Digging deeper into the prosecution of offshore account cases

Tax Notes Today has an article (2010 TNT 13-6) reporting on a Federal Bar Association Tax Section meeting on January 20, 2010, attended by practitioners and government folk. Key points that jumped out at me:

Small number of criminal prosecutions (so far)

There are approximately 150 Department of Justice investigations from the UBS situation, and about 40 criminal prosecutions underway, according to Kevin Downing, who is senior litigation counsel (criminal enforcement) at the DoJ's Tax Division.

My interpretation: The extremely small number (approximately 1% of the 14,700 taxpayers who came forward during the amnesty program) is telling. My guess would be that these are cases with particularly large amounts of tax at stake, particularly egregious situations (sham trusts, corporations, etc. layered on like a wedding cake), or sensitive taxpayers (lawyers and accountants, for instance).

For those of you attempting to guess your risk profile, this helps you understand how the DoJ is allocating resources. My theory in these cases is that it is better to have a money problem (pay lots of tax and penalties, if necessary) than to have a jail problem.

Banks will toss their customers overboard

From the article:

Downing said the DOJ is continuing to push for more information and is often "trying to pit banks against clients" to generate leads.

What a telling statement THAT is. It is clear to me that UBS was faced with losing their ability to do business in the United States, and decided to throw granny under the bus.

This appears to be the key point of leverage that the Department of Justice is attempting to exploit. And it may well work. Banks may roll over. Or individual bankers may go cowboy and become whistleblowers. (However, putting Bradley Birkenfeld in prison might be a spectacular anti-incentive to become a whistleblower.)

If you've ever labored under the delusion that such a thing as "trust" exists, forget it. This -- among all of the collateral damage inflicted by the IRS -- might be their greatest achievement. By damaging the trust relationship between customers and banks, the IRS has created an incentive for taxpayers to not hide money.

This is a cynical and predictable strategy by the Department of Justice. And it works.

Incidentally, this works even if the bank in question is inclined to give the U.S. to GDIAF. It has become much more expensive for foreign banks to have U.S. customers. In deciding whether to keep an existing customer or take on a new one, the cost/benefit equation ("How much profit will we make on this customer?") has suddenly been skewed by a vast increase on the cost side. Normal business decisions are made. I see the reverse for nonresidents coming to the U.S. Many banks simply don't want the business because of the compliance headaches that the Federal government has outsourced to the banks.

Leverage point: do you want to invest in the U.S.?

Here we come to the ultimate leverage point that the U.S. government has, and I would expect this to be brutally exercised for short-term gain by the U.S. From the article:

One consequence of the crackdown has been a hesitation on the part of some foreign institutions to maintain or recruit U.S. clients. [True 'dat. Ed.] Also, the promise of a shield from U.S scrutiny for offshore institutions without a U.S. presence is no longer assured. For most offshore institutions, a prime source of income is the management of non-U.S. clients' activity in the U.S. stock market. To conduct such business, however, offshore institutions must either enter into a qualified intermediary withholding agreement with the United States or do business through a QI.

"QI agreements are pressure points," Downing said, adding that the threat of ending a QI is a powerful weapon in the government's enforcement arsenal. "Pulling a QI is very expensive" for the foreign institution, he said.

Simply put: access to U.S. capital markets comes at a cost -- no secrecy.

People think that they can put money in a foreign bank which is outside the United States, and thus be out of reach of Mr. Downing's crew at the Department of Justice. After all, the failing at UBS was that it had such a massive footprint in the United States and could not afford to lose it. A bank which has no business presence at all in the U.S. is immune from that pressure.

If the bank doesn't touch the United States, perhaps the client's investments will. Mr. Downing is saying that access to the U.S. capital markets will come at a price -- participate in the qualified intermediary program. This makes the sales pitch a bit harder. A U.S. person who has money parked in one of these immune financial institutions may be cut off from buying U.S. stocks and bonds. The tax secrecy comes at a cost of a limit to his investment strategy.

Comment: it is a big world and there are plenty of places to invest. The U.S. is behaving like an actress who is trading on her beauty as her primary asset. At the moment the leverage being exerted is the "Come hither!" siren call of the U.S. economy. That siren call is being slowly destroyed by tax enforcement actions exactly like this. Incrementally, in small amounts and large, decisions are being made by people outside the United States to NOT move capital to the United States. I know this because these people are my clients and they tell me so.

The perception seems to be "Yeah, but we're the biggest economy in the world and everyone wants to live here, invest here, and do business here."

Maybe not. I'm just sayin'.

It is a fair and fine thing to condition investment access on transparency. Just understand that it will diminish the flow of funds to the U.S. Maybe you're fine with that. Maybe you don't want THOSE funds. Just understand the collateral effects.