The Swiss / UBS Fix is in (Almost)

This is perhaps ho-hum by now, but the Swiss today announced here that Switzerland has taken a major step in fixing Swiss law to ex post facto justify the obligations the Swiss and UBS undertook to disclose U.S. taxpayers to the U.S. The step is a protocol to the double tax treaty which will be formally submitted to the Swiss Parliament in April. The guts of the announcement is:

The amending protocol raises the treaty request agreement of August 19, 2009, to the same level as the bilateral double taxation convention. In accordance with the general rules of interpretation, the UBS Agreement now takes precedence over the older and more general convention, and permits Switzerland to provide treaty assistance in cases not only of tax fraud, but also of continued and serious tax evasion. The amending protocol remedies the shortcomings pointed out in the Federal Administrative Court's judgment of January 27, 2010, and ensures that Switzerland is able to fulfill its obligations under international law.

The announcement says that the Swiss Federal Council authorized the provisional application of the protocol before Swiss Parliament approval, but that data will not be disclosed prior to Swiss Parliament approval without customer consent. Any predictions on the Swiss Parliament's action?

Tax Shelter Lawyer Gets Probation

Peter Cinquegrani, a former Arnold & Porter partner, dodged the jail time bullet and was sentenced to only three years probation. He had previously pled to Klein conspiracy and tax evasion. His activity drawing the angst of the Government involved various shelters, including some promoted by Ernst & Young.

Here are some of the quotes attributed to Cinquegrani at the sentencing hearing from the various services cited below:

"I know what I did was wrong."

"I know what I did was wrong, and I did it anyway."

"When you break it down, I helped people cheat on their taxes."

"I helped people cheat on their taxes,"

In justification of the light sentence, the Judge Stein cited Cinquegrani's cooperation with the Government, including explaining the PICO shelter to investigators. Got that concept -- if you are going to cheat, do it in a complex way so that, if you are caught, you can help the Government and mitigate the sentence.

Sources:
Reuters
Business Week
JD Journal

More on Honest Services Fraud

I picked up today from Ellen Podgor's White Collar Crime Prof Blog the Vanderbilt Law Review En Banc Roundtable papers on Skilling v. United States involving the honest services issue. Readers will recall that Skilling and two companion cases are now pending before the Supreme Court on the honest services issue. I have previously blogged the honest services issue and its potential relationship to Tax Obstruction Crimes here.

The articles in the Roundtable are:

Nancy J. King, Introduction: Skilling v. United States, 63 Vand. L. Rev. En Banc 1 (2010)

William H. Farmer, Presumed Prejudiced, but Fair?, 63 Vand. L. Rev. En Banc 5 (2010)

Abbe David Lowell, Christopher D. Man & Paul M. Thompson, “Not Every Wrong is a Crime”: The Legal and Practical Problems with the Federal “Honest-Services” Statute, 63 Vand. L. Rev. En Banc 11 (2010)

Julie R. O’Sullivan, Honest-Services Fraud: A (Vague) Threat to Millions of Blissfully Unaware (and Non-Culpable) American Workers, 63 Vand. L. Rev. En Banc 23 (2010)

Timothy P. O’Toole, The Honest-Services Surplus: Why There’s No Need (or Place) for a Federal Law Prohibiting “Criminal-esque” Conduct in the Nature of Bribes and Kickbacks, 63 Vand. L. Rev. En Banc 49 (2010)

Ellen S. Podgor, Intangible Rights-A Déjà Vu, 63 Vand. L. Rev. En Banc 63 (2010)

The articles may be reviewed and downloaded here.

The Value of Broadly Worded Protective Orders

In SEC v. Merrill Scott & Associates, ___ F.3d ___ (10th Cir. 2010), the taxpayer, an alleged tax evader, "invested money with defendant Merrill Scott & Associates (Merrill Scott) under a nominee arrangement promising large tax savings. The Securities and Exchange Commission (SEC) subsequently sued Merrill Scott for securities." In that SEC proceeding, the SEC obtained the taxpayer's deposition and certain records pursuant to a court protective order that limited the use of the Confidential Information to SEC purposes. As did the Court, I refer to the depositions and records as Confidential Information. The AUSA handling the matter turned the Confidential Information over to the IRS. The IRS started a criminal investigation during which the Special Agent admitted having the Confidential Information. The taxpayer complained. The IRS moved to intervene in the SEC proceeding and the taxpayer moved for a protective order requiring the IRS to return the Confidential Information. The district court ex post facto amended the confidentiality order to allow disclosure to the IRS. The taxpayer complained on appeal, and the Tenth Circuit agreed, ordering the IRS to return the Confidential Information. The Court held that the SEC's ability to turn over documents to other agencies for criminal enforcement purposes was permissive, but did not include the power to violate court protective orders. The Government argued that the effect of ordering the Government to return the Confidential Information was to give the taxpayer the effect of use immunity.

The Court said

E. Use Immunity Argument

The government further argues that by insisting on enforcement of the protective orders, Dr. Gerber is essentially requesting to be granted use immunity for his testimony in the SEC proceedings. Citing In re Grand Jury Subpoena, 836 F.2d 1468 (4th Cir. 1988), it contends that such immunity is unavailable in a civil proceeding. The government further argues that Dr. Gerber has no right to use a protective order as a substitute for either seeking immunity or invoking his Fifth Amendment rights in subsequent proceedings.

These contentions, however, distort Dr. Gerber's position. He has not requested use immunity or even de facto use immunity in this action. He has merely asked the district court to enforce its own protective order in the instant civil suit. Such enforcement does not represent an actual or de facto grant of use immunity.

Moreover, the facts of In re Grand Jury Subpoena are easily distinguished from those in this case. There, the Fourth Circuit, relying in part on "[t]he sweeping power of the grand jury to compel the production of evidence," id. at 1471, ruled that deponents in a civil case could not use a civil protective order to block a grand jury criminal subpoena requiring production of their sealed depositions. But no such criminal subpoena is at issue in this case. n3 The IRS obtained the Confidential Information through the SEC and DOJ's voluntary disclosure, not through a criminal subpoena. This disclosure, unprompted by a grand jury subpoena, clearly violated the plain language of the protective order. The government's "use immunity" argument fails.

n3 The Fourth Circuit noted that the government had two options in seeking to obtain the deposition transcripts: it could subpoena the transcripts as part of a grand jury investigation, or seek permissive intervention in the civil action to request that the protective order be modified or vacated. Grand Jury Subpoena, 836 F.3d at 1470. The government chose the latter option in this case.

Should the Government obtain an indictment of the taxpayer, was the Court's resolution in the current appeal would prejudice the indictment?  The Government almost certainly will face a Kastigar hearing (Kastigar v. United States, 406 U.S. 441 (1972)) as to whether the defendant had waived his Fifth Amendment privilege (he likely had simply by testifying) and, more persuasively, some equivalent of use immunity because of the inappropriate way the IRS obtained access to the Confidential Information.

At a minimum this case underlines the important of getting such confidentiality orders and having them written as broadly as possible.

