Compete or Enforce?

The UBS-Inspired Enforcement Wave Since 2009

Since the U.S. government entered into the historic deferred prosecution agreement with UBS in 2009, news of additional enforcement actions against banks has been unremitting. For example, the following banks, among others, have been publicly named in various types of U.S. enforcement actions: Wegelin & Co., Pictet & Cie, Neue Zuercher Bank, Credit Suisse Group AG, Basler Kantonalbank, Bank Julius Baer, Bank Frey, Bank Hapoalim, Bank Leumi, Mizrahi-Tefahot, and Liechtenstein Landesbank AG. According to the U.S. Department of Justice (DOJ), the government is, as of August 2013, actively investigating the Swiss-based activities of 14 financial institutions. This is in addition to publicly announced enforcement activities in India, Luxembourg, Israel, and the Caribbean.

Perhaps the most important development in the U.S. government's efforts to target offshore banks since the UBS deferred prosecution agreement is the Aug. 29, 2013, agreement between the U.S. and Swiss governments to encourage all Swiss banks to admit their role in U.S. tax evasion in exchange for non-prosecution agreements and substantial monetary penalties. To participate, Swiss banks have to make a complete disclosure of their cross-border activities; provide detailed information on U.S. taxpayers' accounts; and pay a penalty of 20, 30, or 50% of the maximum value of all non-disclosed U.S. accounts that were held by the banks, depending on when the accounts were opened. This will likely attract many Swiss banks and will foreclose the possibility of U.S. taxpayers' evading detection of their Swiss accounts. Presumably, this agreement with Switzerland will be a template for agreements with other countries.

Similarly, the government has aggressively pursued individual U.S. taxpayers. Since 2009, approximately 39,000 taxpayers have taken advantage of the IRS's Offshore Voluntary Disclosure Program (OVDP) to avoid criminal prosecution. They have paid over $5.5 billion in tax, penalties and interest. A number of taxpayers who did not avail themselves of the OVDP have been prosecuted. One of the latest examples is Aaron Cohen of Encino, CA, who pleaded guilty on Aug. 29 to concealing bank accounts at two international banks headquartered in Tel Aviv, Israel. Another is Henry Seggerman, who pleaded guilty on Aug. 28 to charges related to his participation in a scheme with family members to hide money in secret Swiss bank accounts. According to the DOJ, since 2009 the government has charged more than 30 banking professionals and 68 U.S. account holders with violations arising from their offshore banking activities.

The U.S. government is also using so-called “John Doe summonses” to unearth information on U.S. taxpayers' foreign bank accounts. On April 7, 2011, a federal court granted the IRS and DOJ's request for a John Doe summons to force HSBC India to turn over the names of U.S. taxpayers “who at any time during the years ended December 31, 2002 through December 31, 2010, directly or indirectly had interests in or signature or other authority” over “financial accounts maintained at, monitored by, or managed through The Hongkong and Shanghai Banking Corporation Limited in India (HSBC India).”

The scale of the problem is staggering. According to the DOJ's court filings, there are 9,000 U.S. residents of Indian origin who have $100,000-minimum-balance accounts at HSBC India alone. According to the DOJ, however, for calendar year 2009, the most recent year for which information is available, there were only 1,391 FBARs (Reports of Foreign Bank Accounts) filed disclosing 1,921 accounts at HSBC India. This is only one example. In April 2013, the government issued a John Doe summons to the Canadian Imperial Bank of Commerce FirstCaribbean International Bank (FCIB). The source of the government's suspicion that U.S. taxpayers were using FCIB to evade taxes was those very same taxpayers. The government based its application for a John Doe summons on information submitted by more than 120 FCIB customers who participated in the OVDP.

FATCA

Disturbed by the scale of offshore tax evasion that the UBS scandal revealed, Congress enacted FATCA in 2010. Its purpose was to force foreign financial institutions to report their U.S. customers to the IRS, or face a crippling 30% withholding on any payments they receive from a U.S. source. In spite of some delays in its implementation, there is every reason to think that all but the most defiant countries and financial institutions will comply with FATCA. FATCA will allow the IRS to pull a dragnet through the world's financial institutions and catch previously concealed U.S. taxpayers' bank accounts.

A Competition That the U.S. Can Win

While the U.S. government has concluded that it either cannot or should not compete with the favorable tax regimes of other countries, the U.S. enjoys substantial competitive advantages in other areas that help to attract capital to the U.S. Building on these advantages will complement the U.S. government's increased enforcement efforts and improve its effectiveness.

The U.S. must exploit its competitive advantages to make itself more attractive to wealth creators than are tax-haven countries. In the same way that Germany has used its capacity to manufacture high-value, precision products to avoid competing with (and surely losing to) developing countries on the basis of wages, the U.S. must use its unique strengths to convince the world's entrepreneurs to earn and keep their wealth in the United States. The U.S. can complement its efforts with vigorous enforcement of its tax laws to prevent those same entrepreneurs from enjoying the United States' unique offerings while free-riding on their less morally malleable fellow taxpayers by sending their wealth offshore.

