The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs), (Wyly Case) Foreign Trust Tax Issues (excerpted pages 136 – 139):
(a) Background on Trusts
Trusts are established for a variety of reasons, including by persons seeking to provide for the economic security of family members, manage their estates, or fund charitable works to benefit the public. A trust is created when one person, called the grantor or settlor, conveys a property interest to another person, called the trustee, to be held for the benefit of a party called the beneficiary.517 The grantor is the person who establishes the trust and typically contributes the trust assets. The trustee typically takes title to the assets and assumes a fiduciary obligation to exercise reasonable care over the property and to act solely in the interest of the beneficiary. The beneficiary can be a named individual, a charity, or a class of persons such as the grantor’s children. The grantor, in some circumstances, can also serve as the trustee or as one of the beneficiaries. The grantor can create a trust that is revocable or irrevocable. To establish the trust, the grantor, with the assistance of legal counsel, typically executes a written trust agreement identifying the trustee, the beneficiaries, the initial trust assets, and the terms of the trust.
Under U.S. trust law, grantors can retain significant control over assets conveyed to a trust. For example, the trust agreement can authorize the grantor to manage the trust assets or direct the trustee’s performance of certain duties, or require the trustee to obtain the grantor’s written consent prior to taking certain actions.518 Grantors can spend trust funds, replace the trustee, and reserve the right to revoke the trust altogether. Foreign jurisdictions afford grantors similar authority over trust assets. The Isle of Man, for example, which plays a key role in the Wyly case history, allows grantors to establish trusts giving the trustee wide discretion to invest and distribute trust assets. The grantor may then converse directly with the trustee or provide a “letter of wishes” with specific recommendations on how to administer the trust assets.
A trust agreement can also establish a “trust protector,” a person selected by the grantor with authority to oversee the trust assets and often with the power to replace the trustee. The Isle of Man permits trust protectors to interact with trustees on a daily basis, conveying information and recommendations from the grantor about how the trust assets should be handled, and to replace the trustees at will, including, for example, if a trustee declines to follow the protector’s recommendations.519 At the same time, trust law typically assigns final decisionmaking authority over trust assets to the trustee, requiring the trustee to act with due care and in the sole
interest of the trust beneficiaries.
U.S. tax treatment of trust property depends upon the amount of control the grantor retains over the trust. If the grantor places property in an irrevocable trust and gives up all control over the property and the trust, the trust is generally treated as a separate taxpayer and pays tax on the income from the property.520 When the trust distributes the income to the beneficiaries, it gets a deduction for the amount distributed, but the beneficiaries have to pay tax on the income, so that the income is taxed only once.521 On the other hand, if the grantor directly or indirectly keeps the power to revoke the trust or retains significant control over the trust or trust assets, the trust is considered a "grantor trust" and its income is generally attributed to the grantor for tax purposes.522 In some cases where a grantor has supposedly established an irrevocable, independent trust, but secretly retained control over the trusts assets, courts have ruled that the trust was a sham and attributed the trust assets and income to the grantor for tax purposes.523
Trusts formed in foreign jurisdictions originally operated under a different set of tax rules. Generally, foreign trusts were seen as foreign entities outside the normal reach of U.S. tax law, and foreign trust distributions to U.S. persons were generally untaxed. Over the years, some U.S. citizens began to take advantage of the tax status of these foreign trusts. For example, some U.S. persons formed foreign trusts in tax havens, named themselves as the grantor, named U.S. beneficiaries, and placed U.S. assets in those trusts. They claimed that the foreign trusts could then distribute the trust income to the U.S. beneficiaries tax free, and the trusts could accumulate capital gains tax free, unless and until any appreciated assets were brought back into the United States. Congress and the IRS responded with a series of laws and regulations designed to stop
what were seen as tax dodges unintended by the tax code. In 1976, for example, Congress declared that a foreign trust that was funded by a U.S. person and had U.S. beneficiaries was considered a U.S. grantor trust whose income had to be attributed to the U.S. person who transferred the assets.524
Some U.S. persons responded to these new limitations on foreign trusts by convincing a foreign person (rather than a U.S. person) to act as the grantor of the foreign trust and name U.S. beneficiaries. The U.S. person then transferred assets to this “foreign grantor trust” for later distribution to the U.S. beneficiaries tax free. In 1996, in effort to end this practice, Congress enacted legislation essentially requiring the U.S. beneficiaries to pay tax on any distributions from a foreign trust that was not already taxable to a U.S. grantor.525 In passing this law, however, Congress applied it only to assets transferred to foreign trusts after February 6, 1995; foreign trusts funded with assets prior to that date were allowed to continue operating under earlier rules permitting tax-free distributions to U.S. beneficiaries.526
The Wyly case history, which spans a thirteen-year period from 1992 to 2005, reflects this legal tug of war over foreign trusts. The Wylys created and funded some foreign trusts with U.S. grantors, such as the Bulldog and Pitkin Trusts, and other foreign trusts with foreign grantors, such as the Bessie and Tyler Trusts.527 Some of the Wyly-related offshore trust agreements appear to have been written with the express goal of avoiding U.S. tax rules applicable to foreign trusts with U.S. beneficiaries by naming, for example, only foreign charities as the immediate trust beneficiaries and barring any “U.S. person” from receiving trust assets until two years after the death of the grantor, Sam or Charles Wyly.528 The Wyly case history also illustrates the tensions between trust law, which often allows significant grantor control of trust assets, and U.S. tax and securities obligations which often turn on control issues. It illustrates further the tensions created by offshore secrecy laws that make it difficult to determine who really controls an offshore entity.
View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy
Friday, December 7, 2007
Thursday, December 6, 2007
Tax Haven Abuse: (Wyly case) (Beneficial Ownership under Anti-Money Laundering Laws)
The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs), Wyly Case, Beneficial Ownership under Anti-Money Laundering Laws (excerpted pages 296 – 300):
Hiding Beneficial Ownership
From 1992 to 2004, the 58 offshore trusts and corporations in the Wyly offshore structure opened numerous accounts at prominent securities firms in the United States, Credit Suisse First Boston (“CSFB”), Lehman Brothers, and Bank of America. They used these accounts to buy and sell securities, make investments, and send multi-million-dollar wire transfers. All three financial institutions knew that the offshore entities were associated with the Wyly family, but in the face of the offshore entities’ refusal to acknowledge who was behind them, none of the institutions ever required the offshore entities to identify their beneficial owners or document their connection to the Wylys.
These offshore corporations and trusts presented a classic case of hiding beneficial ownership. For more than a decade, U.S. banks have been required to “know their customers” to prevent criminals from misusing bank services; part of that obligation has been, when opening accounts for offshore corporations and trusts from secrecy jurisdictions, to identify the beneficial owners behind the offshore entities. Securities firms did not operate under the same legal requirements until enactment of the 2001 Patriot Act which extended anti-money laundering requirements to securities accounts as well. By July 2002, the Patriot Act required securities firms that opened “private banking accounts” with at least $1 million for foreign account holders, to identify both the nominal and beneficial owners of those accounts. By May 2003, SEC regulations required securities firms to identify the beneficial owner of each account they administered.
By the summer of 2003, the Wyly-related offshore entities had moved to Bank of America and opened dozens of securities accounts. Some of their transactions began tripping alarms in the anti-money laundering surveillance system used by the clearing broker, National Financial Services (“NFS”), that administered the Bank of America accounts. NFS insisted that, if Bank of America wanted it to continue to handle the accounts, it needed the information required by law – the names of the beneficial owners behind the offshore corporations and trusts using the accounts. For more than a year, the offshore entities resisted providing the information, and Bank of America tried to convince NFS not to press for it. Finally, in late 2004, after Bank of America received subpoenas issued by the Manhattan District Attorney seeking information about the accounts, Bank of America closed them.
Bank of America knew that the offshore entities were associated with the Wylys. The key broker who handled the accounts, Louis Schaufele, knew that Sam and Charles Wyly were directing the offshore entities’ investment activities. He nevertheless insisted that the offshore entities be treated as independent of the Wylys and fought efforts to identify the Wylys as their beneficial owners. In addition, when, for tax purposes, the offshore entities submitted W-8BEN forms representing that they were independent foreign entities, beneficially owned the accounts assets, and were not subject to IRS requirements for reporting investment income paid to U.S. persons, Bank of America accepted the forms and never filed a 1099 reporting the account income to the IRS.
Had the offshore entities acknowledged that the Wylys were the beneficial owners of the offshore trusts and corporations for anti-money laundering purposes, and allowed their connection to these entities to be documented at Bank of America, it would have been harder for the Wylys to deny their connection to these entities for tax and securities purposes.