I did note that, because of the dates recounted for the underlying events, I am confused as to why the statute of limitations for criminal prosecution was still open (or was perhaps fast expiring).

Altria #3 - What Were Those Guys Smoking? (3/23/10)

Today is my final installment on Judge Holwell's Altria decision. I today have nothing to offer of tax substance (without making any claims that I have previously offered anything of tax substance). I do provide editorial comment. I caution my readers that, if they are looking for tax crimes nuggets, they won't find them in today's blog.

First, I went to Altria's web site here. The web site tell us that Altria, the maker of Phillip Morris cigarettes (including Marlboro, remember the Marlboro man -- actually more than one -- but three of whom, according to Wikipedia, died of lung cancer caused by, well, I don't have to say), supports regulation of cigarettes. If you believe that, Altria would have liked to have had you on the jury in its case.

Second, I just happen now to be teaching a series at my Church on the History of English Bible Translations. A pivotal focus of the series is, of course, the King James or so-called authorized version of the Bible. King James gets a lot of credit for that version. King James also was quite prescient about the horrors of smoking tobacco. In 1604 shortly after the Hampton Conference which started the process leading to the printing of the KJV in 1611, King James wrote a treatise called "A Counterblaste to Tobacco." The whole treatise (which may be viewed here); see also Wikipedia here) is a great read (and relatively short), but here is a snippet for flavor (in what is now called Early Modern English, about the same time Shakespeare was on his stage):

Have you not reason then to bee ashamed, and to forbeare this fllthie noveltie, so basely grounded, so foolishly received and so grossely mistaken in the right use thereof? In your abuse thereof sinning against God, harming your selves both in persons and goods. and raking also thereby the markes and notes of vanitie upon you: by the custome thereof making your selves to be wondered at by all forraine civil Nations, and by all strangers that come among you. to be scorned and contemned. A custome lothsorne to the eye, hatefull to the Nose, harmefull to the braine, dangerous to the Lungs, and in the blacke stinking fume thereof, neerest resembling the horrible Stigian smoke of the pit that is bottomelesse.

Now, if you like the way those guys expressed themselves in those days, you have the King James Bible 1611 edition, available from any number of sources, but I point particularly to the KJV Translator's Preface here.

Third, now, I just wonder whether those Altria guys were smoking when they got into this goofy deal and then when they decided to litigate it -- particularly before a jury and, if so, what were they smoking?

Altria #2 - Economic Substance and Juries (3/22/10)

In Altria (see blog here for introduction), Judge Holwell submitted the issues to the jury as follows:

The Court instructed the jury to analyze the transactions under the two common law disallowance methods relied on by the Government: the "substance over form" doctrine, and the "economic substance" doctrine. With respect to substance-over-form, the Court instructed the jury to put aside the labels used or names given to the documents and transactions, and decide whether Altria actually acquired and retained a genuine ownership interest in the Seminole, Oglethorpe, and Vallei facilities, and a genuine leasehold interest in the MTA facility. The jury was to consider "all the relevant facts and circumstances surrounding the transactions," including eight non-exclusive factors identified by the Court. 4 (Charge to the Jury, at 33-34 (Docket No. 146).) At the same time, the Court cautioned the jury that its analysis should turn on the facts as it found them, including its understanding of how the transactions were designed to unfold: "You must consider and give the appropriate weight to all the relevant facts and circumstances. In the end, the question is whether Altria retained significant and genuine attributes of traditional owner (or lessor) status." (Id. at 34.)

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Economic Substance Jury Instruction in Larson/Pfaff/Ruble

I previously attached deep in a blog Judge Kaplan’s economic substance charge to the jury in United States v. Larson (S.D. N.Y. No. 05 CR 888 (LAK)), dated 12/11/08, pp. 5225- 5232.  I have decided that, because of the ongoing discussion I should lift it up into a separate blog for those who might have missed it.

In order to prove that element in this case, we focus on the doctrine of economic substance. In this case, the government contends that the taxpayers whose tax returns are the subject of each count of tax evasion, owed more federal income tax then they reported on the returns for one reason only, in each case the taxpayer took a deduction from his taxable income due to a loss that the tax return attributed to one of the four tax strategies at issue in this case. You remember them, FLIP, OPIS, BLIPS and SOS.

The government argues that every one of those tax strategies lacked economic substance. That the tax deduction each one of those taxpayers took was improper, for that reason, and, therefore, that each taxpayer owed more federal income tax than was declared on the tax return. The defendants dispute that. They contend, among other things, that the tax strategies did not lack economic substance, that the deductions were proper, and that the tax returns, therefore, accurately stated the amounts of tax that were due and owing.

This means that your task here, with respect to the first element, is to decide for each count, whether the tax strategy that gave rise to the loss claimed as a deduction on that tax return, lacked economic substance in order to decide whether the relevant taxpayer owed more federal tax, income tax, than was shown that was due on the tax return. So I am now going to instruct you with respect to your consideration of the economic substance issue.

A transaction that lacks economic substance cannot enter into tax computations. Any deduction claimed for a tax loss that allegedly was sustained in such a transaction, therefore, is not properly claimed on a tax return.

In order to establish that a transaction lacks economic substance, the government must prove beyond a reasonable doubt both of two factors. The first factor is that the relevant taxpayer had no business purpose for engaging in the transaction apart from creating the tax deduction.

The second factor is that there was no reasonable possibility that the transaction would result in a profit.

Now, let me define one term and say a few things about each one of these factors.

First the definition. The word profit, as I use it in this context, means a return in excess of the cost of the investment, disregarding entirely any tax benefits. Let me give you an example. If somebody puts a million dollars into a deal, he would have to get a return of more than a million dollars without considering any tax benefits in order for the transaction to be profitable. Common sense. A return of $750,000 on a million dollar investment results in a loss of $250,000, not a profit. That's what I mean by profit. Forget the tax benefits, look at the investment and the return.

Now, let me discuss the first element that I mentioned, whether the taxpayer had any business purpose for entering into the deal. In deciding that question, you, of course, may consider any direct evidence of the taxpayer's motive. But you are not limited to direct evidence in deciding why a taxpayer did a transaction. You can consider circumstantial evidence as well.

I am going to talk to you later about what circumstantial evidence means. But for purposes of the present, think of it just as common sense, and then I will explain it later on.

For example, you may consider the manner in which the transaction was sold to the taxpayer. In other words, you are entitled to consider whether and to what extent it was sold to the taxpayer as a way to create a tax deduction to offset other taxable income, and/or as a way to generate a return, a profit, exclusive of tax benefits on the investment. You are entitled to consider that.

You may consider also whether a reasonable taxpayer would have paid the fees necessary to do the transaction in order to gain the chance of whatever profit potential existed if the transaction did not also carry with it tax benefits.

Now, let me try to put this into plain English. What helped me think about it, maybe it will help you, I am going to give you a couple of examples, so bear with me on the examples. Let's take an example in which a taxpayer has to put up $2 million to enter into some deal or strategy. Suppose further that the strategy in question offers a five percent chance, that's one chance out of 20, resulting in a payout, when all is said and done of $2,050,000. In other words, it's a one in 20 chance of making $50,000 on a $2 million investment.