For all of the gnashing of teeth about the United States' decline relative to countries like China and India, the U.S. still offers enticements to entrepreneurs that neither China nor India are likely to offer any time in the foreseeable future. These “common goods” include a vital democracy, relatively uncorrupt and transparent government, the rule of law, clean air and water, strong infrastructure, cultural openness, and perhaps most important to the innovators of the world, freedom of speech and religion.

The U.S. dominates the world in innovation because it is virtually without peer in providing these inducements to the world's creative entrepreneurs. China fights the Internet; the United States created it.

The government of China imprisons people for asking for a greater say in their own government. The people of the United States are so accustomed to having a voice that they often cannot be bothered to vote.

People in China and India watch government officials grow rich off of their government jobs. They expect to pay bribes to use even the most routine government services. People in the U.S. are so sensitive to government corruption that when it is uncovered, their reaction is moral outrage.'

Rivers and air in China and India are filthy; rivers and the air in the United States are actually cleaner today than they were 40 years ago when President Nixon created the Environmental Protection Agency.

Conclusion

With a flat world, the United States competes with every other country for the world's wealth-creators and capital. It cannot hope to win a tax competition with tax-haven countries any more than it can hope to win a manufacturing wage competition with Bangladesh. In short, the United States must compete for wealth-creators and capital in those areas in which the U.S. has a competitive advantage, while also vigorously enforcing the law to prevent and punish tax evasion.

Jay R. Nanavati, former DOJ Assistant Chief for the Western Criminal Enforcement Section of the Tax Division, is counsel to BakerHostetler. Justin Thornton, a member of this newsletter's Board of Editors, is the principal at Washington, DC's Law Offices of Justin Thornton, where he engages in a broad-ranging white collar criminal defense practice.

'

As many have noted, the world is now flat. Not only can a computer scientist in Bangalore compete with one in Mountain View for software sales, but the government of Liechtenstein can compete with the government of the United States in attracting investors' funds. In other words, if people are dissatisfied with the American tax regime, they can move their money, usually secretly, to a country with a regime that is more hospitable.

Faced with disappearing barriers to the flow of money, the U.S. government has two options. First, it can reduce the tax burden that it imposes in an effort to win the race to the bottom (or the top, depending on your perspective) and have the world's friendliest tax regime. Second, it can try to create new barriers to the outflow of money from the U.S. by stepping up criminal and civil enforcement of existing tax-related reporting requirements and creating new ones. Over the last five years, the U.S. government has emphatically chosen the second option.

The U.S. government recognizes that it cannot compete with tax haven countries on tax rates. The American people are unwilling to do without the things that their tax dollars provide: Social Security; Medicare; a military that costs more than those of the next 10 countries combined; almost 50,000 miles of interstate highways; and comparatively effective government. Instead of competing in a race that it knows it cannot win, it is opting out of the race and stepping up its criminal and civil tax enforcement. The post-UBS prosecutions of banks and individuals who commit tax evasion are one prong of the attack. The Foreign Account Tax Compliance Act (FATCA) is the other.

The UBS-Inspired Enforcement Wave Since 2009

Since the U.S. government entered into the historic deferred prosecution agreement with UBS in 2009, news of additional enforcement actions against banks has been unremitting. For example, the following banks, among others, have been publicly named in various types of U.S. enforcement actions: Wegelin & Co., Pictet & Cie, Neue Zuercher Bank, Credit Suisse Group AG, Basler Kantonalbank, Bank Julius Baer, Bank Frey, Bank Hapoalim, Bank Leumi, Mizrahi-Tefahot, and Liechtenstein Landesbank AG. According to the U.S. Department of Justice (DOJ), the government is, as of August 2013, actively investigating the Swiss-based activities of 14 financial institutions. This is in addition to publicly announced enforcement activities in India, Luxembourg, Israel, and the Caribbean.

Perhaps the most important development in the U.S. government's efforts to target offshore banks since the UBS deferred prosecution agreement is the Aug. 29, 2013, agreement between the U.S. and Swiss governments to encourage all Swiss banks to admit their role in U.S. tax evasion in exchange for non-prosecution agreements and substantial monetary penalties. To participate, Swiss banks have to make a complete disclosure of their cross-border activities; provide detailed information on U.S. taxpayers' accounts; and pay a penalty of 20, 30, or 50% of the maximum value of all non-disclosed U.S. accounts that were held by the banks, depending on when the accounts were opened. This will likely attract many Swiss banks and will foreclose the possibility of U.S. taxpayers' evading detection of their Swiss accounts. Presumably, this agreement with Switzerland will be a template for agreements with other countries.