(a) Background on Beneficial Ownership
For decades, U.S. banks have had an obligation to “know their customers,” to understand the natural persons behind offshore corporations and trusts, to ensure that bank services would not be misused for illegal purposes. U.S. banks have also operated for years under legal obligations to report suspicious transactions to law enforcement to prevent money laundering.
In contrast, until recently, U.S. securities firms did not operate under the same know-your-customer obligations. For many years, brokers were required to evaluate their customers to ensure that they were selling them suitable investments – for example, selling high risk securities to persons with a high tolerance for risk and not to an elderly person on a fixed income – but this obligation was not equivalent to performing a due diligence review to guard against opening an account for a questionable person. Some securities firms set up voluntary anti-money laundering (“AML”) programs, but it was not until passage of the Patriot Act in 2001 that all U.S. securities firms became legally obligated to establish AML programs and to identify and verify the identity of their customers.
Beneficial Ownership under Anti-Money Laundering Laws. Three key laws set out the obligations of U.S. financial institutions to know their customers and guard against misuse of their accounts, the Bank Secrecy Act of 1970, the Money Laundering Control Act of 1986, and the 2001 Patriot Act, which amended both prior laws. These and other anti-money laundering (“AML”) laws have, over time, tightened requirements for banks and other financial institutions to evaluate clients, monitor transactions, and report suspicious activity.
The 1970 Bank Secrecy Act was the first to require U.S. financial institutions operating in the United States to undertake AML efforts, authorizing the Treasury Secretary to issue regulations requiring financial institutions to establish AML programs meeting certain criteria. In 1986, the Money Laundering Control Act was the first in the world to make money laundering itself a crime, prohibiting persons from knowingly engaging in financial transactions involving criminal proceeds. In 1996, the Treasury Secretary began requiring banks to file Suspicious Activity Reports on client transactions raising red flags of possible misconduct. In 1997, the Federal Reserve issued special guidance warning banks catering to wealthy individuals through “private banking accounts” of the need to install controls to detect and report possible money laundering. In 1998 and 2000, federal bank regulators issued guidance on spotting suspicious transactions and strengthening regulatory reviews of banks’ AML programs.
In 2001, after the terrorist attack of September 11th, President Bush announced an intensified effort to uncover and stop terrorist financing, and Congress enacted the Patriot Act which, in part, greatly strengthened federal AML laws. Among other provisions, the Patriot Act required all U.S. financial institutions, including securities firms, to establish AML programs, verify the identity of their account holders, and exercise due diligence when opening and administering private banking accounts for foreign persons. It also required securities firms to begin filing Suspicious Activity Reports.
The Patriot Act imposed a special set of requirements to prevent misuse of “private banking accounts” by foreign account holders. “Private banking accounts” are accounts opened by banks, securities firms, or certain other financial institutions that require a minimum of $1 million in funds or assets, are opened for individuals with a “direct or beneficial ownership interest” in the account, and use an employee, such as a private banker or account officer, to act as a personal liaison between the financial institution and the “direct or beneficial owner.” 31 USC § 5318(i)(4)(B). The law required all financial institutions that opened such private banking accounts for foreign account holders to “ascertain the identity of the nominal and beneficial owners” of the account. 31 USC § 5318(i)(3)(A). This provision included, for example, the requirement that financial institutions ascertain the beneficial owners of accounts opened in the name of foreign corporations or trusts. This provision became legally binding in July 2002.
The Patriot Act also directed the Treasury Secretary to promulgate regulations further delineating the due diligence obligations of financial institutions, and further defining which account holders have “beneficial ownership of an account.” Section 312(b) of the Patriot Act; 31 USC § 5318A(e)(3). In response, Treasury issued proposed regulations in May 2002, an “interim final rule” in July 2002, and a final rule in January 2006. Each of these rules repeated the legal obligation of financial institutions to ascertain the nominal and beneficial owners of private banking accounts.
The U.S. accounts opened by the Wyly-related offshore entities must be viewed through this history of evolving AML laws. In the United States, the offshore entities opened securities accounts, rather than bank accounts, which prior to the Patriot Act operated under fewer legal requirements and less scrutiny. When they opened accounts at CSFB in 1992, for example, know-your-customer practices at securities firms were voluntary, and the SEC exercised no routine oversight. When the accounts moved to Lehman Brothers in 1995, the regulatory environment was little changed. By the time the accounts moved to the securities divisions of Bank of America in 2002, however, the Patriot Act had been enacted, AML concerns had heightened, due diligence regulations were being drafted, and U.S. securities firms should have been on full alert about their obligation to know their customers.
View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy
Hiding Beneficial Ownership
From 1992 to 2004, the 58 offshore trusts and corporations in the Wyly offshore structure opened numerous accounts at prominent securities firms in the United States, Credit Suisse First Boston (“CSFB”), Lehman Brothers, and Bank of America. They used these accounts to buy and sell securities, make investments, and send multi-million-dollar wire transfers. All three financial institutions knew that the offshore entities were associated with the Wyly family, but in the face of the offshore entities’ refusal to acknowledge who was behind them, none of the institutions ever required the offshore entities to identify their beneficial owners or document their connection to the Wylys.
These offshore corporations and trusts presented a classic case of hiding beneficial ownership. For more than a decade, U.S. banks have been required to “know their customers” to prevent criminals from misusing bank services; part of that obligation has been, when opening accounts for offshore corporations and trusts from secrecy jurisdictions, to identify the beneficial owners behind the offshore entities. Securities firms did not operate under the same legal requirements until enactment of the 2001 Patriot Act which extended anti-money laundering requirements to securities accounts as well. By July 2002, the Patriot Act required securities firms that opened “private banking accounts” with at least $1 million for foreign account holders, to identify both the nominal and beneficial owners of those accounts. By May 2003, SEC regulations required securities firms to identify the beneficial owner of each account they administered.
By the summer of 2003, the Wyly-related offshore entities had moved to Bank of America and opened dozens of securities accounts. Some of their transactions began tripping alarms in the anti-money laundering surveillance system used by the clearing broker, National Financial Services (“NFS”), that administered the Bank of America accounts. NFS insisted that, if Bank of America wanted it to continue to handle the accounts, it needed the information required by law – the names of the beneficial owners behind the offshore corporations and trusts using the accounts. For more than a year, the offshore entities resisted providing the information, and Bank of America tried to convince NFS not to press for it. Finally, in late 2004, after Bank of America received subpoenas issued by the Manhattan District Attorney seeking information about the accounts, Bank of America closed them.
Bank of America knew that the offshore entities were associated with the Wylys. The key broker who handled the accounts, Louis Schaufele, knew that Sam and Charles Wyly were directing the offshore entities’ investment activities. He nevertheless insisted that the offshore entities be treated as independent of the Wylys and fought efforts to identify the Wylys as their beneficial owners. In addition, when, for tax purposes, the offshore entities submitted W-8BEN forms representing that they were independent foreign entities, beneficially owned the accounts assets, and were not subject to IRS requirements for reporting investment income paid to U.S. persons, Bank of America accepted the forms and never filed a 1099 reporting the account income to the IRS.
Had the offshore entities acknowledged that the Wylys were the beneficial owners of the offshore trusts and corporations for anti-money laundering purposes, and allowed their connection to these entities to be documented at Bank of America, it would have been harder for the Wylys to deny their connection to these entities for tax and securities purposes.
(a) Background on Beneficial Ownership
For decades, U.S. banks have had an obligation to “know their customers,” to understand the natural persons behind offshore corporations and trusts, to ensure that bank services would not be misused for illegal purposes. U.S. banks have also operated for years under legal obligations to report suspicious transactions to law enforcement to prevent money laundering.
In contrast, until recently, U.S. securities firms did not operate under the same know-your-customer obligations. For many years, brokers were required to evaluate their customers to ensure that they were selling them suitable investments – for example, selling high risk securities to persons with a high tolerance for risk and not to an elderly person on a fixed income – but this obligation was not equivalent to performing a due diligence review to guard against opening an account for a questionable person. Some securities firms set up voluntary anti-money laundering (“AML”) programs, but it was not until passage of the Patriot Act in 2001 that all U.S. securities firms became legally obligated to establish AML programs and to identify and verify the identity of their customers.
Beneficial Ownership under Anti-Money Laundering Laws. Three key laws set out the obligations of U.S. financial institutions to know their customers and guard against misuse of their accounts, the Bank Secrecy Act of 1970, the Money Laundering Control Act of 1986, and the 2001 Patriot Act, which amended both prior laws. These and other anti-money laundering (“AML”) laws have, over time, tightened requirements for banks and other financial institutions to evaluate clients, monitor transactions, and report suspicious activity.
