Foreign-Tax Evasion As Mail and Wire Fraud

The first case involved a scheme to smuggle tobacco products across the Canadian border from a Native American reservation in northern Maine. United States v. Boots, 80 F.3d 580 (1st Cir. 1996). The defendants were convicted of various crimes, including charges under the Travel Act (18 U.S.C. ' 1952) and wire fraud relating to bribery of reservation police and the scheme to evade Canadian taxes. The First Circuit upheld the bribe-related convictions but reversed on the evasion of Canadian taxes. It relied upon the “revenue rule,” which it described as “a firmly embedded principle of common law” going back to the 1775 decision of Lord Mansfield in Holman v. Johnson. Although the rule is often stated as prohibiting courts from enforcing the tax judgments of a foreign state, the First Circuit read the rule more broadly to prohibit the enforcement of the revenue laws of a foreign state. The First Circuit noted the undesirability of having foreign revenue laws “subjected to intrusive scrutiny by the courts of this country.”

The next appellate decision came when the Second Circuit reviewed charges of an alleged scheme to smuggle liquor into Canada. United States v. Trapilo, 130 F.3d 547 (2d Cir. 1997). The defendants were indicted for money laundering in violation of 18 U.S.C. ' 1956 on the theory that they had engaged in financial transactions designed to promote the crime of wire fraud, ie, the evasion of Canadian taxes. The district court had dismissed the indictment on the authority of Boots, but the Second Circuit reversed, adopting a much narrower view of the revenue rule than the First Circuit. Indeed, the Trapilo panel barely discussed the rule at all. Rather, it viewed the case as involving a straightforward interpretation of the wire fraud statute, which it held to be all-encompassing — applying to any scheme to defraud, regardless of victim's identity. Since success of the scheme is not an element of wire fraud, the interpretation of Canadian revenue laws was not at issue, and the revenue rule was not implicated in any way. But Trapilo was not the Circuit's last word. After remand, the defendants were convicted, and a second panel reversed the appealed convictions, stating Trapilo meant only that the indictment was valid on its face. United States v. Pierce, 224 F.3d 158 (2d Cir. 2000). The court then held that the prosecution failed to prove that Canada had a property interest under Canadian law in the tax allegedly evaded, and that the convictions could not stand because the object of depriving a victim of money or property is a necessary element of wire fraud.

The Second Circuit made a further retreat from Trapilo in Attorney General of Canada v. R.J. Reynolds Tobacco Holdings, Inc., 268 F.3d 103 (2d Cir. 2001), a civil RICO action accusing several major tobacco companies of wire and mail fraud for allegedly assisting schemes to smuggle tobacco into Canada. This time, the Second Circuit held that the claims under the mail and wire fraud statutes did violate the revenue rule and repeatedly cited the First Circuit's Boots decision with approval. The panel distinguished Trapilo by reasoning that the revenue rule vindicates the separation of powers when a U.S. Court, as opposed to the Executive Branch, is called upon to interpret foreign law. Separation of powers concerns are mitigated in a criminal case like Trapilo, since the prosecution is brought by the Executive Branch; here, however, a civil RICO was suit brought by the foreign government itself acting in the capacity of a private litigant. (A dissent pointed out that the Supreme Court has consistently held that civil RICO is coterminous with criminal RICO, and so R.J. Reynolds was irreconcilable with Trapilo.)

The Eleventh Circuit has followed R.J. Reynolds. Republic of Honduras v. Philip Morris Cos., 341 F.3d 1253 (11th Cir. 2003). Meanwhile, the Second Circuit ruled last month that the U.S.A. Patriot Act does not overrule R.J. Reynolds, notwithstanding some ambiguities in the legislative history suggesting that at least some Senators believed that the legislation would permit civil suits by foreign governments against tobacco companies for evasion of foreign taxes. European Community v. RJR Nabisco, Inc., – F.3d – , 2004 WL 60976 (2d Cir., Jan. 14, 2004).

Meanwhile, on the criminal front, the Fourth Circuit adopted an extremely narrow view of the revenue rule. United States v. Pasquantino, 336 F.3d 321 (4th Cir. 2003) (en banc). Pasquantino was a prosecution for wire fraud arising out of a scheme to transport low-cost liquor from Maryland for smuggling to Canada. A split panel had reversed the convictions, relying on Boots. Upon rehearing en banc, the Fourth Circuit reinstated the convictions, holding that the revenue rule bars only suits to enforce a foreign tax judgment. A petition for certiorari has been filed in Pasquantino, and this issue may soon be addressed by the Supreme Court.

