[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
HEARING ON BANKING SECRECY PRACTICES
AND WEALTHY AMERICAN TAXPAYERS
=======================================================================
HEARING
before the
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
TUESDAY, MARCH 31, 2009
__________
Serial 111-12
__________
Printed for the use of the Committee on Ways and Means
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COMMITTEE ON WAYS AND MEANS
SELECT REVENUE SUBCOMMITTEE
RICHARD E. NEAL, Massachusetts, Chairman
MIKE THOMPSON, California PATRICK J. TIBERI, Ohio, Ranking
JOHN B. LARSON, Connecticut Member
ALLYSON Y. SCHWARTZ, Pennsylvania JOHN LINDER, Georgia
EARL BLUMENAUER, Oregon DEAN HELLER, Nevada
JOSEPH CROWLEY, New York PETER J. ROSKAM, Illinois
KENDRICK B. MEEK, Florida GEOFF DAVIS, Kentucky
BRIAN HIGGINS, New York
JOHN A. YARMUTH, Kentucky
Janice Mays, Chief Counsel and Staff Director
Jon Traub, Minority Staff Director
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C O N T E N T S
__________
Page
WITNESSES
Hon. Douglas Shulman, Commissioner, Internal Revenue Service..... 6
______
Stephen E. Shay, Tax Partner, Ropes & Gray, Boston, Massachusetts 27
Reuven S. Avi-Yonah, Irwin I. Cohn Professor of Law, University
of Michigan Law Scho........................................... 65
Peter H. Blessing, Partner, Shearman and Sterling, New York, New
York........................................................... 72
SUBMISSIONS FOR THE RECORD
Brian G. Dooley & Associates, Statement.......................... 96
Isle of Man Government, Statement................................ 97
Lyndon S. Trott, Statement....................................... 101
Michael J. McIntyre and Robert S. McIntyre, Statement............ 107
Raymond Baker, Statement......................................... 113
HEARING ON BANKING SECRECY PRACTICES
AND WEALTHY AMERICAN TAXPAYERS
----------
TUESDAY, MARCH 31, 2009
U.S. House of Representatives,
Committee on Ways and Means,
Subcommittee on Select Revenue Measures,
Washington, DC.
The Subcommittee met, pursuant to notice, at 10:03 a.m. in
room 1100, Longworth House Office Building; Hon. Richard E.
Neal (Chairman of the Subcommittee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
SUBCOMMITTEE ON SELECT REVENUE MEASURES
CONTACT: (202) 225-5522
FOR IMMEDIATE RELEASE
March 24, 2009
SRM-1
Neal Announces Hearing on Banking Secrecy Practices and Wealthy
American Taxpayers
House Ways and Means Select Revenue Measures Subcommittee Chairman
Richard E. Neal (D-MA) announced today that the Subcommittee on Select
Revenue Measures will hold a hearing on issues involving banking
secrecy practices and wealthy American taxpayers. The hearing will take
place on Tuesday, March 31, 2009, in the main Committee hearing room,
1100 Longworth House Office Building, beginning at 10:00 a.m.
Oral testimony at this hearing will be limited to invited
witnesses. However, any individual or organization not scheduled for an
oral appearance may submit a written statement for consideration by the
Committee and for inclusion in the printed record of the hearing.
FOCUS OF THE HEARING:
The hearing will focus on limitations of the withholding taxes
imposed by the United States on U.S. source investment earnings
received by foreign persons, the Qualified Intermediary (QI) program
established by the IRS to enforce those withholding taxes, the
limitations of our tax treaties, and the extent to which these may have
contributed to non-compliance by U.S. taxpayers. It will use the
current UBS case as an example of the problems in the existing system.
BACKGROUND:
The United States imposes withholding taxes when U.S. source
investment earnings are paid to a foreign person. Those withholding
taxes were largely designed to collect tax on income earned in the
United States even though the income is earned by a foreign person not
subject to the jurisdiction of our laws. Those withholding taxes also
play a role in preventing non-compliance by U.S. persons holding
investment assets in accounts overseas.
The IRS has established the QI program that authorizes foreign
financial institutions to collect withholding taxes on behalf of the
U.S. Government. The program was implemented to improve compliance for
tax withholding and reporting on U.S. source income that flows offshore
through foreign financial institutions. The recent UBS case indicates
that there are problems with the QI program that permitted tax
avoidance by U.S. persons. Further, even with jurisdictions in which
the United States has a tax treaty, effective information exchange can
sometimes be undermined by local laws providing for banking secrecy
that conflict with U.S. law.
According to the most recent tax year data available (2003), more
than $293 billion in U.S. source income was sent to individuals and
businesses residing abroad. Much of this money flows through U.S.
withholding agents, but some also flows through QI's. Both U.S.
withholding agents and QI's are responsible for withholding taxes, and
in the absence of proper identification, must do backup withholding.
Recently, the GAO found that withholding on these accounts was much
lower.
In announcing the hearing, Chairman Neal stated, ``This will be our
first hearing to address the troublesome issue of international tax
avoidance. The global economic and financial crisis has put pressure on
these international jurisdictions to be less secretive and more
cooperative. The United States and other countries simply can no longer
afford to lose billions of dollars each year in potential revenue to
these secrecy jurisdictions. I expect this hearing to be the start of a
process that leads to bold and decisive action being taken to end
opportunities for tax avoidance through foreign accounts.''
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Chairman NEAL. Let me call this hearing to order.
I encourage all to take their seats. I want to welcome all
of you this morning to this hearing of the Select Revenue
Measures Subcommittee on the issue of bank secrecy and tax
avoidance.
President Kennedy noted that the very word ``secrecy'' is
repugnant in a free and open society. Fostered by today's
technology those comments are truer than ever, but bank secrecy
has long held a certain charm. In fact, mystery writers have
utilized the Swiss Bank as the central focus of intrigue. Where
else would you think to store the secrets of the holy grail but
in a Swiss bank account, as was the case in the novel the ``Da
Vinci Code''.
But events of the last year have chipped away at this
polished veneer to reveal some rather unseemly criminal
behavior. It's been 1 year now since a Swiss banker admitted
that he and his bank assisted, wealthy U.S. taxpayers in hiding
money in offshore accounts that number somewhere between 250
and 50,000 previously hidden U.S. accounts.
The bank has not denied its part and will pay a $780
million fine. Despite the best efforts of the IRS and the
Justice Department, the names of those U.S. taxpayers have not
been divulged. Swiss law has prevented the bank from doing so,
and the treaty is of no help. It seems that there are fewer and
fewer willing to stand up for such confidentiality in the face
of criminal behavior. On the eve of the gathering of leaders of
the wealthiest nations, who, incidentally, generate 80 percent
of the world's wealth, the short list of international issues
to be discussed includes tax havens. And when Prime Minister
Brown, Gordon Brown, addressed the congress in a joint session
earlier this month, he singled out off-shore tax havens as a
threat and received bipartisan applause.
Secretary Geithner just last week stated the Treasury will
be launching a new initiative on tax havens, one to be
underscored by the President at the G20 meeting this week. The
international effort to pressure uncooperative tax havens will
be a diplomatic battle, but Congress must be a partner in this
effort, and this hearing today will explore issues relating to
withholding and reporting, the role of foreign banks in the
collection of U.S. taxes, and how we can better utilize tax
treaties and agreements, which I happen to think constitutes
the key.
It is my hope that this hearing will provide us some
guidance to enhance and strengthen the current system, the
system, which according to one witness today allows $50 billion
of lost tax revenue per year. Following this debate, I'm
hopeful that we can file bipartisan legislation to implement
the recommendations we hear today. Now, let me recognize my
friend, Mr. Tiberi, for his opening statement.
Mr. TIBERI. Thank you Chairman Neal. Thank you for your
leadership.
I share many of the concerns that you outlined in your
statement and look forward to working together on responsible,
common-sense steps that will make our efforts to crack down on
individuals who commit tax fraud more effective. Thank you also
to our witnesses. I appreciate your willingness to join us
today and look forward to your testimony.
Tax evasion through the use of undeclared off-shore bank
accounts or by any other means is a Federal crime. I think we
all are in agreement here today that criminal tax evasion
should be pursued aggressively and punished. Not going after
the dishonest few who commit criminal acts to the fullest
extent possible is unfair to honest, hardworking Americans who
pay their taxes and strive to comply with our country's tax
laws.
The ongoing events surrounding UBS AG and its admitted
criminal role in helping a number of wealthy U.S. individuals
evade U.S. taxes have brought a spotlight to bear on
international tax enforcement and the tools that we have at our
disposal to help ensure compliance. Among those tools is the
qualified intermediary program; and under the QI program,
foreign financial institutions agree to verify the status of
foreign investors and collect and remit the appropriate U.S.
withholding tax, if any. Recent events have demonstrated a
number of areas where the QI program may be strengthened. I
hope that we will discuss some of those today.
Additionally, the U.S. has entered into dozens of tax
treaties, and bilateral mutual legal assistance treaties with
other nations as well as approximately 20 tax information
exchange agreements. In short, the United States is not alone
in the effort to ensure the compliance with our tax laws. A
number of frameworks currently exist across government in the
private sector. As we proceed with this discussion, we should
keep in mind that there are willing partners on the
international front and continuing to improve the work through
our formal network of information exchanges, which is the
responsible way to move forward.
Steps that undermine our international standing could
threaten key information exchanges and invite unintended
consequences that could do significant harm to our economy's
capital markets. This hearing is an important opportunity to
examine the serious tax compliance issues we face, find out
where our current enforcement regime may have fallen short,
explore new tools that may help us fight tax evasion, and close
the international tax gap. As we all know the tax gap is
defined roughly as what is legally owed, but not collected.
I sincerely hope our efforts today will remain focused on
the issues of compliance. The line between illegal tax evasion
and legal tax practices used by U.S. taxpayers around the world
is distinct. To blur that line may only make our compliance
efforts that much more difficult.
Thank you again, Chairman Neal, and thank you for your
leadership on this important issue.
Chairman NEAL. I thank the gentleman for his good comments,
and let me welcome our witnesses here today on our first panel,
the Honorable Doug Schulman, Commissioner of the Internal
Revenue Service.
Thank you, Commissioner, for joining us today.
I want to advise Members that the Commissioner may not be
able to answer specific questions regarding pending legal
matters, including the UBS case. I know the Members of the
panel here, they're likely to try any way.
On our second panel, we will hear from Stephen Shay, a tax
partner at Ropes & Gray in Boston, who was formerly the
International Tax Counsel at the Treasury Department.
And we will also welcome back to the Subcommittee Professor
Avi-Yonah of the University of Michigan Law School who was a
recognized expert in international tax issues, and has served
as a consultant to the Treasury Department and OECD.
Finally, we will hear from Peter Blessing, a law partner at
Sherman and Sterling in New York. Mr. Blessing specializes in
international tax issues and we are fortunate to have his
expertise here today.
Let me note, for the record, that we did extend an
invitation to the Swiss government and to UBS to appear before
the Subcommittee today, both respectfully declined.
Without objection, any other Members wishing to insert
statements as part of the record may do so. All written
statements by the witnesses will be inserted into the record as
well. I'd like to recognize Commissioner Schulman for his
opening statement.
STATEMENT OF HON. DOUGLAS SHULMAN, COMMISSIONER, INTERNAL
REVENUE SERVICE
Mr. SHULMAN. Thank you, Mr. Chairman, Ranking Member
Tiberi, Members of the Subcommittee.
It's a pleasure to be here today to talk to you about the
unprecedented focus that the Internal Revenue Service has
placed on detecting and bringing to justice those who
unlawfully hide assets overseas to avoid paying tax.
In today's economic environment where the Federal
Government is necessarily running deficits to restore economic
growth, it's more important than ever that citizens feel
confident that individuals and corporations are playing by the
rules and paying the taxes that they owe. When the American
public is confronted with stories of financial institutions
helping U.S. citizens to maintain secret overseas accounts
involving sham trusts to improperly avoid U.S. tax, they should
be outraged, as am I. But they should also know that the U.S.
Government is taking unprecedented measures and there is much
more in the works.
As you know, Mr. Chairman, Federal law prohibits the
disclosure of information about civil and criminal tax
investigations. While the Subcommittee may have seen press
accounts and documents entered in the public record about some
recent investigations, these relate to ongoing civil litigation
where the strategies, techniques and opinions of the IRS, and I
might note specifically the IRS Commissioner, are central
elements to the litigation; and, therefore, the Department of
Justice has asked that I not comment on the UBS case
specifically.
With all the recent publicity, the press has also been full
of speculation about those who are advising U.S. taxpayers who
have undeclared offshore accounts and income. My advice to
those taxpayers is simple. They should come in under the IRS'
voluntary disclosure program. We have been steadily increasing
pressure on offshore financial institutions that facilitate
concealment of taxable income by U.S. citizens, and that
pressure will only increase.
The IRS recently issued guidance to its exam personnel who
are addressing voluntary disclosure requests involving
unreported offshore income. We issued this guidance to make
sure that our personnel had standard procedures when someone
voluntarily came in. We believe that this is firm but fair
resolution of these cases. Taxpayers who come in will pay a
significant price, but they will also avoid criminal
prosecution if they come in voluntarily.
Mr. Chairman, there is no silver bullet or one strategy
that will alone solve the problem of offshore tax avoidance.
Rather it's an integrated approach that we have been
developing. My written testimony explores a variety of elements
of that approach. Let me highlight a few. First, since becoming
Commissioner, I have made international issues a top priority.
I have both increased the number of audits in this area and
prioritized stepped-up hiring of international experts and
investigators.
We have had some success with some high profile cases that
you mentioned and we're getting some other results. Several so-
called tax haven countries have pledged to reform bank secrecy
laws, and in the last month have agreed to comply with
international standards for tax and data sharing. The
President's 2010 budget will allow us to increase our resources
in this area and it includes robust funding for a portfolio of
IRS-International tax compliance initiatives.
The IRS is also looking at how to improve the qualified
intermediary program, or QI program. The QI program is an
important tool for the IRS, because it gives us a line of sight
into the activities of U.S. taxpayers who do business with
foreign banks. As with any large and complex program, we have
to strive to continuously improve the program where we see
weaknesses. Several measures that we are considering now with
the Treasury Department include: expanding the information
reporting requirements to include other income besides just the
income from U.S. securities; strengthening documentation rules
to ensure that beneficial owners of accounts cannot hide behind
sham trusts; subjecting trusts or private corporations to U.S.
withholding tax, if we don't have a clear line of sight to the
beneficial owners; and, additionally, we've already proposed
changes that would shore-up the independent review of the
qualified intermediary program in substantial ways.
As you can see, the IRS and Treasury are considering a wide
range of measures to ensure that the QI program works as
intended, but there's always going to be situations when we
discover a potential of violation of tax law after the fact. In
these cases, we need some other administrative and legislative
changes. We are exploring increased use of and potentially more
information reporting requirements around money being
transferred in and out of the United States. And we've also
asked Congress in the past, and we'll continue to ask for an
extension of the statute of limitations when we're working on
cases that involve off-shore tax evasion.
Mr. Chairman, these are important steps forward, but there
will be much more to come. The President's budget committed to
identifying $210 billion in savings over the next decade from
international enforcement and reforming other tax policies in
the international arena. The Administration will have more
detailed and specific announcements in the near future.
We are also looking closely at a variety of legislative
proposals that have been introduced by Members of Congress and
we look forward to continuing dialog over the coming months.
Thank you for this opportunity to provide an update of IRS
activities to combat illegal tax avoidance schemes. Because
this is a global problem it will require a closely coordinated
strategy among nations dedicated to ending this evasion that
deprives our country of precious resources and erodes citizens'
confidence in the fairness of our tax administration system.
I'd be happy to respond to questions.
[The prepared statement of Mr. Shulman follows:]
Statement of The Honorable Douglas Shulman, Commissioner, Internal
Revenue Service
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman NEAL. Thank you very much, Commissioner.
I read your testimony last night. I thought it was really
on target, and like many as I come across data in the last few
weeks, I was surprised to hear that there were 50,000
previously undisclosed bank accounts that UBS held by U.S.
taxpayers; and, I think some clarity here would be helpful.
It's been estimated that these accounts hold $14 billion in
assets. Now, many of those accounts may be simple checking
accounts for U.S. workers in Switzerland, but those accounts
still are probably earning interest income.
Do you support proposals to modify the QI regime so that
QIs would report on all U.S.-held bank accounts, and not just
those accounts which include U.S. securities?
Mr. SHULMAN. As I mentioned, we are having discussions
about a variety of issues. That's certainly one of the issues
on the table. It would be helpful for the IRS and we'll be
coming out, hopefully in the next month or so with a full range
of pieces. But in general I support a wider range of reporting
around the bank accounts held by individuals overseas.
Chairman NEAL. And a year ago the GAO in reviewing the QI
program found it troubling that there were large sums flowing
to unknown jurisdictions and unknown recipients with a
withholding rate at about 4 percent when it should be 30
percent, it makes it seem as if the QI isn't complying with
know your customer rules if they don't know where and with whom
the payment ends up, which I also think is very important.
What has the IRS done since the program audit by GAO to
find an answer for this anomaly or to ensure that QIs actually
know their customers and to collect the tax?
Mr. SHULMAN. There's a couple things we've done. You know,
a combination of some of the external auditor reports as well
as some of our stepped up investigations where we've been
looking closer at banks that are facilitating either legal or
illegal accounts being held overseas.
One is we made a proposal in November that the external
auditor that audits the QI program for the IRS, a) has to
report to the IRS if there's indications of fraud and b) needs
to have some nexus to a U.S. audit firm so that there can be
some supervision of the work by an entity which the IRS has
some authority over. Those proposals are out for comment now.
We have received a lot of comments. We are reviewing them.
Second is what I would refer to in my testimony, which is,
I think, there's a real need. In the past we relied on country-
by-country ``know your customer'' rules. It's clearly the
responsibility of a financial institution to look at
documentation of anyone opening an account with them. We're
looking at some substantially stepped-up proposals to make sure
that when bank accounts are opened by QI that have a U.S.
taxpayer involved, that there's more documentation around who
are the real owners of those accounts.
So that we can look through trusts, private corporations,
where there's a lot of issues, someone sets up a trust in a
foreign jurisdiction, the bank will need to look through. If
there's any indication that there's a U.S. taxpayer that either
we are going to need to see that information or we'll have
automatic withholding.
Chairman NEAL. As promised, the nexus between secrecy and
the number people you believe are avoiding the responsibility,
do you want to quantify a number for us about how much is out
there?
Mr. SHULMAN. You know, let me talk to you about the
problems with quantification since we had a conversation about
this before.
First of all, when the IRS quantifies a number it has some
weight, because we put out the tax cap proposals. The most
reliable way for us to quantify any sort of gap between taxes
owed and taxes paid is for us to do randomly selected audits.
Usually, our audits are selected based on some criteria that
targets people who, we think, would have non-compliance. We
will also set up research programs where we randomly select
audits and we go into audits. The problem with doing this
overseas is we need to work through embassies, local law
enforcement officials, and when there's accounts hidden, it's
much harder to find than a U.S. citizen on U.S. soil.
With that said, I've challenged our team to do some of the
kinds of extrapolation that some of the witnesses have done on
your next panel to see if we are going to come up with our best
estimate. What I would say, though, is a couple of things. Any
enforcement program, and especially this kind of an enforcement
program, that sends a message when there's somebody who has the
means to hide assets offshore--sends a message to average U.S.
citizens, a teacher, a fireman, a policeman who are paying
their taxes--that there's some sort of inequity, that they're
paying their taxes because it's reported on the W-2, and
someone's hiding their assets offshore.
I think it's a matter of fundamental fairness that we have
risk enforcement programs, and we go after people hiding assets
offshore. It's also about protecting the two and a half
trillion dollar revenue base, and having U.S. citizens feel
that there's fundamental fairness in the system so that they'll
continue to voluntarily come forward and pay taxes. And so
whether the number is two billion, five billion or ten billion,
I think we will continue to have a focus in this area because
it protects the overall revenues for the U.S. Government.
Chairman NEAL. The other witnesses are invited to speculate
at the right moment as well.
And with that I would like to acknowledge Mr. Tiberi.
Mr. TIBERI. Thank you, Mr. Chairman.
Commissioner, it appears to me that if a U.S. taxpayer was
intent on evading taxes, and tell me if I'm wrong on this, the
best way to do it would be to find a foreign bank that's not a
QI that doesn't have a U.S. presence somewhere in the world,
how do you together with us prevent that scenario from
happening?
Mr. SHULMAN. Yes, clearly, if we're going to have a
comprehensive approach to the problem of off-shore tax evasion,
we need to focus on strengthening the QI program and also
encouraging people to come into the QI program. And so, we need
to have the QI program work, and make sure that people are
participating through the QI program, we have information on
them and they pay the proper amount of taxes.
I think we also need to encourage other institutions to
become QIs. Some of the items under discussion are looking at
some disincentives around not being a QI. For instance, more
withholding if funds are being transferred to a non-QI versus a
QI, information reporting to the U.S. Government about those
kinds of wire transfers that are going out to non-QIs, so there
needs to be a comprehensive approach that includes both. I
think you're absolutely right on that and I'd agree with you.
Mr. TIBERI. I mentioned in my opening statement the
cooperation that's out there that currently exists, are you
working through those channels as well with other foreign
counterparts?