The 1970 Bank Secrecy Act was the first to require U.S. financial institutions operating in the United States to undertake AML efforts, authorizing the Treasury Secretary to issue regulations requiring financial institutions to establish AML programs meeting certain criteria. In 1986, the Money Laundering Control Act was the first in the world to make money laundering itself a crime, prohibiting persons from knowingly engaging in financial transactions involving criminal proceeds. In 1996, the Treasury Secretary began requiring banks to file Suspicious Activity Reports on client transactions raising red flags of possible misconduct. In 1997, the Federal Reserve issued special guidance warning banks catering to wealthy individuals through “private banking accounts” of the need to install controls to detect and report possible money laundering. In 1998 and 2000, federal bank regulators issued guidance on spotting suspicious transactions and strengthening regulatory reviews of banks’ AML programs.
In 2001, after the terrorist attack of September 11th, President Bush announced an intensified effort to uncover and stop terrorist financing, and Congress enacted the Patriot Act which, in part, greatly strengthened federal AML laws. Among other provisions, the Patriot Act required all U.S. financial institutions, including securities firms, to establish AML programs, verify the identity of their account holders, and exercise due diligence when opening and administering private banking accounts for foreign persons. It also required securities firms to begin filing Suspicious Activity Reports.
The Patriot Act imposed a special set of requirements to prevent misuse of “private banking accounts” by foreign account holders. “Private banking accounts” are accounts opened by banks, securities firms, or certain other financial institutions that require a minimum of $1 million in funds or assets, are opened for individuals with a “direct or beneficial ownership interest” in the account, and use an employee, such as a private banker or account officer, to act as a personal liaison between the financial institution and the “direct or beneficial owner.” 31 USC § 5318(i)(4)(B). The law required all financial institutions that opened such private banking accounts for foreign account holders to “ascertain the identity of the nominal and beneficial owners” of the account. 31 USC § 5318(i)(3)(A). This provision included, for example, the requirement that financial institutions ascertain the beneficial owners of accounts opened in the name of foreign corporations or trusts. This provision became legally binding in July 2002.
The Patriot Act also directed the Treasury Secretary to promulgate regulations further delineating the due diligence obligations of financial institutions, and further defining which account holders have “beneficial ownership of an account.” Section 312(b) of the Patriot Act; 31 USC § 5318A(e)(3). In response, Treasury issued proposed regulations in May 2002, an “interim final rule” in July 2002, and a final rule in January 2006. Each of these rules repeated the legal obligation of financial institutions to ascertain the nominal and beneficial owners of private banking accounts.
The U.S. accounts opened by the Wyly-related offshore entities must be viewed through this history of evolving AML laws. In the United States, the offshore entities opened securities accounts, rather than bank accounts, which prior to the Patriot Act operated under fewer legal requirements and less scrutiny. When they opened accounts at CSFB in 1992, for example, know-your-customer practices at securities firms were voluntary, and the SEC exercised no routine oversight. When the accounts moved to Lehman Brothers in 1995, the regulatory environment was little changed. By the time the accounts moved to the securities divisions of Bank of America in 2002, however, the Patriot Act had been enacted, AML concerns had heightened, due diligence regulations were being drafted, and U.S. securities firms should have been on full alert about their obligation to know their customers.
View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy
Wednesday, December 5, 2007
Tax Haven Abuse: (Wyly Case) (Beneficial Ownership under Anti-Money Laundering Laws)
The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs), Wyly Case, Beneficial Ownership under Anti-Money Laundering Laws (excerpted pages 296 – 300):
Hiding Beneficial Ownership
From 1992 to 2004, the 58 offshore trusts and corporations in the Wyly offshore structure opened numerous accounts at prominent securities firms in the United States, Credit Suisse First Boston (“CSFB”), Lehman Brothers, and Bank of America. They used these accounts to buy and sell securities, make investments, and send multi-million-dollar wire transfers. All three financial institutions knew that the offshore entities were associated with the Wyly family, but in the face of the offshore entities’ refusal to acknowledge who was behind them, none of the institutions ever required the offshore entities to identify their beneficial owners or document their connection to the Wylys.
These offshore corporations and trusts presented a classic case of hiding beneficial ownership. For more than a decade, U.S. banks have been required to “know their customers” to prevent criminals from misusing bank services; part of that obligation has been, when opening accounts for offshore corporations and trusts from secrecy jurisdictions, to identify the beneficial owners behind the offshore entities. Securities firms did not operate under the same legal requirements until enactment of the 2001 Patriot Act which extended anti-money laundering requirements to securities accounts as well. By July 2002, the Patriot Act required securities firms that opened “private banking accounts” with at least $1 million for foreign account holders, to identify both the nominal and beneficial owners of those accounts. By May 2003, SEC regulations required securities firms to identify the beneficial owner of each account they administered.
By the summer of 2003, the Wyly-related offshore entities had moved to Bank of America and opened dozens of securities accounts. Some of their transactions began tripping alarms in the anti-money laundering surveillance system used by the clearing broker, National Financial Services (“NFS”), that administered the Bank of America accounts. NFS insisted that, if Bank of America wanted it to continue to handle the accounts, it needed the information required by law – the names of the beneficial owners behind the offshore corporations and trusts using the accounts. For more than a year, the offshore entities resisted providing the information, and Bank of America tried to convince NFS not to press for it. Finally, in late 2004, after Bank of America received subpoenas issued by the Manhattan District Attorney seeking information about the accounts, Bank of America closed them.
Bank of America knew that the offshore entities were associated with the Wylys. The key broker who handled the accounts, Louis Schaufele, knew that Sam and Charles Wyly were directing the offshore entities’ investment activities. He nevertheless insisted that the offshore entities be treated as independent of the Wylys and fought efforts to identify the Wylys as their beneficial owners. In addition, when, for tax purposes, the offshore entities submitted W-8BEN forms representing that they were independent foreign entities, beneficially owned the accounts assets, and were not subject to IRS requirements for reporting investment income paid to U.S. persons, Bank of America accepted the forms and never filed a 1099 reporting the account income to the IRS.
Had the offshore entities acknowledged that the Wylys were the beneficial owners of the offshore trusts and corporations for anti-money laundering purposes, and allowed their connection to these entities to be documented at Bank of America, it would have been harder for the Wylys to deny their connection to these entities for tax and securities purposes.
(a) Background on Beneficial Ownership
For decades, U.S. banks have had an obligation to “know their customers,” to understand the natural persons behind offshore corporations and trusts, to ensure that bank services would not be misused for illegal purposes. U.S. banks have also operated for years under legal obligations to report suspicious transactions to law enforcement to prevent money laundering.
In contrast, until recently, U.S. securities firms did not operate under the same know-your-customer obligations. For many years, brokers were required to evaluate their customers to ensure that they were selling them suitable investments – for example, selling high risk securities to persons with a high tolerance for risk and not to an elderly person on a fixed income – but this obligation was not equivalent to performing a due diligence review to guard against opening an account for a questionable person. Some securities firms set up voluntary anti-money laundering (“AML”) programs, but it was not until passage of the Patriot Act in 2001 that all U.S. securities firms became legally obligated to establish AML programs and to identify and verify the identity of their customers.
Beneficial Ownership under Anti-Money Laundering Laws. Three key laws set out the obligations of U.S. financial institutions to know their customers and guard against misuse of their accounts, the Bank Secrecy Act of 1970, the Money Laundering Control Act of 1986, and the 2001 Patriot Act, which amended both prior laws. These and other anti-money laundering (“AML”) laws have, over time, tightened requirements for banks and other financial institutions to evaluate clients, monitor transactions, and report suspicious activity.
The 1970 Bank Secrecy Act was the first to require U.S. financial institutions operating in the United States to undertake AML efforts, authorizing the Treasury Secretary to issue regulations requiring financial institutions to establish AML programs meeting certain criteria. In 1986, the Money Laundering Control Act was the first in the world to make money laundering itself a crime, prohibiting persons from knowingly engaging in financial transactions involving criminal proceeds. In 1996, the Treasury Secretary began requiring banks to file Suspicious Activity Reports on client transactions raising red flags of possible misconduct. In 1997, the Federal Reserve issued special guidance warning banks catering to wealthy individuals through “private banking accounts” of the need to install controls to detect and report possible money laundering. In 1998 and 2000, federal bank regulators issued guidance on spotting suspicious transactions and strengthening regulatory reviews of banks’ AML programs.
In 2001, after the terrorist attack of September 11th, President Bush announced an intensified effort to uncover and stop terrorist financing, and Congress enacted the Patriot Act which, in part, greatly strengthened federal AML laws. Among other provisions, the Patriot Act required all U.S. financial institutions, including securities firms, to establish AML programs, verify the identity of their account holders, and exercise due diligence when opening and administering private banking accounts for foreign persons. It also required securities firms to begin filing Suspicious Activity Reports.
