Cross-border US tax enforcement against facilitators of tax evasion

On 27 January 2016, the United States Department of Justice (DOJ) announced the completion of the Category 2 phase under the Swiss Bank Program by entering into a non-prosecution agreement (NPA) with HSZH Verwaltungs AG (HSZH). This was significant in that it was the 78th NPA with the 80th bank since the Swiss Bank Program was launched in August 2013 and showcased once more that the DOJ was willing and able to levy considerable penalties (US$49 million) against a national bank with no US connection save that it had assisted ‘US persons' in the evasion of US tax. In its announcement, the DOJ stated that the completion of this last NPA in relation to ‘category 2 banks' that had come forward voluntarily under the Swiss Bank Program marked a significant milestone in the US authorities' ongoing efforts to combat offshore tax evasion. However, US authorities have also made it clear that their enforcement efforts would not stop or decrease with completion of the Swiss Bank Program. Rather, they have made it clear on a number of occasions that they will be using the abundance of information gathered under the Swiss Bank Program to pursue US accountholders as well as professionals and financial institutions assisting them into other popular offshore jurisdictions, including in Asia.

This article provides an overview of the background and current developments relating to the US offshore tax enforcement initiatives. It then explores issues that financial institutions in key financial centres in Asia are likely to face when grappling with the likelihood that US authorities will soon be extending their investigation and enforcement efforts into Asia.

Background

US citizens and residents (including permanent resident aliens) are generally taxed on their worldwide income. This means that US taxpayers must report assets held and income derived outside the US and, according to relevant tax provisions, pay taxes in relation to those assets and income. Historically, many US taxpayers have held undeclared assets in offshore accounts in jurisdictions that have strong bank secrecy laws with the intention of hiding those assets from the Internal Revenue Service (IRS). Foreign financial institutions (FFIs) or individual relationship managers (RMs) have often knowingly assisted US persons in evading US tax, as this was often not prohibited under their local laws and there was no expectation that US authorities would pursue FFIs outside the US. The US has taken a variety of steps aimed at forcing or enticing both US tax evaders and FFIs to disclose hidden assets and undeclared accounts. These include the introduction of Offshore Voluntary Disclosure Programs (OVDPs), the first one of which was announced in 2009 and the enactment of the Foreign Account Tax Compliance Act (FATCA) in 2014.

FATCA, which imposes record-keeping and reporting requirements on FFIs regarding US account holders, provides the US with a strong tool to combat foreign tax evasion. Since the enactment of FATCA, the US has entered into intergovernmental agreements (IGAs) with 113 jurisdictions around the world, from the Cayman Islands to Uzbekistan, to allow FFIs in those jurisdictions to provide information in relation to US-related accounts either directly to the IRS or through their local tax authorities. Most importantly the IGAs allow for disclosure of information without breaching local bank secrecy, data privacy or client confidentiality laws. The US has entered into IGAs with Singapore and Hong Kong with effect as of March 2015.

Enforcement actions against FFIs

Prior to FATCA, US authorities had already started to pursue various enforcement actions against US taxpayers who failed to declare their offshore assets. In 2008, the US DOJ served its first summons against a large international Swiss-based bank with the aim of obtaining information about undeclared accounts held either directly or indirectly by US persons. In February 2009 the same bank entered into a deferred prosecution agreement (DPA) and, under an order issued by the Swiss Financial Market Supervisory Authority (FINMA), provided the required account information to the US authorities. The bank also exited US customers with undeclared accounts and paid US$780 million in fines, penalties, interest and restitution.

After this first investigation against a Swiss bank, the DOJ commenced criminal investigations against at least 14 other Swiss-based national and international banks (‘Category 1' banks), by the time the Swiss Bank Program was introduced in 2013. A number of those investigations have resulted in considerable fines whereas others are still ongoing. One of the latest resolutions of such an investigation resulted in a DPA with bank Julius Baer on 4 February 2016, involving a monetary sanction of US$547 million and requiring ongoing cooperation.

It is noteworthy that some of the Swiss banks that later became subject to criminal investigations (eg, Wegelin and HSZH) had seen a business opportunity in 2008 when US account holders were being exited by the first Swiss-based bank under investigation and had taken on those ‘leavers', assuming that they were safe from US prosecution due to the fact that they had no presence in the US and transacted very little business in the US. They were mistaken, and Wegelin was fined US$58 million and has since gone out of business and HSZH entered into the 78th NPA under the Swiss Bank Program paying penalties of US$49 million.

