October 7, 2009 - Phil Hodgen

Senator Levin to IRS on FBAR compliance – “Get tough”

From today’s Tax Notes Today at 2009 TNT 192-26 we have a letter from Senator Levin to the IRS Commissioner about FBARs and hedge funds.

So you’re not a hedge fund operator or investor. What’s the big deal? Answer: look to strategic thinking behind the tactical exercise here.

Especially look how Senator Levin deals with the question of defining a “U.S. Person.”  In the instructions for the new FBAR form, “U.S. person” is defined to include some foreign persons.  Sloppy, misleading.  Technically follows the statutes, so technically the form is correct.  But surely it could be done better.

Full letter after the jump.

October 1,2009

The Honorable Douglas Shulman
Internal Revenue Service
Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044

The Honorable James H. Freis
Financial Crimes Enforcement Network
Department of the Treasury
P.O. Box 39
Vienna, VA 22183

RE: Request for Comments on Filing Guidance for Foreign Bank and Financial Accounts (FBARs) CCPA:LPD:PR (Notice 2009-62)

Dear Commissioner Shulman and Director Freis:

The purpose of this letter is to respond to your request for comments on issues affecting the filing of the Foreign Bank and Financial Account Report (FBAR), to encourage the development of guidance that will assist the public in meeting their FBAR filing obligations, and to facilitate law enforcement use of the reports to combat tax evasion, money laundering, and other misconduct.

Need for Information on Foreign Bank Accounts. Over the last decade, the U.S. Senate Permanent Subcommittee on Investigations, which I chair, has conducted multiple investigations into offshore tax abuse, bank secrecy, and money laundering, including investigations which have focused on the ways in which some financial institutions and professionals help clients use foreign financial accounts to hide taxable income and evade their U.S. tax obligations. In 2008 and 2009, for example, the Subcommittee released a report and held hearings showing how two banks, UBS AG in Switzerland and LGT Bank in Liechtenstein, assisted tens of thousands of U.S. clients open foreign financial accounts without reporting the accounts, assets, or investment income to the Internal Revenue Service (IRS). n1

In 2008, the Subcommittee also released a report and held a hearing showing how some financial institutions were helping hedge funds and others avoid payment of U.S. taxes on U.S. stock dividends, in part by conducting transactions and moving funds through foreign jurisdictions. n2 In 2006, the Subcommittee released a report and held hearings on six case studies showing how U.S. financial professionals, including bankers, lawyers, accountants, investment advisors, and others were using tax havens to help U.S. taxpayers dodge payment of U.S. taxes. n3 In 2003 and 2005, the Subcommittee released reports and held hearings showing how leading accounting firms, such as KPMG, were designing, marketing, and implementing abusive tax shelters which, in some instances, made use of offshore financial accounts and transactions to help U.S. taxpayers dodge their tax obligations. n4 The Subcommittee has estimated that offshore tax abuse costs the U.S. Treasury $ 100 billion in lost revenues each year.

The Subcommittee’s work has also shown how foreign bank accounts have been used by criminals to commit money laundering, drug trafficking, financial fraud, corruption, and other crimes. n5 The Subcommittee’s investigations provide concrete evidence of the need for transparency in offshore financial holdings to stop offshore abuses that are undermining the fairness of our federal tax system and fueling crime.

FBAR Requirement. The requirement to file a FBAR was enacted by statute n6 as part of the Bank Secrecy Act of 1970. n7 The Act’s primary purpose was ” to stop the use of secret bank accounts for illegal practices such as: (1) evasion of taxes, (2) taking over of legitimate businesses by organized crime, (3) financing of the narcotic traffic, (4) overstating of the cost of Government contracts in order to defraud the Government . . . (5) manipulation of stock prices on our securities market, (6) violating the margin requirements in purchasing stock, (7) corporate officers trading in their company’s stock because of inside information, (8) illegal buying of gold by American citizens, and (9) hiding of untaxed, skimmed money from Nevada gaming casinos.” n8 The IRS FBAR Workbook states: “The reports filed as a result of this regulation provide leads to investigators that facilitate the identification and tracking of illicit funds or unreported income, as well as providing additional prosecutorial tools to combat money laundering and other crimes.”