Many aspects of the Fourth Circuit's opinion are troubling. First, the narrow construction of the revenue rule may go beyond upholding a criminal prosecution and open the door to civil RICO suits by foreign governments of the sort that the Second and Eleventh Circuits have rejected. Second, Pasquantino is the first case to affirm a sentence based on the district court's calculation of foreign tax as the “amount of the loss” under the Sentencing Guidelines. Thus, the court in Pasquantino did precisely what the Second Circuit took pains to avoid and found unnecessary in Trapilo.

Policy Implications

The use of the mail and wire fraud statutes in connection with the evasion of foreign taxes has significant implications for businesses operating in a multinational setting. While prosecutions to date have involved crude smuggling operations, there is nothing in the reasoning of Trapilo and Pasquantino that limits their scope to smuggling, and nothing that would prevent the U.S. government from bringing a prosecution for mail or wire fraud (or money laundering or RICO) based on any violation of foreign tax law.

Multinational corporations typically carry on activities that raise issues under the tax laws of dozens, if not hundreds, of different jurisdictions. The practical problems posed by the prospect of having to litigate complex questions of foreign tax law in a U.S. court are truly horrific. Such cases would inevitably entail the use of extensive expert testimony to deal with esoteric issues of foreign tax law for which U.S. courts have no expertise. That U.S. juries might have to find “facts” about foreign tax law, as Pierce suggests, is disturbing.

RICO suits brought by foreign governments are even more troubling. Presumably, the foreign governments have their own means of enforcing their tax laws. Foreign governments should not be permitted to forum-shop for benefits, such as treble damages, that are unavailable under their own law.

In Boots, the First Circuit wisely concluded that the revenue rule was designed to address all of these problems, and that U.S. courts should refuse to enforce foreign taxes indirectly through the mail and wire fraud statutes just as they refuse to enforce foreign tax judgments directly. The Second and Fourth Circuits, by failing to apply the revenue rule, may cause a host of problems for businesses operating in the modern global economy.

With deficits plaguing the federal budget, prosecutors might be expected to concentrate their efforts on enforcing U.S. tax laws. Yet federal prosecutors have recently brought charges under the mail and wire fraud statutes (18 U.S.C. '' 1341, 1343) in cases involving the evasion of foreign taxes. Foreign governments themselves have brought civil suits under the RICO statute (18 U.S.C. ''1961 et seq.), on the theory that the evasion of foreign taxes constitutes a predicate act of mail or wire fraud.

The courts have split on whether this works. Generally, RICO claims by foreign governments have failed. Criminal prosecutions for fraud and money laundering have been upheld by the Second and Fourth Circuits, but rejected by the First Circuit. The issue may soon reach the Supreme Court.

The Revenue Rule

The first case involved a scheme to smuggle tobacco products across the Canadian border from a Native American reservation in northern Maine. United States v. Boots , 80 F.3d 580 (1st Cir. 1996). The defendants were convicted of various crimes, including charges under the Travel Act (18 U.S.C. ' 1952) and wire fraud relating to bribery of reservation police and the scheme to evade Canadian taxes. The First Circuit upheld the bribe-related convictions but reversed on the evasion of Canadian taxes. It relied upon the “revenue rule,” which it described as “a firmly embedded principle of common law” going back to the 1775 decision of Lord Mansfield in Holman v. Johnson. Although the rule is often stated as prohibiting courts from enforcing the tax judgments of a foreign state, the First Circuit read the rule more broadly to prohibit the enforcement of the revenue laws of a foreign state. The First Circuit noted the undesirability of having foreign revenue laws “subjected to intrusive scrutiny by the courts of this country.”

The next appellate decision came when the Second Circuit reviewed charges of an alleged scheme to smuggle liquor into Canada. United States v. Trapilo , 130 F.3d 547 (2d Cir. 1997). The defendants were indicted for money laundering in violation of 18 U.S.C. ' 1956 on the theory that they had engaged in financial transactions designed to promote the crime of wire fraud, ie, the evasion of Canadian taxes. The district court had dismissed the indictment on the authority of Boots, but the Second Circuit reversed, adopting a much narrower view of the revenue rule than the First Circuit. Indeed, the Trapilo panel barely discussed the rule at all. Rather, it viewed the case as involving a straightforward interpretation of the wire fraud statute, which it held to be all-encompassing — applying to any scheme to defraud, regardless of victim's identity. Since success of the scheme is not an element of wire fraud, the interpretation of Canadian revenue laws was not at issue, and the revenue rule was not implicated in any way. But Trapilo was not the Circuit's last word. After remand, the defendants were convicted, and a second panel reversed the appealed convictions, stating Trapilo meant only that the indictment was valid on its face. United States v. Pierce , 224 F.3d 158 (2d Cir. 2000). The court then held that the prosecution failed to prove that Canada had a property interest under Canadian law in the tax allegedly evaded, and that the convictions could not stand because the object of depriving a victim of money or property is a necessary element of wire fraud.