Mr. SHULMAN. Yes, absolutely. I would agree with you
wholeheartedly that we need to have bilateral discussions,
multilateral discussions. This is not just a U.S. issue. You
know, a lot of countries are focused and worried about illegal,
offshore tax avoidance.
Clearly, the Treasury Department participates in a variety
of forums. As you know, when the Secretary went a few weeks ago
to the G20 and the President will be at the G20. There's a
forum of tax administrators in the OECD, which I'm an active
participant in. We also have a smaller group called the Leads
Castle Group, where just tax commissioners come together and
discuss these issues. And we have something called the Joint
International Tax Shelter Information Center called JITSIC,
which was originally formed by the IRS and several other
countries to co-locate staff to have more open dialog around
tax shelter issues. We've recently expanded that to look at
some other issues including off-shore tax avoidance; and so I'm
a big fan that this is not a go it alone strategy. That we need
to be actively engaging other countries and this is part of a
diplomatic dialog among nations.
Mr. TIBERI. Can you expand upon the issue of the tax
statute of limitations that you talked about extending for how
long and why?
Mr. SHULMAN. Yes. There's a few proposals out there and a
number of them would work pretty well for us. The proposal we
have on the table is just simply to extend from 3 years to six
years the statute of limitations.
Mr. TIBERI. And why is that important?
Mr. SHULMAN. The reason it's important is when we're
conducting an investigation in the U.S. we have all the
authority of the U.S. And people understand, you know, our
ability to go and do an audit, do an investigation. We know how
to find people. We have agents who can go out and see them.
And, generally, once you cross a border, a) it's harder to find
folks and b) when we're doing exchanges of information or
trying to get information, it can take longer.
People who are operating in the international arena
generally have very sophisticated legal counsel and other
advisors who know exactly where the statute of limitations end
and can play run out the clock with us, and it's just harder to
find information. It takes longer to do investigations. We
sometimes have to work through law enforcement agencies in
other countries which can take time to go through the
administrative process to get it done. And so it's really a
matter of us having a reasonable amount of time to follow the
trail, which can be harder to follow once you cross the border.
Mr. TIBERI. So just to summarize, Commissioner, do you
believe that together with some tools that we can give you
along with some things that you can do with some of your
counterparts and foreign governments and financial services
companies around the world that we can get out this better?
Mr. SHULMAN. Yes.
Mr. TIBERI. Thank you. I yield back.
Chairman NEAL. Thank the gentleman.
The gentleman from New York, Mr. Crowley, is recognized to
inquire.
Mr. CROWLEY. Thank you, Commissioner Shulman, for being
here today and discussing these issues.
Along with Chairman Neal I recognize the need to address
the tax gap and ensure all appropriate owed taxes are paid and
welcome the hearing today on QI. But that brings me to what I
would like to discuss with you today. And let me start by
saying my office has not yet really had the opportunity to
fully vet this with you and your staff, as this is relatively
new to our office as well. But this looks like an issue that I
would like to work with you and your office on and you can
agree or disagree, depending on where we go with this question.
I understand that Americans investing abroad for the most
part are taxed at the maximum withheld rate in most foreign
countries at first, as those tax collection agencies are not
familiar with the identity of the investor, the American
overseas. A meeting for the American invested in the U.K., the
U.K. tax authority would withhold the maximum on any dividends
earned regardless of any tax treaties, as the U.K. wouldn't
know at first what the nationality of the foreign investor was.
Then the American taxpayer can file a tax reclamation form in
that foreign country to reclaim any taxes withheld above the
limits of any tax treaty between the two nations.
Afterward, that American can then file an IRS form 1116 to
claim a U.S. tax credit for any foreign taxes that were legally
paid abroad. The form 1099 dividend form is the form issued by
brokerage houses to U.S. taxpayers that lists the amount of
foreign tax paid and as the basis for the American taxpayer,
that claimed U.S. tax credit on form 1116 for foreign taxes
paid, my question is this form. Form 1099-DIV, issued by the
IRS only asks the amount of foreign tax paid, not the actual
amount of foreign taxes legally owed and paid, not taking into
account taxes paid and then reclaimed by the taxpayer.
Therefore, I could be investing in a foreign country, have
the maximum withheld, reclaim a fair amount of it due to a U.S.
tax treaty. But, on the 1099-DIV form, I can still report the
total amount of taxes paid before reclaiming what was owed to
me and collect a credit based on that total amount paid before
reclamation.
I'm not saying that this is tax fraud by brokerage houses
or U.S. investors individually, but rather maybe the need for
an updated 1099 dividend form to reflect the actual taxes
legally paid. This could help us better tailor this U.S. tax
credit to apply only to those foreign taxes actually paid for
taxes actually owed and not reclaimed.
Could you give us your thoughts on this issue as a possible
candidate to help us narrow the tax gap without increasing
taxes or scaring away investors, both for individual investors
and for hedge funds and other entities as such.
Mr. SHULMAN. Well, you know, I think as you noted, the
intent of a foreign tax credit is to make sure that people
aren't subject to double taxation. They're not paying the same
tax in a foreign country and here. Clearly, there's
opportunity, and I haven't explored this issue and would be
happy to explore it with your office.
We've talked a lot about foreign tax credit generators in
the business context where kind of some of the intent of
foreign tax credits and the confusion around it can have people
not just get rid of double taxation, but actually end up with
some sort of tax benefit. So, in general, what I would say is
the QI program gives us a way to work with foreign banks when
people invest overseas and allows us to set up a set of rules
around them doing proper reporting and withholding. And so I
think strengthening the QI program and the avenue you're going
down should help with that.
Clearly, if people are claiming a credit for foreign taxes
paid, but then they get money back and not doing that, that's
an issue. It's not one that I've explored fully yet.
Mr. CROWLEY. We'd like to work with you and your office on
it.
Mr. SHULMAN. Be happy to work with you on that.
Mr. CROWLEY. Thank you, Commissioner.
Chairman NEAL. Thank you very much.
The gentleman from Nevada, Mr. Heller, recognized to
inquire.
Mr. HELLER. Thank you, Mr. Chairman. Thank you. And thank
you for the opportunity for the Committee to look into an issue
related to international tax compliance, specifically the
recent stories that have come to light regarding big bank
secrecy practices in Switzerland.
I share the serious concerns nearly all Members have that
the practices that occurred must come to a halt. To do that
some changes certainly need to be made. Those who broke the law
need to be brought to justice; however, I do have some concerns
that this particular issue is being used to advance another
agenda, an agenda that's not really about compliance with the
law, more about international tax policy.
While our Committee has jurisdiction and every reason to
look into issues of international tax competition, I think that
someone might be trying to use this one example to dramatically
alter international tax policy. We do have a problem in our
government along with the Swiss government. Financial
institutions are in a process of correcting that problem.
Again, those who broke the law should face the penalties
clearly, but this example should not be the springboard to
massive new regulations.
The banking secrecy practice is being examined today,
already against the law, should not be a platform to creating
new blacklists and financial enemies right at the time when
international financial cooperation is so desperately needed to
address our economy to continue fighting the drug war that is
creeping across our borders, and to continue our fight in the
global war on terror.
Commissioner, thank you very much for being here.
I just want to raise the concerns that have been raised
about this blacklisting approach. There are some that believe
that it threatens critical information exchanges with other
countries, undermines our international standing and invites
retaliation that could do harm to U.S. capital markets.
Would you care to give us your opinion and thoughts on this
issue?
Mr. SHULMAN. Yes. I think the U.S. is not. You know,
there's a broad discussion happening at the G20 about the so-
called black list. I don't think you've seen anybody, you know,
certainly in my office or in the U.S. endorse or not endorse
it.
My personal opinion is that where we need to focus is not
around necessarily names of countries, but are on
characteristics that could help facilitate evasion. And so bank
secrecy, lower tax rates, the QI program where there's not
incentives, not having good information exchange agreements,
and so we're very focused on finding places where there's
evasion and going after them.
We haven't been focused on necessarily naming countries,
which I fully recognize. You know, I've got a view as IRS
Commissioner, but when you want to get into putting names of
country on lists, it's a much broader, diplomatic discussion
involving State Department, Treasury, ultimately the White
House, and others.
Mr. HELLER. Would you discuss, just kind of changing
directions here a little bit, the voluntary disclosure guidance
program that you issued on March 26th?
Mr. SHULMAN. Yes. We issued direction to our field about
how to handle cases of voluntary disclosure where people are
coming in with off-shore bank accounts.
I mean, clearly, we have been seeing some results as we
have been stepping up the pressure. People have been availing
themselves. We wanted to have a consistent approach so that our
agents in the field who work these cases, know exactly what to
do and what was supported in getting a resolution.
We also wanted to have predictability for taxpayers. The
way this works is taxpayers who come in truly voluntarily--not
taxpayers that we've contacted or are under criminal
investigation--will have to pay 6 years in back taxes, plus
interest. They'll have to pay either a delinquency or
inaccuracy penalty, depending which applies, and then they'll
have to pay a penalty in lieu of all other penalties of 20
percent of the highest account balance in their bank account or
their investment or bank account over the last 6 months.
We also issue guidance, and, again, we think this is firm.
We think it's fair, and any time you're having a voluntary
disclosure program what you want to do is make sure that people
aren't getting away Scot free and that regular citizens who
have actually been paying their taxes all along don't feel that
they've been short-changed and that we're giving somebody a
sweetheart deal. So it needs to be tough, but it also needs to
be attractive enough that we bring people in, because
ultimately our goal is to get people into the system.
The other thing we issued in this guidance is that this is
6-month guidance, after which we will reevaluate. And people
who we find who don't come in voluntarily, we've instructed our
agents to fully work those cases and explore all criminal and
civil pursuits and investigations that they can.
Mr. HELLER. Thank you.
Chairman, I yield back.
Chairman NEAL. I thank the gentleman.
Mr. Doggett, the gentleman from Texas is recognized to
inquire.
Mr. DOGGETT. Mr. Chairman, thank you very much, and thank
you especially for holding this hearing. It deals with a very
important topic to every American taxpayer, business, or
individual who's playing by the rules and paying their fair
share of taxes, when other people, as the Commissioner has
pointed out in his testimony--the firefighter, the police
officer, doing their fair share--and some individual or
corporation goes off-shore to avoid doing their fair share.
This hearing as the questions from our colleague just
indicated, also provides us the first opportunity to look more
closely at the tools to address this issue that are advanced in
the stop tax haven legislation that I introduced last session
with Senator Levin.
At that time, Senator Barack Obama was one of our
cosponsors as was Rahm Emanuel, and you, Mr. Chairman, here on
this Committee, we've refilled that legislation joined by
Chairman Neal and sitting Commissioner in the same chair you
are, Treasury Secretary Geithner endorsed the legislation when
he was here testifying to us a few weeks ago.
That would of course be consistent with your own testimony
when you testified earlier this month in front of Senator
Levin's Subcommittee on permanent investigations; and, I
believe your testimony, sir, would be good news for the IRS to
have the enforcement tools available that are included in the
stop tax havens legislation. Is that correct?
Mr. SHULMAN. That is correct.
Mr. DOGGETT. And you believe it would be good for the IRS
to have stop tax havens adopted?
Mr. SHULMAN. It certainly would give us a variety of more
tools. And as I mentioned before, that bill is out there.
Senator Baucus has just introduced a bill, and we're working
pretty aggressively now to make sure that the Administration is
going to come forward with a full package. So we very much
welcome it.
Mr. DOGGETT. And so since little or nothing had been done
in the prior Administration, I am delighted to hear that you
are, I believe, the approach Senator Baucus has, who's far
different than stop tax havens, but it is important for us to
work together to try to get the strongest tools possible.
I applaud your comments about fundamental fairness and
inequity to American taxpayers and the way this jeopardizes our
system when some individuals and some multinational
corporations engage in these kind of shenanigans. As it relates
to specifically to the inquiry that you just received about so-
called black lists, I want to explore with you. As you know,
the original countries that are listed in the stop tax haven
legislation grow out of enforcement actions by the IRS by your
office.
What circumstances, generally, cause you to go in and
question the use of an off-shore account in a place like the
Cayman Islands or Panama, or some other tax-dodging place?
Mr. SHULMAN. Well, the lists that you mention came out of
an initiative that we did where we issued a John Doe summons.
Mr. DOGGETT. What is that?
Mr. SHULMAN. I'm sorry. A John Doe summons is when we think
there's a class of taxpayers, we have no other way to get at
it, and we have some evidence that there's a class of
taxpayers. And rather than naming a taxpayer by name; you know,
Mr. Doggett, we're looking for your information. We have an
identifiable class of taxpayers, and so we've actually recently
issued a John Doe summons on a class of taxpayers in the case
that was mentioned before, just saying we think there's a bunch
of people. We don't have their names, but we're looking for a
bank to come forward with that information.
The list was never really intended to say these countries
have problems all the way across the board. So whether they do
or not, it was intended for a very specific credit card
initiative where we had evidence there were credit cards being
issued from those jurisdictions and we're looking in general
for all the names of the credit card holders.
Mr. DOGGETT. As you know, the stop tax haven legislation
that Secretary Geithner endorsed authorizes the Treasury to
take countries on and off that list. Are there any of those
John Doe summonses that involve countries where you have
subsequently seen improvement under bank secrecy laws and a
John Doe summons would no longer be necessary?
Mr. SHULMAN. Well, those John Doe Summons are closed. We
don't have any kind of broad, open John Doe summons around with
countries named that are open right now. You know, I guess what
I'd say I think the world has paid attention to, both the
legislative interests in this issue, the international focus on
this issue and the IRS has stepped up enforcement in this
issue.
In the last month, you've seen a number of jurisdictions
that either had bank secrecy or didn't have good information
exchange agreements step forward and say that they're going to
start working on information exchange agreements. And so I'm
quite hopeful with some of the progress. That progress alone
isn't going to solve this problem, but is certainly a step in
the right direction.
Mr. DOGGETT. Mr. Chairman, may I pose just one more
question about qualified intermediaries?
Under the program I'd like to know if any institution has
ever been kicked out of the program, what the procedures are
for expelling someone from the program; and, specifically,
given all that we know that has occurred, why UBS has not been
kicked out of the program.
Mr. SHULMAN. Yes. As I mentioned in my opening statement, I
can't speak specifically about UBS, but let me answer the rest
of your questions.
Institutions can be kicked out, and the two criteria are
material failure and no remedy. My goal is to actually protect
the integrity of the system, keep people in the system, because
once you've kicked them out of the system, then we don't have
necessarily a line of sight and agreement between the IRS and
that institution.
We have terminated a number of QIs, close to a hundred in
the past, and the specific question you asked about UBS I just
would refer you to the deferred prosecution agreement with the
Justice Department that actually has a number of issues around
the QI program in there. But, again, when there's a material
failure and there's no remedy, we will kick people out. The
goal though is actually to get remediation, keep people in the
system, so we keep the line of sight on U.S. taxpayers.
Mr. DOGGETT. Thank you, Mr. Chairman.
Thank you, Commissioner.
Chairman NEAL. Thank you, Mr. Doggett.
The gentleman from Illinois, Mr. Roskam.
Mr. ROSKAM. Thank you, Mr. Chairman.
Commissioner, could you just elaborate a little bit more. I
sensed sort of healthy, honest tension in the exchange and I
don't want to over interpret it. But can I give you a couple of
minutes to highlight for us what some of the concerns may be
about what some people are characterizing as a black list for
countries and how that has an impact on your job as a
commissioner that's interacting with other nations seeking
cooperation.
Can you speak to that generally?
Mr. SHULMAN. Well, I mean, sure.
I think, you know, the issue of black lists have been
played out pretty accurately and well in the press. I mean some
will tell you a black list is great, because it shames the
country into compliance. Some will tell you that a black list
is horrible because, you know, there's a lot of other
diplomatic issues. There's a lot of cooperation. You don't want
to put countries on a list.
My view is that what's important is that we need to have a
whole integrated set of tools to combat off-shore tax
avoidance. I mean, the first most important one, as I've said
it's a priority for the IRS, and the President said it's a
priority for the Administration. People take notes.
Second is we're in the process of stepping up and hiring
more examiners, more lawyers, more agents, more special agents
for criminal investigations, placing more people in other
countries. We need to use data better, both data exchanges from
other government agencies, third party data, as well as data
from other government agencies.
We need to strengthen the QI program. We need to look at
legislation, and there's a variety of legislative proposals on
the table. We need better coordination amongst nations, both
formal dialog, but also increased informal dialog and
discussion, so we're seeing trends that are happening. And we
need to keep focused on our litigation and our enforcement
efforts that have been having some impact.
And so I guess what I'd say is I think this will be
continue to be a discussion at the G20. It's a discussion
that's happening now at the level of the President. It doesn't
need to happen at the level of the IRS Commissioner. But
regardless of the outcome of that discussion there's really a
whole suite of things we need to do to tighten the net around
those using the international capital markets to hide assets
overseas.
Mr. ROSKAM. Fair enough. Thank you.
You mentioned earlier that part of the approach here is in
the voluntary program, the imposition of a special penalty and
so forth. Can you walk us through sort of the IRS thinking
about penalties? Now, in the interest of disclosure I asked
Secretary Geithner about his own tax situation and he told this
Committee that he was encouraged by the IRS to seek a waiver of
the penalty.
I'm not asking you to comment on the secretary's individual
situation, because I know you can't, but can you give us a
glimpse into the decisionmaking at the IRS about generally how
you make decisions about imposing penalties and not imposing
penalties as it relates to other policy questions or other
compliance issues.
Mr. SHULMAN. Yes. I mean at the end of the day, for
instance in the off-shore case, this is going to be a broader
initiative, and I'm a big fan. You know, we have limited
resources. We have to triage those resources. We have to decide
where we're focusing both on our service agenda, on our
technology, on our enforcement agenda. I'm a big believer that
when we can set up a unified program with a group of taxpayers
it brings them back into the system and has them be compliant
taxpayers in the future, that settlement initiatives are a good
idea.
What you're seeing now in this off-shore case isn't really
a public settlement initiative. It's guidance to the field that
was then made public. There, what we're doing is we're trying
to say, ``Come in.'' It will be predictable, and you will avoid
criminal prosecution. And that's the kind of thing you'll see
when we're doing broad initiatives for sets of taxpayers.
For penalties in general, obviously, Congress sets the
penalties, but the IRS is given administrative discretion. I'm
a believer that each individual taxpayer that comes in needs to
be looked at individually. We have no discretion about waiving
taxes or interest, but when it comes to penalty, our agents--
and the discretion is put into the hands of individual agents
who are looking at those cases--have the ability to look at
facts and circumstance; look at whether actions were willful or
not willful, whether they were honest mistakes or whether
someone was trying to evade taxes, and they have the ability to
abate penalties in individual circumstances.
They can abate or not abate. There are avenues for appeals,
both within the chain of command of the agent as well as to go
to our appeals function. And then there's obviously tax court
and litigation where these issues can get played out. And so
the penalty regime is an important part of tax administration.
We've got some discretion, and taxpayers have a variety of
avenues they can go to if they think that discretion isn't
being used properly.
Mr. ROSKAM. Thank you, Mr. Chairman.
I yield back.
Chairman NEAL. Thank the gentleman.
The gentleman from Florida, Mr. Meek, is recognized to
inquire.
Mr. MEEK. Thank you, Mr. Chairman, and Commissioner it's
good to see you again and I enjoyed the discussion we had last
week on this topic. And I know that just by this hearing today
we will be able to zero in more on those individuals who are
putting us in this room at this particular time to talk about
this issue.
You know, in 2003, some $293 billion was sent to
individuals and businesses residing abroad, and I think that's
something that especially in these very hard times we have
companies that are here in the United States of America that
have obtained their share of taxes by U.S. law, that we make
sure that we level that playingfield.
I just want to change the channel here, not too far, but on
a recent action that you were able to take; and, as it relates
to the theft loss of those that have been victims of these
Ponzi schemes that have been going on, especially brought to
light in recent days, we know that there has been some
confusion, because we know that there's been a lot of action in
the stock market. Many investors lost great sums of money based
on the stock market and the reaction that it's had to this
economy.
But, as it relates to some 13,000 plus Americans that found
themselves in the situation, not only in the well-known case of
the Madoff case, but several other Ponzi schemes that had been
uncovered since the regulators have been looking at these
individuals a little closer now have lost their entire life
savings in many cases, giving statements that they had a
certain amount of money, paid taxes on those dollars. And, many
of those individuals reside in Florida and throughout the
country.
I know that you have taken action recently and I had an
opportunity to read your testimony from the March 17th hearing
that took place over in the Senate and you addressed some of
the issues that you found that were wrong and that needed to be
dealt with. And you dealt with them, I believe, with a 5-year
theft loss, which I think looking at that is a step in the
right direction.
But there's still work that's undone. The reason why I'm
homing in on this is because 2,000 of these individuals reside
in Florida, and 562 of them reside in the two counties that I
represent in south Florida. And we have a number of seniors,
Commissioner, and I don't need to tell you. But we have a
number of seniors, even with the five-year theft loss that IRS
has ruled on that's in play in this particular case. But we
have a number of seniors at 85, 90 years old, finding
themselves in a situation of having to move out of their homes.