The Patriot Act imposed a special set of requirements to prevent misuse of “private banking accounts” by foreign account holders. “Private banking accounts” are accounts opened by banks, securities firms, or certain other financial institutions that require a minimum of $1 million in funds or assets, are opened for individuals with a “direct or beneficial ownership interest” in the account, and use an employee, such as a private banker or account officer, to act as a personal liaison between the financial institution and the “direct or beneficial owner.” 31 USC § 5318(i)(4)(B). The law required all financial institutions that opened such private banking accounts for foreign account holders to “ascertain the identity of the nominal and beneficial owners” of the account. 31 USC § 5318(i)(3)(A). This provision included, for example, the requirement that financial institutions ascertain the beneficial owners of accounts opened in the name of foreign corporations or trusts. This provision became legally binding in July 2002.
The Patriot Act also directed the Treasury Secretary to promulgate regulations further delineating the due diligence obligations of financial institutions, and further defining which account holders have “beneficial ownership of an account.” Section 312(b) of the Patriot Act; 31 USC § 5318A(e)(3). In response, Treasury issued proposed regulations in May 2002, an “interim final rule” in July 2002, and a final rule in January 2006. Each of these rules repeated the legal obligation of financial institutions to ascertain the nominal and beneficial owners of private banking accounts.
The U.S. accounts opened by the Wyly-related offshore entities must be viewed through this history of evolving AML laws. In the United States, the offshore entities opened securities accounts, rather than bank accounts, which prior to the Patriot Act operated under fewer legal requirements and less scrutiny. When they opened accounts at CSFB in 1992, for example, know-your-customer practices at securities firms were voluntary, and the SEC exercised no routine oversight. When the accounts moved to Lehman Brothers in 1995, the regulatory environment was little changed. By the time the accounts moved to the securities divisions of Bank of America in 2002, however, the Patriot Act had been enacted; AML concerns had heightened, due diligence regulations were being drafted, and U.S. securities firms should have been on full alert about their obligation to know their customers.
View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy
Hiding Beneficial Ownership
From 1992 to 2004, the 58 offshore trusts and corporations in the Wyly offshore structure opened numerous accounts at prominent securities firms in the United States, Credit Suisse First Boston (“CSFB”), Lehman Brothers, and Bank of America. They used these accounts to buy and sell securities, make investments, and send multi-million-dollar wire transfers. All three financial institutions knew that the offshore entities were associated with the Wyly family, but in the face of the offshore entities’ refusal to acknowledge who was behind them, none of the institutions ever required the offshore entities to identify their beneficial owners or document their connection to the Wylys.
These offshore corporations and trusts presented a classic case of hiding beneficial ownership. For more than a decade, U.S. banks have been required to “know their customers” to prevent criminals from misusing bank services; part of that obligation has been, when opening accounts for offshore corporations and trusts from secrecy jurisdictions, to identify the beneficial owners behind the offshore entities. Securities firms did not operate under the same legal requirements until enactment of the 2001 Patriot Act which extended anti-money laundering requirements to securities accounts as well. By July 2002, the Patriot Act required securities firms that opened “private banking accounts” with at least $1 million for foreign account holders, to identify both the nominal and beneficial owners of those accounts. By May 2003, SEC regulations required securities firms to identify the beneficial owner of each account they administered.
By the summer of 2003, the Wyly-related offshore entities had moved to Bank of America and opened dozens of securities accounts. Some of their transactions began tripping alarms in the anti-money laundering surveillance system used by the clearing broker, National Financial Services (“NFS”), that administered the Bank of America accounts. NFS insisted that, if Bank of America wanted it to continue to handle the accounts, it needed the information required by law – the names of the beneficial owners behind the offshore corporations and trusts using the accounts. For more than a year, the offshore entities resisted providing the information, and Bank of America tried to convince NFS not to press for it. Finally, in late 2004, after Bank of America received subpoenas issued by the Manhattan District Attorney seeking information about the accounts, Bank of America closed them.
Bank of America knew that the offshore entities were associated with the Wylys. The key broker who handled the accounts, Louis Schaufele, knew that Sam and Charles Wyly were directing the offshore entities’ investment activities. He nevertheless insisted that the offshore entities be treated as independent of the Wylys and fought efforts to identify the Wylys as their beneficial owners. In addition, when, for tax purposes, the offshore entities submitted W-8BEN forms representing that they were independent foreign entities, beneficially owned the accounts assets, and were not subject to IRS requirements for reporting investment income paid to U.S. persons, Bank of America accepted the forms and never filed a 1099 reporting the account income to the IRS.
Had the offshore entities acknowledged that the Wylys were the beneficial owners of the offshore trusts and corporations for anti-money laundering purposes, and allowed their connection to these entities to be documented at Bank of America, it would have been harder for the Wylys to deny their connection to these entities for tax and securities purposes.
(a) Background on Beneficial Ownership
For decades, U.S. banks have had an obligation to “know their customers,” to understand the natural persons behind offshore corporations and trusts, to ensure that bank services would not be misused for illegal purposes. U.S. banks have also operated for years under legal obligations to report suspicious transactions to law enforcement to prevent money laundering.
In contrast, until recently, U.S. securities firms did not operate under the same know-your-customer obligations. For many years, brokers were required to evaluate their customers to ensure that they were selling them suitable investments – for example, selling high risk securities to persons with a high tolerance for risk and not to an elderly person on a fixed income – but this obligation was not equivalent to performing a due diligence review to guard against opening an account for a questionable person. Some securities firms set up voluntary anti-money laundering (“AML”) programs, but it was not until passage of the Patriot Act in 2001 that all U.S. securities firms became legally obligated to establish AML programs and to identify and verify the identity of their customers.
Beneficial Ownership under Anti-Money Laundering Laws. Three key laws set out the obligations of U.S. financial institutions to know their customers and guard against misuse of their accounts, the Bank Secrecy Act of 1970, the Money Laundering Control Act of 1986, and the 2001 Patriot Act, which amended both prior laws. These and other anti-money laundering (“AML”) laws have, over time, tightened requirements for banks and other financial institutions to evaluate clients, monitor transactions, and report suspicious activity.
The 1970 Bank Secrecy Act was the first to require U.S. financial institutions operating in the United States to undertake AML efforts, authorizing the Treasury Secretary to issue regulations requiring financial institutions to establish AML programs meeting certain criteria. In 1986, the Money Laundering Control Act was the first in the world to make money laundering itself a crime, prohibiting persons from knowingly engaging in financial transactions involving criminal proceeds. In 1996, the Treasury Secretary began requiring banks to file Suspicious Activity Reports on client transactions raising red flags of possible misconduct. In 1997, the Federal Reserve issued special guidance warning banks catering to wealthy individuals through “private banking accounts” of the need to install controls to detect and report possible money laundering. In 1998 and 2000, federal bank regulators issued guidance on spotting suspicious transactions and strengthening regulatory reviews of banks’ AML programs.
In 2001, after the terrorist attack of September 11th, President Bush announced an intensified effort to uncover and stop terrorist financing, and Congress enacted the Patriot Act which, in part, greatly strengthened federal AML laws. Among other provisions, the Patriot Act required all U.S. financial institutions, including securities firms, to establish AML programs, verify the identity of their account holders, and exercise due diligence when opening and administering private banking accounts for foreign persons. It also required securities firms to begin filing Suspicious Activity Reports.
The Patriot Act imposed a special set of requirements to prevent misuse of “private banking accounts” by foreign account holders. “Private banking accounts” are accounts opened by banks, securities firms, or certain other financial institutions that require a minimum of $1 million in funds or assets, are opened for individuals with a “direct or beneficial ownership interest” in the account, and use an employee, such as a private banker or account officer, to act as a personal liaison between the financial institution and the “direct or beneficial owner.” 31 USC § 5318(i)(4)(B). The law required all financial institutions that opened such private banking accounts for foreign account holders to “ascertain the identity of the nominal and beneficial owners” of the account. 31 USC § 5318(i)(3)(A). This provision included, for example, the requirement that financial institutions ascertain the beneficial owners of accounts opened in the name of foreign corporations or trusts. This provision became legally binding in July 2002.
The Patriot Act also directed the Treasury Secretary to promulgate regulations further delineating the due diligence obligations of financial institutions, and further defining which account holders have “beneficial ownership of an account.” Section 312(b) of the Patriot Act; 31 USC § 5318A(e)(3). In response, Treasury issued proposed regulations in May 2002, an “interim final rule” in July 2002, and a final rule in January 2006. Each of these rules repeated the legal obligation of financial institutions to ascertain the nominal and beneficial owners of private banking accounts.