The Second Circuit made a further retreat from Trapilo in Attorney General of Canada v. R.J. Reynolds Tobacco Holdings, Inc. , 268 F.3d 103 (2d Cir. 2001), a civil RICO action accusing several major tobacco companies of wire and mail fraud for allegedly assisting schemes to smuggle tobacco into Canada. This time, the Second Circuit held that the claims under the mail and wire fraud statutes did violate the revenue rule and repeatedly cited the First Circuit's Boots decision with approval. The panel distinguished Trapilo by reasoning that the revenue rule vindicates the separation of powers when a U.S. Court, as opposed to the Executive Branch, is called upon to interpret foreign law. Separation of powers concerns are mitigated in a criminal case like Trapilo, since the prosecution is brought by the Executive Branch; here, however, a civil RICO was suit brought by the foreign government itself acting in the capacity of a private litigant. (A dissent pointed out that the Supreme Court has consistently held that civil RICO is coterminous with criminal RICO, and so R.J. Reynolds was irreconcilable with Trapilo.)

The Eleventh Circuit has followed R.J. Reynolds. Republic of Honduras v. Philip Morris Cos. , 341 F.3d 1253 (11th Cir. 2003). Meanwhile, the Second Circuit ruled last month that the U.S.A. Patriot Act does not overrule R.J. Reynolds, notwithstanding some ambiguities in the legislative history suggesting that at least some Senators believed that the legislation would permit civil suits by foreign governments against tobacco companies for evasion of foreign taxes. European Community v. RJR Nabisco, Inc., – F.3d – , 2004 WL 60976 (2d Cir., Jan. 14, 2004).

Meanwhile, on the criminal front, the Fourth Circuit adopted an extremely narrow view of the revenue rule. United States v. Pasquantino , 336 F.3d 321 (4th Cir. 2003) ( en banc ). Pasquantino was a prosecution for wire fraud arising out of a scheme to transport low-cost liquor from Maryland for smuggling to Canada. A split panel had reversed the convictions, relying on Boots. Upon rehearing en banc, the Fourth Circuit reinstated the convictions, holding that the revenue rule bars only suits to enforce a foreign tax judgment. A petition for certiorari has been filed in Pasquantino, and this issue may soon be addressed by the Supreme Court.

Many aspects of the Fourth Circuit's opinion are troubling. First, the narrow construction of the revenue rule may go beyond upholding a criminal prosecution and open the door to civil RICO suits by foreign governments of the sort that the Second and Eleventh Circuits have rejected. Second, Pasquantino is the first case to affirm a sentence based on the district court's calculation of foreign tax as the “amount of the loss” under the Sentencing Guidelines. Thus, the court in Pasquantino did precisely what the Second Circuit took pains to avoid and found unnecessary in Trapilo.

Policy Implications

The use of the mail and wire fraud statutes in connection with the evasion of foreign taxes has significant implications for businesses operating in a multinational setting. While prosecutions to date have involved crude smuggling operations, there is nothing in the reasoning of Trapilo and Pasquantino that limits their scope to smuggling, and nothing that would prevent the U.S. government from bringing a prosecution for mail or wire fraud (or money laundering or RICO) based on any violation of foreign tax law.

Multinational corporations typically carry on activities that raise issues under the tax laws of dozens, if not hundreds, of different jurisdictions. The practical problems posed by the prospect of having to litigate complex questions of foreign tax law in a U.S. court are truly horrific. Such cases would inevitably entail the use of extensive expert testimony to deal with esoteric issues of foreign tax law for which U.S. courts have no expertise. That U.S. juries might have to find “facts” about foreign tax law, as Pierce suggests, is disturbing.

RICO suits brought by foreign governments are even more troubling. Presumably, the foreign governments have their own means of enforcing their tax laws. Foreign governments should not be permitted to forum-shop for benefits, such as treble damages, that are unavailable under their own law.

In Boots, the First Circuit wisely concluded that the revenue rule was designed to address all of these problems, and that U.S. courts should refuse to enforce foreign taxes indirectly through the mail and wire fraud statutes just as they refuse to enforce foreign tax judgments directly. The Second and Fourth Circuits, by failing to apply the revenue rule, may cause a host of problems for businesses operating in the modern global economy.