Because FBARs are used to combat both tax evasion and other crimes, FBARs have become a shared responsibility between the Treasury Department’s Financial Crimes Enforcement Network (FinCEN), a key federal anti-money laundering agency charged with issuing FBAR regulations, and the IRS which has been designated by FinCEN to help enforce the FBAR filing requirements. An FBAR is not itself a federal tax return, but a report that must be filed separately with the Treasury Secretary.

Over the years, annual FBAR filings have slowly increased, although other evidence — such as the 52,000 U.S. clients with secret Swiss accounts at UBS — indicates that many U.S. taxpayers with foreign financial accounts have yet to disclose them to the Treasury. According to recent FinCEN reports, about 168,000 FBARs were filed in FY2000. In FY2004, the number increased to over 218,000 FBAR filings. In FY2008, the number increased again to nearly 345,000.

Despite these increases, the comment letters filed in response to your Notice continue to raise questions about who must file an FBAR and what accounts must be disclosed. Most of these questions do not involve straightforward foreign bank or securities accounts opened by individuals, but complex offshore financial investments and instruments, including offshore hedge fund and private equity fund investments, foreign special purpose investment vehicles, offshore derivatives, foreign exchange traded funds, offshore partnerships, and passive foreign investment corporations (PFICs). It is ironic that some of the persons responsible for these complex offshore investments are now complaining about the difficulty of applying FBAR rules to their financial engineering.

Response to Request for Comments. Your Notice requests comment on a variety of issues related to FBARs. This letter addresses three: (1) FBAR filing requirements for U.S. persons with complex offshore investments; (2) the definition of “U.S. persons” required to file FBARs; and (3) FBAR filing requirements for account signatories.

Complex offshore investments. The 2008 FBAR filing instructions define the “financial accounts” that must be reported on the form to include “any bank, securities, securities derivatives or other financial instruments accounts,” including “any accounts in which the assets are held in a commingled fund, and the account owner holds an equity interest in the fund (including mutual funds).” An IRS official indicated earlier this year that this definition includes U.S. persons who invest in offshore hedge funds, and stated that these investors must file FBARs disclosing their offshore investment accounts. Apparently, from the surprised reactions that followed, the application of FBAR filings to these types of financial accounts had not received much attention, perhaps in part because relatively few Americans invest in offshore hedge funds. Typical hedge fund investors include pension funds, universities, foundations, financial institutions, other hedge funds, and wealthy individuals. Apparently, many of these offshore investors were unaware that they had to disclose their offshore accounts in an FBAR.

Some of the representatives of these offshore investors contend that offshore hedge fund investments are not made through financial accounts and therefore should not be subject to FBAR disclosure obligations. But offshore hedge fund investments, like other complex offshore investments involving large sums of money, are typically tracked through individual investor accounts. The investigations conducted by the Subcommittee show, for example, that the normal practice is for an investor to wire money to an offshore hedge fund administrator to purchase shares or proportional interests in an offshore investment fund. The offshore administrator typically deposits the money into an offshore “feeder fund” account that commingles monies from multiple investors. Periodically, the offshore administrator will wire an aggregate amount from the offshore account to a “master fund” account at a U.S. bank for further investment. In addition, the offshore administrator typically establishes an account for each investor to track the dates and amounts of the investor’s contributions to the offshore hedge fund, any investment income that is earned on those contributions, and any distributions that are paid to the investor. These accounts function in a similar manner to foreign bank and securities accounts by tracking monies associated with a particular investor. These offshore financial accounts are precisely the types of accounts that should be disclosed on FBARs to help tax and law enforcement authorities discover and trace offshore funds involved in money laundering, tax evasion, or other misconduct.

Some comment letters claim that offshore hedge fund investments should be exempt from the FBAR, because many are illiquid, explaining that most hedge funds “lock up” invested funds for a two-year period or longer and may use the money to purchase illiquid assets that can’t be redeemed quickly. They reason that the FBAR was intended primarily to uncover money laundering, and illiquid investments are not typically used by money launderers who want quick access to their cash. But some money launderers are content to let their funds sit for an extended period. For example, Subcommittee investigations of foreign heads of state and their relatives who deposited suspect funds in U.S. and offshore financial accounts showed that they allowed their funds to be invested for years at a time at a single financial institution. n9