Importantly, US authorities are taking the view that as of 2008/2009, when the first investigation was commenced against the first international bank and a DPA was entered into, the financial sector was put on notice worldwide that assisting US account holders to evade US tax would be considered an offence under US law and would be prosecuted by the DOJ regardless of whether the evasion of foreign tax laws was also considered an offence under the laws of an FFI's home jurisdiction.

The Swiss Bank Program

Following several successful enforcement actions, the DOJ came up with a novel approach that aimed to address the bank secrecy concerns of most FFIs in Switzerland, streamline the enforcement process, obtain information about US account holders and encourage FFIs to self-report wrongdoing and cooperate with the US authorities.

In August 2013, the DOJ issued a joint statement with the Swiss Federal Department of Finance announcing the Swiss Bank Program which, subject to certain conditions, encouraged Swiss banks not subject to ongoing criminal investigations to disclose information about accounts held by US taxpayers and pay a penalty in exchange for an NPA. The NPAs generally last for four years, with cooperation requirements sometimes extending until the conclusion of related investigations or proceedings.

Swiss banks eligible to participate in the Program were divided into three categories. Banks that had reasons to believe they may have committed tax-related offences, called Category 2 banks, were required to:

• make a complete disclosure of their cross-border activities;
• provide detailed information on an account-by-account basis for accounts in which US taxpayers have a direct or indirect interest;
• cooperate with treaty requests for account information;
• provide detailed information concerning other banks that transferred funds into undeclared accounts or that accepted funds when undeclared accounts were closed;
• agree to close accounts of accountholders who fail to comply with US reporting obligations; and
• pay appropriate penalties.

Banks had four months from the time of the announcement of the Swiss Bank Program until the end of 2013 to decide whether they wanted to come forward as Category 2 banks to take advantage of the ability to enter into an NPA and therewith avoid a criminal prosecution. Eighty banks opted for Category 2 status and the DOJ reached the first NPA for a Category 2 bank under the Swiss Bank Program in March, 2015. The total penalties levied against Category 2 banks by the time the last NPA was entered into earlier this year amounted to US$1.36 billion.

The Swiss Bank Program also allowed banks that believed that they had not committed a tax offence (Category 3) and those that predominantly had a local client base and met certain FATCA compliance requirements (Category 4) to request a non-target letter. The review of these banks under the Swiss Bank Program is ongoing.

Following the money

Having concluded the Swiss Bank Program for Category 2 banks, the DOJ has indicated that it will follow the money to other jurisdictions. A major benefit of the Swiss Bank Program is the large amount of account information provided to the DOJ by the participating banks, including information about where funds were transferred to by US account holders who tried to avoid being caught through the Swiss Bank Program. Thus, if US account holders moved their assets from banks in Switzerland to banks in other tax havens, the DOJ can trace the funds to the recipient banks. Representatives of the DOJ have repeatedly stated that teams within the DOJ and IRS are reviewing the information obtained under the Swiss Bank Program as well as from other sources to trace funds and identify future targets for investigations. As a result of this review, the US authorities have identified a number of offshore jurisdictions they plan to focus on, including Singapore, Hong Kong, Belize, the British Virgin Islands, the Cayman Islands, the Cook Islands, India, Israel, Liechtenstein, Luxembourg, the Marshall Islands and Panama.

In addition to information obtained under the Swiss Bank Program, the US authorities have collected information from taxpayers who have disclosed their offshore accounts under OVDPs as well as from whistleblowers, and cooperating bank employees. It will come as no surprise that when providing evidence, US account holders will often blame their RMs for suggesting tax evasion measures such as the opening of numbered or ‘hold mail' accounts or the use of offshore vehicles in order to exonerate themselves.

The US authorities are also using traditional methods to obtain information. For example, civil trial attorneys within the DOJ's Tax Division are requesting the issuance of John Doe summonses (ie, summonses that seek information regarding specific unidentified persons) and are seeking the enforcement of Nova Scotia summonses (ie, summonses served on a US branch of an overseas bank requesting the production of bank records held by parts of the bank located in a jurisdiction with strict bank secrecy laws) mostly against financial institutions. These summonses, which are peculiar to the US legal system, are aimed at obtaining information from FFIs about US-related account holders who may be holding undeclared funds offshore.

For example, in February 2016, the DOJ filed a petition against a Swiss-based international bank in the US federal court in Florida to enforce an IRS summons served on the bank in July 2013. The summons and petition sought to compel the bank to turn over records concerning a US taxpayer's account held at the bank's Singapore branch. Interestingly, the IRS knew about the existence of the Singapore bank account as a result of information obtained as part of the investigations of Swiss banks in 2008 and onwards described earlier in this article. The relevant US tax payer had originally opened a Swiss bank account, but had transferred his funds to Singapore when he was informed that his account would need to be disclosed under new ‘qualified intermediary' rules introduced by the US in 2000.