Assume also that the taxpayer has a huge amount of income, and that there is a very big tax benefit to the strategy, maybe a $10 million tax loss or deduction.

Now, common sense will tell you that few, if any, people, no matter how rich they are, would put up $2 million for a five percent chance, a one out of 20 chance, of making $50,000. So on those facts you might conclude that there must have been only one reason for the taxpayer to have paid the $2 million. And that the $10 million tax loss or deduction probably was the only reason.

Let me give you another example, also an example in which the same taxpayer has to put up the same $2 million.

What's different in this example is this, assume there is a 33 percent chance, now it's one out of three we are talking about, of getting a payout of $3 million. And thus a profit of a million dollars within a year. Now, a 33 percent chance, a one out of three chance of making a profit, is not bad odds, it's pretty good odds. And a million dollars is nothing to sneeze at, even if you are very rich.

In this second example, the high likelihood, relatively high likelihood, and the large size of the potential profit, would be circumstances that might tend to show that the taxpayer had a nontax reason for doing the deal.

Many people might consider it a very good investment opportunity, without regard whether there was any tax benefit.

In the end, what you would do, is to consider all the evidence, direct, if there is any, and circumstantial, to decide whether the government had proved that the tax benefits were the only reason for doing the deal.

Those are my examples.

So let me come back to this case. If you find that the government has proved that the tax benefits were the only reason for doing the deal involved in any particular count, you will go on to consider the second part of the economic substance test that I gave you a moment ago. And that I am going to talk about more in a minute.

If you find, however, that the government has not proved that the tax benefits were the only reason for doing the deal, you must reject the government's economic substance argument. And you, therefore, must reject its contention that there was additional tax due and owing. That in turn would require you to find the defendant or defendants in question, not guilty on the particular tax evasion count that related to the particular taxpayer and year in question.

Now, let me say a word about the second fact in the economic substance test, which is whether there was a reasonable possibility that the strategy involved on the count you are considering would result in a profit.

Now, at one level this is largely self-explanatory, but I want to emphasize to you that this factor requires you to come to an objective judgment about whether the government has proved that there was no reasonable possibility that the strategy would result in a profit. In other words, this doesn't depend on what the taxpayer believed about the tax potential -- excuse me, the profit potential -- it requires you to consider all the evidence that you have, and reach a conclusion about whether the government has proved beyond a reasonable doubt, that there was no reasonable possibility of a profit.

In doing this, you are going to have to consider the evidence concerning investment aspects of each of the four tax strategies at issue in this case. For example, the transactions involving the Argentine peso and the Hong Kong dollar that were involved in the BLIPS strategy, and the foreign currency options that were involved in the SOS strategy. Of course, you have to consider the particulars of the other two strategies, as well, I mentioned those because they come immediately to mind.

Now, in considering whether the government has met its burden on the second factor, you should take into account whether the taxpayer, considering all the aspects of the strategy, had any reasonable chance of making a profit or suffering a loss as a result of changes in the market.

To take one example, if you are considering a BLIPS deal, you should consider whether the taxpayer had any reasonable chance of making a profit or suffering a loss as a result of changes in the value of the Argentine peso and the Hong Kong dollar, given the terms of the deal. If you find that the government has proved beyond a reasonable doubt both prongs of the economic substance test, in other words, both that the taxpayer had no nontax reason for doing the deals on the count in question, and that there was no reasonable possibility of making a profit, you may find that the requirement of additional tax due and owing will have been satisfied, and you will go on to consider whether the government has proved that the additional tax due and owing was substantial.

Altria # 1 - Frank Lyon and tax shelters (3/20/10)

I write today about a decision in a refund suit because it involves a jury verdict in a highly structured tax shelter. I have spent some words in this blog discussing concerns about the task a criminal jury faces in determining criminal liability for structured tax shelters, so I think this case is notable for this blog. In Altria Group, Inc. v. United States, 2010 U.S. Dist. LEXIS 25160 (S.D.N.Y. 2010), the jury was tasked to determine whether the substance over form or the economic substance doctrines (or both) applied to deny the taxpayer the tax benefits of ownership.

As introduction to the case and today's topic, I quote Judge Holwell's introductory summary of the case:

This case concerns federal income tax deductions plaintiff Altria Group Inc. and its subsidiary Phillip Morris Capital Corp. ("PMCC" or "Altria, " collectively with plaintiff) generated by leasing big pieces of infrastructure from tax-indifferent counterparties. These tax shelter transactions are known in the leasing industry as SILOs ("Sale-In-Lease-Out") and LILOs ("Lease-In-Lease-Out"). Following a two-week trial, the jury concluded on the facts presented to it that plaintiff's SILOs and LILOs lacked economic substance and failed to transfer tax ownership of the properties to Altria, thereby justifying disallowance by the IRS of certain deductions claimed by Altria. Several courts and another jury have reached similar conclusions in other jurisdictions. See BB&T Corp. v. United States, 523 F.3d 461 (4th Cir. 2008); AWG Leasing Trust v. United States, 592 F. Supp. 2d 953 (N.D. Ohio 2008); Fifth Third Bancorp & Subs. v. United States, 05 Civ. 350 (S.D. Ohio, April 18, 2008) (jury verdict); Wells Fargo & Co. v. United States, 91 Fed. Cl. 35 (Fed. Cl. 2010). But see Consolidated Edison Co. v. United States, 90 Fed. Cl. 228 (Fed. Cl. 2009).

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The Reliance Defense as Bearing on Willfulness: Expert Testimony

The issue in a tax crimes case having a willfulness element (all of the significant ones except the tax obstruction crimes) is whether the defendant intentionally violated a know legal duty. Defendants will often try to deflect the blame other orthers, particularly the accountants and tax return preparers. In US v. St. Pierre, 599 F.3d 19 (1st Cir. 2010), the defendant sought to introduce expert testimony that the acountant/tax return preparer's failure to meet standards of care at least raised a reasonable doubt as to the defendant's state of mind. The district court denied the attempt, citing tangential relevance of the proffered expert testimony to the issue of the defendant's state of mind, and, in any event, FRCrP 403 that the evidence might not be helpful to the jury. Rule 403 provides: "Although relevant, evidence may be excluded if its probative value is substantially outweighed by the danger of unfair prejudice, confusion of the issues, or misleading the jury, or by considerations of undue delay, waste of time, or needless presentation of cumulative evidence." The Court of Appeals rejected the defendant's appeal on the issue.

The Court of Appeals went through the steps as follows:

1. Defendant was charged with tax evasion for 2000-2002 and tax obstruction under Section § 7212(a).

2. At trial, St. Pierre's underpayment of her personal taxes was undisputed; the central issue was whether St. Pierre had the requisite state of mind for the various offenses.

3. One of the accountants testified "that St. Pierre had been told to deposit company income into Staab's corporate bank account, as such deposits would enable the accountants to track Staab income that had to be reported on Staab's corporate and St. Pierre's personal income tax returns." There was apparently other "evidence that St. Pierre's accountants had explained to her -- in connection with past failures that she had claimed to be inadvertent -- the obligation to report company income on Staab's books."