The U.S. accounts opened by the Wyly-related offshore entities must be viewed through this history of evolving AML laws. In the United States, the offshore entities opened securities accounts, rather than bank accounts, which prior to the Patriot Act operated under fewer legal requirements and less scrutiny. When they opened accounts at CSFB in 1992, for example, know-your-customer practices at securities firms were voluntary, and the SEC exercised no routine oversight. When the accounts moved to Lehman Brothers in 1995, the regulatory environment was little changed. By the time the accounts moved to the securities divisions of Bank of America in 2002, however, the Patriot Act had been enacted; AML concerns had heightened, due diligence regulations were being drafted, and U.S. securities firms should have been on full alert about their obligation to know their customers.
View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy
Tuesday, December 4, 2007
Tax Haven Abuse: (Wyly Case)(Summary)
The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs) described Wyly Case History (see excerpted pages 7,8) :
Wylys: 58 Offshore Trusts and Corporations
The sixth, and final, case history comprises the most elaborate offshore operations reviewed by the Subcommittee. Over a thirteen-year period from 1992 to 2005, two U.S. citizens, Sam and Charles Wyly, assisted by an army of attorneys, brokers, and other professionals, transferred over 17 million stock options and warrants representing approximately $190 million in compensation to a complex array of 58 trusts and shell corporations. The offshore trusts had either been established by the Wylys or named them as beneficiaries; the trusts owned the shell corporations that took possession of the stock options and warrants. In return, the Wylys obtained private annuity agreements from the offshore corporations. The Wylys took the position, on the advice of counsel, that because they had exchanged their stock options for annuities of equivalent value, no tax was due on their stock option compensation, until they received actual annuity payments years later. The first annuity payment was made ten years later in 2003. To date, about $124 million in stock option compensation remains offshore and untaxed.
From 1992 through 2004, the Wylys and their representatives directed the offshore entities on exercising the stock options and warrants, and engaging in a wide range of securities trades and other transactions. The Wylys and their representatives conveyed their decisions to two individuals the Wylys had selected, called “trust protectors,” who communicated the decisions, worded as “recommendations,” to the offshore trustees, who implemented them. In addition to cashing in many of the options, the offshore entities used the cash and shares to generate substantial investment gains. The Wylys did not pay taxes on these gains, on advice from counsel, even though the U.S. tax code generally requires that income earned by a trust controlled by a U.S. person who funded or is a beneficiary of the trust be attributed to that U.S. person for tax purposes. The Wyly legal position was that the offshore trusts were independent entities. Over the thirteen years examined in this Report, the offshore entities used more than $600 million from untaxed stock sales and other investment gains to issue substantial loans to Wyly interests, finance Wyly-related business ventures, and acquire U.S. real estate, furnishings, art, and jewelry for the personal use of Wyly family members. The offshore entities placed nearly $300 million of these offshore dollars in two hedge funds and an investment fund established by the Wylys.
The stock options exercised by the offshore entities came from three publicly traded corporations with which the Wylys were associated, Michaels Stores Inc., Sterling Software Inc., and Sterling Commerce Inc. In addition to the tax issues, a key concern is whether, by sending millions of company stock options and warrants to offshore entities whose investments they directed, the Wylys were using offshore secrecy laws to circumvent basic U.S. principles intended to ensure fair and transparent capital markets, including disclosure requirements for major shareholders, trading restrictions on privately acquired shares, and prohibitions against trading on nonpublic information. For most of the thirteen years examined in this Report, U.S. securities regulators and the investing public were not informed of the extent of the Wyly-related offshore stock holdings and trading activity.
The Wyly transactions also raise issues related to compliance with anti-money laundering laws. Over the years, the 58 offshore trusts and corporations opened securities accounts at three prominent U.S. financial institutions, Credit Suisse First Boston (“CSFB”), Lehman Brothers, and Bank of America. All three financial institutions knew that the offshore entities were associated with the Wyly family, but never required the offshore entities to identify their beneficial owners. By 2003, when Bank of America had the accounts, the law was clear that the Bank had to identify the beneficial owners. Despite being pressed for nearly a year by its clearing broker to do so, Bank of America allowed the accounts to operate without obtaining the information required by law. In addition, when for tax purposes, the Wyly-related offshore entities submitted forms representing they were independent foreign entities not subject to IRS 1099 reporting requirements for U.S. taxpayers, Bank of America accepted the forms, despite knowing the Wylys were directing the offshore entities’ investments and benefitting from their account income. Had the offshore entities acknowledged that the Wylys were the beneficial owners of the offshore trusts and corporations for purposes of complying with the anti-money laundering laws, and allowed their connection to the Wylys be documented at Bank of America, it would have been harder for the Wylys to deny a connection to these entities for tax and securities purposes.
Many of the offshore mechanisms used in this case history raise serious tax, securities, or other concerns, including the stock option-annuity swaps; pass-through loans using an offshore vehicle; securities traded by offshore entities associated with corporate insiders; and the use of hedge funds and other investment vehicles to control use of funds placed offshore. Sam and Charles Wyly reaped a number of benefits from their offshore activities, including attempted deferral of taxes on their stock option compensation, nonpayment of taxes on hundreds of millions of dollars in offshore capital gains by entities they directed, a ready source of capital for their business ventures in the United States, and a ready source of funds to finance their personal interests. Among those impacted by the Wyly offshore activities are the U.S. Treasury, U.S. taxpayers who have to make up the lost revenue, and the investing public who were kept in the dark about the offshore stock holdings and trading activity of entities controlled by the directors of three publicly traded corporations.
View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy
Wylys: 58 Offshore Trusts and Corporations
The sixth, and final, case history comprises the most elaborate offshore operations reviewed by the Subcommittee. Over a thirteen-year period from 1992 to 2005, two U.S. citizens, Sam and Charles Wyly, assisted by an army of attorneys, brokers, and other professionals, transferred over 17 million stock options and warrants representing approximately $190 million in compensation to a complex array of 58 trusts and shell corporations. The offshore trusts had either been established by the Wylys or named them as beneficiaries; the trusts owned the shell corporations that took possession of the stock options and warrants. In return, the Wylys obtained private annuity agreements from the offshore corporations. The Wylys took the position, on the advice of counsel, that because they had exchanged their stock options for annuities of equivalent value, no tax was due on their stock option compensation, until they received actual annuity payments years later. The first annuity payment was made ten years later in 2003. To date, about $124 million in stock option compensation remains offshore and untaxed.
From 1992 through 2004, the Wylys and their representatives directed the offshore entities on exercising the stock options and warrants, and engaging in a wide range of securities trades and other transactions. The Wylys and their representatives conveyed their decisions to two individuals the Wylys had selected, called “trust protectors,” who communicated the decisions, worded as “recommendations,” to the offshore trustees, who implemented them. In addition to cashing in many of the options, the offshore entities used the cash and shares to generate substantial investment gains. The Wylys did not pay taxes on these gains, on advice from counsel, even though the U.S. tax code generally requires that income earned by a trust controlled by a U.S. person who funded or is a beneficiary of the trust be attributed to that U.S. person for tax purposes. The Wyly legal position was that the offshore trusts were independent entities. Over the thirteen years examined in this Report, the offshore entities used more than $600 million from untaxed stock sales and other investment gains to issue substantial loans to Wyly interests, finance Wyly-related business ventures, and acquire U.S. real estate, furnishings, art, and jewelry for the personal use of Wyly family members. The offshore entities placed nearly $300 million of these offshore dollars in two hedge funds and an investment fund established by the Wylys.
The stock options exercised by the offshore entities came from three publicly traded corporations with which the Wylys were associated, Michaels Stores Inc., Sterling Software Inc., and Sterling Commerce Inc. In addition to the tax issues, a key concern is whether, by sending millions of company stock options and warrants to offshore entities whose investments they directed, the Wylys were using offshore secrecy laws to circumvent basic U.S. principles intended to ensure fair and transparent capital markets, including disclosure requirements for major shareholders, trading restrictions on privately acquired shares, and prohibitions against trading on nonpublic information. For most of the thirteen years examined in this Report, U.S. securities regulators and the investing public were not informed of the extent of the Wyly-related offshore stock holdings and trading activity.
