Tax Considerations of FCPA Violations

Section 6663(a) imposes penalties on fraudulent filings. It provides that “[i]f any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.” Id. ' 6663(a). For section 6663(a) to apply, the government must show by clear and convincing evidence (See Pub. L. No. 91-172, Section 902, 83 Stat. at 710) that the underpayment of taxes was due to fraud. Gagliardi v. United States, 81 Fed. Cl. 772, 774, 785 (Ct. Cl. 2008); Cole v. Comm'r, 637 F.3d 767, 780 (7th Cir. 2011); Petzoldt v. Comm'r, 92 T.C. 661, 699 (T.C. 1989). “The fraud determination turns on whether the taxpayer had an actual, specific intent to evade a tax owed.” Cole, 637 F.3d at 780 (quotations omitted).

A taxpayer's fraudulent intent can be demonstrated indirectly via evidence of “badges of fraud,” which include: 1) understating income; 2) maintaining inadequate records; 3) implausible or inconsistent explanations of behavior; 4) concealment of income or assets; 5) failing to cooperate with tax authorities; 6) engaging in illegal activities; 7) intent to mislead which may be inferred from a pattern of conduct; 8) lack of credibility of taxpayer's testimony; 9) filing false documents; 10) failing to file tax returns; and 11) dealing in cash. Aston v. Comm'r, 2003 WL 21000282, at *4 (T.C. May 2, 2003) (citing Spies v. United States, 31 U.S. 492, 499 (1943)); see also Bradford v. Comm'r, 796 F.2d 303, 307 (9th Cir. 1986) (similar); Cole, 637 F.3d at 780 (similar). See also Badaracco v. Comm'r, 464 U.S. 386, 394 (1984) (“[A] taxpayer who submits a fraudulent return does not purge the fraud by subsequent voluntary disclosure”).

The Statute of Limitations

The statute of limitations provides very little, if any, refuge in fraud penalty proceedings. Generally, a tax must be assessed by the IRS “within 3 years after the return was filed.” 26 U.S.C. ' 6501(a). Once the tax is assessed, the IRS has 10 years to seek to collect the tax by administrative means or institute a suit for collection or judgment. Id. ' 6502(a). Section 6501 of the Code, however, provides that “[i]n the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time.” Id. ' 6501(c)(1). Indeed, in 1995, the tax court held that the IRS properly assessed tax, penalty, and interest for fraudulent returns filed from 24 to 30 years earlier, i.e., those filed in the period including tax years 1964 to 1970. Id. ' 6501(c)(1).

Criminal Penalties

Deducting or attempting to deduct an illegal payment may also give rise to a variety of potential criminal charges. See 26 U.S.C. ” 7201-12. Section 7201 of the Code, for example, prohibits any person from willfully attempting to evade or defeat tax or the payment thereof. Id. ' 7201. Similarly, section 7206(1) prohibits any person from willfully making “any return, statement, or other document, which contains or is verified by a written declaration that it is made under the penalties of perjury, and which he does not believe to be true and correct as to every material matter” (Id. ' 7206(1)), while section 7206(2) criminalizes the willful aid or assistance in preparing a return, affidavit or claim “which is fraudulent or is false as to any material matter.” Id. ' 7206(2). (This conduct is criminal, irrespective of whether the taxpaying entity or individual had knowledge of the fraud.) Section 7207 punishes any person's willful disclosure “to the Secretary any list, return, account, statement, or other document known by him to be fraudulent or to be false as to any material matter.” Id. ' 7207. Of particular import for corporate officers, “[a]ny person” is not limited to a taxpayer, but includes “an officer or employee of a corporation, or a member or employee of a partnership.” Id. ' 7343.