I have legislation that is H.R. 1159 that's going to set it
back by 10 years to allow them to be able to claim theft loss
on those dollars that they paid taxes on. They thought they
had, but was not necessarily there. Also, their issues as it
relates to foundations that were not addressed in the ruling
that are providing services to many of these seniors that found
themselves in a very bad situation, I was hoping if you could
elaborate and clarify a little further on the action that you
took and as it relates to the seniors with a 10-year. And
that's an act that the Congress is going to have to move on,
which I'm pushing a legislative hearing on soon, and also
talking with the Administration on.
How would it assist seniors to move it from five versus ten
years? I guess that's my question.
Mr. SHULMAN. Yes. The actions we took were really making
sure that the Treasury and the IRS lawyers give clear
interpretation of the current laws on the books around
investment theft losses. We thought this was important, because
when you're having a declining stock market, when you're in a
serious economic slump, that's when Ponzi schemes come to
light, because there's no longer money flowing in, so they
can't be paying out money to old investors.
What we did was just interpret the law, said it's
investment theft loss. Once you have an investment theft loss,
you go into the typical NOL carry-back language, which is three
years generally. The American Recovery Act actually provided
for five-year carry back, if you have less than 50 million of
income, and so our interpretation said that that was the case.
We also put out a revenue procedure that put a safe harbor in
place, because a lot of times it takes many years to litigate
these cases to find out how much you're going to actually
recover from the trustees and etcetera; and, really, the place
people get money back is from SIPIC and from the IRS. And so
our safe harbor said that you could take 95 percent of your
loss, minus SIPIC and what you reasonably expected to regain.
And so ours was pure interpretation. As we had a chance to
talk about, we'll obviously follow whatever law Congress puts
in place; and, you know, I can't really opine on, you know, we
don't have the authority to do a 10-year carry back. We have an
authority just to interpret the laws as they're on the books.
Mr. MEEK. But, if I can, Mr. Chairman, basically
Commissioner what I'm trying to get to the 10 year carry back
will assist seniors at a greater level to be able to recover,
because if you're in your 50s and 40s you have an opportunity
to do so. Will I be correct in saying that?
Mr. SHULMAN. I mean I would think so. I mean, obviously,
10-year carry back can go back from 10 years instead of five.
All I'm saying is it's kind of not in my bailiwick to make the
call on.
Mr. MEEK. I understand.
Mr. Chairman. Thank you so very much, Commissioner.
Mr. Chairman, as you know, this is an issue and concern of
many of us that represent people of age and I'm hoping that we
can work with Administration and work with others, but I would
like to commend the Commissioner and IRS for making the ruling
that they have under this situation; and, I look forward, Mr.
Chairman, to working with you on the reason why we're here
today in getting to the bottom of some of this off-shore
business.
Chairman NEAL. Thank the gentleman, and part of this
hearing today was scheduled based on Mr. Meek's prompting.
So, the gentleman from Kentucky, Mr. Davis, is recognized
to inquire.
Mr. DAVIS. We just call it the Kentucky seat now after the
three Members. Thanks, Mr. Chairman.
Commissioner, I appreciate you coming in and the time
you've invested in getting to know us, as well as talking about
a number of issues. I think as my colleague from Illinois said,
there is occasionally a bit of creative tension on the
Committee, on a variety of issues, and certainly on this one.
But I think there is unanimity across the board on really
dealing with tax evasion and effective compliance mechanisms so
the agency can function, and legitimate revenue can be gotten
into the agency.
To the extent that you agree that international exchange of
information in particular are a key element of the ongoing
efforts to fight tax evasion, do you feel it's reasonable for
us to be concerned about a blacklist, in the sense that it
might make listed countries willing--or less willing to provide
the IRS with information that you need to combat this evasion
effectively?
Mr. SHULMAN. You know, I guess I don't have a lot to add to
what I've said in general about blacklists. I always focus on
characteristics of jurisdictions where we might see tax
evasion, rather than listing those jurisdictions, things like
bank secrecy, things like lack of information exchange, things
like non-transparent laws and cooperation with the U.S.
And so clearly there's pieces of a blacklist that could be
quite useful to the IRS, because you could then change some
presumptions and target specific rules around there. And I
fully understand the diplomatic issues around a blacklist,
which are pretty large.
Mr. DAVIS. Well, I guess the reason that I was asking is I
was wondering if you could confirm for the record. The U.S.
currently has tax information exchange agreements with several
countries that are included on the Levin-Doggett proposal
proposed blacklist, including the Cayman Islands and New
Jersey.
And I guess taking this just one step further, could you
also confirm for the record, in that same vein, that our Nation
actually has full-fledged tax treaties with at least three
countries that are on that proposed blacklist, Switzerland,
Luxembourg, and Cypress.
Mr. SHULMAN. You know, I don't want to get this wrong, so
if you'd let me just come back to you, and I'll give you the
list of all the countries that we have, and submit it for the
record, I would be happy to do that.
Mr. DAVIS. Okay. Thank you, Mr. Chairman. I yield back.
Chairman NEAL. Thank you, Mr. Davis.
I want to thank the Commissioner for the time that he has
spent with us, and also the time that he spent preparing for
the hearing today.
And we look forward to working with you on these issues.
You can see that there was pretty good attendance this morning.
There's a lot of interest. Media accounts, I think, day after
day, indicate the nature of the problem, and we hope you will
continue to be part of the narrative as we seek to solve it.
And with that, I'd like to call our second panel.
Mr. SHULMAN. Thanks for your leadership on this, Mr.
Chairman.
Chairman NEAL. Thank you.
Let me thank our second panel, and the Chair recognizes Mr.
Shay.
STATEMENT OF STEPHEN E. SHAY, TAX PARTNER, ROPES & GRAY
Mr. SHAY. Thank you, Mr. Chairman, Ranking Member Tiberi,
and Members of the Committee. My name is Stephen Shay. I'm a
partner at the law firm Ropes & Gray in Boston.
With the Chairman's permission, I will submit my testimony
for the record, and just summarize my principal observations. I
also want to make clear I'm appearing in an individual
capacity, and what I'm going to say does not represent the
views of my law firm or my clients.
The key points I'd like to make with respect to the focus
of this hearing are that in order to attract foreign capital,
and for historic administrative reasons, the United States
taxes very little U.S. source investment income paid to foreign
persons.
We exempt from withholding tax most capital gains of non-
residents on sales of securities, and U.S. interest paid to
unrelated non-resident lenders. Our source withholding tax
principally imposes tax on payments of dividends to non-
residents. We do not impose U.S. withholding tax on payments of
foreign source income to foreign persons.
Our source withholding regime for U.S. source income
payments is designed to determine whether the owner of the
income is a foreign person and, if so, what withholding rate
should apply.
Generally, the United States does not have enforcement
jurisdiction over a foreign financial institutions-- that is
not owned by U.S. persons and that does not carry on business
itself, in the entity, in the United States.
The QI system was developed to overcome these
jurisdictional limitations, and allow a U.S. withholding agent,
that is, a U.S. institution making a payment to what it thinks
is a foreign person, to rely on documentation received from
foreign banks that are acting as qualified intermediaries.
The QI system relies on the foreign bank that has the
direct relationship with the foreign customer to exercise
normal banking know-your-customer disciplines in assuring that
the documentation it received, and that it provides the U.S.
withholding agent in turn, was correct.
The QI regime prescribes audits by the bank's external
auditors to confirm that its processes are being used
appropriately.
Because some of the income that we exempt is exempted on a
unilateral basis, not just to residents and other treaty
countries that have given reciprocal exemptions, it is not
possible to rely on the other countries' governmental audits to
check the QI system.
So this is a feature of the extent of our unilateral
exemption, particularly of portfolio interested source.
As noted by others, the qualified intermediary regime is a
opt-in system, and--where the foreign bank elects to
participate--applies to accounts that are designated as QI
accounts.
Accordingly, under current law rules, it is possible for a
QI to act as a QI and also have accounts that are not covered
by the QI requirements, including accounts for U.S. persons.
The cross-border withholding system for payments to foreign
persons is not designed itself to provide information reporting
on U.S. persons. It is just designed to screen for and apply
the appropriate withholding tax rate to foreign persons.
In this regard, one of the key decisions made in
implementing these rules was to follow traditional tax rules
and respect a foreign corporation under U.S. principles. As a
non-transparent beneficial owner of income without regard to
whether it was owned by U.S. persons.
When a payor of these payments is within the U.S. tax
jurisdiction, payments of interest, dividends and gross
proceeds from sales of securities to a U.S. person are subject
to domestic information reporting and back-up withholding
rules. These have become a very important part of our
compliance system.
It is possible, however, for a U.S. person to have an
account at a foreign financial institution that is not subject
to third party information reporting.
Under the structure of the rules just described, some U.S.
persons are able to masquerade as foreign persons, or hide
behind foreign corporations, without reporting this income.
As a jurisdictional matter, the United States can only
obtain information on U.S. persons' foreign accounts at foreign
financial institutions if the foreign financial institution
agrees to participate, for example, through a QI system, or
through information requests on a bilateral basis with other
countries.
In my testimony, I have set out a series of proposals, some
of which have been made by others--many of which have been made
by others, that I think would be feasible ways to overcome the
limitations I've described.
In the interest of time, I'll be happy to answer any
questions on those. Thank you, Mr. Chairman.
[The prepared statement of Mr. Shay follows:]
Statement of Stephen E. Shay, Tax Partner, Ropes & Gray, Boston,
Massachusetts
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman NEAL. Thank you. In fact, during the questioning
period, I'll have an opportunity to raise that with you.
Professor.
STATEMENT OF REUVEN S. AVI-YONAH, IRWIN I. COHN PROFESSOR OF
LAW, UNIVERSITY OF MICHIGAN LAW SCHOOL
Mr. AVI-YONAH. Chairman Neal, Ranking Member Tiberi, and
honored Members of the Committee and the staff, thank you very
much for inviting me today to testify before you again on this
issue.
I think the UBS method shows that there are serious
problems with the QI initiative as it is currently drafted.
Basically, though, as we all know, UBS enabled American
citizens to hide behind sham corporations in various other
secrecy jurisdictions other than Switzerland, and thereby for a
while escape the notice of the IRS.
And to some extent still, because they claim that under
Swiss bank secrecy law, they can't disclose the identity of the
other new American accountholders, even when specifically
requested by the IRS to do so.
Now stepping back for a moment, what is the basic problem
with the QI program from my perspective? The QI program was set
up in order to enable foreigners to invest in the U.S. through
the QI, without the U.S. withholding agent knowing the identity
of those foreigners.
If a foreign person invests directly into United States,
then the--in principle, the U.S. withholding agent has the
ability to collect information about that foreign person. The
U.S.--in the end the payments come from the United States.
There is a U.S. withholding agent, and when the U.S.
withholding agent makes a payment, even a payment that is
exempt, let's say, under the portfolio interest exemption,
there is the potential of collecting information about--and the
Form W-8BEN, from that person to know the identity of that
person, whether or not there is a treaty.
And then--if there is a treaty, then there is the potential
for the IRS to get that information from the American financial
institution, in exchanging under the treaty information
exchange.
Now the QI program was essentially set up so that this
would not happen. Under regulations proposed by the Clinton
Administration, but not yet finalized, American banks were
supposed to collect information about payments that are exempt
under the portfolio interest exemption.
And under the version proposed by the Bush Administration,
that would still apply, but only to 16 designated countries. I
think it should apply to every country and that these
regulations should be finalized.
But under the QI agreement, once you go with the QI--once a
foreigner goes with the QI, then the QI only reports to the
American withholding agents, essentially summary or pooled
information about all the beneficiaries that it knows are
eligible for let's say, the reduced withholding tax and
dividends.
And the American withholding agent knows only that, only
the pooled information, and therefore there's no information
available for treaty information exchange.
And I think that this is a problem, and what it enables, is
essentially for Americans to pretend that they are foreigners,
submit Form W-8BEN to the QI.
Now here's--they should--Mr. Shay identifies the QI is not
supposed to look behind this corporation to see whether there's
an American behind it.
Now there's some debate in the background material about
when--if the QI has actual knowledge that the corporation is
owned by an American, whether they should be--my view is that
if a QI has actual knowledge that there's an American, then it
should treat it as an American and do back-up withholding and
information reporting.
But it's not entirely clear that under the current
regulations and the modern QI agreement, they have the
obligation to do that. Maybe they can just accept the corporate
form as hiding the American sufficiently. And I think to that
extent, that should be changed.
Now the fundamental issue, though, is that I think that we
are doing this wrong, in the sense that--the reason that we're
doing it the way we're doing it, is that we want to essentially
enable residents of other countries to evade those countries'
taxes.
And that's how the QI agreement is set up. And the idea is
they will not invest in the United States if they are subject
to residence based taxation.
And I think that the solution to this, and in general to
the issue of source based withholding, is that we will prevent
people--capital from flying away from the United States, if we
are willing to cooperate with other residence countries and
they are willing to cooperate with us.
We should have under the G-20, let's say, full information
exchange with other countries. We should not try to cooperate
with tax evasion by residents of other countries. We should
expect other countries that have income taxes to cooperate with
the information exchange with us.
Fundamentally the whole tax haven and secrecy jurisdiction
issues is about cooperation by the rich countries in the world.
It's not really about the tax havens themselves.
Thank you very much.
[The prepared statement of Mr. Avi-Yonah follows:]
Statement of Reuven S. Avi-Yonah, Irwin I. Cohn Professor of Law,
University of Michigan Law School
My name is Reuven S. Avi-Yonah. I am the Irwin I. Cohn Professor of
Law and Director of the International Tax Master of Law Program at the
University of Michigan Law School. I hold a JD (magna cum laude) from
Harvard Law School and a PhD in History from Harvard University. I have
twenty years of full and part time experience in the tax area, and have
been associated with or consultant to leading law firms like Wachtell,
Lipton, Rosen & Katz and Cravath, Swaine & Moore. I have also served as
consultant to the U.S. Treasury Office of Tax Policy and as member of
the executive committee of the NY State Bar Tax Section. I am currently
Chair of the ABA Tax Section Committee on VAT, a member of the Steering
Group of the OECD International Network for Tax Research, and a
Nonresident Fellow of the Oxford University Center on Business
Taxation. I have published thirteen books and over 80 articles on
various aspects of U.S. domestic and international taxation, and have
fifteen years of teaching experience in the tax area (including basic
tax, corporate tax, international tax and tax treaties) at Harvard,
Michigan, NYU and Penn Law Schools.
I would like to thank Representatives Neal and Tiberi and the
Subcommittee staff for inviting me to testify today on the issues
underlying the recent dispute involving Swiss banking secrecy and
American taxpayers. Some of the following testimony is based on an
article I co-authored with Joe Guttentag, but I remain solely
responsible for what follows.\1\
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\1\ See Joseph Guttentag and Reuven Avi-Yonah, Closing the
International Tax Gap, in Max B. Sawicky (ed.), Bridging the Tax Gap:
Addressing the Crisis in Federal Tax Administration (EPI, 2005), 99.
---------------------------------------------------------------------------
1. The UBS Case.
On June 19, 2008, Bradley Birkenfeld, a senior banker in UBS's
private banking division, pled guilty in U.S. District Court, Southern
District of Florida, to conspiracy to evade U.S. taxes. Mr. Birkenfeld,
a U.S. citizen who worked at Zurich-based UBS's private banking unit
from 2001 to 2006, told a judge he helped real estate developer Igor
Olenicoff dodge $7.2 million in U.S. Federal income taxes on $200
million in assets hidden in Liechtenstein and Switzerland.
The Press Release by the IRS stated that:
According to statements and documents filed with the court,
Birkenfeld's services to American clients violated a 2001 agreement
that the Swiss bank entered into with the United States. Under the
terms of the agreement, the bank would identify and document any
customers who received reportable U.S. source income or would withhold
and anonymously pay a 28 percent withholding tax. This agreement was a
major departure from historical Swiss bank secrecy laws under which
Swiss banks concealed bank information for U.S. clients from the IRS.
When the bank notified its U.S. clients of the requirements of this
agreement, many of the bank's wealthy U.S. clients refused to be
identified, to have taxes withheld from the income earned on their
offshore assets or to sell their U.S. investments. These accounts were
known at the Swiss bank as the United States undeclared business.
In evidence provided by Birkenfeld to the court, managers and
bankers at the firm, including Birkenfeld, assisted the U.S. clients in
concealing their ownership of the assets held offshore by helping these
wealthy customers create nominee and sham entities. This was done to
prevent the risk of losing the approximately $20 billion of assets
under management in the United States undeclared business, which earned
the bank approximately $200 million per year in revenues. To this end,
Birkenfeld, managers and bankers at the Swiss bank, and U.S. clients
prepared false and misleading IRS forms that claimed that the owners of
the accounts were sham off-shore entities and failed to prepare and
file IRS forms that should have identified the true U.S. owner of the
accounts.\2\
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\2\ BANKER PLEADS GUILTY TO HELPING AMERICAN REAL ESTATE DEVELOPER
EVADE INCOME TAX ON $200 MILLION, http://www.usdoj.gov/usao/fls/
PressReleases/080619-01.html.
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Subsequently, On February 18, 2009, UBS entered into a deferred
prosecution agreement on charges of conspiring to defraud the United
States by impeding the IRS. UBS agreed to pay $780 million and to
provide the IRS with the identities and account information of 250 U.S.
residents. However, UBS refused to provide any information about the
identity of an estimated 52,000 other U.S. clients holding bank
accounts with $14.8 billion in assets in Switzerland, citing Swiss bank
secrecy law. It claimed that the terms of its 2001 ``Qualified
Intermediary'' (QI) agreement with the IRS protected it from having to
reveal the identity of its U.S. clients. The IRS is currently in
litigation with UBS over this matter.
The Extent to Which U.S. Residents Move Assets Offshore.
UBS's U.S. clients relied on four simple realities: First, in
today's world, anyone can open a bank account in Switzerland for a
minimal fee over the internet, without leaving the comfort of their
home. Second, the account can be opened in the name of a Caymans
corporation, which can likewise be set up long-distance for minimal
transaction costs (as evident from any perusal of the back pages of the
Economist magazine, where law firms advertising such services abound).
Third, money can be transferred into the account electronically from
the U.S. or from abroad, and in most cases there would not be any
reporting of such transactions to tax authorities. Finally, the funds
in the Swiss account can then be used for investments in the U.S. and
in other high tax jurisdictions, and there would generally be no
withholding taxes on the resulting investment income, no Swiss taxes,
and no information on the true identity of the holder available to the
IRS or any other tax authority. Significantly, other than the use of
Switzerland, both the underlying funds that were deposited in the UBS
accounts, and the investment income, were generally purely domestic
transactions, and the tax evaded was U.S. income tax on U.S. source
income beneficially owned by U.S. residents.
The ability to use offshore tax havens to evade income taxes is a
relatively recent phenomenon. Since about 1980 there has been a
dramatic lowering of both legal and technological barriers to the
movement of capital, goods and services, as countries have relaxed
their tariffs and capital controls, much of the world economy has
shifted from goods to services, and electronic means of delivering
services and transferring funds have developed. At the same time, the
tools used by tax administrations to combat tax evasion have not
changed significantly: Most tax administrations are limited to
enforcing taxes within their jurisdiction, and for international
transactions, can only rely on outdated mechanisms like exchange of
information under tax treaties with other high-tax countries, which are
unavailing for income earned through tax haven corporations. Simply
put, we have the technology which enables people to conduct their
affairs without regard to national borders and without transparency,
while restricting tax collectors to geographic borders, meaningless in
today's world.
The U.S. legitimately boasts one on the world's higher compliance
rates for tax collections. However, most of the taxes collected by the
IRS are from income that is subject either to withholding at source
(e.g., wages) or to automatic information reporting to the IRS by
financial institutions (e.g., interest or dividends from U.S. payors).
The IRS has recently estimated that in 2001 there was a total ``tax
gap'' (i.e., a difference between the taxes it collected and the taxes
it should have collected under existing law) of between $312 and $345
billion, or about 16 percent of total taxes owed.\3\ A large portion of
this gap results from income that is subject to neither withholding nor
information reporting, such as most income of small businesses and
income earned from foreign payors. For these types of income, the
compliance rate falls from over 90 percent to under 50 percent.\4\
---------------------------------------------------------------------------
\3\ Internal Revenue Service, The Tax Gap, www.irs.gov/pub/irs-utl/
tax_gap_facts-figures (2005).
\4\ Testimony of Treasury Assistant Secretary for Tax Policy Eric
Solomon before Senate Finance Committee on Ways to Reduce the Tax Gap
(April 18, 2007); Henry J. Aaron and Joel Slemrod (eds.), The Crisis in
Tax Administration. Washington, DC: The Brookings Institution (2004).
---------------------------------------------------------------------------
No one, including the IRS, has a good estimate of the size of the
international tax gap.\5\ This is not surprising given that the
activities involved are illegal, but one can make an educated guess
based on a few publicly available numbers. In 2003, the Boston
Consulting Group estimated that the total holdings of cash deposits and
listed securities by high net worth individuals in the world were $38
trillion, and that of these, $16.2 trillion were held by residents of
North America. Out of these $16.2 trillion, ``less than'' 10 percent
was held offshore (as compared with, for example, 20-30 percent
offshore for Europe and 50-70 percent offshore for Latin America and
the Middle East).\6\
---------------------------------------------------------------------------
\5\ See TIGTA, IRS Lacks Estimate for International Tax Gap, 2009
WTD 28-25 (Feb. 12, 2009).
