The Tax Man Cometh

In this and the following two issues of Business Crimes Bulletin, we address: 1) issues arising under section 162 of the Internal Revenue Code of 1986, as amended (Code), which bars the deduction of payments that violate the anti-bribery provisions of the FCPA; and 2) the tax treatment of payments to the U.S. government and others in connection with resolution of allegations of FCPA violations.

Non-Deductibility of Illegal Payments and the FCPA

Since the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), U.S. tax law has specifically barred deduction of bribe payments made illegal under the FCPA, stating:

No deduction shall be allowed under subsection [162] (a) for any payment made, directly or indirectly, to an official or employee of any government, or of any agency or instrumentality of any government, if the payment constitutes an illegal bribe or kickback or, if the payment is to an official or employee of a foreign government, the payment is unlawful under the Foreign Corrupt Practices Act of 1977. The burden of proof in respect of the issue, for the purposes of this paragraph, as to whether a payment constitutes an illegal bribe or kickback (or is unlawful under the Foreign Corrupt Practices Act of 1977) shall be upon the Secretary to the same extent as he bears the burden of proof under section 7454 (concerning the burden of proof when the issue relates to fraud). 26 U.S.C. ' 162(c)(1).

Whether commercial bribe payments are deductible for federal income tax purposes implicates Code provisions concerning the tax treatment of payments that violate the federal (and state) laws used to prosecute the making of such payments. See Code ' 162(c)(2); Tax Reform Act of 1969, Pub. L. No. 91-172, ' 902(b), 83 Stat. 487, 710 (1969); S. REP. NO. 91-552, at 275 (1969); Revenue Act of 1971, Pub. L. 92-178, ' 310(a), 85 Stat. 497, 525 (1971); S. REP. NO. 92-437, at 72'73 (1971). Those laws include, among others, the federal Travel Act. See Paul R. Berger, Bruce E. Yannett, and David M. Fuhr, “The Use of the Travel Act to Prosecute Foreign Commercial Bribery: A Review of the Denial of the Defense Motion in United States v. Carson,” FCPA Update, Vol. 3, No. 3 (Oct. 2011), http://www.debevoise.com/newseventspubs/publications/detail.aspx?id=64730281-500e-48e2-85ca-630f30a991ee.

If a taxpayer has admitted making payments that violate the anti-bribery provisions of the FCPA, amendments to earlier-filed returns may need to be filed. (Generally, a business may deduct any expenses that are “ordinary and necessary,” Id. ' 162(a), but if a payment was once characterized as an “ordinary and necessary” expense, but later revealed as an illegal bribe, a company may need to amend its previous years' returns to forego the deduction to the extent of the value of the bribe.) This will raise issues of potential civil penalties and interest. Id. ” 6601(a) (“if any amount of tax imposed by this title ' is not paid on or before the last date prescribed for payment, interest on such amount at the underpayment rate ' shall be paid for the period from such last date paid.”) Depending on the circumstances, a corporation or corporate employee who helped prepare the flawed tax returns while aware of the underlying corrupt payments involved could also face criminal liability. At a minimum, in-house tax, finance, accounting, and legal and compliance personnel face the task of weighing the relevant evidence in the face of uncertainty before making determinations of deductibility, and, at a broader level, of instituting internal controls to assure compliance with FCPA-related tax regulations.

These tax issues can affect a broad range of U.S. taxpayers, including U.S. corporations, U.S. shareholders of controlled foreign corporations, partnerships and individuals. (The controlled foreign corporation (CFC) rules are an anti-deferral regime that, among other things, subject certain direct and indirect U.S. shareholders of a CFC to U.S. federal income tax on their proportionate share of the so-called “subpart F income” of the CFC, even if the CFC does not make distributions to its shareholders. Id. ' 951(a). Subpart F income includes “the sum of the amounts of any illegal bribes, kickbacks, or other payments (within the meaning of section 162(c)) paid by or on behalf of the corporation during the taxable year” which would be unlawful under the FCPA. Id. ' 952(a). As a result, a U.S. shareholder in a CFC may be subject to current U.S. tax on the amount of any illegal FCPA payment made by the CFC even if the CFC has not made any distributions to its shareholders.)