Criminal tax violations, of course, are subject to the requirement that the government prove the elements of the offense beyond a reasonable doubt. Moreover, a successful prosecution requires proof of “willful” misconduct by the defendant. See United States v. Bishop, 412 U.S. 346, 360-61 (1973) (meaning of “willful”). The U.S. Supreme Court has held that, by including this term, Congress departed from “[t]he general rule that ignorance of the law or mistake of law is no defense to criminal prosecution.” Cheek v. United States, 498 U.S. 192, 199-200 (1992). The government must prove “that the law imposed a duty on the defendant, that the defendant knew of this duty, and that he voluntarily and intentionally violated that duty.” Id. at 201; see also Bishop, 412 U.S. at 360. To prove the second element, the government must “negat[e] a defendant's claim of ignorance of the law or a claim that because of a misunderstanding of the law, he had a good faith belief that he was not violating any of the provisions of the tax laws.” Cheek, 498 U.S. at 202. It is not sufficient on this front that the defendant's belief is unreasonable. Id.

Section 6531 governs the statute of limitations with respect to criminal tax violations, generally establishing that “[n]o person shall be prosecuted, tried, or punished for any of the various offenses arising under the internal revenue laws unless the indictment is found or the information instituted within 3 years next after the commission of the offense.” 26 U.S.C. ' 6531. This section, however, also includes exceptions for which the applicable statute of limitations can be six years. Id. (Section 6531 mandates a six-year statute of limitations “for offenses described in sections 7206(1) and 7207 (relating to false statements and fraudulent documents)” as well as for the offenses “described in section 7212(a) [and] 7214(a) [.]” Id. ' 6531(5)-(7). Section 6531 also establishes a six-year limitation period for offenses in other sections, but by describing the misconduct rather than by explicit reference to the section. For example, section 6531(2) establishes a six-year statute of limitation for section 7201 by providing that “the period of limitation shall be 6 years ' for the offense of willfully attempting in any manner to evade or defeat any tax or the payment thereof.” Id. ' 6531(2); cf. id. ' 7201 (criminalizing the willful attempt “to evade or defeat any tax imposed by this title or the payment thereof”). Other sections for which 6531 establishes a six-year statute by describing misconduct rather than by explicit reference include sections 7202 (willfully failing to pay any tax), 7203 (willful failure to file return), and 7206(2) (willfully aiding or assisting in the preparation of false or fraudulent returns). See Id. ' 6531(2)-(4). Additionally, a six-year statute of limitations also applies to the prohibition on conspiracy to evade taxes, which is codified not in the Code but rather at 18 U.S.C. ' 371. See Id. ' 6531(8).)

Finally, criminal tax proceedings against a corporation for fraud or willful misconduct, like prosecutions under the FCPA itself, raise potential questions relating to the “collective knowledge” doctrine, under which “[a] corporation is considered to have acquired the collective knowledge of its employees and is held responsible for their failure to act accordingly.” Bank of New England, 821 F.2d at 856. In N.Y. Cent. R.R. & Hudson River R.R. Co v. United States, the U.S. Supreme Court held that a corporation could be criminally prosecuted for the misconduct of its agents acting within their scope of employment. 212 U.S. 481 (1909). This remains the law. See United States v. Koppers Co., Inc., 652 F.2d 290, 298 (2d Cir. 1981); United States v. Halpin, 145 F.R.D. 447, 449 (N.D. Ohio 1992). The collective knowledge doctrine expands this rule by enabling a corporation to be held criminally liable even when no single employee engaged in covered misconduct with the required knowledge, or, depending on the court applying the doctrine, mens rea. United States v. Bank of New England, 821 F.2d 844, 856 (1st Cir. 1987).