4. Without telling her accountants, St. Pierre established at least 10 bank accounts unknown to the accoutants and deposited business revenue into the accounts, diverting over 3,000 business checks into those accounts. "Records indicated unreported income of $1,248,327 for the three-year period; the taxes avoided by the failure to report this income amounted to over $500,000, apart from interest."

5. This pattern existed in the years 2000-2002. By 2002 a tax audit had started, and the defendant doctored documents to affect the audit.

6. The jury acquitted the defendant of evasion for 2000 & 2001, but convicted for tax evasion in 2002 and for obstruction. The Court noted (fn. 1): "Although the unpaid taxes for 2000 and 2001 were also substantial, the government suggests that the jury may have given St. Pierre the benefit of the doubt as to her understanding of her obligations prior to 2002. By the time she signed her 2002 return, a tax audit was underway and St. Pierre had told IRS auditors that she understood her obligation to report company income."

7. The defendant claimed on appeal that the trial court's exclusion of the proffered expert testimony violated her Sixth Amendment right to present a defense and that the trial court misapplied the rules of evidence in denying the testimony.

8. The Court of Appeals rejected the defendant's claim as follows (footnote omitted):

At first blush, one might think that whether St. Pierre's accountants exercised due care was flatly irrelevant to any issue properly in the case. Mere failure of the accountants to detect her under-reporting or to give St. Pierre better directions, even if negligent, would not be a defense to a knowing effort by St. Pierre to evade taxes or willfully create false documents. n2 The jury was told what elements were required to prove tax evasion and obstruction, and the evidence amply permitted the jury to find that St. Pierre had the requisite consciousness of wrongdoing.

The trial judge was probably wise to invoke Rule 403, thereby assuming arguendo some possible relevance of the proffered evidence, however minimal or doubtful. Cases can be imagined where an accountant's neglect could bear on the likelihood that a taxpayer's under-reporting was due to honest reliance rather than deliberate dishonesty. And, although not at all a straightforward inference in this case, in some situations the professional standards governing accountants might in turn have some bearing on whether there was such neglect.

However, the scheme as charged and proved in this case was not hospitable to such reasoning. The government's evidence allowed the jury to find that St. Pierre, in diverting company income to personal ends but not reporting it as income to the company or herself, had acted against warnings; that St. Pierre had used multiple personal accounts not disclosed to accountants; that the scale of diversion was huge; that the accountants were unaware of most of what was occurring; and that St. Pierre herself engaged in creating false documents to cover her tracks.

By contrast, St. Pierre's proposed accounting standards evidence, by shifting the focus to whether the accountants were doing a good job, did have a potential to confuse and mislead a jury -- precisely because her accountants' failure to prevent the fraud would not be a defense. To the extent that St. Pierre relied on what she said her accountants or lawyer or bankers told her, she was permitted to offer such evidence. Her own beliefs about what they were responsible for doing might also be pertinent to her state of mind. Evidence of accounting standards, unknown to St. Pierre, had at best little tendency to negate the damning inferences against her, and Rule 403 was properly applied."

Restitution in the Coplan Tax Shelter Enabler Case

In United States v. Coplan (SD NY No. (S1) 07 Cr. 453 (SHS), the Government wanted to prove the restitution amount through the closing agreements with the taxpayers involved. (Note in regard to restitution that, although restitution is normally not available in tax cases, the defendants were convicted of the Klein / defraud conspiracy, which is a Title 18 offense permitting restitution.) Since the taxpayers involved had paid the tax agreed upon in the closing agreement, the restitution amount was the difference between the supposedly correct tax and the amount the IRS agreed to take to induce the taxpayers to settle.  Here's how the judge responded (Transcript pp. 7-8 (for full transcript see here)):

I believe it is the first section I read that is operative here, that is, 18 U.S.C. 3663A(c)(3), but both sections are essentially saying the same thing. And I am making the requisite findings under each that it is clear that determining complex issues of fact related to the cause or the amount of the IRS's losses here would substantially prolong the sentencing process to a degree that the need to provide restitution to the IRS is outweighed by the burden on the sentencing process. And, similarly, I determine that the complication and prolongation of the sentencing process that would result from fashioning an order of restitution here outweighs the need to provide restitution to the IRS.

That's especially true here. It is extremely difficult to figure out on a taxpayer-by-taxpayer basis exactly what the specific loss to the IRS is. As we discussed with only one taxpayer, I think it was back in November when we had the argument on the common issues, it's very difficult to figure out the specific loss. The closing agreements here with the taxpayers are quite complicated. Under the closing agreements individual taxpayers were able to keep part of the loss, and then the taxpayer also had to recognize a certain amount of income. There was a reallocation by the IRS in the example that we looked at of short-term and long-term gain, which in turn had implications for the following tax year. So there was recharacterization of various income/loss items over the next tax year. It would be far too great a burden on the process to try to fashion that order of restitution.

In addition, the government here is seeking restitution in hundreds of millions of dollars, and to impose restitution in addition to the other aspects of the judgments that I am going to direct be entered here would truly be unnecessarily punitive. So my conclusion is I am not imposing restitution on any of the four defendants for the reasons stated.

I have three observations here. 

1.  I understand that there was a legal issue lurking in the Government's attempt to use the closing agreements as it did.  An argument can be made based on the closing agreement statute that, once a closing agreement is reached, the amount in the closing agreement is the correct tax.  The tax is what the closing agreement says it is and, accordingly, there is no unpaid amount for restitution purposes.  The court's resolution by punting avoided having to deal with this issue.  (The same argument cannot be made for purposes of the tax loss calculation because even if the agreed upon amounts were the amounts that were the intended object of the crime and the settlements could be anticipated, the amount agreed upon in the closing agreements still pumped the intended tax loss up to the highest Base Offense Level.)

2.  As noted in an earlier blog, the jury was tasked to find a substantial tax due, although it was not required to come up with a number. As I also noted in that blog, the Government's case rested upon it, in effect, proving that each of the taxpayers involved committed tax fraud. If there had been a sentencing proceeding for each of those taxpayers, I have little doubt that a court would have been up to the task of coming up with a proper amount for restitution (although the defendant probably would have negotiated contractual contractual restitution in the plea agreement). I think the problem was that the Government attempted to short-circuit the proof required by a preponderance of the evidence with closing agreements signed by an out of court party (the taxpayer) and precious little else. Certainly, there may be an inference that the amount in the closing agreement is correct (perhaps as a minimum), but whether that inference alone should be relied upon for important criminal consequences -- whether the burden is preponderance, clear and convincing, or beyond a reasonable doubt -- is quite another matter. At least, that's my story and I am sticking to it (until corrected).