Peter F.G. Schuur is a partner in the New York office of Debevoise & Plimpton LLP. He is a member of the firm's Tax Department. Bruce E. Yannett is a partner, Steven S. Michaels is a counsel, and John T. Pierpont is an associate in same office; they are members of the Litigation Department and White Collar Litigation Practice Group. The authors may be reached at [email protected], [email protected], [email protected], and [email protected].

The fact that FCPA violations carry the risk of significant U.S. tax law consequences is important throughout the year. Indeed, the tax consequence of FCPA violations is an issue U.S. law enforcement personnel are highlighting, as indicated by case filings and appearances by representatives of the Internal Revenue Service (IRS) at FCPA conferences. (At the January 2012 “FCPA Boot Camp” hosted by the American Conference Institute in Houston, Clarissa M. Balmaseda, a Special Agent in Charge of IRS Criminal Investigation in the Northern District of California, signaled the IRS's newfound willingness to step into the FCPA arena. American Conference Institute, “FCPA Boot Camp” at 4 (Jan. 2012) (on file with author). Another IRS representative, Debra Meyer, a Senior Agent in International Operations in the District of Oregon, spoke on the IRS' role in FCPA enforcement at the American Conference Institute's FCPA conference for the pharmaceutical, medical device and life sciences industry in May 2012. See American Conference Institute, “FCPA & Anti-Corruption for the Life Sciences” (May 2012) (on file with author).)

Introduction

Prosecution of tax violations connected to FCPA issues is nothing new, with the list of corporate and individual matters including United States v. Titan Corp., No. 05-CR-314-BEN, Information at 42-46 (S.D. Cal. 2005), United States v. Liebo , and United States v. Green , 923 F.2d 1308, 1310 n.1 (8th Cir. 1991), among others. See also United States v. Green, No. 08-CR-59(B)-GW, Second Superseding Indictment at 30 (C.D. Cal. Mar. 11, 2009); Morgan R. Hirst & Elizabeth H. Jenkins, Adding Insult to Injury: Tax Consequences of FCPA Violations, Tax Notes, 1074'75 (June 6, 2011). Potential tax liabilities can increase the costs of non-compliance with the FCPA's substantive standards and accounting provisions, and complicate corporate and individual FCPA settlement discussions. It has long been the case that that non-prosecution agreements and deferred prosecution agreements entered into by the U.S. Department of Justice (DOJ) of FCPA matters leave open the possibility of further criminal or civil tax prosecutions. (For the most recent language used by the DOJ. See, e.g., United States v. Smith & Nephew, Inc., No. 12-CR-00030, Deferred Prosecution Agreement at 5 (D.D.C. Feb. 1, 2012); United States v. Marubeni Corp., No. 12-CR-022, Deferred Prosecution Agreement at 7 (S.D. Tex. Jan. 17, 2012); In re Aon Corp, Non-Prosecution Agreement at 2 (Dec. 20, 2011); In re Deutsche Telekom, AG, Non-Prosecution Agreement at 1 (E.D. Va. Dec. 29, 2011); see also Hirst & Jenkins, note 3, supra at 1076.)

In this and the following two issues of Business Crimes Bulletin, we address: 1) issues arising under section 162 of the Internal Revenue Code of 1986, as amended (Code), which bars the deduction of payments that violate the anti-bribery provisions of the FCPA; and 2) the tax treatment of payments to the U.S. government and others in connection with resolution of allegations of FCPA violations.