In its petition, the DOJ asserted that ‘even if Singapore's bank secrecy laws, as [the bank] contends, preclude disclosure of the summoned bank records [relating to the taxpayer's] Singapore accounts, international comity requires that the records be disclosed. The interest of the United States in combating tax evasion by US taxpayers through the use of secret foreign bank accounts substantially outweighs the interest of Singapore in preserving the privacy of its bank customers'. This statement highlights the tension that FFIs in jurisdictions will face when confronted with the prospect of becoming subject to US tax enforcement efforts.

According to a statement made by the bank's spokesperson, the bank was eventually able to provide the requested information based on client consent. The Monetary Authority of Singapore (MAS) said in relation to this matter, which was followed with considerable interest by the Singapore financial sector, that ‘Singapore's laws and regulations do not prohibit sharing of information for investigations into possible tax offences' and that ‘banking information could be disclosed through client's consent or via Singapore mutual legal assistance'.

What can FFIs do to respond to the threat of US tax enforcement?

With the threat of substantial penalties and losing access to the critical US financial system, FFIs are under increasing pressure to cooperate with US investigations and to consider the need to voluntarily come forward with information before being contacted by US authorities. This is likely to raise questions under foreign bank secrecy or data privacy laws. However, unlike in the early days of enforcement, US authorities already hold considerable information from the Swiss Bank Program and voluntary disclosures, which often include the identity of the account holder and the fact that the account holder has moved his or her funds to a particular bank within a particular jurisdiction.

We discuss below some key issues an FFI can face in relation to US tax investigations and information requests and some ideas how FFIs can assess and manage the risks affiliated with holding, or having held, undisclosed US-related accounts.

The direction of US offshore tax enforcement going forward

As mentioned earlier in this article, the DOJ has made it clear that they are analysing information gathered so far with a view to following the money to FFIs in other jurisdictions favoured by US accountholders. Singapore is one of the jurisdictions that has been identified as a priority jurisdiction. The DOJ has indicated that it is unlikely that they will announce another NPA programme similar to the Swiss Bank Program and that it would be imprudent for FFIs to wait for the announcement of such a programme. Instead, the DOJ has made it clear that they expect FFIs who believe that they may have engaged in problematic behaviour to proactively approach US authorities with information about their current or historic US account holders in a ‘timely' manner, before the DOJ contacts the FFI based on information collected under the Swiss Bank Program and as a result of disclosure from other sources.

How to assess the risk?

FFIs will want to know whether and to what extent they are at risk of facing a criminal investigation from the US so that they can decide what steps to take to manage that risk. When undertaking such an exercise it will be prudent to look to the Swiss Bank Program to identify the indicia of fraud the DOJ is likely to look for when determining whether an account is likely to fall within the scope of an investigation and whether the FFI or its employees are at risk of being seen as having knowingly assisted customers in the evasion of US tax.

Many FFIs will have conducted a thorough review under FATCA and related IGAs and may have off-boarded all problematic accounts and think that they are therefore no longer at risk. However, there is a danger of confusing compliance with FATCA with the risk of becoming subject to a tax investigation with respect to historic behaviour. FATCA is a forward-looking tool that requires disclosure of information in relation to accounts from 2014 onwards. However, US authorities are also interested in behaviour between 2009 when the financial sector was ‘put on notice' by the first DPA and 2014 when FATCA came into force and most FFIs went through their accounts with a fine-tooth comb. There is an additional wrinkle, in that the indicia that the DOJ applies to determine whether an account is perceived to be US-related are wider than the indicia applied under FATCA. This means that an FFI may still hold relevant accounts that have not been picked up in the course of the FATCA-induced review and that may pose a problem under a future US tax investigation. The fact that investigations are likely to look at historic as well as current behaviour means that even FFIs that have sold their private wealth business in the last few years may still face exposure under the US offshore tax enforcement regime.