The Wyly transactions also raise issues related to compliance with anti-money laundering laws. Over the years, the 58 offshore trusts and corporations opened securities accounts at three prominent U.S. financial institutions, Credit Suisse First Boston (“CSFB”), Lehman Brothers, and Bank of America. All three financial institutions knew that the offshore entities were associated with the Wyly family, but never required the offshore entities to identify their beneficial owners. By 2003, when Bank of America had the accounts, the law was clear that the Bank had to identify the beneficial owners. Despite being pressed for nearly a year by its clearing broker to do so, Bank of America allowed the accounts to operate without obtaining the information required by law. In addition, when for tax purposes, the Wyly-related offshore entities submitted forms representing they were independent foreign entities not subject to IRS 1099 reporting requirements for U.S. taxpayers, Bank of America accepted the forms, despite knowing the Wylys were directing the offshore entities’ investments and benefitting from their account income. Had the offshore entities acknowledged that the Wylys were the beneficial owners of the offshore trusts and corporations for purposes of complying with the anti-money laundering laws, and allowed their connection to the Wylys be documented at Bank of America, it would have been harder for the Wylys to deny a connection to these entities for tax and securities purposes.
Many of the offshore mechanisms used in this case history raise serious tax, securities, or other concerns, including the stock option-annuity swaps; pass-through loans using an offshore vehicle; securities traded by offshore entities associated with corporate insiders; and the use of hedge funds and other investment vehicles to control use of funds placed offshore. Sam and Charles Wyly reaped a number of benefits from their offshore activities, including attempted deferral of taxes on their stock option compensation, nonpayment of taxes on hundreds of millions of dollars in offshore capital gains by entities they directed, a ready source of capital for their business ventures in the United States, and a ready source of funds to finance their personal interests. Among those impacted by the Wyly offshore activities are the U.S. Treasury, U.S. taxpayers who have to make up the lost revenue, and the investing public who were kept in the dark about the offshore stock holdings and trading activity of entities controlled by the directors of three publicly traded corporations.
View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy
Monday, December 3, 2007
Tax Haven Abuse: the Enablers, the Tools and Secrecy (Findings)
U.S. Senate (8/1/06 Report) Report Findings
1. Control of Offshore Assets. Offshore “service providers” in tax havens use trustees, directors, and officers who comply with client directions when managing offshore trusts or shell corporations established by those clients; the offshore trusts and shell corporations do not act independently.
2. Tax Haven Secrecy. Corporate and financial secrecy laws and practices in offshore tax havens make it easy to conceal and obscure the economic realities underlying a great number of financial transactions with unfair results unintended under U.S. tax and securities laws.
3. Ascertaining Control and Beneficial Ownership. Corporate and financial secrecy laws and practices in offshore tax havens are intended to make it difficult for U.S. law enforcement, creditors, and others to learn whether a U.S. person owns or controls an allegedly independent offshore trust or corporation. They also intentionally make it difficult to identify the beneficial owners of offshore entities.
4. Offshore Tax Haven Abuses. U.S. persons, with the assistance of lawyers, brokers, bankers, offshore service providers, and others, are using offshore trusts and shell corporations in offshore tax havens to circumvent U.S. tax, securities, and anti-money laundering requirements.
5. Anti-Money Laundering Abuses. U.S. financial institutions have failed to identify the beneficial owners of offshore trusts and corporations that opened U.S. securities accounts, and have accepted W-8 forms in which offshore entities represented that they beneficially owned the account assets, even when the financial institutions knew the offshore entities were being directed by or were closely associated with U.S. taxpayers.
6. Securities Abuses. Corporate insiders at U.S. publicly traded corporations have used offshore entities to trade in the company’s stock, and these offshore entities have taken actions to circumvent U.S. securities safeguards and disclosure and trading requirements.
7. Stock Option Abuses. Because stock option compensation is taxed when exercised, and not when granted, stock options have been used in potentially abusive transactions to defer and in some cases avoid U.S. taxes.
8. Hedge Fund Transfers. U.S. persons who transferred assets to allegedly independent offshore entities in a tax haven have then directed those offshore entities to invest the assets in a hedge fund controlled by the same U.S. persons, thereby regaining investment control of the assets.
Report Recommendations
1. Presumption of Control. U.S. tax, securities, and anti-money laundering laws should include a presumption that offshore trusts and shell corporations are under the control of the U.S. persons supplying or directing the use of the offshore assets, where those trusts or shell corporations are located in a jurisdiction designated as a tax haven by the U.S. Treasury Secretary.
2. Disclosure of U.S. Stock Holdings. U.S. publicly traded corporations should be required to disclose in their SEC filings company stock held by an offshore trust or shell corporation related to a company director, officer, or large shareholder, even if the offshore entity is allegedly independent. Corporate insiders should be required to make the same disclosure in their SEC filings.
3. Offshore Entities as Affiliates. An offshore trust or shell corporation related to a director, officer, or large shareholder of a U.S. publicly traded corporation should be required to be treated as an affiliate of that corporation, even if the offshore entity is allegedly independent.
4. 1099 Reporting. Congress and the IRS should make it clear that a U.S. financial institution that opens an account for a foreign trust or shell corporation and determines, as part of its anti-money laundering duties, that the beneficial owner of the account is a U.S. taxpayer, must file a 1099 form with respect to that beneficial owner.
5. Real Estate and Personal Property. Loans that are treated as trust distributions under U.S. tax law should be expanded to include, not just cash and securities as under present law, but also loans of real estate and personal property of any kind including artwork, furnishings and jewelry. Receipt of cash or other property from a foreign trust, other than in an exchange for fair market value, should also result in treatment of the U.S. person as a U.S. beneficiary.
6. Hedge Fund AML Duties. The Treasury Secretary should finalize a proposed regulation requiring hedge funds to establish anti-money laundering programs and report suspicious transactions to U.S. law enforcement. This regulation should apply to foreign based hedge funds that are affiliated with U.S. hedge funds and invest in the United States.
7. Stock Option-Annuity Swaps. Congress and the IRS should make it clear that taxes on stock option compensation cannot be avoided or deferred by exchanging stock options for other assets of equivalent value such as private annuities.
8. Sanctions on Uncooperative Tax Havens. Congress should authorize the Treasury Secretary to identify tax havens that do not cooperate with U.S. tax enforcement efforts and eliminate U.S. tax benefits for income attributed to those jurisdictions.
1. Control of Offshore Assets. Offshore “service providers” in tax havens use trustees, directors, and officers who comply with client directions when managing offshore trusts or shell corporations established by those clients; the offshore trusts and shell corporations do not act independently.
2. Tax Haven Secrecy. Corporate and financial secrecy laws and practices in offshore tax havens make it easy to conceal and obscure the economic realities underlying a great number of financial transactions with unfair results unintended under U.S. tax and securities laws.
3. Ascertaining Control and Beneficial Ownership. Corporate and financial secrecy laws and practices in offshore tax havens are intended to make it difficult for U.S. law enforcement, creditors, and others to learn whether a U.S. person owns or controls an allegedly independent offshore trust or corporation. They also intentionally make it difficult to identify the beneficial owners of offshore entities.
4. Offshore Tax Haven Abuses. U.S. persons, with the assistance of lawyers, brokers, bankers, offshore service providers, and others, are using offshore trusts and shell corporations in offshore tax havens to circumvent U.S. tax, securities, and anti-money laundering requirements.
5. Anti-Money Laundering Abuses. U.S. financial institutions have failed to identify the beneficial owners of offshore trusts and corporations that opened U.S. securities accounts, and have accepted W-8 forms in which offshore entities represented that they beneficially owned the account assets, even when the financial institutions knew the offshore entities were being directed by or were closely associated with U.S. taxpayers.
6. Securities Abuses. Corporate insiders at U.S. publicly traded corporations have used offshore entities to trade in the company’s stock, and these offshore entities have taken actions to circumvent U.S. securities safeguards and disclosure and trading requirements.
7. Stock Option Abuses. Because stock option compensation is taxed when exercised, and not when granted, stock options have been used in potentially abusive transactions to defer and in some cases avoid U.S. taxes.
8. Hedge Fund Transfers. U.S. persons who transferred assets to allegedly independent offshore entities in a tax haven have then directed those offshore entities to invest the assets in a hedge fund controlled by the same U.S. persons, thereby regaining investment control of the assets.
Report Recommendations
1. Presumption of Control. U.S. tax, securities, and anti-money laundering laws should include a presumption that offshore trusts and shell corporations are under the control of the U.S. persons supplying or directing the use of the offshore assets, where those trusts or shell corporations are located in a jurisdiction designated as a tax haven by the U.S. Treasury Secretary.
2. Disclosure of U.S. Stock Holdings. U.S. publicly traded corporations should be required to disclose in their SEC filings company stock held by an offshore trust or shell corporation related to a company director, officer, or large shareholder, even if the offshore entity is allegedly independent. Corporate insiders should be required to make the same disclosure in their SEC filings.
3. Offshore Entities as Affiliates. An offshore trust or shell corporation related to a director, officer, or large shareholder of a U.S. publicly traded corporation should be required to be treated as an affiliate of that corporation, even if the offshore entity is allegedly independent.