However, it must be noted that the collective knowledge doctrine remains controversial, and its application in the criminal tax context is a largely untested question. In United States v. Science Applications Int'l Corp., 626 F.3d 1257, 1274-76 (D.C. Cir. 2010), for example, the D.C. Circuit expressed strong doubts about the collective knowledge doctrine, noting that “we are dubious of the legal soundness of the 'collective intent' theory, under which, as we explained, a corporation's specific intent to defraud can be inferred if the company's public statements contradict the accumulated 'collective knowledge' of the corporation's employees.” (quotation marks omitted)). See also Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 365 F.3d 353, 366 (5th Cir. 2004); Nordstrom, Inc. v. Chubb & Son, Inc., 54 F.3d 1424, 1435 (9th Cir. 1995). Some commentators question the doctrine's applicability to specific intent crimes, see Sarah Kelly-Kilgore & Emily M. Smith, Corporate Criminal Liability, 48 Am. Crim. L. Rev. 421, 431-32 (2011), while others conclude that “when courts have aggregated knowledge, they invariably have done so as a technique in response to willful blindness to inculpatory knowledge.” Thomas A. Hagemann & Joseph Grinstein, Mythology of Aggregate Corporate Knowledge: A Deconstruction, 65 Geo. Wash. L. Rev. 210, 236'37 (1997). District courts outside of the First Circuit have also confined Bank of New England to its facts. See, e.g., United States v. Walthers, 779 F. Supp. 2d 735, 738 (N.D. Ill. 2011).

One state court has flatly disagreed with the First Circuit and broadly held that “a corporation acts with a given mental state in a criminal context only if at least one employee who acts (or fails to act) possesses the requisite mental state at the time of the act (or failure to act).” Commonwealth v. Life Care Ctrs. of Am., 926 N.E.2d 206, 212 (Mass. 2010). But see State v. Zeta Chi Fraternity, 696 A.2d 530 (N.H. 1997). Although the U.S. Supreme Court has cited Bank of New England, it has never opined on the collective knowledge doctrine, let alone its application to tax cases. Staub v. Proctor Hosp., 131 S. Ct. 1186, 1192 (2011); Ratzlaf v. United States, 510 U.S. 135, 141 (1994).

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 the firm's New York 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], respectively.

Last month, we began examination of some of the tax consequences of violations of the Foreign Corrupt Practices Act (FCPA). We continue with that discussion herein.

Civil Penalties

Civil penalties for improper deductions of payments that violate the FCPA's anti-bribery provisions can range from accuracy related-penalties to fraudulent filing penalties. Section 6662 of the Code establishes an accuracy-related penalty of 20% of an underpayment of tax that is attributable to various errors and omissions (26 U.S.C. ' 6662(a)), including negligence, disregard of IRS rules or regulations, or substantial understatement of income tax (26 U.S.C. ' 6663(a)).

Section 6663(a) imposes penalties on fraudulent filings. It provides that “[i]f any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.” Id. ' 6663(a). For section 6663(a) to apply, the government must show by clear and convincing evidence (See Pub. L. No. 91-172, Section 902, 83 Stat. at 710) that the underpayment of taxes was due to fraud. Gagliardi v. United States , 81 Fed. Cl. 772, 774, 785 (Ct. Cl. 2008); Cole v. Comm'r , 637 F.3d 767, 780 (7th Cir. 2011); Petzoldt v. Comm'r , 92 T.C. 661, 699 (T.C. 1989). “The fraud determination turns on whether the taxpayer had an actual, specific intent to evade a tax owed.” Cole , 637 F.3d at 780 (quotations omitted).

A taxpayer's fraudulent intent can be demonstrated indirectly via evidence of “badges of fraud,” which include: 1) understating income; 2) maintaining inadequate records; 3) implausible or inconsistent explanations of behavior; 4) concealment of income or assets; 5) failing to cooperate with tax authorities; 6) engaging in illegal activities; 7) intent to mislead which may be inferred from a pattern of conduct; 8) lack of credibility of taxpayer's testimony; 9) filing false documents; 10) failing to file tax returns; and 11) dealing in cash. Aston v. Comm'r, 2003 WL 21000282, at *4 (T.C. May 2, 2003) (citing Spies v. United States , 31 U.S. 492, 499 (1943)); see also Bradford v. Comm'r , 796 F.2d 303, 307 (9th Cir. 1986) (similar); Cole, 637 F.3d at 780 (similar). See also Badaracco v. Comm'r , 464 U.S. 386, 394 (1984) (“[A] taxpayer who submits a fraudulent return does not purge the fraud by subsequent voluntary disclosure”).