Particular areas of risk are likely to exist in relation to:

• customer funds received by an FFI either directly or indirectly from Switzerland after 2008/2009. The DOJ has said that it is looking at ‘flow of funds' and is likely to interpret the acceptance of customer funds from Switzerland in the wake of enforcements against Swiss banks as a ‘badge of fraud';
• accounts off-boarded as a result of an FFI's FATCA-related review. The DOJ is likely to be interested in when and under what circumstances the account was opened or received funds (eg, after 2009) and how the client was exited. Under certain circumstances the manner of the account closure may be seen as a (further) act of assisting in the tax evasion (eg, if sums were paid out in cash or in the form of precious metals rather than being transferred to a FATCA-compliant bank);
• unusual requests for account documentation received from customers, as this may indicate that the customer is considering disclosure under an OVDP, including possible allegations that the FFI was complicit in tax evasion measures.

If an initial review uncovers potential areas of risk, FFIs may wish to consider further review steps which may include:

• exploring whether there was a formal or informal internal policy in place within relevant pockets of the FFI's business to attract ‘leaver' funds exiting jurisdictions that were being scrutinised by the US authorities;
• checking whether certain clusters of account openings may be attributable to RMs that had recently moved from FFIs under scrutiny; and
• interviewing RMs of potentially problematic accounts and reviewing relevant account information including KYC checks and file notes.

Disclosure of account information to US authorities

As mentioned above, the DOJ has made it clear that although there is no plan to formally replicate the Swiss Bank Program for other jurisdictions, it expects Category 2 equivalent banks to voluntarily come forward with information. Alternatively, FFIs may be requested to provide account information under John Doe or Nova Scotia summonses served on their US branches. When considering whether to provide information to US authorities either voluntarily or under US summonses, FFIs will need to consider local privacy and confidentiality laws. FFIs will also want to consider their local regulators' likely attitude to such a disclosure. As mentioned above the recent Nova Scotia summons aimed at information held by the Singapore branch of an international bank was resolved based on customer consent.

Consent is an important tool when it comes to information disclosure issues under local bank secrecy and privacy laws. For new clients, FFIs will have often asked customers to sign widely drafted waivers at the outset of the banking relationship. However, similar consents may not have been obtained from historic clients or may simply not be found on the file. Also, questions may be raised about the scope of the waiver language and the validity of the waiver depending on local laws relating to contractual inclusion of what are often standard terms and the necessity of drawing the customer's attention to certain key terms.

There is clearly tension between US authorities' insistence that FFIs provide information and local laws. It is noteworthy that the MAS referred to either customer consent or mutual legal assistance as the two available avenues to obtain ‘banking information'. However, the options for obtaining (or providing) banking information from Singapore under the mutual legal assistance route are currently limited due to a lack of tax information exchange agreements or treaties between the US and Singapore. It is further noteworthy in this context that the US and Singapore governments have recently announced in a joint statement to negotiate and sign ‘as soon as possible with the aim of doing so by the end of 2017' a reciprocal IGA and a tax information exchange agreement that will facilitate the exchange of information required for tax enforcement purposes. This indicates that easing the route for US tax enforcement with respect to other offshore jurisdictions is high on the US government's agenda.

Risks under local money laundering laws

Where FFIs identify US related funds that may be subject to US tax enforcement, they will also need to consider whether these raise issues under local anti-money laundering laws (AML laws) which may trigger reporting obligations to local regulators and enforcement agencies.

For example, the evasion of foreign tax laws was elevated to a predicate offence under Singapore AML Laws in September 2014 which makes it a criminal offence under Singapore law to assist a person in the evasion of foreign tax laws or to handle proceeds stemming from foreign tax evasion. As evasion of foreign tax laws became a predicate offence around the same time that FATCA was introduced it is possible that Singapore FFIs may have less of an issue in this regard if they off-boarded their problematic accounts prior to the new AML law coming into effect. However, the same may not be true for other jurisdictions. For example Hong Kong's anti-money laundering laws have extended to (foreign) tax evasion as an ‘indictable offence' for a much longer time.

Conclusion

In summary, the DOJ and the IRS have demonstrated a clear focus on targeting undisclosed US taxpayer accounts. They have made it clear that they will investigate and prosecute taxpayers who evade their taxes, as well as the individuals and entities that facilitate the evasion. Moreover, the DOJ has said that it has largely completed the Swiss Bank Program and is now ready to focus on other jurisdictions, based on the vast amount of information gathered since 2008. In that respect, US authorities have a considerable advantage over FFIs in that they know where funds have gone to, whereas FFIs may not have that information readily available and can often only guess at what information the US authorities may or may not hold in relation to them. FFIs are therefore well advised to close that information gap as quickly as possible so that they can assess whether and to what extent they are at risk of receiving a ‘knock on the door' from the DOJ and can start managing that risk.

The authors thank Geng Li, associate in Herbert Smith Freehills' New York office, for her assistance in preparing this article.