In addition, FBARs are intended to help uncover, not only money laundering, but tax evasion, and it is not uncommon for tax dodgers to deposit funds offshore for substantial periods of time to allow a build-up of untaxed investment income. In the case of LGT Bank in Liechtenstein, for example, the Subcommittee uncovered a U.S. taxpayer, James Marsh, who made millions of dollars in cash deposits at the bank, used those funds to purchase foreign mutual funds and other investments, and allowed his invested funds at the bank to remain essentially undisturbed for nearly 20 years. n10 In the Subcommittee’s 2006 investigation, two U.S. taxpayers, Sam and Charles Wyly, established two hedge funds known as Maverick and Ranger which operated with both U.S. master funds and Cayman Island feeder funds. The Wylys secretly directed millions of dollars from a network of offshore trusts and corporations they controlled to be deposited into the offshore hedge fund feeder accounts, and then caused those funds to be invested through the U.S. master funds in a variety of U.S. investments –without paying tax on either the transferred sums or the investment income later produced. n11 Like Mr. Marsh, the Wylys allowed their investments to remain with the offshore hedge funds for years at a time. Also like Mr. Marsh, the Wylys have been investigated by the IRS for tax dodging. The Marsh and Wyly case histories provide ample evidence that the extent to which offshore investments are illiquid is simply not a persuasive basis for exempting them from FBAR disclosure obligations.

The same analysis can be applied to other types of complex offshore investments as well, including money transferred to foreign private equity funds, special purpose investment vehicles, offshore partnerships, and PFICs. Investors in each of these offshore entities typically have offshore accounts that track their contributions, investment income, and distributions. Each such investor should file an FBAR disclosing that account.

Foreign financial products continue to evolve and proliferate as the barriers to international investment fall, and U.S. persons are increasingly able to access global markets. In addition, financial professionals continue to design complex offshore investments that take advantage of tax havens with strict secrecy laws that make it difficult for U.S. authorities to learn of the transactions. FBAR filing requirements are one of the few tools that U.S. tax and law enforcement authorities have to uncover, investigate, and punish instances of money laundering, tax evasion, and other illegal activity through offshore accounts. FinCEN and the IRS should continue to use an expansive definition of “financial account” to ensure that financial engineering does not succeed in weakening the FBAR disclosure obligation for complex offshore investments.

Defining U.S. Persons. Another tack taken in some comment letters is to narrow the FBAR filing obligation by advocating a restrictive interpretation of the category of covered persons. Right now, in order to be subject to the FBAR filing requirements, an individual or entity must be a “United States person.” The FBAR statute and 2008 FBAR filing instructions define “United States person” as a “citizen or resident of the United States, or a person in and doing business in the United States.” The 2008 FBAR filing instructions take an additional step by incorporating 31 C.F.R. 103.11(z) into the definition of “person.” By incorporating 31 C.F.R. 103.11(z), the instructions apply the FBAR filing obligation to any United States “individual, corporation, partnership, trust or estate, joint stock company, association, syndicate, joint venture, other unincorporated organizations or groups, Indian Tribe (as defined in the Indian Gaming Regulatory Act), and all entities cognizable as legal personalities” with a foreign financial account.

Some comment letters criticize the 2008 filing instructions for taking such a broad approach and raise a number of questions about who is a United States “resident” and who is “in and doing business in the United States.” Some of these letters contend that these terms must be defined in the same way as they are defined in the tax code, even though FBARs are not tax returns, are not part of the tax code, and are used to combat not only tax violations, but also money laundering, terrorist financing, drug trafficking, financial fraud, and a host of other crimes. Turning again to the example of offshore hedge funds, some might deny that these funds are “U.S. persons” under the FBAR rules, because they are incorporated offshore and have been carefully constructed so that they do not trigger U.S. taxes by “doing business in the United States.” At a recent Subcommittee hearing, however, three prominent offshore hedge funds admitted that, although they were incorporated in the Cayman Islands, they had no Cayman office or personnel, and their offices, hundreds of employees, and investment activities were located in the United States. n12 Such facts suggest that these offshore hedge funds should qualify as “in and doing business in the United States” for purposes of the FBAR filing obligation, even if they do not qualify as U.S. taxpayers.

To ensure the continued usefulness of FBAR filings to investigate, not only tax violations, but a wide spectrum of serious crime, FinCEN and the IRS should reject the principle that “U.S. persons” should be defined narrowly and solely with reference to the tax code, and instead use a broader approach aimed at supporting the broader uses of FBAR filings.