3.  In any event the amount of restitution sought by the Government was probably moot anyway.

Klein Conspiracy Instruction

In United States v. Coplan (SD NY No. (S1) 07 Cr. 453 (SHS), Judge Stein gave the following jury instruction on the Klein / defraud conspiracy based solidly on the Supreme Courts decision in Hammerschmidt v. United States, 265 U.S. 182 (1924) (see also the Ninth Circuit's decision in United States v. Caldwell, 989 F.2d 1056, 1058 (9th Cir. 1993)), emphasis supplied:

Not all conduct that impedes the lawful functions of a government agency is illegal — to be unlawful such conduct must entail fraud, deceit, or other dishonest means. Thus, it is not illegal simply to make the IRS’s job harder. Only an agreement to engage in conduct that tends to impede the IRS, and also involves fraudulent, deceitful, or dishonest means, does constitute an illegal agreement to defraud the United States.

Judge Stein had variations of this theme in other portion of the Klein / defraud conspiracy instructions.  For the entire set of jury instructions, see here and for the particular set of instructions on the Klein / defraud conspiracy go to pages 29-31.

For a less succinct statement of this concept see my article: John A. Townsend, Tax Obstruction Crimes: Is Making the IRS's Job Harder Enough?, 9 Hous. Bus. & Tax L.J. 260 (2009).

More on the Honest Services Supreme Court Cases and Tax Obstruction

I have previously blogged here the possibility that the pending cases before the Supreme Court on honest services fraud might portend some constriction of the scope of the Tax Obstruction Crimes. I found this discussion of the issue in the sentencing hearing transcript (pp. 49-59) in United States v. Coplan (SD NY No. (S1) 07 Cr. 453 (SHS) (the full transcript is here); the Judge is Sidney Stein and the attorney is Dennis Riordan of Riordan & Horgan who apparently will work on the appeal but handled the honest services issue connection to the conviction):

MR. RIORDAN: And Nat Lewin, who is going to be appellate counsel for Nissenbaum, are present in court today and we have been in intensive discussions for several months about this juncture that we are reaching here where we would present these questions to the court. I don't know -- and as a result of that we sort of have divided responsibility. So there are issues that I am prepared to address, but we will be cross-referencing each other's presentations and I don't know whether the court would prefer that at the end of the sentencings for Mr. Nissenbaum and Mr. Shapiro the three of us jointly address this question or whether you would like me to present some argument on the issues that I was prepared to address.

THE COURT: Well, I guess the answer to that question is, tell me what substantial question of law or fact is going to be raised on appeal that is likely to result in reversal or an order for a new trial. That's what I want to know. Tell me what your argument is.

MR. RIORDAN: Yes, your Honor. I will do that. There is going to be a major issue in this case, and I don't have the burden of asking the court to find any error on its own part because this issue did not exist at the beginning of this trial and did not really germinate fully until well after the convictions were returned, and that is that when this case is argued in the Supreme Court -- in the Second Circuit, the Second Circuit --

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More on Economic Substance in Criminal Tax Cases - the Coplan Instructions.

I have previously blogged on the application of the economic substance doctrine in criminal cases. I offer in this blog the application of the economic substance doctrine in the jury instructions in United States v. Coplan (SD NY No. (S1) 07 Cr. 453 (SHS)). Coplan was the E&Y-related criminal case and, in respect to economic substance, involved the same range of issues and problems as the KPMG-related criminal case on which I have previously blogged. (The entire set of jury instructions here; I shall quote the parts I believe most relevant below.)

The economic substance instruction in Coplan came as a subset of the instruction on the Tax Due element for tax evasion. The Court instructed the jury that the Government was required to prove that there was "a substantial amount of due." (Instr. p. 42.) This is a pretty straight-forward instruction.

Before moving to economic substance, I comment briefly on the task the jury is asked to perform in determining tax due in complex tax cases, including tax shelter cases. These shelters are usually very complex. When they are litigated in a civil context by the taxpayer who actually may owe the taxes, the litigation usually produces a lengthy opinion from a trained judge making many findings of fact and applying sometimes arcane principles of tax law in coming to a conclusion that the shelter works or doesn't work (usually doesn't work in this type of aggressive shelter). The jury by its general verdict of guilt or innocence just cuts to the chase on that issue (and the other elements of the crime(s) charged) without having to be bothered with a detailed analysis to support the conclusion. At least with detailed findings of fact and conclusions of law, the judge has been forced to go through the rigorous steps from a to z and appellate courts and the public can determine whether the conclusion is good. With general verdicts of guilty or not guilty, we cannot test the jury's rationale. But that is the nature of the general jury verdict, so I move on.

The Court then treated the economic substance doctrine as being the central determinant of whether there was a tax due and owing. In other words, most of these shelters had other, more tax-geeky problems that were potentially fatal, but the trial centered around the alleged economic substance defect and that was the instruction that was given. I quote now the relevant instructions (pp. 43 - 48).

The government contends with respect to Counts Two and Three that there was a tax due and owing because losses claimed as a result of the CDS Add-On tax shelter were not properly deductible under the tax laws, and thus that the clients understated the taxes they owed when those losses were reported on their tax returns as deductions that offset taxable income or gains. The government’s position is that the CDS Add-On shelter lacked economic substance.

This means that you must decide whether or not the CDS Add-On tax shelters implemented in Counts Two and Three lacked economic substance, and thus whether any of the relevant taxpayers claiming deductions from the shelter owed more federal income tax than was reflected on their individual tax returns.

* * * *

I will now instruct you on how to determine whether economic substance exists with respect to each relevant taxpayer.

Under our system of tax laws, a loss produced through a financial transaction that lacks economic substance cannot enter into a taxpayer’s tax computations. Any [*45] deduction claimed for a tax loss sustained in such a transaction cannot properly be claimed on a tax return. Thus, if you find that the tax losses from the CDS Add-On shelter were not properly deducted, you may conclude that the taxpayers owed more in taxes than was reported on their income tax returns, and proceed to decide whether that amount was substantial.

In order to establish that a transaction lacks economic substance, the government must prove two elements beyond a reasonable doubt:

The first element is that there was no reasonable possibility that the transaction would result in a “profit.”

The second element is that the relevant taxpayer had no business purpose for engaging in the transaction in question apart from the creation of the tax deduction.

Now, let me define a term and then say a few things about each of these elements.

First the definition. The word “profit” in this context means a return in excess of all the fees and costs incurred by the client in connection with entering into the tax shelter, disregarding entirely the value of any tax benefits.

Now let me say a few words about your determination whether there was a reasonable possibility that the shelter would result in a profit. This element requires you to reach an objective judgment about whether the government has proved that there was no reasonable possibility that the shelter would result in a profit. In other words, this does not depend upon what the taxpayer believed about the profit potential. It requires you to consider all of the evidence and reach a conclusion about whether the government has proved beyond a reasonable doubt that there was no reasonable possibility of a profit on the tax shelter after the fees and other costs were paid. If you find that the government [*46] has proved beyond a reasonable doubt that there was no reasonable possibility of a profit, then you move on to the second element, whether the relevant taxpayer had no business purpose for engaging in the tax shelter. If you find that the government has not proved the lack of a reasonable possibility of a profit, then you must reject the government’s theory and find the defendants not guilty.