\6\ Boston Consulting Group, Global Wealth Report, www.bcg.com/
publications/PUBID=899 (2004). For consistent figures see also Merrill
Lynch, World Wealth Report, www.ml.com/media/18252.pdf (2004).
---------------------------------------------------------------------------
If one translates this estimate into approximately $1.5 trillion
held offshore by U.S. residents, and if one assumes that the amount
held offshore earns 10 percent annually, the international component of
the tax gap would be the tax on $150 billion a year, or about $50
billion. This figure is in the mid range of estimates of the
international tax gap in 2002 by former IRS Commissioner Charles O.
Rossotti ($40 billion) and by IRS consultant Jack Blum ($70
billion).\7\
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\7\ Martin A. Sullivan, U.S. Citizens Hide Hundreds of Billions in
Cayman Accounts, 103 Tax Notes 956 (2004).
3. The Potential for Offshore Entities to Serve as a Vehicle for
---------------------------------------------------------------------------
Circumventing U.S. Tax Laws.
U.S. Tax Law currently includes several provisions designed to
prevent U.S. residents from using offshore entities to circumvent U.S.
tax law. In particular, the anti-deferral rules (primarily Subpart F,
IRC secs. 951-964, and the PFIC rules, IRC secs. 1291-1298) provide for
current taxation of U.S. shareholders on certain types of income
(primarily passive income) earned through foreign corporations.
However, it is unclear to what extent the IRS is successful in
enforcing these rules. In particular, the PFIC rules apply to any U.S.
share ownership in a foreign corporation that earns primarily passive
income. Since the U.S. shareholder does not have to control the foreign
corporation, it is difficult for the IRS to adequately monitor how many
U.S. citizens or residents own shares in a PFIC, especially in
situations in which treaty information exchange is not available (e.g.,
when the PFIC is located in a tax haven and bank secrecy provisions
apply).
4. The Effect of Foreign Jurisdiction Secrecy Rules on the
Efficacy of Tax Law.
Foreign tax haven jurisdictions typically have strict bank secrecy
laws that prohibit release of depositor information. The U.S. currently
has bilateral information exchange agreements with several tax haven
jurisdictions. However, most of the existing agreements are restricted
only to criminal matters. Criminal matters are a very small part of
overall tax collections, and pose very difficult evidentiary issues in
the international context. Moreover, the agreements sometimes require
the subject matter to be criminal in both the U.S. and the tax haven,
which would never be the case for pure tax evasion. In addition, they
typically require the U.S. to make a specific request relating to
particular individuals, and they also typically do not override bank
secrecy provisions in tax haven laws. These limitations mean that
existing tax information exchange agreements, while helpful and
important in some cases, are of limited value in closing the overall
international tax gap.
5. The Adequacy of Reporting and Withholding Rules.
Under current U.S. rules, withholding is required (under IRC secs.
1441-1442) if the U.S. payor knows (or has reason to know) that the
payment is subject to withholding. Similar rules apply to information
reporting. However, if a U.S. payor receives a Form W-8BEN from a payee
certifying that it is a foreign corporation, it may not withhold or
submit Form 1099 (information report) to the IRS, even if it knows that
the foreign corporation is a shell that is de facto controlled by a
U.S. person.
The problem is exacerbated by the ``Qualified Intermediary'' (QI)
program, set up by the IRS in 2000. This program is described by Shay,
Fleming and Peroni as follows:
Generally, a U.S. withholding agent that makes payment of income
subject to withholding to a foreign person reports the amount of the
payment and the identity of the payee to the Service on a Form 1042-S
attached to the withholding agent's own return on Form 1042. The
information from Form 1042-S is one of the most important elements of
information provided to certain treaty partners under the Service's
program for routine exchange of information under income tax treaties.
Under the current QI regime, the QI does not pass on to the
withholding agent the identity of beneficial owners claiming treaty
relief but does retain the information. Assuming, as is the case most
of the time, that the QI has not assumed withholding responsibility,
the withholding agent makes payments to accounts grouped according to
withholding pools and files a single Form 1042-S for the pool without
identifying the individual payee. Thus, for example, the withholding
agent files a single Form 1042-S for the pool of accounts eligible for
the 15 percent treaty dividend rate. In this case, the identity of the
payee remains unknown unless the Service makes a specific request for
the identity of payees. The pooling approach, which is central to the
efficiency and attractiveness of the QI regime to a foreign financial
institution, cuts off the potential practical utility of pooled
information for exchange under income tax treaties. This is because the
information is not broken down by taxpayer and therefore is unsuitable
for exchange with a treaty partner. Similarly, the United States for
years limited its information exchange of bank deposit interest to
accounts held by Canadians and, after strong lobbying by banks,
recently proposed only a limited extension of collection of this
information from foreign persons resident in a limited number of
selected treaty countries. Why is this significant? Domestically, the
United States relies on comprehensive information reporting for
payments of interest, dividends, and gross proceeds from the sale of
securities to individuals and other nonexempt recipients. If a taxpayer
does not supply a correct taxpayer identification number, the threat of
a back-up withholding tax on the payment, currently at a rate of 30
percent, provides a significant backstop to the information reporting
rules. The final withholding tax regulations integrate the domestic
information reporting and back-up withholding rules with the Chapter 3
withholding rules so that payments to foreign intermediaries acting for
U.S. persons are covered by the domestic information reporting system.
There are limits on the reach of these rules, however. Generally, U.S.
persons, controlled foreign corporations, and foreign corporations more
than 50 percent of whose income is effectively connected with a U.S.
trade of business must apply the information reporting and back-up
withholding rules. The QI regime also preserves Form 1099 reporting
with respect to U.S. persons that are not exempt from information
reporting under domestic rules. As a practical matter, however, the
comprehensive U.S. regime for enforcement of tax on income from capital
stops at the water's edge.\8\
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\8\ Stephen E. Shay, J. Clifton Fleming Jr. and Robert J. Peroni,
The David R. Tillinghast Lecture, ``What's Source Got to Do With It?''
Source Rules and U.S. International Taxation, in The Tillinghast
Lectures 1996-2005, 301-302 (2001) (emphases added).
---------------------------------------------------------------------------
Fundamentally, the QI regime represents a bargain: The QI agrees to
verify the identities and residency status of the beneficial owners of
its accounts. In exchange, the U.S. agrees to trust the QI and as a
result neither the U.S. withholding agent nor the IRS (unless it
specifically requests) gets any information that can be transmitted to
our treaty partners under the exchange of information provisions of our
tax treaties.\9\
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\9\ The U.S. currently has one of the most extensive tax treaty
networks in the world, comprising of 67 full fledged treaties and 23
Tax Information Exchange Agreements. John Venuti et al., Current Status
of U.S. Treaties and International Tax Agreements, 38 Tax Management
Int'l J. 174 (March 2009).
---------------------------------------------------------------------------
Essentially, the U.S. was telling foreign investors that instead of
putting their money into the U.S. directly, in which case it might be
subject to exchange of information and revealed to their country of
residence, they could use the QI program to ensure that neither the
U.S. withholding agent nor the IRS has the information. Thus, the IRS
could tell the treaty partner with a straight face that it did not have
the information the treaty partner needed to enforce its tax laws on
its own residents, even though it was the IRS itself that entered into
the agreement that prevented it from having the requisite information.
As the UBS case shows, however, the QI program can easily be
abused. Since the IRS does not have the information on beneficial
ownership from the QI, it has to trust the QI to either report accounts
held by U.S. residents on Form 1099 or perform backup withholding. Not
surprisingly, a QI like UBS is tempted to accept funds from U.S.
residents and not comply with information reporting or backup
withholding, since it knows the IRS will in all likelihood not audit it
(since an audit may give the IRS the information on foreign residents
that the QI program was designed for it not to have).
In my opinion, a better way to deal with our treaty partners is to
help them enforce their tax laws on their own residents, and expect
them to help the U.S. enforce its laws on its residents. Cooperation,
not competition, is the solution to the offshore tax abuse problem.
6. Recommendations to Address Offshore Tax Abuses.\10\
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\10\ In addition to these recommendations, Congress should enact
and the President should sign S. 506/H.R. 1265, the Stop Tax Havens
Abuse Act, introduced on March 2, 2009 by Sen. Carl Levin, D-Mich.,
Sen. Sheldon Whitehouse, D-RI, Sen. Claire McCaskill, D-Mo. and Sen.
Bill Nelson, D-Fla. in the Senate and by over 40 Members led by Rep.
Lloyd Doggett, D-Tex. and Rep. Rosa DeLauro, D-Conn in the House.
---------------------------------------------------------------------------
a. Increased IRS enforcement.
It is well known that the IRS has in recent years faced an
increased workload with diminished resources. From 1992 to 2001, IRS
``full time equivalent'' staff decreased by about 20,000 positions.
This trend has been reversed more recently, but as former Commissioner
Rossotti has written, the increase is not enough to keep up with the
increase in complexity of the tax system and the size of the
economy.\11\ Congress has repeatedly in recent years increased the
complexity of our tax law without adding funding to the IRS. Bipartisan
groups like the Committee for Economic Development have called for more
resources and political support to be given to the IRS.\12\
---------------------------------------------------------------------------
\11\ Charles O. Rossotti, Letter to Senators Charles Grassley and
Max Baucus (March 22, 2004).
\12\ Committee for Economic Development, A New Tax Framework: A
Blueprint for Averting a Fiscal Crisis (2005).
---------------------------------------------------------------------------
I believe the IRS should dedicate more resources to attempting to
close the international tax gap. In particular, the IRS should give
more priority, and be given more resources, to audit compliance with
existing laws requiring U.S. taxpayers to report ownership of foreign
bank accounts and stock in foreign corporations. If the UBS case is any
indication, such increased attention may generate many dollars in tax
revenue for every dollar spent on enforcement.
b. Bilateral information exchange.
The Organization for Economic Cooperation and Development (OECD)
has recently modified Article 26 (Exchange of Information) in its model
income tax treaty, and has adopted a model Tax Information Exchange
Agreement (TIEA), both of which are intended address the problems with
current exchange of information agreements discussed above. Under the
new Article 26 and model TIEA, exchange of information relates to civil
as well as criminal tax liabilities, does not require ``dual
criminality'' or suspicion of a crime other than tax evasion, and
overrides bank secrecy provisions in domestic laws. These are the
principles that underlie the vast majority of U.S. TIEAs, and where
they fall short, the U.S. should renegotiate the TIEAs to incorporate
these principles.
I will discuss below the steps I believe are needed to induce tax
haven jurisdictions to negotiate such agreements with the US. For other
jurisdictions that are not tax havens, the inducement is the
information they can obtain from the U.S. on their own residents. To
ensure such information is available, the Treasury should finalize
regulations proposed by the Clinton Administration that require U.S.
banks and financial institutions to collect information on interest
payments made to overseas jurisdictions when the interest itself is
exempt from withholding under the portfolio interest exemption.\13\ The
Treasury has proposed to limit such regulations to 16 designated
countries, but as Blum writes, there is no legitimate privacy or other
reason to impose such limitations. The banks should collect all the
information, and the Treasury should use its existing authority not to
exchange it in situations in which it might be misused by non-
democratic foreign governments (e.g., when freedom fighters use U.S.
bank accounts).
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\13\ Cynthia Blum, Sharing Bank Deposit Information with Other
Countries: Should Tax Compliance or Privacy Claims Prevail, 6 Fl. Tax
Rev. 579 (2005).
---------------------------------------------------------------------------
c. Cooperation with OECD and the G20.
Current Treasury policy is to focus on bilateral agreements to
obtain needed information exchange cooperation. However, the OECD has
been at the forefront of persuading tax haven jurisdictions to
cooperate with information exchange, and is an organization that the
U.S. had traditionally played a leading role in and whose work benefits
both governments and the private sector. The U.S. should cooperate with
the OECD and other appropriate international and regional
organizations, such as the G20, in their efforts to improve information
exchange and in particular to persuade the tax havens of the world to
enter into bilateral information exchange agreements based on the OECD
model. The OECD has made significant progress since it began focusing
on this issue in 1998, but more needs to be done, both on persuading
laggard jurisdictions to cooperate and on increasing the level of
information exchange available from cooperating jurisdictions.\14\
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\14\ See Reuven S. Avi-Yonah, The OECD Harmful Tax Competition
Report: A Tenth Anniversary Retrospective, forthcoming in Brooklyn J.
Int'l L. (2009)
d. Incentives to tax havens.
The U.S. should adopt a carrot and stick approach to tax havens in
order to provide incentives to cooperate with information exchange. In
particular, the U.S. and other donor countries, multilateral and
regional organizations should increase aid of a type which would enable
those countries to shift their economies from reliance on the offshore
sector to other sources of income.
It should be noted that the common perception that the benefits of
being a tax haven flow primarily to residents of the tax haven is
misguided. The financial benefits of tax haven operations, while
funding a minimal level of government services, often flow primarily to
professionals providing banking and legal services, many of whom live
in rich countries, rather than to the often needy residents of the tax
havens. Thus, with some transitional support, it is likely that most of
the tax havens would see the welfare of their own residents improve as
they wean themselves from dependence on the offshore sector.
3. Sanctions on non-cooperating tax havens.
In the case of non-cooperating tax havens, I support the U.S.
Treasury using its existing authority to prospectively deny the
benefits of the portfolio interest exemption to countries that do not
provide adequate exchange of information.\15\ This step is necessary,
in my opinion, to prevent non-cooperating tax havens from aiding U.S.
residents to evade U.S. income tax.
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\15\ See IRC section 871(h)(6). If this step is taken, Treasury
should adopt Limitation on Benefits regulations to ensure against abuse
of the portfolio interest exemption by nonresidents in cases that it
does apply. For a model, see Treas. Reg. 1.881-3 (the conduit financing
regulations).
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A principal problem of dealing with tax havens is that if even a
few of them do not cooperate with information exchange, tax evaders are
likely to shift their funds there from cooperating jurisdictions,
thereby rewarding the non-cooperating ones and deterring others from
cooperation. Thus, some jurisdictions have advertised their refusal to
cooperate with the OECD efforts.
However, if the political will existed, the tax haven problem could
easily be resolved by the rich countries through their own action. The
key observation here is that funds cannot remain in tax havens and be
productive; they must be reinvested into the rich and stable economies
in the world (which is why some laundered funds that need to remain in
the havens earn a negative interest rate). If the rich countries could
agree, they could eliminate the tax havens' harmful activities
overnight by, for example, refusing to allow deductions for payments to
designated non-cooperating tax havens or restricting the ability of
financial institutions to provide services with respect to tax haven
operations.
The EU and Japan have both committed themselves to tax their
residents on foreign source interest income. The EU Savings Directive,
in particular, requires all EU members to cooperate in automatic and
comprehensive exchange of information or impose a withholding tax on
interest paid to EU residents.\16\ Both the EU and Japan would like to
extend this treatment to income from the US. Thus, this would seem an
appropriate moment to cooperate with other OECD and G20 member
countries by imposing a withholding tax on payments to tax havens that
cannot be induced to cooperate in exchange of information, without
triggering a flow of capital out of the US.
---------------------------------------------------------------------------
\16\ EU Directive 2003/48/EC on Taxation of Savings (2003).
---------------------------------------------------------------------------
f. Withholding and Information Reporting.
The IRS should revise its regulations (under IRC secs. 1441-1442)
to provide that U.S. payors may not accept W8-BEN as evidence of
foreign status, and must issue Form 1099s, when they know (or have
reason to know) that payments to foreign corporations in fact inure to
the benefit of U.S. persons. In addition, the QI program should be
revised to require QIs to automatically provide information on actual
beneficial ownership of all accounts to the IRS.
7. 7. Conclusion.
The UBS saga indicates that the international tax gap is a
significant component of the overall tax gap. In order to maintain any
kind of tax system, the U.S. public needs to be confident that current
law can be enforced and that tax evasion will be caught and prosecuted.
Thus, I hope that bipartisan support can be found for taking the steps
identified above to close the international tax gap. These steps offer
the potential of raising additional revenue without raising taxes, and
of leveling the playing field between ordinary Americans who pay their
fair share of taxes and others who do not.
Chairman NEAL. Mr. Blessing.
STATEMENT OF PETER H. BLESSING, PARTNER, SHEARMAN AND STERLING
Mr. BLESSING. Chairman Neal, Ranking Member Tiberi, and
Members of the Subcommittee, thank you for asking me to testify
today.
I will focus on two issues in respect to detecting
unreported investment income in overseas accounts, in
particular tax treaty information exchange agreements and the
qualified intermediary procedures.
There are two principal types of bilateral agreements that
are chiefly used by the tax authorities for information
exchange. These are the comprehensive income tax treaties and
secondly, the tax information exchange agreements, which are
stand alone agreements.
However, under each of these, typically the information
that's required to be exchanged is limited to what's available
in the normal course of the tax administration of the requested
country as a matter of sovereignty and domestic law, but this
can include bank secrecy provisions.
Very recently, in response to the pending G-20 blacklist of
uncooperative countries and pressure from particular countries,
including the United States and France and Germany, a number of
countries that previously had relied on their bank secrecy
provisions have announced they'll override their domestic
limitations, and not claim bank secrecy as preventing
production, subject to implementing this in new agreements.
This experience shows that used carefully, multilateral
action by countries, including blacklists or threatened
blacklists, can be an effective tool to convince certain
countries that information exchange in is their best interest.
I'm not suggesting that every blacklist necessarily is
helpful. The Stop Tax Haven Abuse Act contains a proposed
unilateral blacklist of 34 countries for a very different
purpose. One concern is that the safeguards be there for
designating countries.
Furthermore, the Act would be--the Act would represent a
substantial shift in enforcement burden onto financial
institutions, which would be required to report voluminous
information covering virtually all financial transactions
involving an offshore secrecy jurisdiction. The benefits of the
provision must be weighed against the compliance cost.
Turning now to the QI program, of great interest is a
report on withholding procedures released in January of this
year, which was prepared by the informal consultative group
established by the OECD Committee on fiscal affairs.
Notably, the group's report recommends a system that looks
very much like the U.S. QI system. In that system, a foreign
financial institution enters into an agreement with the IRS,
pursuant to which it may accept primary withholding and
documentation obligations subject to external audit, in
exchange for a simplified pooled reporting and non-disclosure
of client identities to the IRS, and to--most importantly, to
its competitors down--upstream in the chain of information.
A significant difference from the QI system is that the
identities of beneficial owners of payments would be disclosed
to the source countries, something Professor Avi-Yonah was just
suggesting would be a good thing.
This would address the flip side of information exchange,
namely the needs of a country to obtain information about its
residents. The United States would benefit from another country
affirmatively apprising the U.S. tax authorities of accounts
beneficially owned by U.S. residents and citizens.
The United States in turn would be expected to do the
converse. However, there's a problem here. For example, the IRS
W-8BEN is not currently required to be filed with the IRS under
the QI program, so the IRS has no--or otherwise, for that
matter, so the IRS has no record of the identity of payees of
the QI system.
For non-QI payments, there is reporting to the IRS in 1042-
S, but as the GAO report noted, the IRS is not currently able
to process that effectively for use.
The U.S. Government Accounting Office reported in the QI
program in December of 2007. While it concluded that the QI
program contains features that give the IRS some assurance that
QIs are more likely to properly withhold and report tax on U.S.
source income than other withholding agents, it suggested that
the audit standards be enhanced by requiring the external
auditor to report any indications of fraud or illegal activity
that could significantly affect the results of the review.
In response, the IRS issued proposed changes to the model
QI agreement and the audit procedures in November of 2008, as
Commissioner Shulman noted, to broaden the requirement and the
required self-reporting by the QI and increase the procedures
required to be performed, and documentation required to be
examined by the auditor.
The IRS has received comments on the proposal from certain
audit firms and QIs. Clearly, a balance will be needed to be
struck between the interests of a viable review and audit
procedures, and the increased costs associated with the
proposed procedures, which may be beyond the ability of smaller
QIs to meet.
In conclusion, I believe that the QI program overall is
well conceived, plays a key role in the U.S. withholding tax
system, and should be supported, including with adequate
funding. Attention is appropriately being paid to strengthening
the external review process.
A particular limiting factor is that external ``audits''
are required only to be in accordance with the agreed upon
procedure standard, which means that they do not constitute an
audit or review, and therefore are not an expression of an
opinion by the auditor.
I would be happy to take any questions. Thank you very
much.
[The prepared statement of Mr. Blessing follows:]
Statement of Peter H. Blessing, Partner, Shearman and Sterling, New
York, New York
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman NEAL. Thank the panelists.
Mr. Shay, you and others have suggested that QIs need to
know more about the beneficial owners of foreign corporations
than is currently required, which results in QIs basically
accepting it at face value.
What exactly would you require of QIs in order to be in
compliance with this additional mandate?
Mr. SHAY. I think, Mr. Chairman, that in fact QIs often do
know a fair amount about beneficial owners of corporations,
because of the know-your-customer rules when they're closely
held.
But for purposes of this discussion, I think what I would
recommend is, subject to working through with the IRS fairly
carefully, is consideration of requiring a QI to provide
information about thresholds U.S. owners of foreign
corporations. In my testimony we said 10 percent or more owners
of U.S. corporations--for a couple of reasons.
If that information is provided to the IRS, then it can
then cross check and be sure that those U.S. persons have
complied with their income tax obligations with respect to
those corporations.
If those corporations were either closely controlled or
hold primarily passive assets, under our existing U.S. rules,
they should have included income currently in their U.S.
taxable income, so this would be an effective check. There may
be circumstances where it would make sense to go beyond that.