The Statute of Limitations

The statute of limitations provides very little, if any, refuge in fraud penalty proceedings. Generally, a tax must be assessed by the IRS “within 3 years after the return was filed.” 26 U.S.C. ' 6501(a). Once the tax is assessed, the IRS has 10 years to seek to collect the tax by administrative means or institute a suit for collection or judgment. Id. ' 6502(a). Section 6501 of the Code, however, provides that “[i]n the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time.” Id. ' 6501(c)(1). Indeed, in 1995, the tax court held that the IRS properly assessed tax, penalty, and interest for fraudulent returns filed from 24 to 30 years earlier, i.e., those filed in the period including tax years 1964 to 1970. Id. ' 6501(c)(1).

Criminal Penalties

Deducting or attempting to deduct an illegal payment may also give rise to a variety of potential criminal charges. See 26 U.S.C. ” 7201-12. Section 7201 of the Code, for example, prohibits any person from willfully attempting to evade or defeat tax or the payment thereof. Id. ' 7201. Similarly, section 7206(1) prohibits any person from willfully making “any return, statement, or other document, which contains or is verified by a written declaration that it is made under the penalties of perjury, and which he does not believe to be true and correct as to every material matter” (Id. ' 7206(1)), while section 7206(2) criminalizes the willful aid or assistance in preparing a return, affidavit or claim “which is fraudulent or is false as to any material matter.” Id. ' 7206(2). (This conduct is criminal, irrespective of whether the taxpaying entity or individual had knowledge of the fraud.) Section 7207 punishes any person's willful disclosure “to the Secretary any list, return, account, statement, or other document known by him to be fraudulent or to be false as to any material matter.” Id. ' 7207. Of particular import for corporate officers, “[a]ny person” is not limited to a taxpayer, but includes “an officer or employee of a corporation, or a member or employee of a partnership.” Id. ' 7343.

Criminal tax violations, of course, are subject to the requirement that the government prove the elements of the offense beyond a reasonable doubt. Moreover, a successful prosecution requires proof of “willful” misconduct by the defendant. See United States v. Bishop , 412 U.S. 346, 360-61 (1973) (meaning of “willful”). The U.S. Supreme Court has held that, by including this term, Congress departed from “[t]he general rule that ignorance of the law or mistake of law is no defense to criminal prosecution.” Cheek v. United States , 498 U.S. 192, 199-200 (1992). The government must prove “that the law imposed a duty on the defendant, that the defendant knew of this duty, and that he voluntarily and intentionally violated that duty.” Id. at 201; see also Bishop, 412 U.S. at 360. To prove the second element, the government must “negat[e] a defendant's claim of ignorance of the law or a claim that because of a misunderstanding of the law, he had a good faith belief that he was not violating any of the provisions of the tax laws.” Cheek, 498 U.S. at 202. It is not sufficient on this front that the defendant's belief is unreasonable. Id.

Section 6531 governs the statute of limitations with respect to criminal tax violations, generally establishing that “[n]o person shall be prosecuted, tried, or punished for any of the various offenses arising under the internal revenue laws unless the indictment is found or the information instituted within 3 years next after the commission of the offense.” 26 U.S.C. ' 6531. This section, however, also includes exceptions for which the applicable statute of limitations can be six years. Id. (Section 6531 mandates a six-year statute of limitations “for offenses described in sections 7206(1) and 7207 (relating to false statements and fraudulent documents)” as well as for the offenses “described in section 7212(a) [and] 7214(a) [.]” Id. ' 6531(5)-(7). Section 6531 also establishes a six-year limitation period for offenses in other sections, but by describing the misconduct rather than by explicit reference to the section. For example, section 6531(2) establishes a six-year statute of limitation for section 7201 by providing that “the period of limitation shall be 6 years ' for the offense of willfully attempting in any manner to evade or defeat any tax or the payment thereof.” Id. ' 6531(2); cf. id. ' 7201 (criminalizing the willful attempt “to evade or defeat any tax imposed by this title or the payment thereof”). Other sections for which 6531 establishes a six-year statute by describing misconduct rather than by explicit reference include sections 7202 (willfully failing to pay any tax), 7203 (willful failure to file return), and 7206(2) (willfully aiding or assisting in the preparation of false or fraudulent returns). See Id. ' 6531(2)-(4). Additionally, a six-year statute of limitations also applies to the prohibition on conspiracy to evade taxes, which is codified not in the Code but rather at 18 U.S.C. ' 371. See Id. ' 6531(8).)