Non-Deductibility of Illegal Payments and the FCPA

Since the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), U.S. tax law has specifically barred deduction of bribe payments made illegal under the FCPA, stating:

No deduction shall be allowed under subsection [162] (a) for any payment made, directly or indirectly, to an official or employee of any government, or of any agency or instrumentality of any government, if the payment constitutes an illegal bribe or kickback or, if the payment is to an official or employee of a foreign government, the payment is unlawful under the Foreign Corrupt Practices Act of 1977. The burden of proof in respect of the issue, for the purposes of this paragraph, as to whether a payment constitutes an illegal bribe or kickback (or is unlawful under the Foreign Corrupt Practices Act of 1977) shall be upon the Secretary to the same extent as he bears the burden of proof under section 7454 (concerning the burden of proof when the issue relates to fraud). 26 U.S.C. ' 162(c)(1).

Whether commercial bribe payments are deductible for federal income tax purposes implicates Code provisions concerning the tax treatment of payments that violate the federal (and state) laws used to prosecute the making of such payments. See Code ' 162(c)(2); Tax Reform Act of 1969, Pub. L. No. 91-172, ' 902(b), 83 Stat. 487, 710 (1969); S. REP. NO. 91-552, at 275 (1969); Revenue Act of 1971, Pub. L. 92-178, ' 310(a), 85 Stat. 497, 525 (1971); S. REP. NO. 92-437, at 72'73 (1971). Those laws include, among others, the federal Travel Act. See Paul R. Berger, Bruce E. Yannett, and David M. Fuhr, “The Use of the Travel Act to Prosecute Foreign Commercial Bribery: A Review of the Denial of the Defense Motion in United States v. Carson,” FCPA Update, Vol. 3, No. 3 (Oct. 2011), http://www.debevoise.com/newseventspubs/publications/detail.aspx?id=64730281-500e-48e2-85ca-630f30a991ee.

If a taxpayer has admitted making payments that violate the anti-bribery provisions of the FCPA, amendments to earlier-filed returns may need to be filed. (Generally, a business may deduct any expenses that are “ordinary and necessary,” Id. ' 162(a), but if a payment was once characterized as an “ordinary and necessary” expense, but later revealed as an illegal bribe, a company may need to amend its previous years' returns to forego the deduction to the extent of the value of the bribe.) This will raise issues of potential civil penalties and interest. Id. ” 6601(a) (“if any amount of tax imposed by this title ' is not paid on or before the last date prescribed for payment, interest on such amount at the underpayment rate ' shall be paid for the period from such last date paid.”) Depending on the circumstances, a corporation or corporate employee who helped prepare the flawed tax returns while aware of the underlying corrupt payments involved could also face criminal liability. At a minimum, in-house tax, finance, accounting, and legal and compliance personnel face the task of weighing the relevant evidence in the face of uncertainty before making determinations of deductibility, and, at a broader level, of instituting internal controls to assure compliance with FCPA-related tax regulations.

These tax issues can affect a broad range of U.S. taxpayers, including U.S. corporations, U.S. shareholders of controlled foreign corporations, partnerships and individuals. (The controlled foreign corporation (CFC) rules are an anti-deferral regime that, among other things, subject certain direct and indirect U.S. shareholders of a CFC to U.S. federal income tax on their proportionate share of the so-called “subpart F income” of the CFC, even if the CFC does not make distributions to its shareholders. Id. ' 951(a). Subpart F income includes “the sum of the amounts of any illegal bribes, kickbacks, or other payments (within the meaning of section 162(c)) paid by or on behalf of the corporation during the taxable year” which would be unlawful under the FCPA. Id. ' 952(a). As a result, a U.S. shareholder in a CFC may be subject to current U.S. tax on the amount of any illegal FCPA payment made by the CFC even if the CFC has not made any distributions to its shareholders.)

Peter F.G. Schuur is a partner in the New York office of Debevoise & Plimpton LLP. He is a member of the firm's Tax Department. Bruce E. Yannett is a partner, Steven S. Michaels is a counsel, and John T. Pierpont is an associate in same office; they are members of the Litigation Department and White Collar Litigation Practice Group. The authors may be reached at [email protected], [email protected], [email protected], and [email protected].