One other comment I would make. In my testimony, I have
highlighted the important role that QIs play in the withholding
system. This would be an additional burden for a foreign
corporation that's participating.
It is a judgement call, but my judgement is that being a
qualified intermediary now is sufficiently important for
foreign banks in the international capital markets, that they
would be willing to take on some additional burden.
I urge the Committee to give the IRS flexibility to work
out the detail, so that the system doesn't cause QIs to leave
the system.
Chairman NEAL. Thank you, Mr. Shay.
Mr. Blessing, you nuanced part of this--in your testimony,
you nuanced part of this question that I'm about to raise. I'm
interested in the EU Savings Directive that is explained in
your testimony, and you did speak to this issue.
Do you think that the U.S. could participate in such an
automatic reporting regime, or would it overwhelm our banks and
financial institutions, so that it would be deemed
overburdensome?
Mr. BLESSING. The EU Savings Directive is a very different
type of system, which requires the reporting of interest to
EU--by EU participants to external parties, to non-EU parties.
In the U.S. reporting system, I don't think that there's
anything quite comparable. We do require reporting of most
payments. We have declined to require reporting of bank
payments by domestic banks. That was not--at the time, there
was some concern that that would be a burden on the systems.
But the primary concern, I believe, was that there would be
a impact on the capital flow to banks. In other words, U.S.
domestic banks lobbied against that provision, because they
were concerned that they would not receive the same deposits if
they were required to report the interest. I don't think the
systems is a problem anymore, my own view.
Chairman NEAL. And Professor Avi-Yonah, you seem to be the
lone voice against the QI system today. We've heard your
testimony that the dark secret before the QI system was
implemented was that no one had any idea where the payments
were going, and at least with QI they have some idea.
Would you support this system with modifications that were
outlined by the Commissioner today?
Mr. AVI-YONAH. Yes. I didn't mean to imply that I think the
QI system is worthless. I think there is a world imaginable in
which we would not need the QI system, and I think that would
be a preferable world, in which we in fact withhold on all
payments that are not, for example, to treaty countries, that
is we would repeal the portfolio interest exemption, or at
least the Treasury Secretary applies his ability to suspend it
to all payments to countries that don't participate in full
exchange of information.
But that--I appreciate following Mr. Blessing's testimony
just now, we can't really under current circumstances, do that
unilaterally without triggering a capital outflow for the
United States.
I think that can only be done in cooperation with the
Europeans, with other Members of the G-20, because they are
already on record, because of the Savings Directive and other
initiatives, OECD initiatives, that they would be interested in
extending such a regime to fundamentally deal with the tax
haven problem.
But as long as that is not done, I think we need something
like the QI program, but I think that the issue with the QI was
always about, to some extent, sharing information--not sharing
information from the QI to the foreign--to the U.S. withholding
agent, who may be a competitor.
And that I accept. But when we had the previous hearing
where the GAO presented the QI report, the QI representatives
all said, ``We are fully willing to share information with the
IRS. That is, this is not about not sharing information with
the IRS.''
Well, lo and behold, UBS is not willing to share
information with the IRS, even when asked--even when given a
John Doe summons. And the other QIs also, I don't think they're
really willing to share information with the IRS.
I think we could live with the QI program if the QIs have
to share all the Forms W-8BEN with the IRS, and if they provide
information about U.S. people that they know about, and
provide--and also share the information about foreign people,
in which case it's available under the shared information, and
that I don't think will kill the QI program.
Chairman NEAL. Thank you, Professor. Mr. Tiberi.
Mr. TIBERI. Thank you, Chairman. Mr. Blessing, in your
testimony the tax information exchange agreements, and if we
look at those and other agreements that we have with other
foreign entities, whether they be foreign governments or
financial institutions, would you predict any backlash if we
pursued a policy of blacklisting specific countries, rather
than maybe strengthening those agreements and adding folks to
those agreements?
Mr. BLESSING. I think that a unilateral blacklist is a very
different concept than a multilateral----
Mr. TIBERI. And that's what----
Mr. BLESSING [continuing]. Blacklist.
Mr. TIBERI [continuing]. I'm talking about. Yes, that's
what I mean.
Mr. BLESSING. I think what I'd comment on was that the G-20
approach, which was a multilateral approach, was very
effective. It represents 80 percent of the economies of the
world in terms of trade.
Mr. TIBERI. Right.
Mr. BLESSING. And together, countries can do a lot.
Together, the pressure was enormous, and the facts speak for
themselves. A number of countries that previously had relied on
their banks--EU Chrissy--dropped their objections, under that
pressure.
A unilateral blacklist could--well, the first thing is it's
not going to raise revenue. It may have some other benefits,
for example, the benefit of changing the burden of proof and so
forth, but it's not going to raise revenue, because obviously
the deposits will go to another country.
And it's very hard to administer. It's one thing to
threaten. It's another thing to actually select the countries
in a fair way, have a system that permits them to be added and
taken off.
And it's a very onerous process, and much of a
sledgehammer. So I'd be very cautious about blacklists.
Mr. TIBERI. Thank you. And to just extend that a little
bit. We had heard earlier about the number of countries that
don't apply--that aren't involved in the Q1--the QI program. I
keep saying Q1, the name of a band back home--the QI program,
and the number of foreign banks that aren't involved.
How do we get them engaged more, either through these
agreements, or other mechanisms? Because obviously, very easy
for someone who wants to break the law, to try to go outside
one of these participating countries, or participating
financial institutions. How do we expand the scope?
Mr. BLESSING. It is a bit of a Catch-22, because on the one
hand, we're trying to tighten--we as a country are trying to
tighten the reporting, rightfully so, and the audit procedures,
and so forth, which imposes additional expense--will impose
additional expense. And I do fear that, at least for smaller
QIs, at least what I have heard, is that they may not be able
or willing to continue to participate.
For the larger QIs, I think it's still beneficial.
Certainly, Steve Shay has just testified to that effect as
well. I think it's--what we can do to encourage more? It's--I
think the process that's taking place in the OECD generally,
may lead in that direction.
I referred to this OECD report by the informal consultative
group. Now that's a number of years away from any real action,
but it is very, very, telling and interesting that they have
selected the type of program that we have--is our QI program--
as the model going forward that countries would optimally
implement.
Right now it's just a discussion draft, but it was put
together by Members of a number of OECD countries and, most
importantly, the financial community as well.
Mr. TIBERI. Can you comment on that, sir?
Mr. SHAY. It is--as a number of us said in testimony, the
QI is an opt-in system. Let me take a slightly different
approach to your question.
I think it's fair to say that until recently, efforts to
make coordinated international attack on cross-border evasion
have been frustrated by lack of interest by countries,
politics, and basically a general lack of urgency.
Today, after what has been happening in the last several
months, if a bank, even if it's not a QI, is found to have a
U.S. tax evader, I think there's a sense of obloquy that is
attached to that, that may not have been as true not long ago.
And I think that's a very positive development.
So I think part of--and this goes to Commissioner Shulman's
multi-strategy approach--part of this is simple shaming. What
happened in a major bank did not pass what we in the
practitioner community call the Wall Street Journal test. It
showed up on the front page of the Wall Street Journal, and it
was extremely----
Chairman NEAL. You should know I have failed that test many
times.
Mr. SHAY. Well, we can also call it the Boston Globe test.
Thank you, sir.
Mr. TIBERI. Thank you. Thank you, Mr. Chairman. I yield
back.
Chairman NEAL. Thank you, Mr. Tiberi. The gentleman from
Nevada, Mr. Heller.
Mr. HELLER. Thank you very much, Mr. Chairman, and I want
to thank the gentlemen for being here this morning.
Questions were asked specifically, and you can tell, the
four out of five questions that have been asked, at least on
this side, have dealt with specifically the blacklisting.
You heard the Commissioner's response to Mr. Davis'
question as to whether tax information exchange agreements with
several companies are included in the Levin-Doggett blacklist,
and I think I can confirm that there are.
Also, I think I can confirm for the record that there are
actually full-fledged tax treaties with at least three
countries, that are on the Levin-Doggett blacklist.
So I guess my point is, and Mr. Blessing, you did answer
that question, but I share the concern that the blacklisting
approach could invite retaliation from listed countries that
could do significant harm to our struggling economies' capital
markets, given that the U.S. itself sometimes is described as a
tax haven, with respect to its treatments of non-residents,
especially considering the fact that the U.S. does not impose
tax on U.S. Treasury Bond interest paid to foreign investors.
Do you think that there could be potential backlash from
other countries that could disrupt our capital markets at this
delicate time for our economy? And I'd like the Professor and
Mr. Shay to answer this question.
Mr. Blessing, thank you for answering the question earlier.
Mr. AVI-YONAH. Well, I mean, let me say a couple of things
about blacklists in general. First of all, we are not the
inventor of blacklists, not even of unilateral blacklists.
Lists in general are employed by most other countries in
the world, for example, in the context of their so called CFC
regimes, stuff like that. Most countries, unlike us, designate
countries that are eligible to be exempted from their anti-
deferral regimes, and other countries that are specifically
included, that is that income from those countries will be
subject to the anti-deferral measures, because of their
judgement that these countries are ``tax havens.''
So we haven't invented this at all. In addition, of course
the history of this goes back to the OECD list from 1998, 1999,
and that list was remarkably effective. It started with, I
think, 42 countries, and ended up with four countries, and that
is because the other countries all agreed to participate in the
OECD standards about sharing information.
The problem is that they said they would, and then they
didn't. And this is why the G-20 now proposes to put a lot of
these countries back on the list. And I think that those
efforts are all to the good, and this the only tool that would
really make countries cooperate, is listing them. I mean, not
the only tool, but this is a pretty effective tool, as has been
shown historically.
Now frankly, I don't think that that's where they show the
capital market comes from at all. The capital--investors cannot
leave their money in tax havens. That's the basic point. The
money has to go to the rich countries, the big countries,
because that's where the investment opportunities are.
If you leave your money in the tax havens because you are a
money launderer or a drug lord, it earns a negative interest
rate, because you have to pay the bank interest in order to
keep the money there, and not have it disclosed.
If the money goes into one of the rich countries, the rich
countries, the G-20, you know, 85 percent of the world economy
are all in agreement about this. And I don't see that making
further progress on this, even unilaterally, would have any
negative impact on the United States at all.
Mr. HELLER. So Professor, can I interpret from your answer
that you support blacklisting?
Mr. AVI-YONAH. I support the Levin-Doggett bill, and I
think it should be enacted tomorrow and signed by the
President.
Mr. HELLER. Mr. Shay.
Mr. SHAY. I would note, as a matter of history, that tax
information exchange agreements first were authorized in the
Caribbean Basin Initiative in the early eighties. A carrot
approach was used.
Countries that entered in to a tax information exchange
agreement were given a more favorable treatment of deductions
by Americans who attended conventions in those countries.
There was second carrot, which has since gone away, which
was an advantage under the foreign sales corporation
legislation. And that did encourage a number of Caribbean
countries to enter into tax information exchange agreements.
More recently, the efforts of the OECD, in the harmful tax
competition exercise in the late 'nineties also encouraged
countries both to become parties to tax information exchange
agreements, and to provide information under them.
So I think both those have brought about a lot of progress.
I also would just note that real progress in this area will
call for international cooperation, and not just at the level
of exchange agreements, at the level of collecting information,
including by the United States.
I endorse the proposals, I think of both my colleagues
here,to expand the collection of information on non-resident
bank accounts, so that it can be exchanged with treaty
partners, so that we can get them to give us information.
But all of that will only work effectively if we create a
system that will allow us to do it electronically, and to bring
it into the IRS electronic matching systems.
This is difficult stuff. It's going to take real work. It's
not going to happen in the short term, but directionally, I can
see a lot of--particularly in Peter's testimony, things that he
is highlighting that are very favorable, and I encourage this
Committee to support it.
Mr. HELLER. Thank you, Mr. Chairman.
Chairman NEAL. Thank the gentleman.
Mr. Doggett is recognized to inquire.
Mr. DOGGETT. Mr. Chairman, thank you. And thank you. I
think the testimony that each of you offered is important as we
craft this legislation. Since the most ringing endorsement for
my proposal was Senator Levin joining Secretary Geithner and
Senator Obama endorsing that proposal was from you, Professor
Avi-Yonah, I want to direct most of my questions to you.
One thing we haven't really explored fully yet in the
hearing that I think is important, the immense dimensions of
the problem we're dealing with. And you address this in your
written testimony, but do I understand that the best estimates
are that about one and a half trillion dollars is kept offshore
by U.S. residents?
Mr. AVI-YONAH. That is an estimate that was done by the
Boston consulting group and Merrill Lynch some six years ago,
so it's not up to date.
Mr. DOGGETT. So it's a very conservative estimate. Six
years ago, Merrill Lynch estimates one and a half trillion
dollars offshore by U.S. residents. Is that individuals only,
or corporations as well?
Mr. AVI-YONAH. This is high net worth individuals.
Mr. DOGGETT. All right.
Mr. AVI-YONAH. So it's not corporations.
Mr. DOGGETT. And your conservative analysis using that data
and other studies, is that what we're talking about for
individuals only, not corporations, is $50 billion of tax
evasion every year?
Mr. AVI-YONAH. Yes. I mean, this is conservative because
what I did was simply take the one and a half trillion, assume
10 percent, you know, income on that, which seems reasonable,
so that's 150 billion, and then apply the U.S. tax rate, so
that's about 50 billion.
But that assumes that the one and a half trillion are all
aftertax income----
Mr. DOGGETT. Right.
Mr. AVI-YONAH [continuing]. That has been subject to tax
already. If it was some earned overseas, transferred, you know,
to Switzerland or the Caymans, and never disclosed, then part
of the one and a half trillion principal is also----
Mr. DOGGETT. Exactly. And I think that is why Senator
Levin, Senator Carl Levin, has estimated that when you add in
the corporations to these individuals, and recognize that data
is--that we're using is 6 years old, that the amount may be a
100 to 150 billion dollars every year that is lost in tax
evasion.
Mr. AVI-YONAH. The truth is that nobody knows. I mean,
there's a whole range of estimates.
Mr. DOGGETT. It's hard to get a precise number.
Mr. AVI-YONAH. Right.
Mr. DOGGETT. But what we do know is that it's big. It's
very big. And my reaction, and I think the reaction of that
firefighter or that police officer, or that small business on
main street in Bastrop, Texas, is that if there's that much tax
evasion, we don't just need a sledgehammer, we need something
bigger than that, because it's very unfair. It does strike to
fundamental fairness, as the Commissioner of the Internal
Revenue Service said.
Now let me ask you as well, while your testimony has
focused on individuals, we know that with the click of a mouse,
an individual can become a corporation. And that's one of the
ways, as several of you mentioned, through hiding behind
corporations, that individuals can dodge their tax liability.
It is also particularly galling, I think, that some of the
biggest recipients of taxpayer money in the bailout that has
occurred over the last few months--Morgan Stanley, 158 of these
subsidiaries, Citigroup, 90 of these offshore tax-dodging
entities, Bank of America, 59. Now that doesn't compete with
the over 300 that Enron had before it failed, but it's a very
significant amount of use of these international tax
subsidiaries to dodge taxes.
Let me ask you if you agree that there is a serious
problem, not just for individuals, but for corporations using
foreign subsidiaries to dodge their tax responsibilities, which
my business on main street in Bastrop or Lockhart or Smithville
cannot do?
Mr. AVI-YONAH. Well, there is a difference that I do want
to draw between things that are clearly illegal tax evasion,
and things that are tax avoidance using legal loopholes.
I think what most corporations, certainly the ones that
you've mentioned do, is not illegally hide their taxes. I mean,
as was mentioned before, there are rules on the--in the codes
that say that any foreign corporation that's owned by an
American over certain thresholds subjects that American to
taxes in one way or another.
Mr. DOGGETT. Well, I couldn't agree with you more. It's not
only what's illegal, but what's legal that should not be legal
because it's inequitable to businesses here in the United
States.
While most of the questions that you have received this
morning have been about the blacklist portion as it is termed
of the Stop Tax Haven bill, I want to ask you about another
very important part of it that relates to corporations.
One of the provisions of the bill is to treat a corporation
that is incorporated abroad as a domestic United States
corporation, if substantially all the executive officers and
senior management are located primarily here in the United
States.
I think this is an important provision to restore tax
fairness, by recognizing that if you have a shell corporation
abroad, and it's really a United States company, that just
having a paper certificate and a sunny tax haven, is not enough
to make you foreign.
Do you agree that this type of provision is needed to
restore tax equity, by not letting corporations play these type
of illegitimate games to avoid taxes?
Mr. AVI-YONAH. Yes, I personally think that this is a very
good improvement on existing law. I first made this suggestion
back in 2001 in response to the so-called inversion
transaction, when American corporations set up shell parent
corporations in Bermuda, without changing anything in terms of
the actual place of managing control of the corporation. And
this was done in joint--endorsed by the Joint Committee on
taxation as one of their options of reforming the law.
Most countries in the world have some kind of management
control standard. And I think under the limitations that are in
the bill, this is a very sensible provision that will add
greatly to the enforcement of our tax laws.
Mr. DOGGETT. Thank you, Mr. Chairman.
Chairman NEAL. I thank the gentleman. I want to also thank
our witnesses today for their commentary, it was very
thoughtful. There may be some written questions, and we would
hope that you would be able to answer promptly if requested.
And if there are no other comments? Hearing none, then the
hearing stands adjourned. Thank you.
[Whereupon, at 11:44 a.m., the Subcommittee was adjourned.]
[Submissions for the Record follow:]
Statement of Brian G. Dooley & Associates
As a certified public accountant assisting the small business owner
and legal immigrants located in Orange County, California, I am concern
that the large tax penalties for late filing foreign trust information
returns and late filing of the FBAR causes non-compliance.
In California, literally million of legal residents and citizens
have family in foreign countries. Often their inheritance is held in a
foreign trust, which has a foreign bank account.
Most of these legal immigrants are unaware of the reporting
requirement. They often prepare their own returns using computer
software or have a general practioners without knowledge of the
reporting requirements.
Many tax compliant taxpayers discover that they failed to file a
FBAR, a Form 3520 or a Form 3520-A. Voluntary disclosure does abate
disproportionately harsh tax penalties. A thirty-five percent to fifty
percent penalty of principle far exceeds the tax liability.
Abatement of penalties requires both ``reasonable basis'' and lack
of ``willfulness.''
The courts have held that lack of knowledge of a tax law is not a
``reasonable basis.''
Thus, the other wise compliant taxpayer remains non-tax compliant
in future years fearing discovery of a past year tort.
I am writing to respectfully request that the IRC be amended to
allow abatement of the penalties if the taxpayer can show lack of
willfulness with no requirement for reasonable basis.
Economic Substance Statue
The Stop Tax Haven Abuse Bill prevents the preparation of complete
and accurate tax returns by not allowing taxpayers and their tax
preparers to apply the statue.
Further, the Bill may avoid such activities as an IRA, which are
only formed and funded for tax reasons. Most tax election has no
purpose other than the tax benefit.
The change is important to allow taxpayers that discover that they
are in a tax shelter to not report an abusive transaction; and instead
to report the transaction under the economic substance doctrine.
Imposing a penalty after forcing a taxpayer to improperly report a
transaction appears to be an abuse by the government.
Respectfully submitted,
Brian Dooley
Brian G. Dooley, CPA, MBT
Statement of Isle of Man Government
Chairman Neal, Ranking Member Tiberi and Members of the
Subcommittee, thank you for the opportunity to share with you
information about the Isle of Man. The Isle of Man is pleased to
provide facts about the regulation of its financial services industry
and its practices regarding transparency and international co-operation
in tax matters to guide the Subcommittee in its review of offshore U.S.
tax evasion.
I. Summary of Statement
The Isle of Man is a well-regulated, co-operative and transparent
jurisdiction. It is not a ``tax haven'' or an ``offshore secrecy
jurisdiction'' and does not condone, encourage or facilitate tax
evasion by U.S. citizens or any other foreign or domestic taxpayers.
The Isle of Man has been evaluated by international organizations
including the International Monetary Fund (``IMF''), Financial Action
Task Force (``FATF'') and the Organisation for Economic Co-operation
and Development (``OECD'') and commended for being compliant on all
matters of financial regulation and international co-operation to
prevent evasion of taxes. In fact, on April 2, 2009, the G20 noted the
OECD list of countries assessed by the OECD Global Forum against the
international standard for the exchange of tax information. This listed
the Isle of Man alongside the United States as having substantially
implemented the internationally agreed tax standard, which requires the
exchange of information on request in all tax matters for the
administration and enforcement of domestic tax law without regard to a
domestic tax interest requirement or bank secrecy for tax purposes.\1\
The Isle of Man respectfully requests that if the Subcommittee does
proceed with legislation that includes any blacklist of tax havens or
offshore secrecy jurisdictions, such a list should not include those
jurisdictions, such as the Isle of Man, that the OECD has determined
have substantially implemented the internationally agreed tax standard.
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\1\ This list is posted at: http://www.oecd.org/document/57/
0,3343,en_2649_34487_42496569_1_1
_1_1,00.html
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II. About the Isle of Man
Located in the middle of the Irish Sea at the centre of the British
Isles, the Isle of Man has a total land area of 227 square miles. The
resident population is just over 80,000 (2006 interim census).
