Tax shelter shake-up hits home
A federal crackdown and a new act make life tougher for lawyers and accountants.
Criminal tax attorney Robert Fink views the conviction and sentencing of his client Dr. Michael Canale—on tax fraud charges in New York state federal court in 2012—as representative of everything that’s wrong with the government crackdown on tax shelters and fraud.
Dr. Canale, a former Army surgeon, was sentenced to six months in prison for filing false returns on a UBS Swiss bank account he inherited from his father in 2000. By 2010, the account had swelled to $1.5 million. Prosecutors said the doctor had evaded at least $216,000 and never came forward to disclose the account.
Mr. Fink, a partner in the New York law firm of Kostelanetz & Fink, argued that his client was a war hero who was ordered by an authoritarian father never to disclose the account and to use it solely to care for Dr. Canale’s mother. Mr. Fink believes the matter should not have been handled criminally.
The Canale case was another victory for Preet Bharara, the U.S. attorney for the Southern District of New York, who has been aggressively pursuing offshore tax offenses. On Aug. 20, Mr. Bharara elicited a guilty plea from a Florida man who was hiding more than $1 million in secret bank accounts in Switzerland and Israel.
A 2008 Senate report found that the use of secret offshore accounts to evade U.S. taxes costs the Treasury at least $100 billion annually.
The federal crackdown on offshore accounts and the July 1 implementation of the Foreign Accounts Compliance Taxation Act, or FACTA, has had a significant impact on the New York state tax bar and on accounting practices, according to professionals in the tax industry.
Those professionals condemned abusive tax shelters and tax-fraud schemes, but insisted that the indicted individuals and the representatives who helped design them were only a small pool of “bad apples.”
“A lot of what you see with indictments has to do with evasion where there wasn’t necessarily some very complicated or sophisticated tax shelter,” said Amy Heller, a partner at Manhattan law firm McDermott Will & Emery. “Some people just have accounts through their own names or through company structures that they just weren’t reporting, and there may have been advisers who were aiding and abetting.”
Be that as it may, a source with substantial knowledge of international tax law said that the prosecution and imprisonment of tax offenders was having a profound effect on legal practice in New York. Attorneys are giving more conservative advice to clients, even on legal offshore tax shelters and structures, because they don’t want to risk prosecution or federal scrutiny.
“The brandishing of criminal liability of just giving advice has a very chilling effect,” he said.
Yet the government crackdown and FACTA, which was passed by Congress in 2010, have also been a financial boon to many New York lawyers and accountants who have the expertise to cash in on another revenue source.
One partner and authority on international tax issues at a New York accounting firm likened FACTA to “the accountant’s employment act.”
Mr. Fink acknowledged that he has more clients today than he did five years ago because of “the breaking down of bank secrecy.” And he expects the implementation of the latest effort, via FACTA, to be even better for his practice. Despite the business benefits, professionals condemned the law as overreaching, confusing and vague.
Helpful law”I would say FACTA is clearly beneficial for practice because there are so many compliance issues that we have to stay on top of, that we have to make sure our clients are complying with,” said Andrew Rotter, a partner in the tax department at New York-area accounting firm Citrin Cooperman. “Clearly we need to understand laws to be able to explain to many of our clients what the issues are and what they need to do.”
Mr. Rotter said his office has handled about 150 Offshore Voluntary Disclosure Initiative cases. The IRS established the initiative to encourage taxpayers with offshore accounts to come forward, pay a uniform tax penalty and avoid prosecution. The program was modified recently to accommodate taxpayers whose failure to disclose assets is characterized as unintentional.
Since New York is the home to many foreign financial institutions, private-equity funds and hedge funds with foreign affiliates, much of the private-sector compliance effort is being driven in New York City.
“Because the aim of FACTA is really at foreign banking institutions and foreign entities, the majority of that practice is New York City-centric,” said Daniel Mulcahy, senior counsel at Cadwalader Wickersham & Taft. “The New York lawyers will generally get higher volume, earlier questions and often highly nuanced questions.”
The crackdown on offshore accounts began gaining traction in 2008 and 2009, when the Department of Justice and the IRS struck a deal with UBS, Switzerland’s largest bank, ultimately leading to a $780 million settlement. The bank turned over details on the accounts of about 4,700 clients, according to a February 2014 report by the U.S. Senate Permanent Subcommittee on Investigations. The report said that in the U.S., more than 43,000 taxpayers joined a voluntary IRS disclosure program and paid more than $6 billion in back taxes.
The government is betting that FACTA will be another nail in the coffin of offshore bank secrecy. The law requires foreign financial institutions and their American clients to disclose all foreign accounts or risk severe penalties.
Overseas outlook
There is a 30% withholding tax penalty on the U.S. income of foreign banks that refuse to share information about accounts owned by U.S. citizens. Individuals who continue to hide funds or file false returns face harsh criminal and civil penalties. About 100 nations are supporting the legislation with intergovernmental agreements that promise cross-border cooperation.
McDermott’s Ms. Heller said that her international clients who have no intention of evading taxes are being negatively affected by FACTA and that the law will have many unintended consequences. Other lawyers say many foreign banks are rejecting American clients because of FACTA.
Ms. Heller added that the most significant impact on her practice in the past several years has come from the shift in dealing with FACTA compliance issues just as much as actual tax planning. Ms. Heller explained that the FACTA forms are so complicated that financial institutions are recommending that foreign clients hire lawyers to assist them just to fill them out.
Mark Howe, a partner at Cadwalader, said that the biggest change for tax lawyers in private practice is the technical aspect of dealing with FACTA, including documentation and compliance.
“The costs are in the tens of millions of dollars to build compliance,” said Mr. Howe in discussing the effect on financial institutions. “The biggest impact is on in-house counsel in setting up strong compliance systems and modifying existing due diligence.”
Mr. Howe added that there have been “systematic alterations of all types of documentation,” including changes in disclosure agreements, changes in subscription agreements and, for banks, systematic changes to transactional documentation (bank statements) and loan agreements.
On the accounting side, one professional said that his firm has developed a more stringent vetting process of clients who are making voluntary disclosures and not just “taking it at face value” that a client has acted in a “non-willful manner.” He said that clients planning to open operations overseas will receive the same advice as before, “because our structures have always been legitimate in conformity with the law.”
But even with all the added federal scrutiny and new laws, there will still be ways clients and their representatives will try to outsmart the government and the IRS.
“People are always looking for reasons to reduce their tax burdens, so that won’t go away,” said the source with expertise in international law. “Thoughtful, ingenious structures will always be looked at. But the wide retail selling of shelters that occurred in the early aughts and late ’90s, I can’t believe that’s coming back.”