4. 1099 Reporting. Congress and the IRS should make it clear that a U.S. financial institution that opens an account for a foreign trust or shell corporation and determines, as part of its anti-money laundering duties, that the beneficial owner of the account is a U.S. taxpayer, must file a 1099 form with respect to that beneficial owner.
5. Real Estate and Personal Property. Loans that are treated as trust distributions under U.S. tax law should be expanded to include, not just cash and securities as under present law, but also loans of real estate and personal property of any kind including artwork, furnishings and jewelry. Receipt of cash or other property from a foreign trust, other than in an exchange for fair market value, should also result in treatment of the U.S. person as a U.S. beneficiary.
6. Hedge Fund AML Duties. The Treasury Secretary should finalize a proposed regulation requiring hedge funds to establish anti-money laundering programs and report suspicious transactions to U.S. law enforcement. This regulation should apply to foreign based hedge funds that are affiliated with U.S. hedge funds and invest in the United States.
7. Stock Option-Annuity Swaps. Congress and the IRS should make it clear that taxes on stock option compensation cannot be avoided or deferred by exchanging stock options for other assets of equivalent value such as private annuities.
8. Sanctions on Uncooperative Tax Havens. Congress should authorize the Treasury Secretary to identify tax havens that do not cooperate with U.S. tax enforcement efforts and eliminate U.S. tax benefits for income attributed to those jurisdictions.
Friday, November 30, 2007
Unreported Income: Voluntary Disclosure
A tax crime is complete on the day the false return was filed.
Between 1945 and 1952, the IRS had a "voluntary disclosure" policy under which a taxpayer who failed to file a return or declare his full income and pay the tax due could escape criminal prosecution through voluntary disclosure of the deficiency, (so long as the voluntary disclosure was made before an investigation was started).
If the IRS determined that a voluntary disclosure had been made, no recommendation for criminal prosecution would be made to the Department of Justice.
Under current IRS practice, the review includes whether there was a true "voluntary disclosure" along with other factors in determining whether or not to recommend prosecution to the Department of Justice. (IRM, Chief Counsel Directive Manual (31) 330 (Dec. 11, 1989) (Voluntary Disclosure).
IRM 9781, Special Agents Handbook § 342.14, MT 9781-125 (Apr. 10, 1990) (Voluntary Disclosure). (although prosecution after voluntary disclosure is not precluded, the "IRS will carefully consider and weigh the voluntary disclosure, along with all other facts and circumstances, in deciding whether or not to recommend prosecution"). See also IRM 9131(1), MT 9-329 (Mar. 24, 1989). (Prosecution Guidelines).
IRS administrative practice recognizes that a taxpayer may still avoid prosecution by voluntarily disclosing a tax violation, provided that there is a qualifying disclosure that is (1) timely and (2) voluntary. A disclosure within the meaning of the practice means a communication that is truthful and complete, and the taxpayer cooperates with IRS personnel in determining the correct tax liability. Cooperation also includes making good faith arrangements to pay the unpaid tax and penalties "to the extent of the taxpayer's actual ability to pay."
A disclosure is timely if it is received before the IRS has begun an inquiry that is (1) "likely to lead to the taxpayer" and (2) the taxpayer is reasonably thought to be aware" of that inquiry; or the disclosure is received before some triggering or prompting event has occurred (1) that is known by the taxpayer and (2) that triggering event is likely to cause an audit into the taxpayer's liabilities.
Voluntariness is tested by the following factors: (1) how far the IRS has gone in determining the tax investigation potential of the taxpayer; (2) the extent of the taxpayer's knowledge or awareness of the Service's interest; and (3) what part the triggering event played in prompting the disclosure (where the disclosure is prompted by fear of a triggering event, it is not truly a voluntary disclosure).
No voluntary disclosure can be made by a taxpayer if an investigation by the Service has already begun. Therefore, once a taxpayer has been contacted by any Service function (whether it be the Service center, office examiner, revenue agent, or a special agent), the taxpayer cannot make a qualifying voluntary disclosure under IRS practice.
A voluntary disclosure can be made even if the taxpayer does not know that the Service has selected the return for examination or investigation may be too restrictive. Consequently, if there is no indication that the Service has started an examination or investigation, Tax Counsel may send a letter to the Service stating that tax returns of the taxpayer have been found to be incorrect and that amended returns will be filed as soon as they can be accurately and correctly prepared. This approach has the advantage of putting the taxpayer on record as making a voluntary disclosure at a time when no known investigation is pending. However, neither the taxpayer nor the lawyer can be completely certain that the voluntary disclosure will prevent the recommendation of criminal prosecution.
Where no IRS examination or investigation is pending a taxpayer’s alternative is the preparation and filing of delinquent or amended returns. The advantage of filing delinquent or amended returns without a communication drawing attention to them is that the returns may not even be examined after being received at the Service center. In such an event, the taxpayer not only will have made a voluntary disclosure but will have avoided an examination as well. The disadvantage is that during the time the returns are being prepared, the taxpayer may be contacted by the Service and a voluntary disclosure prevented.
If a taxpayer who cannot make a qualifying voluntary disclosure nevertheless files amended or delinquent tax returns, these returns (1) constitute an admission that the correct income and tax were not reported and (2) if incorrect, may serve as an independent attempt to evade or as a separate false statement.
No formula exists, and a taxpayer must endure the uncertainty of the risk that a voluntary disclosure will not be considered truly voluntary by the Service. If so, an investigation that has already started but has lagged may be pursued more overtly and aggressively as a result of the disclosure.
Between 1945 and 1952, the IRS had a "voluntary disclosure" policy under which a taxpayer who failed to file a return or declare his full income and pay the tax due could escape criminal prosecution through voluntary disclosure of the deficiency, (so long as the voluntary disclosure was made before an investigation was started).
If the IRS determined that a voluntary disclosure had been made, no recommendation for criminal prosecution would be made to the Department of Justice.
Under current IRS practice, the review includes whether there was a true "voluntary disclosure" along with other factors in determining whether or not to recommend prosecution to the Department of Justice. (IRM, Chief Counsel Directive Manual (31) 330 (Dec. 11, 1989) (Voluntary Disclosure).
IRM 9781, Special Agents Handbook § 342.14, MT 9781-125 (Apr. 10, 1990) (Voluntary Disclosure). (although prosecution after voluntary disclosure is not precluded, the "IRS will carefully consider and weigh the voluntary disclosure, along with all other facts and circumstances, in deciding whether or not to recommend prosecution"). See also IRM 9131(1), MT 9-329 (Mar. 24, 1989). (Prosecution Guidelines).
IRS administrative practice recognizes that a taxpayer may still avoid prosecution by voluntarily disclosing a tax violation, provided that there is a qualifying disclosure that is (1) timely and (2) voluntary. A disclosure within the meaning of the practice means a communication that is truthful and complete, and the taxpayer cooperates with IRS personnel in determining the correct tax liability. Cooperation also includes making good faith arrangements to pay the unpaid tax and penalties "to the extent of the taxpayer's actual ability to pay."
A disclosure is timely if it is received before the IRS has begun an inquiry that is (1) "likely to lead to the taxpayer" and (2) the taxpayer is reasonably thought to be aware" of that inquiry; or the disclosure is received before some triggering or prompting event has occurred (1) that is known by the taxpayer and (2) that triggering event is likely to cause an audit into the taxpayer's liabilities.
Voluntariness is tested by the following factors: (1) how far the IRS has gone in determining the tax investigation potential of the taxpayer; (2) the extent of the taxpayer's knowledge or awareness of the Service's interest; and (3) what part the triggering event played in prompting the disclosure (where the disclosure is prompted by fear of a triggering event, it is not truly a voluntary disclosure).
No voluntary disclosure can be made by a taxpayer if an investigation by the Service has already begun. Therefore, once a taxpayer has been contacted by any Service function (whether it be the Service center, office examiner, revenue agent, or a special agent), the taxpayer cannot make a qualifying voluntary disclosure under IRS practice.
A voluntary disclosure can be made even if the taxpayer does not know that the Service has selected the return for examination or investigation may be too restrictive. Consequently, if there is no indication that the Service has started an examination or investigation, Tax Counsel may send a letter to the Service stating that tax returns of the taxpayer have been found to be incorrect and that amended returns will be filed as soon as they can be accurately and correctly prepared. This approach has the advantage of putting the taxpayer on record as making a voluntary disclosure at a time when no known investigation is pending. However, neither the taxpayer nor the lawyer can be completely certain that the voluntary disclosure will prevent the recommendation of criminal prosecution.