Constitutionally, the Isle of Man is a self-governing British Crown
Dependency with its own ancient parliament (Tynwald), government and
laws. The United Kingdom, on behalf of the Crown, is ultimately
responsible for the Isle of Man's international relations, although in
recent years, reflecting significant differences in UK and Manx law and
policies, the Isle of Man has--in agreement with the United Kingdom and
its international partners \2\--represented its own interests
internationally, notably by concluding a significant number of
bilateral tax agreements. The Isle of Man is financially autonomous and
receives no financial assistance either from the United Kingdom or the
European Union (``EU''). The Isle of Man is not represented in the
United Kingdom or European Parliaments.
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\2\ The Isle of Man has, for example, signed agreements giving
effect to the European Commission's Taxation of Savings Interest
Directive with all 27 Member States. Likewise, it has so far negotiated
and signed 14 TIEAs with partner countries inside and outside the EU.
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The Isle of Man's relationship with the EU is set out in Protocol 3
to the United Kingdom's Act of Accession (1972). In essence, in
accordance with Article 299(6)(c) of the treaty establishing the
European Community, the Isle of Man is outside the EU except for EU law
and policy on the customs union and the free movement of goods. In all
other matters, including tax and financial services, the Isle of Man is
in the position of a ``third country'' or non-Member State with respect
to the EU.
III. The Isle of Man Is Well-Regulated, Co-operative and
Transparent
The Isle of Man takes seriously its role as a world-class location
for financial services and investment.
A. Isle of Man Regulation of Financial Services
Business is attracted to the Isle of Man by local expertise in
professional services, a supportive government, a world-class
telecommunications infrastructure, sound financial regulation and a
competitive tax system. New growth areas include e-commerce, the film
industry, international shipping, aviation, and space and satellite
businesses, whilst traditional sectors, like tourism (including the
famous Tourist Trophy motorcycle races) remain important.
The Isle of Man has enacted legislation covering all financial
services sectors, as well as related areas such as audit, accounting,
company law and anti-money laundering. The Isle of Man's legislation in
these fields is modern and based on the highest international
standards. Although the Isle of Man is outside the EU for financial
services and related fields, its legislation in all these areas is
based broadly on corresponding EU secondary legislation.
The Isle of Man's Financial Supervision Commission (``FSC'') was
established in 1983 as an independent statutory body to license and
regulate financial activities in the Isle of Man. The FSC regulates and
supervises all deposit-taking, investment business, services to
collective investments, trust services, company services, fiduciary
services and money transmission services in or from the Isle of Man.
These powers include the maintenance and development of the regulatory
regime for regulated activities, the oversight of directors and persons
responsible for the management, administration or affairs of commercial
entities, and the operation of the Companies Registry.
A number of international organisations have assessed the Isle of
Man's regulatory practices against global standards and have determined
that the Isle of Man is well regulated, co-operates fully in the
pursuit of international financial crime and that its money laundering
legislation complies with the highest global standards, including those
applied by the EU and its Member States.
B. Isle of Man Co-operation in Tax Matters and Financial Crime
The Isle of Man's co-operative approach is based on openness and
``constructive engagement'' with its partners around the world. As a
non-sovereign Crown Dependency of the United Kingdom, an important G20,
OECD and EU Member State, the Isle of Man cannot represent its own
interests on a basis of sovereign equality, either with G20, OECD or EU
Member States. Formally, therefore, the Isle of Man must rely on the
United Kingdom to represent and defend its interests and reputation in
these organisations of sovereign states.
Increasingly, however, by agreement with the United Kingdom under a
``framework for developing the international identity of the Isle of
Man'' signed in May 2007, the Isle of Man is ``entrusted'' to represent
and defend its own laws and policies internationally, in full
consultation and co-operation with the United Kingdom.\3\ It is in this
context that the Isle of Man has adopted a policy of constructive
engagement with all its major international partners, including the EU
and the United States.
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\3\ http://www.gov.im/lib/docs/cso/
iominternationalidentityframework.pdf
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Within the context of the OECD's work on transparency and effective
exchange of information, the Isle of Man is at the forefront of the
development of a comprehensive network of Tax Information Exchange
Agreements (``TIEAs''), based on mutual economic benefit.
To date, the Isle of Man has 14 TIEAs, based on the OECD's Model
Agreement on exchange of information on tax matters, 12 of which are
with OECD members, including the United States. These agreements are
ratified by Tynwald, the Isle of Man's parliament. The Isle of Man is
in TIEA negotiations with a number of other countries, including
members of the OECD and the G20, in respect of further TIEAs.
The Isle of Man believes its consistent and long-standing actions
in respect of tax agreements and its commitment to adhering to
internationally accepted standards of financial regulation provide
tangible evidence of its co-operation with the international community.
This is supported by the statement of Jeffrey Owens, Director of the
OECD's Centre for Tax Policy and Administration, who welcomed the Isle
of Man's TIEA with Germany (March 2009) as a further step in efforts to
bring greater transparency and fairness to cross-border financial
transactions. ``The time has now come for all jurisdictions that have
made commitments to the international standards of transparency and
exchange of information to follow the Isle of Man's lead in
implementing them,'' Owens said. ``I am particularly pleased with the
excellent progress the Isle of Man has made in extending its network of
these agreements.''
C. Isle of Man Transparency
The Isle of Man has no bank secrecy laws, customs or practices that
impede the ability of the United States or other TIEA partners to
request and receive tax information. The Isle of Man has access to the
beneficial ownership information that makes tax information exchange an
effective tool for other countries to enforce their domestic tax laws.
The Isle of Man has successfully responded to all requests for
information by the United States under the TIEA between the Isle of Man
and the United States.
As noted earlier, all company and trust service providers are
licensed and regulated pro-actively to ensure that high levels of due
diligence are applied in all areas of the business. The Isle of Man's
customer due diligence (``CDD'') regulations as set forth in its Anti-
Money Laundering and Countering the Financing of Terrorism Handbook
require both identification and relationship information.
Licenceholders must collect relevant CDD information to identify: (i)
the customer; (ii) the beneficial ownership and control of the
customer; (iii) the nature of the customer's business and the
customer's economic circumstances; (iv) the anticipated relationship
with the licenceholder; (v) and the source of funds. Licenceholders
must, in all cases, know the identity of underlying principals and/or
beneficial owners at the outset of a business relationship. This is
irrespective of the geographical origin of the client, or of any
introducer or fiduciary, or of the complexity of a legal structure.
When requested, regulated intermediaries must provide relevant
information to the regulators and law enforcement authorities who have
appropriate powers to assist in domestic and cross-border
investigations. Access to this beneficial ownership information ensures
that the Isle of Man can provide the United States with accurate and
usable information under the TIEA.
The regulation of corporate and trust service providers is also a
clear example of the Isle of Man's proactive effort to identify a
potential threat to its reputation and enact pioneering legislation to
prevent financial fraud. In so doing, and in regulating business that
still remains unsupervised in most major jurisdictions, the Isle of Man
has acted to ensure that its reputation as a well-regulated and
transparent jurisdiction is protected.
IV. International Assessments and Recognition of the Isle of Man
A number of international organisations have assessed the Isle of
Man's regulatory practices against global standards and have determined
that the Isle of Man is well regulated, co-operates fully in combating
international tax evasion and financial crime, and that its anti-money
laundering legislation complies with the highest global standards,
including those applied by the EU and its Member States.
On April 2, 2009, the OECD issued a detailed progress report on
jurisdictions' efforts to implement the OECD's internationally agreed
standard requiring the exchange of information on request in all tax
matters for the administration and enforcement of domestic tax law
without regard to a domestic tax interest requirement or bank secrecy
for tax purposes. In this report, the Isle of Man was listed alongside
the United States as having ``substantially implemented the
internationally agreed tax standard.''
Just prior to the publication of this new OECD report, Jeffrey
Owens, Director of the OECD's Centre for Tax Policy and Administration,
issued a statement on March 27, 2009 further commending the Isle of
Man's co-operative efforts. ``At a time when many countries have been
promising change, Guernsey, Jersey and the Isle of Man have been
delivering,'' Owens said. ``I am particularly pleased that the Isle of
Man now has 12 TIEAs with OECD countries in accordance with the OECD
standard. This is an important milestone in implementing its commitment
to international co-operation.''
In 2003, the IMF conducted a full assessment of the Isle of Man's
compliance with all of the international standards referred to above.
The Isle of Man was found to have a ``high level of compliance.'' The
IMF report commended the Isle of Man for its attention given to:
``upgrading the financial regulatory and supervisory system to meet
international supervisory and regulation standards in banking,
insurance, securities, and anti-money laundering and combating the
financing of terrorism.''
A further review by the IMF was undertaken in September 2008 as
part of its ongoing programme of assessment. The results are to be
published shortly, and the Isle of Man is confident that the IMF will
again confirm positive findings.
Under the auspices of the FATF, the Isle of Man has been assessed
on two occasions in respect of anti-money laundering measures and has
been found to be co-operative and in compliance with all key FATF
recommendations. The Isle of Man has never been listed as non co-
operative by the FATF. All anti-money laundering actions on the Isle of
Man are co-ordinated through an industry-wide Joint Anti-Money
Laundering Advisory Group.
The Financial Stability Forum (``FSF'') has considered the effect
that offshore centres generally can have on global financial stability.
The Isle of Man was placed in the top group of centres reviewed based
on responses from FSF members (Group 1 Category of offshore
jurisdictions).
The Isle of Man Financial Supervision Commission is a member of the
International Organisation of Securities Commissions (``IOSCO'') and is
a full signatory to the benchmark IOSCO Multilateral Memorandum of
Understanding. As such, the Isle of Man has been judged fully competent
in having the legislative ability to provide full co-operation in
dealing with market manipulation and abuse, insider dealing and other
securities malpractices. The Isle of Man Financial Supervision
Commission has established a strong track record of co-operation in
this area.
The Isle Man Financial Supervision Commission is a member of the
Enlarged Contact Group, which is a discussion forum for global
regulators of collective investments that considers policy developments
and market issues and is a member of the Offshore Group of Banking
Supervisors (of the Basel Committee on Banking Supervision).
The Isle of Man Insurance and Pensions Authority is a member of the
International Association of Insurance Supervisors (``IAIS'') and the
Offshore Group of Insurance Supervisors. Its regulation has been
assessed against the IAIS Insurance Core Principles, as part of the
IMF's assessment. In addition, the Isle of Man has made contributions
to the development of IAIS guidance papers.\4\
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\4\ Particularly the IAIS Guidance Paper on the Regulation and
Supervision of Captive Insurers. http://www.iaisweb.org/_temp/
17_Guidance_paper_No_3_6_on_regulation_and_supervision
_of_captive_insurers.pdf
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The Isle of Man's regulators have also exchanged individual
memoranda of understanding (``MOUs'') with international regulators in
a number of international jurisdictions which underpin its ability to
co-operate on supervisory, regulatory and enforcement matters,
including in the cross-border supervision of international financial
services groups.
The Financial Supervision Commission, which regulates financial
services activities in and from the Isle of Man (with the exception of
insurance and pensions) has entered into MOUs with equivalent
regulators in Bahrain, Bermuda, Cayman Islands, Cyprus, Czech Republic,
Dubai, Gibraltar, Guernsey, Iceland, Ireland, Jersey, Malta, Mauritius,
Qatar, South Africa, United Arab Emirates, United Kingdom and the
United States.
The IPA has entered into MOUs with regulators in Bahrain, Dubai,
Hong Kong, Malta, Qatar, and the United Kingdom. In addition, the IPA
will, in due course, also become a signatory to the IAIS Multilateral
Memorandum of Understanding, which is currently in the early stages of
implementation.
In addition, the Isle of Man's financial services legislation
includes extensive powers for its regulators to exchange information
with other regulators' relevant organisations. These powers ensure that
information can be exchanged whether or not specific MOUs are in place.
The UK Treasury has granted the Isle of Man ``designated
territory'' status, which provides the legal basis for the marketing
and sale of Isle of Man investment funds in the United Kingdom. This
status is subject to regular review by the UK Financial Services
Authority (``FSA'') on behalf of the UK Treasury.
The Isle of Man has been placed on a list of jurisdictions approved
by the U.S. Internal Revenue Service under its Qualified Intermediary
(``QI'') program. Broadly speaking, the legislation requires local
financial institutions to apply for QI status if they wish to invest in
U.S. securities and claim exemption from U.S. withholding tax for their
clients.
The Isle of Man operates compensation programs for depositors,
investors and policyholders, as well as a financial services ombudsman
program within the Isle of Man's Office of Fair Trading.
V. Legislative Solutions
The United States is rightly concerned that it collects the taxes
owed by its citizens. The Isle of Man shares this concern and does not
seek to impede legislative efforts to improve compliance and
enforcement of U.S. tax law.
As a TIEA partner with the United States, the Isle of Man is,
however, concerned that some proposals under discussion in Congress
would incorrectly ``blacklist'' the Isle of Man as an ``offshore
secrecy jurisdiction'' or a ``tax haven.'' In particular, the ``Stop
Tax Haven Abuse Act,'' introduced by Representative Lloyd Doggett and
cosponsored by several members of the Ways and Means Committee, was
discussed at several points during the Subcommittee's hearing on March
31, 2009. This bill, enrolled as H.R. 1265 in the House and S. 506 in
the Senate, uses a list of jurisdictions in a 2005 IRS ``John Doe''
summons, which includes the Isle of Man, to identify jurisdictions that
are treated as ``offshore secrecy jurisdictions.'' Such a provision
ignores the previously stated facts about the Isle of Man and runs
counter to the recent OECD determination.
It is important to note that Internal Revenue Service Commissioner
Douglas Shulman, the Administration's chief tax enforcer, declined to
endorse the blacklisting approach in the Stop Tax Haven Abuse Act when
asked at the hearing. He instead expressed a preference for identifying
the characteristics of jurisdictions that could help facilitate
evasion. Commissioner Shulman identified these characteristics as bank
secrecy, lack of information exchange, non-transparent laws, and nonco-
operation with the United States. The Isle of Man strongly endorses
this approach, which takes into account current facts and would
properly target U.S. compliance and enforcement efforts, ensuring that
co-operative partners like the Isle of Man are not mislabeled as rogue
jurisdictions. Placement on a blacklist, however temporary, would harm
the rightfully earned reputation of the Isle of Man without
justification.
Commissioner Shulman also criticized the source of the list in the
Stop Tax Haven Abuse Act, stating that the ``John Doe'' summons list
was never intended to say these countries have problems. Rather, the
summons list was intended for a very specific credit card initiative
where the Internal Revenue Service had evidence there were credit cards
being issued from those jurisdictions.
The Isle of Man would again respectfully request that if the
Subcommittee does proceed with legislation that includes any blacklist
of tax havens or offshore secrecy jurisdictions, such a list should not
include those jurisdictions, such as the Isle of Man, that the OECD has
determined have substantially implemented the internationally agreed
tax standard.
Respectfully submitted by:
James Anthony Brown
Chief Minister
Isle of Man Government
Government Office
Bucks Road
Douglas
Isle of Man
IM1 3PG
April 14, 2009
Statement of Lyndon S. Trott
1.1 Guernsey is a well-regulated financial centre committed to
maintaining international financial stability and transparency.
Guernsey has consistently demonstrated this commitment through
international co-operation and information exchange.
1.2 As a general principle, Guernsey does not support the use of
``blacklists'' and endorses the views of the U.S. Department of the
Treasury that the use of such lists ``to simplify what is a complex
area--can lead to misunderstanding and mistakes.'' \1\ Guernsey has
consistently argued that each jurisdiction should be considered on its
own merits as assessed against internationally recognised standards.
Guernsey is not a ``tax haven'' or an ``offshore secrecy
jurisdiction.'' In any event, there is no internationally agreed
definition of either.
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\1\ Letter from Deputy Assistant Treasury Secretary (International
Tax Affairs) Michael Mundaca to General Accountability Office (``GAO'')
Director (Tax Issues) James R. White, commenting on GAO report: Large
U.S. Corporations and Federal Contractors with Subsidiaries in
Jurisdictions Listed as Tax Havens or Financial Privacy Jurisdictions,
December 18, 2008.
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1.3 By any objective measure, Guernsey is not a ``tax haven'' or an
``offshore secrecy jurisdiction'' for the following reasons:
Guernsey has never had any form of banking secrecy
legislation;
Guernsey has entered into 13 Tax Information Exchange
Agreements (``TIEAs'') so far, including one with the United States,
and is committed to continuing to be a leader in this field;
Guernsey has well-developed powers to investigate
financial crime and tax evasion and regularly assists other
jurisdictions in such investigations;
Guernsey has had mutual legal assistance legislation in
force since 1998 and regularly exchanges information under that
legislation;
Guernsey provides assistance to jurisdictions so that
requests for information comply with Guernsey law and does not attempt
to obstruct investigations; and
Guernsey has a well-developed regulatory regime which
complies with all recognised international standards.
1.4 Guernsey is a participant in the Global Tax Forum, an
initiative of the Organisation for Economic Co-operation and
Development (the ``OECD''). The OECD recognises that Guernsey has
substantially implemented the OECD standard on information exchange in
tax matters by entering into 13 TIEAs. Further agreements are under
negotiation and Guernsey intends to continue to conclude such
agreements in the near future. The OECD published a list of co-
operative jurisdictions on 2 April 2009, which places Guernsey
alongside jurisdictions such as the United States, France, Germany, and
the United Kingdom in having effective tax information exchange.\2\
Guernsey is delivering on its international commitments to transparency
and co-operation.
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\2\ This list is posted at: www.oecd.org/document/57/
0,3343,en_2649_34487_42496569_1_
1_1_1,00.html.
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1.5 In the event that the Subcommittee on Select Revenue Measures
decides to develop anti-tax haven abuse legislation that uses a list of
``tax havens'' or ``offshore secrecy jurisdictions,'' then Guernsey
respectfully suggests that the only appropriate list to follow is the
list most recently issued by the OECD, the leading global authority on
international tax practices, of jurisdictions that have not
substantially implemented the OECD standard for effective exchange of
tax information.
1.6 Guernsey's reputation as a premier provider of international
financial services has been built on a number of foundations,
including:
an effective regulatory regime that meets or exceeds all
international standards on financial regulation, anti-money laundering
and combating the financing of terrorism;
international co-operation on regulation and the
investigation of financial crime;
regular, external, and independent reviews--in the
majority of cases at Guernsey's express invitation and in all cases
with Guernsey's full co-operation and assistance;
a highly skilled and educated workforce; and
proximity to the European mainland.
1.7 The authorities in Guernsey have substantial investigatory
powers. They work closely with their counterparts in other
jurisdictions in investigating regulatory, taxation, and criminal
matters and assisting in freezing and recovering the proceeds of crime.
Guernsey has consistently provided assistance to the United States in
investigating crime, freezing assets, and recovering the proceeds of
crime.
Lyndon S. Trott
Chief Minister
States of Guernsey
14 April 2009
Background Information
A. Guernsey's Status and International Relationships
1. The Government of Guernsey
1.1 Guernsey is the principal island of the Bailiwick of Guernsey,
a British Crown Dependency.\3\ It has never been a colony or a British
dependent or overseas territory. Its status constitutionally is, and
always has been, distinctly different from that of the British Overseas
Territories. Guernsey has its own directly-elected legislative
assembly, the States of Deliberation, comprising 47 independent
members, and its own administrative, fiscal and legal systems. Its
government, the States of Guernsey, is principally conducted through 10
Government Departments overseen by the Policy Council, constituted by
the Chief Minister and the 10 Ministers. Guernsey's right to raise its
own taxes is a long-established constitutional principle.
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\3\ This section is drawn from Ogier, D, The Government and the Law
of Guernsey, 2005. Further information on Guernsey is available at:
www.gov.gg/aboutguernsey.
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2. Guernsey's Relationship with the United Kingdom
2.1 Guernsey is not, and never has been, represented in the UK
Parliament, which therefore does not legislate on behalf of Guernsey
without first obtaining the consent of Guernsey's administration. The
extension to Guernsey of an Act of Parliament by Order in Council is
occasionally requested. However, the usual practice is for the States
of Deliberation, which always has been legislatively independent from
the United Kingdom regarding insular affairs, to enact its own
legislation. Primary legislation (``Laws'') requires Royal Sanction
from Her Majesty in Council (``the Privy Council'').
2.2 The British Crown acts on behalf of Guernsey through the Privy
Council on the recommendations of Ministers of the UK Government in
their capacity as Privy Counsellors. For example, the UK Ministry of
Justice acts as the point of contact between Guernsey and the British
Crown for the purpose of obtaining Royal Sanction for Laws, but is not
otherwise involved in Guernsey's internal affairs. The Judicial
Committee of the Privy Council is Guernsey's final appellate court.
3. Guernsey's International Affairs
3.1 The United Kingdom is responsible for Guernsey's external
relations and defence. In recent years, Guernsey has increasingly acted
internationally on its own behalf, particularly in relation to matters
for which it has complete autonomy.\4\ The UK Government has recognised
the appropriateness of Guernsey further developing its international
identity.
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\4\ For example, co-operation agreements with the 27 EU Member
States (in relation to Directive 2003/48/EC on taxation of savings
income) and agreements for the exchange of information relating to tax
matters.