Now let me discuss the second element that I mentioned—whether the taxpayer had any business purpose, that is, a non-tax reason, for participating in the shelter. In deciding that question, you may consider any direct evidence of the taxpayer’s motive. For instance, you may consider testimony or other statements by the taxpayer as to his or her reason or reasons for participating in the shelter.

But you are not limited to direct evidence in deciding why a taxpayer participated in the shelter. You may consider circumstantial evidence as well. For example, you may consider the manner in which the shelter was marketed or sold to the taxpayer. Thus, for instance, you are entitled to consider whether and to what it extent the shelter was advertised as a tax savings device, a means of obtaining a profit, and so forth. You may also consider the likelihood of a significant profit in relation to the amount of fees that clients were required to pay to participate in the tax shelter. Common sense tells you that if the client pays large fees to enter into a transaction with a large intended tax benefit and a very small likelihood of profit, that fact might tend to show that the client did not have a non-tax reason for doing the shelter. Conversely, if there is a significant possibility that the transaction will return a profit greater than all fees and costs, such a fact might tend to show that the client did have a non-tax reason for doing the transaction.

Taking into account both direct and circumstantial evidence of the relevant taxpayer’s intent, you must determine whether the government has proved beyond a reasonable doubt that the relevant taxpayer had no business or non-tax reason for doing the tax shelter in order to conclude that it lacked economic substance.

If you unanimously find with respect to at least one relevant taxpayer in each of Counts Two and Three that the government has proved beyond a reasonable doubt both prongs of the economic substance test—that is, losses were claimed on an individual tax return as a result of a tax shelter for which there was no reasonable possibility of making a profit and where the relevant taxpayer had no business purpose for engaging in the shelter—you may find that the requirement of additional tax due and owing is satisfied with respect to the count you are considering. * * * *

However, if you do not find that both elements of the economic substance test have been proven beyond a reasonable doubt as to losses claimed by any relevant taxpayer in a given count, then the government will not have proved that additional tax was due and owing as to that count, and you must find the defendants not guilty of the tax evasion count you are considering.

Well, that's it. The court invites the jury to consider indirect evidence as to the "relevant taxpayer's" purpose in participating in the shelter. This is a wholly subjective inquiry as to the relevant taxpayers. Since, I speculate here, these taxpayers made representations that they had such an independent profit motive, the jury must have concluded that those "relevant taxpayers" lied in making the representation and, therefore, that they too were guilty of tax evasion. Now tax evasion in such circumstances in criminal trials against the taxpayers is usually proved by circumstantial evidence since the taxpayer usually does not testify and, in any event, there is no direct proof of the mental state of mind required. But, I suspect that in these cases, the criminal jury is sorely tempted to conflate the two economic substance prongs -- we the jury find that there is no reasonable possibility of profit and therefore the taxpayer cannot have reasonably had a profit motive and therefore he or she did not have a profit motive. I just wonder if the jury actually has enough evidence to make the latter conclusion without the erroneous intervening logical step. In other words, there is no requirement in the economic substance test that the taxpayer's profit motive be reasonable or correct; just that the taxpayer have the profit motive. To give the jury the tools / record to get properly to the conclusion, the Government would have had to prove up a separate evasion case against each of the "relevant taxpayers." My suspicion / speculation is that the Government did not do that and left the jury to speculate that the taxpayers did not have the required profit motive because, in the jury's collective mind, no reasonable taxpayer could have the required profit motive.

And this does not even address what a reasonable profit motive even is.

Foreign Account Tax Compliance Act of 2009 (FATCA) Near Passage

Tax Notes Today reports this morning that the Senate is poised to pass the Foreign Account Tax Compliance Act of 2009 (FATCA) as part of the larger bill now called Hiring Incentives to Restore Employment (HIRE) Act.

Tax Notes reports the key provisions of the FATCA subtitle would:

• impose a 30 percent tax withholding on payments either to foreign banks and trusts that fail to identify U.S. accounts and their owners and assets to the IRS, or to foreign corporations that do not supply the name, address, and tax identification number of any U.S. individual with at least 10 percent ownership in the firm (effective for payments made after December 31, 2012, with certain exceptions for grandfathered agreements);

• extend bearer-bond tax penalties to any such bonds marketed to offshore investors, and prevent the U.S. government from issuing bearer bonds (effective two years after the date of enactment);

• impose penalties as high as $50,000 on U.S. taxpayers who own at least $50,000 in offshore accounts or assets but fail to report the accounts on their annual income tax return (effective for tax years beginning after the date of enactment);

• levy a 40 percent penalty on the amount of any understatement attributed to undisclosed foreign assets (effective for tax years after the date of enactment);

• extend to six years the statute of limitations for "substantial" omissions -- exceeding $5,000 and 25 percent of reported income -- derived from offshore assets (effective for returns filed after the date of enactment, or for any return filed on or before that date if the section 6501 assessment period for that return has not expired as of the date of enactment);

• require shareholders in passive foreign investment companies to file annual returns (effective upon enactment);

• mandate that financial firms file electronic returns with respect to withholding taxes, even if they file fewer than 250 returns annually (effective for returns due after the date of enactment);

• codify Treasury regulations that treat foreign trusts as having U.S. beneficiaries if any current, future, or contingent beneficiary is a U.S. person;

• allow the Treasury Department to presume that a foreign trust has U.S. beneficiaries if a U.S. person directly or indirectly transfers property to the trust (effective for transfers of property after the date of enactment);

• establish a $10,000 minimum failure-to-file penalty for certain foreign-trust-related information returns (effective for notices and returns due after December 31, 2009); and

• subject dividend equivalent payments included in notional principal contracts and paid to overseas corporations to the same 30 percent withholding tax levied on dividends paid to foreign investors (effective for payments made on or after 180 days after enactment).

Addendum

The provisions of the HIRE Act are accessible at the Wikisource web site here. The particular provisions relevant to this discussion are in Title V Subtitle A, Foreign Account Tax Compliance Act (FATCA) here.

Another Foreign Bank in the U.S. Government Sights

A series of news articles appear this morning centered around a statement made by the IRS Special Agent in Charge of the Tampa Field Office. The key items are:

1. The U.S. will soon go against another foreign bank for the "the same behavior that got UBS in trouble." The timing is likely to be timed to have maximum publicity effect during this return filing season (a common gambit to squeeze the maximum deterrent effect out of the prosecution), by reminding U.S. taxpayers of their obligations on 1040 and the FBAR due 6/30/10.

2. Further "tax evasion" prosecutions are likely to be brought based on the information gathered from the voluntary disclosures. Presumably, the prosecutions will be of others than the taxpayers making the voluntary disclosures. She is quoted as saying these cases will come "in waves over the next six to eight months." The voluntary disclosure information will "be a source of cases for years for us." My experience is that the principal information of misbehavior in the voluntary disclosures relates to the enablers rather than other taxpayers who did not make voluntary disclosures.

3. She notes that at least l2,000 have come in since the closing of the formal voluntary disclosure initiative on October 15, 2009, and more are coming.

4. The articles quote unnamed lawyers who suggest that the U.S. may have it sights on information that the French obtained on HSBC clients, by making a treaty request to the French.