Where no IRS examination or investigation is pending a taxpayer’s alternative is the preparation and filing of delinquent or amended returns. The advantage of filing delinquent or amended returns without a communication drawing attention to them is that the returns may not even be examined after being received at the Service center. In such an event, the taxpayer not only will have made a voluntary disclosure but will have avoided an examination as well. The disadvantage is that during the time the returns are being prepared, the taxpayer may be contacted by the Service and a voluntary disclosure prevented.
If a taxpayer who cannot make a qualifying voluntary disclosure nevertheless files amended or delinquent tax returns, these returns (1) constitute an admission that the correct income and tax were not reported and (2) if incorrect, may serve as an independent attempt to evade or as a separate false statement.
No formula exists, and a taxpayer must endure the uncertainty of the risk that a voluntary disclosure will not be considered truly voluntary by the Service. If so, an investigation that has already started but has lagged may be pursued more overtly and aggressively as a result of the disclosure.
Thursday, November 29, 2007
Unreported Income: Jeopardy Assessment
Under a jeopardy assessment, Taxpayers who have unreported income may be subject to immediate IRS seizure of assets. If the IRS determines that tax collection is at risk, the IRS may immediately seize taxpayer assets without prior notice.
The IRS must have made a determination that a deficiency existed and that tax collection would be jeopardized if the IRS were to follow normal assessment and collection procedures. (IRC § 6861(a)).
In the event of a jeopardy assessment, the IRS is permitted to send a notice and demand for payment immediately. (IRC § 6861(a)).
Normally, the IRS assertion of an income tax deficiency is made after the taxpayer’s year closes and the tax return is filed. However, if the IRS determines that a Taxpayer (who received significant income) may prejudice tax collection (e.g., leave the country, place assets beyond IRS reach) the IRS may issue a jeopardy assessment (levy on Taxpayer’s property without prior notice (IRC § 6861(a)).
IRS jeopardy assessment requirements:
1. The Taxpayer’s year is completed;
2. The due date of the tax return (with extensions) has passed;
3. Either:
a. Taxpayer did not file tax return or;
b. Tax liability on the filed return is understated, and;
c. Tax collection is jeopardized.
Treas. Reg. Sections 301.6861 – 1(a)
IRS general levy requirements (IRC § 6330, 6331) do not apply if the IRS finds that tax collection is in jeopardy.
Under IRC § 6330(f), the IRS is entitled to levy on taxpayer’s property, without prior notice to Taxpayer.
To justify a jeopardy levy, the IRS must be able to show:
1. The Taxpayer is (or appears to be) designing to quickly depart from the U.S.;
2. The Taxpayer is (or appears to be) designing to quickly place their assets beyond the reach of the IRS by:
a. Removing assets from the U.S.;
b. Concealing assets;
c. Dissipating assets;
d. Transferring assets to third parties; or
3. The Taxpayer is in danger of becoming insolvent (bankruptcy or receivership, alone is not sufficient evidence to establish financial insolvency for jeopardy purposes).
The IRS procedures for a jeopardy levy, (as stated in the Internal Revenue Manual):
1. IRS chief counsel must personally give prior written approval to a jeopardy levy (IRC § 7429(a));
2. Thereafter, the IRS must provide Taxpayer with a written statement, within five days, of the information upon which the IRS relied in making its jeopardy levy (IRC § 7429(a)(1)(B));
3. IRM 5.11, Notice of Levy Handbook section 3.5(5) instructs the IRS to try to give Taxpayer notice in person, or certified mail (last known address);
4. IRS notice should include:
a. Reason for jeopardy levy;
b. Taxpayer’s rights to administrative and judicial review (IRC § 7429);
c. Notice of Taxpayer’s rights to administrative and judicial review within a reasonable period of time (under IRC § 6330).
The jeopardy assessment may be made either:
1. Before or after a notice of tax deficiency is issued, and;
2. Also, either before or after a Tax Court petition is filed (IRC § 6861(a), Treas. Reg. Section 301.6861 – 1(a).
IRS notice and demand for payment gives the Taxpayer ten days to pay the tax in full or post a bond to stay collection (Treas. Reg. Section 301.6861 – 1(d).
If tax collection is determined to be in jeopardy, the IRS may immediately levy on Taxpayer’s assets (without 30 day notice of intent to levy) (IRC § 6331(d)(3)), subject to IRS chief counsel personally approving the levy in writing (IRC § 7429(a)(1)(A)).
The IRS must send a formal notice of deficiency within 60 days after making the jeopardy assessment (IRC § 6861(b)). Upon receipt of notice of deficiency, the Taxpayer may file a Tax Court petition for redetermination of the deficiency amount (IRC § 6213(a)).
Under IRC § 6213(a), the Tax Court petition stops additional IRS assessments until the Tax Court decision is finalized. However, upon receipt of the notice of deficiency, payment (of the tax assessed), or a bond is required, within ten days, to stay collection (IRC § 6863(a)).
Under a jeopardy assessment, any amount collected by the IRS, in excess of the amount determined by the Tax Court, (as the final assessment), is refunded (IRC § 6861(f)).
The IRS must have made a determination that a deficiency existed and that tax collection would be jeopardized if the IRS were to follow normal assessment and collection procedures. (IRC § 6861(a)).
In the event of a jeopardy assessment, the IRS is permitted to send a notice and demand for payment immediately. (IRC § 6861(a)).
Normally, the IRS assertion of an income tax deficiency is made after the taxpayer’s year closes and the tax return is filed. However, if the IRS determines that a Taxpayer (who received significant income) may prejudice tax collection (e.g., leave the country, place assets beyond IRS reach) the IRS may issue a jeopardy assessment (levy on Taxpayer’s property without prior notice (IRC § 6861(a)).
IRS jeopardy assessment requirements:
1. The Taxpayer’s year is completed;
2. The due date of the tax return (with extensions) has passed;
3. Either:
a. Taxpayer did not file tax return or;
b. Tax liability on the filed return is understated, and;
c. Tax collection is jeopardized.
Treas. Reg. Sections 301.6861 – 1(a)
IRS general levy requirements (IRC § 6330, 6331) do not apply if the IRS finds that tax collection is in jeopardy.
Under IRC § 6330(f), the IRS is entitled to levy on taxpayer’s property, without prior notice to Taxpayer.
To justify a jeopardy levy, the IRS must be able to show:
1. The Taxpayer is (or appears to be) designing to quickly depart from the U.S.;
2. The Taxpayer is (or appears to be) designing to quickly place their assets beyond the reach of the IRS by:
a. Removing assets from the U.S.;
b. Concealing assets;
c. Dissipating assets;
d. Transferring assets to third parties; or
3. The Taxpayer is in danger of becoming insolvent (bankruptcy or receivership, alone is not sufficient evidence to establish financial insolvency for jeopardy purposes).
The IRS procedures for a jeopardy levy, (as stated in the Internal Revenue Manual):
1. IRS chief counsel must personally give prior written approval to a jeopardy levy (IRC § 7429(a));
2. Thereafter, the IRS must provide Taxpayer with a written statement, within five days, of the information upon which the IRS relied in making its jeopardy levy (IRC § 7429(a)(1)(B));
3. IRM 5.11, Notice of Levy Handbook section 3.5(5) instructs the IRS to try to give Taxpayer notice in person, or certified mail (last known address);
4. IRS notice should include:
a. Reason for jeopardy levy;
b. Taxpayer’s rights to administrative and judicial review (IRC § 7429);
c. Notice of Taxpayer’s rights to administrative and judicial review within a reasonable period of time (under IRC § 6330).
The jeopardy assessment may be made either:
1. Before or after a notice of tax deficiency is issued, and;
2. Also, either before or after a Tax Court petition is filed (IRC § 6861(a), Treas. Reg. Section 301.6861 – 1(a).
IRS notice and demand for payment gives the Taxpayer ten days to pay the tax in full or post a bond to stay collection (Treas. Reg. Section 301.6861 – 1(d).
If tax collection is determined to be in jeopardy, the IRS may immediately levy on Taxpayer’s assets (without 30 day notice of intent to levy) (IRC § 6331(d)(3)), subject to IRS chief counsel personally approving the levy in writing (IRC § 7429(a)(1)(A)).
The IRS must send a formal notice of deficiency within 60 days after making the jeopardy assessment (IRC § 6861(b)). Upon receipt of notice of deficiency, the Taxpayer may file a Tax Court petition for redetermination of the deficiency amount (IRC § 6213(a)).
Under IRC § 6213(a), the Tax Court petition stops additional IRS assessments until the Tax Court decision is finalized. However, upon receipt of the notice of deficiency, payment (of the tax assessed), or a bond is required, within ten days, to stay collection (IRC § 6863(a)).
Under a jeopardy assessment, any amount collected by the IRS, in excess of the amount determined by the Tax Court, (as the final assessment), is refunded (IRC § 6861(f)).
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