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B. Guernsey's Taxation System
1.1 Guernsey has a well-developed taxation system. Taxes in
Guernsey are set on the basis of the need to fund public services and
the need to ensure that Guernsey's economy remains strong. Taxation in
Guernsey is managed by the Director of Income Tax who is responsible
for administering legislation relating to Income Tax and Foreign
Retention Tax in support of the European Union (``EU'') Directive on
the Taxation of Savings Income (2003/48/EC). There is no capital gains
or any other taxes on capital in Guernsey. Guernsey's personal income
tax is set at 20 percent, a rate which has remained unchanged for over
40 years. Guernsey does not have a Value Added Tax but does have a
range of indirect taxes and duties. As part of its commitment to
eliminating harmful tax competition, Guernsey has complied fully with
the EU Code of Conduct on Business Taxation. Guernsey's tax system is
relatively uncomplicated and effective, which minimises the compliance
costs on business.
C. Guernsey's Economy and the Financial Services Sector
1. Development of the Finance Sector
1.1 Guernsey's financial services sector began to grow in the 1960s
with the establishment of operations in Guernsey by UK merchant banks
and the establishment of investment funds which they sponsored. By
1987, the banking, insurance and collective investment fund sectors had
developed to such an extent that the States of Guernsey acted to
establish an independent regulatory body staffed by dedicated
professionals. This was in accordance with internationally accepted
best practices at the time. The Guernsey Financial Services Commission
(the ``Commission'') was established in 1988. During the 1990s,
Guernsey emerged as one of the world's largest captive insurance
centres. Today, Guernsey is Europe's largest captive insurance centre,
and the fifth largest in the world. The Channel Islands Stock Exchange
(``CISX''), which is based in Guernsey and is the only stock exchange
in the Channel Islands, commenced operations in 1998. The CISX has been
recognised by the U.S. Securities and Exchange Commission, the
Financial Services Authority (``FSA'') and Her Majesty's Revenue and
Customs (``HMRC''). As the sector continues to develop, an increasing
number of professional firms exist to service the finance industry,
particularly in the accounting, legal and actuarial professions. There
are presently more than 8,000 people employed in financial services in
Guernsey.
1.2 Financial services account for approximately 35 percent of
Guernsey's Gross Domestic Product. Guernsey also has well-developed
industries in business services, electronic commerce, information
technology and light manufacturing.
1.3 Guernsey's financial services industry is diverse and includes
banking, collective investment funds, insurance and fiduciary services.
The workforce in Guernsey is highly skilled and provides a full range
of services, including administration of funds, corporate
administration, public listing of companies on European stock
exchanges, investment advice, and insurance brokerage services. In many
respects, Guernsey's success as a financial service centre exists
because many of Guernsey's professionals are recognised as world
leaders in their particular fields with a high level of skills and
expertise.
1.4 Due to its long-established financial services industry,
Guernsey has developed considerable expertise in administering
collective investment funds, captive insurance, and trust and company
structures. In addition, Guernsey operates a ``full-service'' finance
centre. It does not merely provide a domicile for activities undertaken
elsewhere.
1.5 Guernsey has been ranked 12th in the latest Global Financial
Centres Index (``GFCI''), released in March 2009. Since the previous
survey published in September 2008 the Island has moved up four places.
The report is produced by the Z/Yen Group for the City of London and
ranks financial centres based on external benchmarking data and current
perceptions of competitiveness and resilience in the face of the global
financial downturn.
2. Regulation of Financial Services in Guernsey
2.1 The Commission was one of the world's first unitary regulatory
bodies, and is responsible for the regulation of banks, insurers and
insurance intermediaries, investment firms, trust companies, company
administrators and professional company directors providing
directorship services by way of business in Guernsey. It has been given
wide-ranging powers to supervise and investigate regulated entities
under a variety of regulatory laws. It also takes appropriate
enforcement action when necessary. The Commission considers that the
prevention of financial instability is a key function of effective
regulation.
2.2 Guernsey is one of the few jurisdictions in the world to
regulate trust and company service providers in a manner consistent
with the prudential regulation of banks, investment firms and insurance
companies. It has regulated trust and company service providers in this
way since 2001.
2.3 In performing its regulatory and supervisory work according to
international standards, the Laws and Regulations administered by the
Commission comply with those established by:
The Basel Committee on Banking Supervision;
The International Association of Insurance Supervisors
(``IAIS'');
The International Organization of Securities Commissions
(``IOSCO'');
The Offshore Group of Insurance Supervisors (``OGIS'');
The Offshore Group of Banking Supervisors (``OGBS''); and
The Financial Action Task Force (``FATF'').
2.4 The International Monetary Fund (``IMF'') conducts a regular
independent and external review of Guernsey's compliance with those
international standards. The next IMF review is likely to occur later
this year.
2.5 The Commission is actively involved with international
regulatory and supervisory organisations. Guernsey was a founding
member of IAIS, OGIS, and OGBS. The Commission is also a full member of
IOSCO and a member of the enlarged contact group on the Supervision of
Collective Investment Funds.
D. Co-operation on Taxation, Regulation, Financial Intelligence and
Anti-Money Laundering
1. Information Exchange 1.1 On 21 February 2002, Guernsey publicly
committed to complying with the OECD's principles of effective exchange
of tax information.\5\ Guernsey signed its first TIEA, with the United
States, on 19 September 2002. It has been fully operative since 2006.
Guernsey has subsequently concluded TIEAs with the Netherlands (25
April 2008), the seven Nordic Council countries (Denmark, the Faroe
Islands, Finland, Greenland, Iceland, Norway and Sweden) (28 October
2008), the United Kingdom (20 January 2009), France (24 March 2009),
Germany (26 March 2009) and Ireland (26 March 2009). Guernsey is
actively pursuing TIEA negotiations with other countries with a view to
finalising agreements as soon as practicable.
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\5\ See letter at www.oecd.org/dataoecd/61/13/2067884.pdf.
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1.2 Guernsey's commitment to transparency and international co-
operation has been recognised by the OECD and the European Commission.
The OECD published a progress report listing co-operative jurisdictions
on 2 April 2009, which places Guernsey alongside jurisdictions such as
the United States, France, Germany, and the United Kingdom in having
effective tax information exchange. At a press conference held on 7
April 2009 the OECD recognised:
``Guernsey . . . [has] made a real commitment, not just before the
G20, but years ago and they have implemented those commitments.''
1.3 Guernsey currently has two double tax arrangements, one with
the United Kingdom, signed in 1952, and the other with Jersey, signed
in 1955. The agreements provide for the exchange of information in
order to prevent fiscal evasion or avoidance. For many years, Guernsey
has been able to provide information from its tax files to the UK tax
authorities, and has done so on a regular basis, both spontaneously and
as requested by the United Kingdom. Exchange of information under the
double tax arrangement with the United Kingdom has led to the opening
of investigations or advancement of existing investigations by HMRC.
2. Mutual Legal Assistance
2.1 The European Convention on Mutual Legal Assistance (1959) and
the Council of Europe Convention on Laundering, Search, Seizure and
Confiscation of the Proceeds of Crime (1990) have both been extended to
Guernsey.
2.2 Mutual legal assistance is provided by the Law Officers of the
British Crown under a range of Guernsey Laws. Between 1999 and 2007,
over 90 requests for information specifically related to taxation
matters were received, of which 46 were from the United Kingdom, 28
from other EU Member States, 7 from the United States and 9 from other
foreign jurisdictions. In 2008, there were 34 requests of all types.
Guernsey does not approach requests to see if they can be rejected but
rather offers assistance to other jurisdictions to enable them to
perfect their requests so they comply with the form required by the
relevant Guernsey Laws.
3. Banking Secrecy and Transparency
3.1 Guernsey has never had banking secrecy laws and does not
perpetuate a regime of banking secrecy. As in the United Kingdom,
general principles of Guernsey law preserve the confidentiality of
information properly regarded as private. Against such due respect for
privacy, however, must be balanced compliance with domestic law
provisions requiring persons to divulge information to relevant
authorities (e.g., the Director of Income Tax has extensive
information-gathering powers and the Commission has wide-ranging powers
of supervision and investigation).\6\ Relevant authorities in Guernsey
then share appropriate information with partners internationally.
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\6\ See Income Tax (Guernsey) Law, 1975, Part VIA (inserted by the
Income Tax (Guernsey) (Amendment) Law, 2005).
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3.2 Guernsey's company law has introduced a new requirement that
all private companies in Guernsey appoint a local resident agent who is
under an ongoing duty to identify the beneficial owner of that company.
That information must be made available to law enforcement and
regulatory bodies upon request. Guernsey believes that it is the first
jurisdiction in the world to introduce such a regime. This further
strengthens the pre-existing Anti-Money Laundering and Combating the
Financing of Terrorism (``AML/CFT'') regime which requires corporate
service providers to identify the beneficial owner of the companies
they administer as part of the anti-money laundering regime.
3.3 Guernsey has a long-standing commitment to transparency and
international co-operation. This was recognised by U.S. Treasury
Secretary Paul O'Neill at the signing of the TIEA between Guernsey and
the United States in 2002. Treasury Secretary O'Neill said:
The United States and Guernsey already have a close and cooperative
relationship on law enforcement matters, including criminal tax
matters. We are well aware of Guernsey's commitment to cooperation in
targeting criminal abuse of the world's financial systems.
This new agreement will formalize and streamline our current
cooperation in criminal tax matters and will allow exchange of
information on specific request in civil tax matters as well. This
agreement is an important development, and further demonstrates
Guernsey's long standing commitment to cooperating with the United
States on law enforcement matters and to upholding international
standards in this area.
Today's agreement with an important financial centre of Europe
demonstrates our commitment to securing the cooperation of all our
neighbours, not just those near our shores but those more distant too.
I hope that Guernsey's cooperation with the United States in
negotiating this tax information exchange agreement will serve as an
example to other financial centres in its region and around the world.
4. Regulatory Transparency and Information Exchange
4.1 The Commission has the legal authority to disclose information
to other supervisory authorities. It can also disclose information to
other authorities for the purposes of preventing, detecting,
investigating and prosecuting financial crime. In addition, the
Commission may obtain information from licensees on behalf of foreign
supervisory bodies. The Commission shares information with supervisory
authorities and other bodies spontaneously, as well as on request.
Although it has 15 Memoranda of Understanding (``MoUs'') with
international partners (including the U.S. Commodity Futures Trading
Commission, U.S. Federal Deposit Insurance Corporation and the FSA), an
MoU is not required to allow information exchange. In light of the
links between UK financial services businesses and Guernsey, it is
common for the Commission to co-operate and exchange information with
the FSA.
4.2 Regarding transparency of transactions, the AML/CFT legislation
and rules made by the Commission require financial services businesses
to undertake customer due diligence on their potential customers and to
look through legal persons, such as companies, legal arrangements and
trusts to undertake customer due diligence on beneficial owners,
settlors, beneficiaries and other underlying principals, and to
maintain both customer due diligence and transaction records. In
addition, rules made under the Protection of Investors Law require
investor transaction records to be maintained (for example, contract
notes). The Attorney General (HM Procureur) and the Commission have
powers under the legislation they administer to obtain that information
on behalf of foreign authorities and to disclose it to those
authorities.
5. Guernsey's Financial Intelligence Service
5.1 The Financial Intelligence Service (``FIS'') is responsible for
the collation and dissemination of intelligence relating to financial
crime in Guernsey.\7\ Formed in 2001, the FIS is operationally
independent, although it is staffed and funded by the law enforcement
agencies of the Guernsey Police and the Customs and Excise, Immigration
and Nationality Service (``Customs''). The strategic aims of the FIS
are:
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\7\ See the FIS website available at: www.guernseyfis.org. Also
available at that website are the FIS annual reports which provide data
on the FIS' activities in each year.
The provision of quality intelligence with regard to all
financial crime, with a special emphasis on combating money laundering
and countering the financing of terrorism;
The provision of full international co-operation, within
the law, to competent and relevant overseas authorities; and
The provision of services to enhance the co-ordination
and the development of criminal intelligence to combat financial crime.
5.2 The staff of law enforcement (the FIS, the Fraud and
International Team, and the Commercial Fraud and International Affairs
Team) are highly skilled specialists and experienced in the
investigation of financial crime. The FIS also is the point of contact
for those seeking assistance in relation to financial crime and
receives requests for assistance from both local law enforcement and
overseas agencies. Since 1997, Guernsey's law enforcement team has been
a member of the Egmont Group of Financial Intelligence Units. Where the
FIS receives intelligence enquiries of a criminal nature that are
proportionate and justified, the FIS does not require an MoU in order
to exchange information. However, where an authority in another
jurisdiction does require an MoU to allow information exchange, the FIS
will enter into such an agreement if there is an operational need. At
present, the FIS is party to 13 MoUs with international partners,
including the UK Serious Organised Crime Agency (``SOCA'').
5.3 The FIS is the designated authority to receive suspicious
transaction reports (``STRs'') in Guernsey. The FIS investigates all
STRs with most being disseminated to relevant local and overseas
agencies. In 2008, there were 519 disclosures and 465 requests for
assistance received, of which 63 percent came from outside Guernsey.
STRs largely relate to suspicions of tax evasion, large cash
transactions, and unexplained lifestyles. STRs relating to suspected
terrorism are relatively rare and comprise only a small portion of
reports received. The high number of reports demonstrates the high
level of awareness of AML/CFT obligations in the finance industry in
Guernsey. Over 75 percent of STRs do not relate to local Guernsey
residents. Where there is evidence of tax evasion, it is Guernsey
policy to disseminate all STRs to the appropriate jurisdiction as it
would any other STR relating to any other criminal activity. Recent
legislation allows intelligence to be disseminated to the SOCA to
assist civil investigations in the United Kingdom (and elsewhere). The
FIS also regularly provides STRs to EU Member States and OECD
countries.
5.4 To counter the significant threat posed by sophisticated
international money laundering, Guernsey has introduced new legislation
to give law enforcement even greater powers to freeze and recover the
proceeds of crime through both criminal and civil action. The laws also
make it easier for law enforcement to prosecute money laundering
offences. Guernsey regularly assists other jurisdictions that request
assistance in obtaining evidence, tracing and freezing assets, and
recovering assets related to criminal proceedings. Guernsey has had
considerable success in freezing and recovering assets on behalf of
many other jurisdictions, including the United Kingdom,\8\ other EU
Member States \9\ and the United States. In many cases, substantial
sums were involved and repatriated to the requesting nation. A
significant portion of matters in which Guernsey provides assistance
relate to taxation.
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\8\ The number of requests from the United Kingdom amount to 49
percent of the total number requests for assistance.
\9\ The number of requests from other EU Member States amount to 30
percent of the total number of requests for assistance.
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6. AML/CFT Framework
6.1 Guernsey's AML/CFT regime complies with the FATF standards. The
Guernsey authorities are committed to ensuring that money launderers,
terrorists, those financing terrorism and other criminals, including
those seeking to evade tax, cannot launder those criminal proceeds
through Guernsey, or otherwise abuse Guernsey's finance sector. The
AML/CFT authorities in Guernsey endorse the FATF's 40 Recommendations
on Money Laundering and the FATF's Nine Special Recommendations on
Terrorist Financing. Guernsey has introduced new legislation, amended
existing legislation, and the Commission has introduced rules and
guidance in order to continually keep compliant with the FATF's
developing standards.
6.2 All businesses and individuals are required by the AML/CFT
legislation to report possible money laundering when they suspect or
have reasonable grounds to suspect that funds are the proceeds of
criminal activity. This includes tax evasion. The same obligation to
report suspicion applies to assets where there are reasonable grounds
to suspect or they are suspected to be linked or related to, or to be
used for terrorism, terrorist acts or by terrorist organisations or
those who finance terrorism. Businesses and individuals reporting
suspicion are protected by law from any breach of confidentiality.
6.3 Extensive AML/CFT countermeasures apply to all financial
service businesses operating in Guernsey, plus trust and company
service providers, all of which are subject to regular on-site
inspections by the Commission. The international standards set by the
FATF did not apply to trust and company service providers until June
2003. However, the revised AML/CFT framework that entered into force in
Guernsey on 1 January 2000 subjected trust and company service
providers to AML/CFT regulation well before the FATF requirements. As a
result, since 2000 trust and company service providers have been
required to identify the beneficial owners of companies, the identity
of settlors and beneficiaries of trusts and the identity of any other
underlying principals.
7. Stolen Asset Recovery Initiative
7.1 In March 2008, the World Bank and the United Nations Office on
Drugs and Crime invited Guernsey to participate in the Stolen Asset
Recovery Initiative (``StAR Initiative''), a project endorsed at the
G20 meeting in Washington in November 2008. The StAR Initiative is an
integral part of the World Bank's anti-corruption strategy and will
enhance co-operation, build relationships and help developing counties
recover stolen assets. Guernsey has a continuing involvement in the
project and has been asked, and agreed, to participate in two further
projects under this initiative.
Statement of Michael J. McIntyre and Robert S. McIntyre
We thank the subcommittee for the opportunity to present our views
on how the United States can reduce international tax evasion by
wealthy Americans. One of us, Michael J. McIntyre, is a professor of
law at Wayne State University in Detroit. He has written extensively on
international tax matters. The other of us, Robert S. McIntyre, is the
Director of Citizens for Tax Justice.
The recent revelations of aggressive facilitation of tax evasion by
the Swiss banking titan, UBS, has given a public face to the
longstanding suspicion that a major segment of the international
banking community is fundamentally corrupt. Of course, no knows for
sure how many banks have engaged in the types of practices for which
UBS has been called to account. The widespread tax fraud by
Liechtenstein banks, widely reported in the press, makes clear,
nevertheless, that UBS is not just a special case. We believe that the
United States and its major trading partners have a major systemic
problem of bank fraud that requires major systemic solutions.
We will discuss here three important ways that wealthy Americans
evade taxes on their investment income. The first is by transferring
assets to offshore tax havens that maintain secrecy to avoid IRS
detection. The second is by fraudulently taking advantage of the
exemption provided under Internal Revenue Code Section 871(h)(1) for
portfolio interest paid to foreign persons. The third is by posing as
foreign persons and taking advantage of U.S. income tax treaties,
typically treaties with countries that maintain bank secrecy rules.
After our discussion of each problem area, we offer solutions that the
Congress could pursue to reduce tax evasion in that area.
1. Transfer of Assets to Offshore Tax Havens
A. Statement of the Problem
Abusive tax avoidance typically involves complex transactions. In
contrast, tax-evasion transactions are unambiguously illegal. Under
U.S. tax laws, American citizens and residents are required to report
all of their income from whatever source derived, including income
earned through deposits in banks located in offshore tax havens. There
is no ambiguity or confusion about the applicable law. Yet it is widely
suspected that hundreds of thousands of wealthy Americans are moving
assets offshore and are failing to report the income earned on those
assets. They are not relying on some obscure or ambiguous provision of
the law to justify their conduct. They simply are hoping not to get
caught.
The Internal Revenue Service has significant powers to ferret out
tax evasion that is accomplished by holding assets within the United
States. It is understaffed, and its ability to cope even with domestic
tax evasion has been compromised over the past decade. Still, the tools
for combating domestic evasion are in place and work reasonably well
when they are applied. Those tools include withholding at source,
information reporting by third parties, and easy assess to records of
banks and other financial institutions.
None of these tools is available to catch tax cheats who move their
assets to offshore tax havens. These tax havens have strict bank
secrecy laws that shelter their financial institutions from any
effective reporting requirements. There is no obligation of these banks
or other investment agents to withhold taxes due to the United States
or to provide the United States with periodical information reports on
income paid to American taxpayers. In some cases, the Internal Revenue
Service (IRS), through tips or otherwise, may discover that certain
American taxpayers appear to be engaging in tax fraud. In some such
cases, the IRS may be able to get some limited assistance from the
government of an offshore tax haven. In general, nevertheless, the
Internal Revenue Service is being asked to locate the proverbial needle
in the haystack.
In 1998, the OECD, with support from the United States, sought to
pressure offshore tax havens into offering cooperation to OECD member
states seeking to combat international tax evasion and abusive
avoidance. This initiative had some success. For example, as a result
of the initiative, the Cayman Islands negotiated a Tax Information
Exchange Agreement (TIEA) in 2001 with the United States, which went
into force in 2006. The OECD initiative slowed considerably after 2001,
due in part to lack of support from the United States. It has recently
been revived, and the revised initiative has already borne fruit.
Several tax havens that are infamous for their collusion with tax
cheats have signed TIEAs or have promised to do so. Even Switzerland
had signaled a willingness to depart from its strict bank secrecy rules
in special cases, although it apparently expects the process of
agreeing to the terms of any TIEAs to be drawn out over a lengthy
period.
The U.S. experience with TIEAs is highly secret. No reports on the
use of those agreements are provided to the public. Our general
impression, nevertheless, is that the TIEAs have been ineffective in
curtailing tax evasion. Some commentators have suggested that they may
have a negative value in some cases by giving the appearance of
propriety to a government that is fully engaged in the business of
attracting and protecting tax cheats. That claim was made, for example,
with respect to the executive agreement between the United States and
Liechtenstein. The Liechtenstein banks have been in the news of late,
due to the discovery that they were facilitating tax evasion by German
citizens and, it was soon learned, by citizens of many other countries,
including the United States.