Account Signatories. A third set of issues raised in the comment letters involves FBAR filing obligations that apply to multiple account signatories. Right now, FBAR filing instructions require every U.S. person who has signatory authority over a foreign bank account to file a separate FBAR. This approach was taken to address the problem created when the primary signatory on an account is a non-U.S. person or a nominee whose identity may be used to conceal the identity of the account’s true owner.

Some comment letters object to requiring FBARs to be filed by persons who have signature authority but no personal financial interest in a foreign financial account set up by a large corporation, foundation, or university. They point to large corporations where multiple persons during a year may have signature authority for the same financial account and question the usefulness of having each of these account signatories, as well as the corporation itself, file separate FBARs with the same account information. To address these concerns, it may be appropriate for FinCEN and the IRS to allow highly regulated business entities, such as U.S. publicly traded corporations, banks, and broker-dealers, and well-established U.S. charitable and educational institutions, such as large foundations and universities, to file a single FBAR with a list of each account’s signatories during the year, and relieve the individual signatories for these accounts of the obligation to file individual FBARs. However, individuals, shell companies, family trusts, and similar entities with foreign accounts should continue to be required to file multiple FBARs to ensure that offshore accounts are disclosed to U.S. tax and law enforcement authorities.

Thank you for this opportunity to comment on the FBAR filing obligation.


Carl Levin
Permanent Subcommittee on
United States Senate
Washington, DC


n1 – U.S. Senate Permanent Subcommittee on Investigations, “Tax Haven Banks and U.S. Tax Compliance,” S.Hrg. 110-614 (July 17 and 25, 2008) and “Tax Haven Banks and U.S. Tax Compliance: Obtaining the Names of U.S.

n2 – U.S. Senate Permanent Subcommittee on Investigations, “Dividend Tax Abuse: How Offshore Entities Dodge Taxes on U.S. Stock Dividends,” S.Hrg. 110-778 (Sept. 11, 2008) (hereinafter “Subcommittee Dividend Tax Abuse Hearing”).

n3 – U.S. Senate Permanent Subcommittee on Investigations, “Tax Haven Abuses: The Enablers, The Tools and Secrecy,” S.Hrg. 109-797 (Aug. 1, 2006)(hereinafter “Subcommittee Tax Haven Abuse Hearing”).

n4 – U.S. Senate Permanent Subcommittee on Investigations, “U.S. Tax Shelter Industry: The Role of Accountants, Lawyers, and Financial Professionals,” S.Hrg. 108-473 Nov. 18 and 20, 2003) and “The Role of Professional Firms in the U.S. Tax Shelter Industry,” S.Rept. 109-54 (April 13, 2005).

n5 – See, e.g., U.S. Senate Permanent Subcommittee on Investigations, “Money Laundering and Foreign Corruption: Enforcement and Effectiveness of the Patriot Act,” S.Hrg. 108-633 (July 15, 2004); “Role of U.S. Correspondent Banking in International Money Laundering,” S.Hrg. 107-84 (March 1, 2 and 6, 2001); and “Private Banking and Money Laundering: A Case Study of Opportunities and Vulnerabilities,” S.Hrg. 106-428 (Nov. 9 and 10, 1999)(hereinafter “Subcommittee Money Laundering Hearings”).

n6 – 31 USC section 5314.

n7 – Bank Secrecy Act, Pub. L. No. 91-508, 84 Stat. 1114 (codified as amended in scattered sections of 31 U.S.C.).

n8 – 116 CONG. REC. 16951-16952(1970).

n9 – See, e.g., Subcommittee Money Laundering Hearings, in particular case studies involving Raul Salinas whose money was invested at Citibank in Switzerland, Omar Bongo whose money was invested with banks in France, and Augusto Pinochet whose money was invested with Riggs Bank in London.

n10 – See Subcommittee Tax Haven Bank Hearings, case history involving the Marsh Family.

n11 – See Subcommittee Tax Haven Abuse Hearing, case history involving the Wylys, Maverick, and Ranger.

n12 – See Subcommittee Dividend Tax Abuse Hearing, testimony of Maverick Capital, Highbridge Capital, and Angelo, Gordon & Co., pp. 25-27.

Voluntary Disclosure