5. The articles mention the Swiss Government plan to seek legislative approval to make the disclosures required by the U.S. / Swiss / UBS agreement.

See the Reuters version here.

Obstruction of Justice At Trial

In United States v. Dehlinger, 2010 U.S. App. LEXIS (4th Cir. No. 09-4099 2010) (unpublished), the Fourth Circuit gives a cautionary lesson for practitioners as to the risks of going to trial and mounting a defense that the jury does not accept. Here's the lesson (case citations omitted):

As to the second of Dehlinger's sentencing issues, the district court did not err in increasing Dehlinger's offense level by two levels for obstruction of justice. The Sentencing Guidelines allow a two level increase if "the defendant willfully obstructed or impeded, or attempted to obstruct or impede, the administration of justice with respect to the investigation, prosecution, or sentencing of the instant offense of conviction and any relevant conduct." U.S.S.G. § 3C1.1. Obstruction of justice includes committing perjury at trial. U.S.S.G. § 3C1.1, comment (n.4(b)). A district court applying an enhancement based on obstruction of justice must necessarily find, by a preponderance of the evidence, that the defendant (1) gave false testimony, (2) concerning a material matter, (3) with the willful intent to deceive while under oath.

The district court found that Dehlinger committed perjury when he testified (extensively) under oath that he relied on others, taking advice from his accountant and financial planner, as well as Dr. Chari, regarding the legality and soundness of the AAA programs. Specifically, Dehlinger claimed that he took certain deductions "because Richard Marks and George Benoit said they were appropriate deductions." Tr. 108. As an initial matter, the district court's enhancement for perjury did not constitute double counting (even though Dehlinger's crime constituted lying to the IRS) because the crime for which he was convicted was completed by the time he went on trial. Indeed, his crime was complete after he had filed the fraudulent tax returns. Lying under oath constitutes a new and different circumstance designed to hide the already completed crime. In short, the conduct underlying Dehlinger's conviction is different from the conduct upon which the district court based its enhancement.

Second, the district court properly reasoned that, since the jury found Dehlinger guilty of all tax evasion charges, it must have rejected all of his testimony regarding good faith and lack of willfulness. During sentencing, the district court discussed at length its reasons for enhancing Dehlinger's sentence; namely, that Dehlinger (1) gave false testimony, (2) concerning a material matter, (3) with the willful intent to deceive while under oath. The district court said,

[Defendant's] testimony was to say, if it is detrimental reliance, if that is the description, the proper description, it may well be; but it was more specific about what was going on, what I did and, gosh, I really did not know that this was not on the up and up. And it seems that the jury evaluated that testimony and the jury found the defendant guilty and ignored that testimony altogether. . . .

But [defendant] was very specific about what he had done and the fact that it was not bad motive or criminal intent by him; but the specifics were such that, it seems to me, there was a rejection of those facts. . . . But the testimony was detailed and specific about what happened; and he asked the jury to rely on his position that he did not know what was up in light of a lot of evidence that indicated that he knew some of the things that were going on simply were not legal, and ultimately the jury concluded they were criminal.

Sent. Tr. 34-38. These observations by the district court support its determination that Dehlinger committed perjury for the sole purpose of deceiving the jury regarding his culpability and involvement with AAA. The district court therefore properly sentenced Dehlinger.

For more on this subject, I offer the following which is a footnote in my current Federal Tax Crimes Book:

See United States v. Ellis, 548 F.3d 539 (7th Cir. 2008) (the enhancement is not warranted in every case of false testimony; the court’s formulation seems to be that if the defendant commits perjury in her defense, the enhancement can apply even though, presumably, the defendant might be separately prosecuted and sentenced for the perjury; I suspect but have no empirical evidence that the standard unelaborated denial of guilt by a defendant on the stand will not draw the enhancement, but the elaborate, egregious lie will; note, also, that for the sentencing enhancement the Government’s burden is preponderance of the evidence); see also United States v. Holmes, 406 F.3d 337 (5th Cir. 2005) (a nontax case).

Downing Warns Taxpayers and Tax Practitioners

Tax Notes Today for 3/8/10, in an article titled Jermiah Coder, Practitioners Handling Offshore Account Cases Warned About Sanctions for Nondisclosure, 2010 TNT 44-4, reports the following noises by the Government's apparent DOJ Tax chief mouthpiece for the Offshore Account full court press:

Kevin Downing, an attorney in the DOJ's Tax Division, said that under 18 U.S.C. 3506, individuals must provide the U.S. attorney general with notice if they challenge a U.S. request for evidence from a foreign government or agency.

Downing, who spoke at the 34th annual Federal Bar Association Section on Taxation Tax Law Conference in Washington, said that attorneys who represent clients in these matters without filing with the DOJ a copy of their opposition motion will be referred to the IRS Office of Professional Responsibility. There is no Fifth Amendment right not to comply with the statute, as filing with a foreign court waives that right, Downing said.

Two referrals for not filing copies with the government have already been made, he said.

Downing emphatically warned taxpayers who think they can use the voluntary disclosure program if their court challenges fail that the DOJ will not honor that disclosure. He added that he hopes Congress will enact penalties to provide greater enforcement of the provision.

Downing said some taxpayers who have yet to come clean are continuing to engage in felonious behavior by filing false returns not listing foreign accounts or by failing to file foreign bank account reports. The "treasure trove" of information the government has received on foreign professionals as a result of pursuing more banks means the DOJ will be able to bring 100 to 200 criminal cases a year for a long time, he said.

The United States is using tools other than treaty requests and the voluntary disclosure program to gather more information on offshore tax evasion, Downing said. For example, the IRS whistleblower program is proving useful, he said, and there is no prohibition on the U.S. government using account information it did not directly procure from a foreign bank.

All of the comments ascribed to Mr. Downing are quite interesting, but I do call specifically to the attention of the readers the assertion that "DOJ will be able to bring 100 to 200 criminal cases a year for a long time." Practitioners have speculated for some time about what level of criminal enfrocement the Government could really pursue, given limited systemic resources (including investigative (whether IRS or grand jury), court, probation office and bureau of prisions resourece). Apparently, 100 to 200 is about it, and is consistent (within a range) with the speculations I have heard and even made myself. One could further speculate that the Government will pick only the more egregious cases to focus its criminal angst upon (although there might have to be smattering of the less egregious cases to send the message that taxpayers don't get a pass simply by being not as bad as the really bad guys).

More on the Yip Criminal Case - FBARs and other Matters

I have previously blogged here on the Ninth Circuit's published decision in United States v. Yip, ___ F.3d ___ (9th Cir. 2010). That decision dealt with inclusion of state tax loss in relevant conduct. At the same time as issuing that precedential decision, the Ninth Circuit entered an unpublished decision with limited precedential effect. See United States v. Yip, 2010 U.S. App. LEXIS 4639 (9th Cir. 2009). The unpublished decision cryptically presents its many holdings, but I thought it helpful to present some of them for readers:

In Yip, the defendant appealed from convictions of one count of Klein / defraud conspiray, one count of tax perjury and two counts of failure to file FBARs.