TIEAs are not useless. They are a useful first step in encouraging
offshore tax havens to cooperate with organized efforts to curtail
international tax evasion, and even without further progress can be
helpful in a few isolated cases. However, they have not provided a
systemic solution to international tax evasion and cannot be expected
to do so. As illustrated by the agreement with the Cayman Islands, an
exchange of information is limited to cases in which the U.S. tax
authorities have already targeted an individual for tax evasion and can
``demonstrate the relevance of the information sought'' by providing
the Cayman tax authorities with the name of the suspected taxpayer, the
reason for believing the information requested is within the possession
of a person under the jurisdiction of the Cayman government, and so
forth. That is, the Cayman government has agreed to be of assistance
when the U.S. government has already fingered the tax cheat. It is
unwilling to be helpful in identifying U.S. tax cheats in the first
instance.
B. Suggested Solutions
i. Provide IRS with the resources and legal protections it needs
to detect and prosecute tax evaders
Virtually all independent observers agree that the IRS does not
have the resources needed to fight international tax evasion
effectively. It is underfunded in this area by several orders of
magnitude. We do not offer advice on what the revised budget should be,
since budget recommendations ought to be based on specific proposals
for how the requested funding would be used. We simply join those who
say that the current level of funding is ridiculously low. One data
point suggesting inadequate resources is that the IRS, when it does
uncover widespread tax fraud, is led to offer some form of amnesty from
fines and criminal prosecution to the offenders who admit their guilt
without the need for a trial. Amnesty for tax cheats obviously
undercuts the penalties that were devised by Congress to discourage tax
evasion. The IRS should be given the resources it needs to make
decisions to prosecute tax-evasion cases on the merits.
Congress also needs to make sure that IRS agents working in the
field are not subject to personal suit for legitimate actions taken to
combat international tax evasion. Stopping tax evasion is a rough and
tumble business. Agents often act on tips, and tips sometimes are
wrong. Many taxpayers engaged in evasion are belligerent and litigious.
There is little doubt that morale at the IRS has been low in recent
years, partly due to fears that they would be subject to prosecution
and litigation just for doing their job. That fear is due in
significant part to a few noxious provisions in the Internal Revenue
Service Restructuring and Reform Act of 1998 (H.R. 2676), enacted after
the infamous Senate Finance Committee hearings in late 1997. Congress
needs to revisit those provisions in an atmosphere less hostile to
enforcement of the nation's tax laws.
ii. Broaden TIEAs to include automatic information exchanges
What makes U.S. banks a poor choice for the American tax cheat is
that banks regularly provide the IRS with information reports about the
income earned by their depositors. It is that kind of regular
information flows that the United States needs to receive from the
financial institutions in the offshore tax havens. Getting agreement
from these countries will not be easy. The United States will need to
work with the OECD and other groups to fashion a policy that rewards
governments that cooperate and imposes penalties on governments that
continue to facilitate international tax evasion. The OECD, by
extracting TIEAs from some of the world's greatest scofflaw countries,
has demonstrated the value of the stick. Practical experience in other
areas suggests that the carrot can be even more effective.
iii. Impose greater reporting requirements on U.S. financial
institutions, accounting firms, and law firms
Many Americans engaging in offshore tax evasion are assisted by
U.S. financial institutions, international accounting firms and law
firms. These facilitators of evasion should be required to provide the
U.S. tax authorities with information reports on transfers to any
jurisdiction that is not cooperating with international efforts at
curtailing international tax evasion and abusive tax avoidance.
iv. Endorse the United Nations Code of Conduct on Cooperation in
Combating International Tax Evasion
At its meeting in October of 2008, the United Nations Expert
Committee on International Cooperation on Tax Matters endorsed in
principle a code of conduct that would charge participating governments
with a moral obligation to take various steps to curtail international
tax evasion and abusive tax avoidance. The code, as revised, is
expected to be ratified by the committee by June of this year. The code
codifies an emerging international standard on transparency and
cooperation. One objective of the code is to put moral pressure on
rogue governments that refuse to provide information exchange or that
actively promote tax evasion by allowing the owners of legal entities
to remain anonymous.\1\
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\1\ In the interests of full disclosure, it may be noted that one
of us (Michael McIntyre) prepared the initial draft of the UN Code of
Conduct when he served as interim chair of the Committee's subcommittee
on information exchange.
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2. The Exemption for Portfolio Interest
A. Statement of the Problem
The exemption for portfolio interest was added to the Code by the
1984 tax act. Under that exemption, nonresident alien individuals and
foreign corporations receiving interest paid on qualifying bonds issued
by U.S. persons are not subject to the 30-percent tax under Code
section 871(a). The bonds may be in bearer form or in registered form.
A qualifying bond must be issued in a fashion that reduces the risk
that it will to be held by U.S. persons. The issuer does not need to
have actual knowledge, however, of the identity or even the nationality
of the holder for the exemption to apply.\2\
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\2\ Regulations have been issued that specify the requirements that
U.S. issuers must meet in order for interest on their bonds to be
deductible. Reg. Sec. 1.163-5(c)(2) (1997). These regulations are
effective January 1, 2001. For tax years before 2001, see Temp. Reg.
Sec. 35a.9999-5 (1990) (questions and answers) and Reg. Sec. 1.163-5T
(1990)
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Congress enacted the exemption for portfolio interest to expand
access of U.S. borrowers to the Eurobond market and other international
capital markets. Interest rates on bonds traded in the Eurobond market
have tended to be lower than U.S. interest rates. The Treasury
Department was particularly keen to gain access to the Eurobond market
in order to reduce the cost of financing the large Federal deficits
that were incurred during the 1980s. The reason for the lower interest
rates was quite simple--those lending money in that market were not
reporting the income on their investments to their home country.
Whether by design or otherwise, the Eurobond market has provided an
ideal investment environment for tax evaders.
Congress and the Treasury Department were aware that many of the
purchasers of portfolio-interest bonds sold on the Eurobond market
would be tax cheats. Indeed, the portfolio-interest rules were designed
to facilitate tax evasion by investors in portfolio-interest bonds. As
noted above, the beneficial owners of the bonds were not required to
identify themselves to the bond issuers.
In addition, the beneficial owners of portfolio-interest bonds were
allowed to invest in those bonds through so-called ``qualified
intermediaries.'' A qualified intermediary typically was a bank or
other financial intermediary that consolidated the investments of
various tax cheats and purchased the portfolio-interest bonds on their
behalf. The rules were designed to make it difficult for the U.S.
government to learn who the tax cheats were. Such ignorance was
important because the United States is obligated to provide information
about the investment income of residents of countries having a tax
treaty with the United States under the treaty's exchange-of-
information article.
Code section 871(h) provides some weak rules intended to prevent
American taxpayers from holding portfolio-interest bonds. As the UBS
case illustrates, these rules are not effective in preventing Americans
from acquiring such bonds. We warned Congress of that danger when the
portfolio-interest exemption was first adopted.\3\ In brief, the rules
designed to make the portfolio-interest bonds attractive to foreign tax
cheats by making their invests anonymously make it difficult to prevent
Americans from using the cloak of anonymity to become the beneficial
owner of portfolio-interest bonds.
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\3\ See ``Statement of Robert S. McIntyre and Michael J.
McIntyre,'' Hearings Before the Subcommittee on Savings, Pensions and
Investment Policy And the Subcommittee on Taxation and Debt Management
of the Senate Committee on Finance Concerning S. 1557, a Bill to Exempt
Foreign Individuals and Corporations from the 30 Percent Withholding
Tax on Interest Income,'' September 19, 1983
---------------------------------------------------------------------------
In adopting the portfolio-interest rules, the United States
actively recruited financial institutions to help foreigners evade the
taxes imposed by their government on interest income derived from the
United States. This evasion was intended to benefit U.S. borrowers by
allowing them to borrow from the tax cheats at a reduced interest rate.
The United States also adopted rules intended to prevent these same
financial institutions from extending their fraudulent behavior to
assist Americans in evading U.S. taxes. The legal rules applicable to
these financial institutions were clear. The moral underpinning of
those rules was not.
The Treasury Department was given the authority in the 1984
legislation to impose rules that might limit the opportunities for
qualified intermediaries to assist Americans in evading U.S. taxes. It
waited, however, over a decade to issue regulations governing the
withholding obligations of qualified intermediaries. The resulting
regulations seemed to assume that the financial institutions that were
facilitating foreign tax evasion would act in good faith to prevent
evasion by Americans of U.S. taxes. The regulations did not accomplish
their goal, as the UBS fraud has illustrated.
The bank secrecy rules of countries such as Switzerland, Belgium,
and Luxembourg complicate the problem of determining whether Americans
have been investing illegally in portfolio-interest bonds. These
countries might provide information to U.S. tax authorities under their
tax treaty with the United States if the U.S. tax authorities are able
to produce compelling evidence that one or more identified Americans
had engaged in tax fraud. As a practical matter, however, it seems
highly unlikely that the U.S. tax authorities have obtained any useful
information from treaty partners that have strong bank secrecy rules.
B. Suggested Solutions
i. Eliminate the portfolio-interest exemption
The world have changed a lot since the portfolio-interest exemption
was adopted in 1984. Today, most tax professionals recognize that a
country cannot solve its problems of international tax evasion and
abusive avoidance without some rather high level of cooperation with
its major trading partners. It is unrealistic for the United States to
expect other countries to help it police its tax system when it is
actively encouraging the residents of those countries to invest ``tax
free'' in the United States. The United States must end is sordid deal
with foreign tax cheats by limiting the exemption for portfolio
interest to foreign persons who are complying with the laws of their
home country.
The easy way, from a technical perspective, for the United States
to get out of the tax evasion business would be for Congress to simply
repeal the portfolio-interest exemption. That way is also the best way
in our view.
ii. Limit the portfolio-interest exemption to complying taxpayers
Although the portfolio-interest exemption was designed to attract
investment by tax cheats, it also may attract investments from
taxpayers who are not subject to tax on foreign income in their country
of residence. For example, residents of oil-rich countries, such as
Qatar and Saudi Arabia, do not impose an income tax on their residents.
Congress may decide to revise the portfolio-interest exemption so that
it is unattractive to tax cheats but remains attractive to complying
taxpayers.
To make the portfolio-interest exempt unattractive to tax evaders,
Congress should take two steps. First, it should require withholding
agents, including financial intermediaries, to verify the true
residence of taxpayers claiming the exemption. If the withholding
agents cannot do so, they would be required to withhold tax at a rate
of 10 percent. That money would be held in escrow by the U.S. Treasury
Department for a reasonable period and would be paid out to claimants
able to substantiate their residence claim.
Second, the Internal Revenue Service should establish procedures
for the automatic exchange of information about payments of portfolio
interest to residents of countries with which the United States has an
tax treaty with an exchange of information article. As noted above, the
United States seems to have structured the ``qualified intermediary''
rules to reduce the likelihood that it would be able to provide treaty
partners with information about the tax evasion of their residents. The
qualified-intermediary regulations need to be modified substantially,
perhaps with a new congressional mandate.
3. Treaty Shopping by American Investors
A. Statement of the Problem
The United States has entered into over 60 bilateral income tax
treaties, almost all of which significantly reduce the 30 percent
withholding rate otherwise imposed by Code section 871 (individuals)
and 881 (corporations) on investment income derived from the United
States. The typical tax treaty reduces the withholding tax on interest
and royalties to zero.
In principal, the reduced treaty rate applies only to persons who
are not U.S. persons and who are bonafide residents of the U.S. treaty
partner. In practice, the United States has difficulty verifying that
those claiming treaty benefits are entitled to those benefits. When the
treaty partner has adopted strict bank secrecy rules, it typically
offers the United States little help in ascertaining the true residence
status of those claiming treaty benefits from the United States. A
significant number of these so-called foreign investors are thought to
be American citizens.
Treaty shopping is often engaged in by foreign persons who are
actually resident in a country that does not have a treaty with the
United States. In addition, residents of a country having a tax treaty
with the United States may engage in treaty shopping if the treaty
entered into with the United States by their country of residence is
less favorable than the treaty of some third country. American citizens
and residents may engage in treaty shopping by posing as foreign
persons entitled to treaty benefits under a tax treaty between the
United States and the country in which they are claiming residence. In
all of these cases, the U.S. Treasury loses tax revenues to which it is
entitled.
The United States has attempted since the late 1970s to curtail
treaty shopping by including a ``Limitation on Benefits'' article
(typically Article 22) in its tax treaties. In some cases (e.g., the
U.S.-Netherlands treaty), that article is long and complex. How
effective the anti-treaty shopping articles have been is unclear. As
best we can determine, the Internal Revenue Service has not litigated a
single case in which it sought to prevent a taxpayer from obtaining
treaty benefits under the ``Limitation on Benefits'' article.
What is clear is that the United States cannot enforce its anti-
treaty shopping rules without obtaining rather detailed information
about the status and financial affairs of the persons claiming treaty
benefits. Such information is generally difficult to obtain. It may be
nearly impossible to obtain when the treaty partner at issue is
enforcing strict bank secrecy rules.
The United States has been nearly alone in its efforts to combat
treaty shopping, which began in earnest during the Carter
Administration. Countries have agreed to include a limitation-on-
benefits article in their treaties with the United States, but they
rarely do so in their treaties with other countries. The OECD has taken
some action, primarily at the urging of the United States, to deal with
treaty shopping through its Commentary on its Model Tax Convention. The
tax guides available worldwide make clear, nevertheless, that treaty
shopping is widespread and implicitly condoned by many governments.
Governments seem willing to condone treaty shopping for two
reasons. First, they may be indifferent to tax evasion that does not
diminish the tax revenues of their country. Second, they may believe
that they may obtain some investments in their own country from tax
cheats engaging in treaty shopping. They are either unaware or
unconcerned that their own residents may be engaging in treaty shopping
to earn income tax free in their own country.
B. Suggested Solutions
i. Tentative withholding tax on payments to uncooperative states.
We recommend that Congress adopt legislation that would impose a
tentative withholding tax of 2 percent on all interest, dividends and
royalties paid to persons claiming treaty benefits under a treaty with
a country that does not engage in an effective exchange of information.
An effective exchange would entail not only the provision of
information on specific request but also automatic exchanges of
information. To avoid abrogating U.S. treaty obligations in violation
of international law, the legislation should make clear that the 2-
percent withholding tax is refundable in full, with interest, if the
taxpayer claiming the treaty benefit proves that it is actually
entitled to a zero rate of withholding.
In response to widespread pressures to curtail international tax
evasion by banks and other financial institutions, a number of
countries, including Switzerland, Luxembourg, and Singapore, very
recently have agreed to provide for an exchange of information,
notwithstanding their bank secrecy rules. Switzerland, however, has
indicated that it will not break with its bank secrecy regime unless
the requesting state provides solid evidence that tax evasion may have
occurred by a named individual or entity. Other states may impose
similar or additional limitations on their willingness to cooperate
with foreign taxing jurisdictions.
A withholding tax, even at a rate as low as two percent, will raise
some revenue and, more importantly, will trigger a record-keeping
obligation on the persons responsible for withholding. In addition, by
watching which taxpayers seek to claim the proffered refund, the U.S.
tax authorities will get some clues as to the extent of tax evasion
that is occurring.
ii. Eliminate zero rate in new and revised treaties
The United States has been a leader in encouraging countries to
agree to impose a zero rate on interest and royalties and even on
certain related-person dividends. This policy was thought to increase
U.S. tax revenues because the tax forgone in the foreign source
countries would reduce the amount of the foreign tax credit that the
U.S. would need to give to its residents investing abroad. That policy
was never effective in augmenting U.S. tax revenues. Now that the U.S.
is a net importer of capital, it clearly is a revenue loser. It is also
bad policy. The source country ought to be given a fair share of the
income derived from investment within its borders, as the League of
Nations acknowledged nearly 90 years ago.
The rules on withholding rates are central to any treaty
negotiation, so the United States cannot unilaterally change its treaty
rules on withholding rates without violating international law. But it
can decline to continue the failed policy of offering zero rates at the
negotiating table.
iii. Terminate bad treaties
The United States has a few treaties that are widely viewed as bad
treaties that do not serve the interest of the United States. The
Treasury Department from time to time has tried to revise these
treaties without success. The proper action now is simply to give
proper notice of termination. It is possible that such a notice will
prompt negotiations that would result in a treaty beneficial to the
United States. If so, all to the good. The more likely result, however,
is that the United States would have one additional country with which
it does not have a tax treaty. That result is clearly better than the
status quo.
4. Conclusion
The ability of Americans to tax themselves and fund government
programs has declined over the past two decades--and precipitously in
the past eight years. To regain the lost power to tax, the government
needs to take action to fix its international tax rules and procedures.
In particular, it needs to strengthen its system for taxing American
citizens and residents on income stashed in tax havens.\4\
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\4\ See Michael J. McIntyre, ``A Program for International Tax
Reform,'' 122 Tax Notes 1021 (Feb. 23, 2009).
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Effective action against tax evasion and abusive avoidance schemes
requires countries with conflicting economic interests to cooperate in
fairly sophisticated ways. In the past, countries have made a show of
stopping tax evasion and abusive avoidance only to settle for formal
arrangements with little practical effect. Fortunately, the prospects
for international tax reform have never been better. This opportunity
is the result of several factors, most significantly the major decline
in the traditional power of the international financial community and
the discrediting of the market as the appropriate mechanism for
regulating banks and other financial institutions. Also, the reputation
of the big accounting firms has never been worse.
The movement to curtail international tax evasion will not occur
without leadership in high places. The Obama Administration will need
to lead the way in negotiations with its OECD partners and with the
many developing countries that are excluded from the OECD.
Congress also has a major role to play in combating international
tax evasion. It must repeal beggar-thy-neighbor policies intended to
attract investment in the United States by foreign tax cheats. It needs
to provide funds and legal protection to the IRS so that the IRS can
ferret out the tax cheats and bring them to justice. It needs to
encourage the Administration to revise tax-treaty policies that
currently facilitate international tax avoidance and evasion. Finally,
it needs to take the moral high road by promoting transparency and
cooperation in the struggle to contain international tax evasion. One
step in that direction would be to endorse the UN's forthcoming code of
conduct on that topic.
Statement of Raymond Baker, Director of Global Financial Integrity
The U.S. is at a critical juncture. Recent events have underscored
the severity of the problem of offshore financial centers, banking
secrecy, and loopholes in current U.S. laws as well as how these enable
illicit financial practices such as tax evasion and fraud.
Abusive offshore schemes are depriving the U.S. of approximately
$100 billion a year at a time when the economy is in a recession and
the resources are strained.
President Barack Obama has stated that he firmly supports action to
crackdown on tax havens and illicit financial practices and has
endorsed the Stop Tax Haven Abuse Act sponsored by Senator Carl Levin
(S. 506) and Congressman Lloyd Doggett (H.R 1265) introduced March 2,
2009.
Calls to confront tax havens have come from several quarters,
including the IMF, the Vatican, and leaders from Germany, France, and
the UK. The G-20 has also issued strong words of intent to address the
economic crisis when it convenes April 2nd in London.
This presents the U.S. with the dual task of working as part of a
global coalition to address a global economic crisis, while also
attending to legislative and regulatory reform at home. President
Obama's announcement of a new Task Force to review and offer
recommendations for changes to the U.S. tax code which would reduce tax
evasion and substantially close the estimated $300 billion per-year tax
gap signals that this second task is indeed a priority for the new
Administration. GFI applauds those efforts.
In considering measures to improve compliance by U.S. taxpayers and
improve the overall system of tax collection, Global Financial
Integrity recommends the following provisions be included in
legislation being considered by Congress aimed at curtailing tax haven
abuse. The following measures are crucial to achieving success in
improving tax assessment and collection and in curtailing fraud.
Automatic Information Exchange
1) Section 101 of the Stop Tax Haven Abuse Act states, ``a
jurisdiction shall be deemed to have ineffective information exchange
practices unless the Secretary determines, on an annual basis, that--
`(i) such jurisdiction has in effect a treaty or other information
exchange agreement with the United States that provides for the prompt,
obligatory, and automatic exchange of such information as is forseeably
relevant for carrying out the provisions of the treaty or agreement or
the administration or enforcement of this title.'' (emphasis added).
Beneficial Ownership Requirement
2) The Incorporation Transparency Act (S. 659) would require States
to obtain a list of the beneficial owners of each corporation or
limited liability company (LLC) formed under its laws, conduct annual
updates of beneficial ownership information, and provide this
information to civil or criminal law enforcement upon receipt of a
subpoena or summons.
Close Loopholes in the Existing Tax Code
3) Section 108 of the Stop tax Haven Abuse Act would ensure that
non-U.S. persons pay U.S. stock dividends by ending the practice of
using complex financial transactions to recast taxable dividend
payments as allegedly tax free dividend equivalent or substitute
dividend payments.
Deterrence
4) Section 102 of the Stop Tax Haven Abuse Act would expand
Treasury Department authority under section 311 of the Patriot Act (31
U.S.C. 5318 (a) to impose sanctions on foreign jurisdictions, financial
institutions or transactions found to be ``impeding tax collection.''
5) Section 301-302 of the Stop Tax Haven Abuse Act would strengthen
penalties for promoting abusive tax shelters and knowingly aiding or
abetting a taxpayer in understating tax liability by specifically:
1. Increasing fines for promotion of abusive tax shelters from 50
percent of the promoter's gross income from the activity to an amount
``not to exceed'' 150 percent of the promoter's gross income from the
prohibited activity.
2. Increasing the maximum fine of $1,000 ($10,000 for a
corporation) to an amount ``not to exceed'' 150 percent of the aider-
abettor's gross income from the prohibited activity.