accounts may be subject to exposure to the IRS, and therefore suggested preemptive disclosure, Americans with accounts at HSBC in India received letters from the DOJ in 2010, making it clear that the DOJ already had their names. In such a case, preemptive disclosure is impossible; the IRS will reject a voluntary disclosure if the taxpayer is already under investigation or if the IRS already has the taxpayer’s name (regardless of the source).

It appears that the stolen LGT bank data purchased by the German government (noted above) were also shared with the government of India. The Indian authorities have launched prosecutions of Indian citizens who had undeclared accounts outside of India. In 2010 India signed a protocol to the income tax treaty with Switzerland, and India is in the process of negotiating tax treaties with 65 countries. While there currently is no tax treaty between India and Liechtenstein, Liechtenstein has shown its new transparency by promulgating multiple tax treaties with other countries, including the U.S., and a future treaty with India is likely. But even in the absence of such a treaty, India already has names, thanks to the LGT affair. The LGT information is almost certainly in the possession of the IRS as well.

Another IRS Target: Israel
Some Americans feel comfortable not disclosing their Israeli bank accounts to the IRS because of Israel’s close ties with the U.S. They believe the IRS is reluctant to investigate Israeli banks. However, owners of accounts in Israel may soon feel the brunt of the next wave of the IRS crackdown on offshore banking.

Israel is in a unique situation in relation to the IRS because of ties between Israel and Jews around the world, including Jews who have inherited so-called Holocaust accounts. One example of a Holocaust account is an account established in Switzerland by European Jews before the Holocaust in an attempt to safeguard their assets from the rise of Nazi Germany. Another example is an account established after World War II by a Holocaust survivor in order to receive German reparation payments. In either case, tax avoidance was not the motivation behind the establishment of the accounts. (The same can be said of Greeks fleeing persecution in Turkey, who put their funds in Switzerland for reasons of safety and stability, or Egyptian Jews fleeing the military coup and dictatorship of Gamal Nasser, or various other refugees who put their money is Swiss banks to preserve and protect their assets in the face of persecution and upheaval.) Now, many decades later, their descendants who have inherited these accounts are in a position of unintended tax noncompliance because they were not aware of their obligation to annually report these accounts to the Treasury Department on Form TD 90-22.1, the ‘‘Report of Foreign Bank and Financial Accounts’’ (FBAR), even if no tax was due.

While Swiss bank secrecy laws presented a formidable challenge to the IRS before the UBS case, pursuing undisclosed accounts in Israel will not require nearly as much effort. The tax treaty between the U.S. and Israel enables the two countries to ‘‘exchange such information as is pertinent to . . . fraud or fiscal evasion in relation to the taxes which are the subject of this Convention.’’ Cooperation between the U.S. and Israel is routine in many matters, tax and otherwise. According to the Israeli Ministry of Justice, ‘‘The [Israeli government] has cooperated with requests from U.S. law enforcement in matters of financial crime.’’ Although this statement refers to Israel’s fight against money laundering, it is not a stretch to conclude that the ministry would cooperate with requests from the IRS in matters specifically pertaining to undisclosed bank accounts.

Also, the U.S. and Israel currently grant legal assistance to each other in criminal matters via a mutual legal assistance treaty (MLAT). The MLAT states that the U.S. and Israel ‘‘express their understanding that this treaty applies to . . . criminal tax offenses.’’ It is particularly noteworthy from an offshore banking perspective that for ‘‘serious [fiscal] offenses involving willful, fraudulent conduct,’’ the treaty even provides for the exchange of bank records.

It is not our conclusion that the IRS is specifically targeting Holocaust accounts. Indeed, while the OVDI penalty for offshore accounts is 25 percent, a specially reduced 5 percent penalty applies, in certain circumstances, to Holocaust accounts. We believe that the presence of undeclared assets in Israel (whatever their source, including the cash-heavy jewelry trade) presents a specific target to the IRS. Along these lines, in 2010 Israel’s Bank Leumi took the extraordinary step of sending letters to its U.S. customers, strongly advising them to disclose their accounts to the IRS. That Credit Suisse bankers allegedly advised clients to transfer funds to Bank Leumi also presents the IRS with a roadmap to Israeli accounts.

A Glimmer of Relief
In February 2011 the IRS announced its OVDI, mentioned earlier, which closely mirrors the 2009 offshore voluntary disclosure program (OVDP) with a few refinements. The new penalties are 25 percent, greater than the 20 percent penalty under the prior OVDP, yet less than the 50 percent penalty that the IRS has been imposing in recent criminal tax fraud prosecutions.

The new OVDI presents an opportunity for Americans
with foreign accounts who did not come forward under the 2009 OVDP but who still want to avoid criminal prosecution and bring their foreign accounts into compliance. As noted repeatedly, the IRS continues to target foreign accounts. Taxpayers are strongly advised to bring noncompliant foreign accounts into tax compliance in order to avoid discovery by the IRS, higher penalties, and criminal prosecution. In this new era of international transparency, decreased banking secrecy, cooperation and information between governments, and stronger enforcement efforts, offshore banking compliance is very highly recommended.