Similarly, the government has aggressively pursued individual U.S. taxpayers. Since 2009, approximately 39,000 taxpayers have taken advantage of the IRS's Offshore Voluntary Disclosure Program (OVDP) to avoid criminal prosecution. They have paid over $5.5 billion in tax, penalties and interest. A number of taxpayers who did not avail themselves of the OVDP have been prosecuted. One of the latest examples is Aaron Cohen of Encino, CA, who pleaded guilty on Aug. 29 to concealing bank accounts at two international banks headquartered in Tel Aviv, Israel. Another is Henry Seggerman, who pleaded guilty on Aug. 28 to charges related to his participation in a scheme with family members to hide money in secret Swiss bank accounts. According to the DOJ, since 2009 the government has charged more than 30 banking professionals and 68 U.S. account holders with violations arising from their offshore banking activities.

The U.S. government is also using so-called “John Doe summonses” to unearth information on U.S. taxpayers' foreign bank accounts. On April 7, 2011, a federal court granted the IRS and DOJ's request for a John Doe summons to force HSBC India to turn over the names of U.S. taxpayers “who at any time during the years ended December 31, 2002 through December 31, 2010, directly or indirectly had interests in or signature or other authority” over “financial accounts maintained at, monitored by, or managed through The Hongkong and Shanghai Banking Corporation Limited in India (HSBC India).”

The scale of the problem is staggering. According to the DOJ's court filings, there are 9,000 U.S. residents of Indian origin who have $100,000-minimum-balance accounts at HSBC India alone. According to the DOJ, however, for calendar year 2009, the most recent year for which information is available, there were only 1,391 FBARs (Reports of Foreign Bank Accounts) filed disclosing 1,921 accounts at HSBC India. This is only one example. In April 2013, the government issued a John Doe summons to the Canadian Imperial Bank of Commerce FirstCaribbean International Bank (FCIB). The source of the government's suspicion that U.S. taxpayers were using FCIB to evade taxes was those very same taxpayers. The government based its application for a John Doe summons on information submitted by more than 120 FCIB customers who participated in the OVDP.

FATCA

Disturbed by the scale of offshore tax evasion that the UBS scandal revealed, Congress enacted FATCA in 2010. Its purpose was to force foreign financial institutions to report their U.S. customers to the IRS, or face a crippling 30% withholding on any payments they receive from a U.S. source. In spite of some delays in its implementation, there is every reason to think that all but the most defiant countries and financial institutions will comply with FATCA. FATCA will allow the IRS to pull a dragnet through the world's financial institutions and catch previously concealed U.S. taxpayers' bank accounts.

A Competition That the U.S. Can Win

While the U.S. government has concluded that it either cannot or should not compete with the favorable tax regimes of other countries, the U.S. enjoys substantial competitive advantages in other areas that help to attract capital to the U.S. Building on these advantages will complement the U.S. government's increased enforcement efforts and improve its effectiveness.

The U.S. must exploit its competitive advantages to make itself more attractive to wealth creators than are tax-haven countries. In the same way that Germany has used its capacity to manufacture high-value, precision products to avoid competing with (and surely losing to) developing countries on the basis of wages, the U.S. must use its unique strengths to convince the world's entrepreneurs to earn and keep their wealth in the United States. The U.S. can complement its efforts with vigorous enforcement of its tax laws to prevent those same entrepreneurs from enjoying the United States' unique offerings while free-riding on their less morally malleable fellow taxpayers by sending their wealth offshore.

For all of the gnashing of teeth about the United States' decline relative to countries like China and India, the U.S. still offers enticements to entrepreneurs that neither China nor India are likely to offer any time in the foreseeable future. These “common goods” include a vital democracy, relatively uncorrupt and transparent government, the rule of law, clean air and water, strong infrastructure, cultural openness, and perhaps most important to the innovators of the world, freedom of speech and religion.

The U.S. dominates the world in innovation because it is virtually without peer in providing these inducements to the world's creative entrepreneurs. China fights the Internet; the United States created it.

The government of China imprisons people for asking for a greater say in their own government. The people of the United States are so accustomed to having a voice that they often cannot be bothered to vote.

People in China and India watch government officials grow rich off of their government jobs. They expect to pay bribes to use even the most routine government services. People in the U.S. are so sensitive to government corruption that when it is uncovered, their reaction is moral outrage.'

Rivers and air in China and India are filthy; rivers and the air in the United States are actually cleaner today than they were 40 years ago when President Nixon created the Environmental Protection Agency.

Conclusion

With a flat world, the United States competes with every other country for the world's wealth-creators and capital. It cannot hope to win a tax competition with tax-haven countries any more than it can hope to win a manufacturing wage competition with Bangladesh. In short, the United States must compete for wealth-creators and capital in those areas in which the U.S. has a competitive advantage, while also vigorously enforcing the law to prevent and punish tax evasion.

Jay R. Nanavati, former DOJ Assistant Chief for the Western Criminal Enforcement Section of the Tax Division, is counsel to BakerHostetler. Justin Thornton, a member of this newsletter's Board of Editors, is the principal at Washington, DC's Law Offices of Justin Thornton, where he engages in a broad-ranging white collar criminal defense practice.

'