Finally, criminal tax proceedings against a corporation for fraud or willful misconduct, like prosecutions under the FCPA itself, raise potential questions relating to the “collective knowledge” doctrine, under which “[a] corporation is considered to have acquired the collective knowledge of its employees and is held responsible for their failure to act accordingly.” Bank of New England, 821 F.2d at 856. In N.Y. Cent. R.R. & Hudson River R.R. Co v. United States, the U.S. Supreme Court held that a corporation could be criminally prosecuted for the misconduct of its agents acting within their scope of employment. 212 U.S. 481 (1909). This remains the law. See United States v. Koppers Co., Inc. , 652 F.2d 290, 298 (2d Cir. 1981); United States v. Halpin , 145 F.R.D. 447, 449 (N.D. Ohio 1992). The collective knowledge doctrine expands this rule by enabling a corporation to be held criminally liable even when no single employee engaged in covered misconduct with the required knowledge, or, depending on the court applying the doctrine, mens rea. United States v. Bank of New England , 821 F.2d 844, 856 (1st Cir. 1987).

However, it must be noted that the collective knowledge doctrine remains controversial, and its application in the criminal tax context is a largely untested question. In United States v. Science Applications Int'l Corp. , 626 F.3d 1257, 1274-76 (D.C. Cir. 2010), for example, the D.C. Circuit expressed strong doubts about the collective knowledge doctrine, noting that “we are dubious of the legal soundness of the 'collective intent' theory, under which, as we explained, a corporation's specific intent to defraud can be inferred if the company's public statements contradict the accumulated 'collective knowledge' of the corporation's employees.” (quotation marks omitted)). See also Southland Sec. Corp. v. INSpire Ins . Solutions, Inc. , 365 F.3d 353, 366 (5th Cir. 2004); Nordstrom, Inc. v. Chubb & Son, Inc. , 54 F.3d 1424, 1435 (9th Cir. 1995). Some commentators question the doctrine's applicability to specific intent crimes, see Sarah Kelly-Kilgore & Emily M. Smith, Corporate Criminal Liability, 48 Am. Crim. L. Rev. 421, 431-32 (2011), while others conclude that “when courts have aggregated knowledge, they invariably have done so as a technique in response to willful blindness to inculpatory knowledge.” Thomas A. Hagemann & Joseph Grinstein, Mythology of Aggregate Corporate Knowledge: A Deconstruction, 65 Geo. Wash. L. Rev. 210, 236'37 (1997). District courts outside of the First Circuit have also confined Bank of New England to its facts. See, e.g., United States v. Walthers , 779 F. Supp. 2d 735, 738 (N.D. Ill. 2011).

One state court has flatly disagreed with the First Circuit and broadly held that “a corporation acts with a given mental state in a criminal context only if at least one employee who acts (or fails to act) possesses the requisite mental state at the time of the act (or failure to act).” Commonwealth v. Life Care Ctrs. of Am. , 926 N.E.2d 206, 212 (Mass. 2010). But see State v. Zeta Chi Fraternity , 696 A.2d 530 (N.H. 1997). Although the U.S. Supreme Court has cited Bank of New England, it has never opined on the collective knowledge doctrine, let alone its application to tax cases. Staub v. Proctor Hosp ., 131 S. Ct. 1186, 1192 (2011); Ratzlaf v. United States , 510 U.S. 135, 141 (1994).

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 the firm's New York 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], respectively.