1. The defendant argued that the evidence was insufficient to support his convictions for failure to file FBARs. The Court of Appeals dismissed that claim as follows:

Defendant's accountant, who prepared Defendant's taxes for seven years before the first tax filing at issue here, testified that it was his usual practice to review the foreign account question on Defendant's tax form with him each year. This constituted sufficient evidence for a rational jury to have inferred that Defendant knew of his duty and willfully failed to report the foreign accounts.

Although this holding is too cryptic for meaningful comment, I do note that a return preparer will have an incentive to claim that he or she did cover this question specifically with the taxpayer when, in fact, they may not have actually covered it, at least not as crisply as they imagine it when their own conduct might be under scrutiny.

2. The defendant argued that the Judge had improperly instructed the jury on the Ratzlaf issue. Ratzlaf v. United States, 510 U.S.135 (1994) Many of the readers of this blog know the nuances of Ratzlaf, but for those who do not, I need to set up the context of the argument. Ratzlaf was the Supreme court case involving structuring (piecemealing financial transactions that would otherwise require financial reporting, there the $10,000+ cash deposit reporting requirement). The structuring statute then required that the defendant act willfully. Willfully is a term of art in tax and sometimes in financial crimes which can have several distinct meanings -- indeed, the Supreme Court said on more than one occasion that it’s a word of many meanings. Bryan v. United States, 524 U.S. 184 (1998), citing Spies v. United States, 317 U.S. 492, 497 (1943). In the tax area, the requirement -- sometimes referred to as Cheek willfulness -- is that the defendant have intentionally violated a known legal duty. This is a stricter standard than is often found for criminal laws, where, per the famous slogan, ignorance of the law is not a defense. Ignorance is a defense in crimes requiring willfulness -- at least in those crimes where the willfully requirement is interpreted the same as in tax crimes. In Ratzlaf, the Court interpreted the structuring willfulness requirement the same -- to require that the defendant acted with intent to avoid the reporting requirements and with knowledge that thus avoiding was unlawful. As stated in Ratzlaf, “the Government must prove that the defendant acted with knowledge that his conduct was unlawful.” Ratzlaf v. United States, p. 137. In Ratzlaf, the Government had not proved that the defendant knew that struturing to avoid the reporting requirement was unlawful. The structuring statute was subsequently amended to delete the willfully element, so that the defendant must only act with intent to evade the reporting requirement whether or not he knew such structuring was illegal. In other words, the defendant must know of the law's requirements and act to avoid them, but he does not need to know that avoiding the law's requirements is a unlawful. (OK, I won't go down the rabbit trail you are thinking about.) Despite the change in the structuring statute, Ratzlaf is a case of continuing importance in reporting cases and in tax cases where crimes require willfulness interpreted to require the stronger level of proof that the defendant intentionally violated a known legal duty. The FBAR criminal statute requires that the defendant act willfully, hence Ratzlaf supports the key proposition that the taxpayer must fail to file the FBAR with intent to fail to file and that failing to file is unlawful.  The Ninth Circuit opinion in Yip addresses the taxpayer's Ratzlaf argument as follows (Ratzlaf parallel citations omitted and other case citation omitted):

3. Defendant argues that the jury instruction was defective because it failed to include the knowledge element required by Ratzlaf v. United States, 510 U.S. 135, 149 1994). We review for plain error. The instruction was not erroneous, because it informed the jury that conviction required a finding that Defendant knew that he had a legal duty to report his foreign bank accounts.

I suppose that, from a practical perspective, that is a cryptic and fair holding. I would have liked to see more from the court. But then it is an unpublished decision of little precedential effect except for the defendant involved, and the court was not writing for me.

3. Following through on this line, the Court addressed the defendant's argument that the instruction on the FBAR counts was invalid because it failed to instruct the jury on the willfulness element. The Court reasoned, again cryptically (case citation omitted):

The omission of the mens rea was an error, and an obvious one. However, not every error affects a defendant's substantial rights. This one did not. The jury found that Defendant knew of his duty to file the form. Because the jury found that Defendant willfully filed a 1999 return falsely stating that he had no foreign bank account, it almost certainly would have found that his failure to file the associated Treasury forms in 1998 and 1999, as he knew that he had a duty to do, was also willful.

This seems somewhat circular, but again the court ruled on the basis of the plain error standard.

4. The defendant then raised an actus reus argument. Here is the entire discussion (case citations omitted):

5. Defendant argues that the jury instruction was defective because it failed to include the actus reus for the counts of failure to file a Treasury form reporting his foreign bank accounts in 1998 and 1999. We review for plain error. The omission of the actus reus was an obvious error, but it did not affect Defendant's substantial rights. At trial, Defendant did not dispute his failure to file the forms.

5. This one is just too cryptic to do anything other than cut & paste (case citation omitted):

7. Defendant argues that his sentence of 67 months' imprisonment for conviction of conspiracy to defraud the United States exceeds the statutory maximum sentence of 60 months. 18 U.S.C. § 371. We review for plain error. We hold that the district court plainly erred in sentencing Defendant to a sentence in excess of the statutory maximum. Id. We vacate Defendant's sentence on the conspiracy conviction and remand for resentencing in conformity with 18 U.S.C. § 371.

6. This one's pretty good (I delete only the all case citations and references except Booker):

8. Defendant argues that the district court erred by sentencing him under the 2001 version of the Sentencing Guidelines on counts completed earlier than 2001. We review for plain error. A continuing offense must be sentenced under the Guidelines version in effect at the conclusion of the offense, if a later version is unfavorable to the defendant. n2 However, when a defendant is convicted of both a continuing offense and offenses completed earlier, the earlier offenses must be sentenced under the version in effect when they were completed. Here, the conspiracy count was properly sentenced under the 2001 Guidelines because the last overt acts of the conspiracy occurred after that version took effect. But the district court erred in sentencing Defendant under the 2001 Sentencing Guidelines for the crimes that were completed in earlier years--namely, filing false tax returns and failing to file the Treasury forms. The error was clear and obvious under [omitted cases]. It affected Defendant's substantial rights because the 2001 version of § 2T4.1 resulted in a lengthier sentence than the range recommended by the earlier version. Sentencing Defendant to a term of imprisonment longer than that recommended by a proper application of the Guidelines seriously affects the fairness of judicial proceedings. We vacate Defendant's sentence on Counts 4 through 7, and 9 through 11. We remand to the district court for resentencing under the proper versions of the Guidelines.

n2 We note that there is some uncertainty as to whether the Ex Post Facto Clause is implicated by the advisory use of the Sentencing Guidelines after United States v. Booker, 543 U.S. 220 (2005). We need not and do not decide whether Booker is irreconcilable with our [other case] holdings, because neither of the parties before us so contends.

7. The Court clearly got this one right (case citations omitted):

13. Defendant argues that the district court erred by increasing his offense level under the § 2T1.1(b)(2) enhancement for the use of sophisticated means. Defendant's use of foreign bank accounts to hide his unreported income and the creation of several sham loans to conceal his crimes were not necessary for the commission of the crimes. These activities were sufficiently complex to support application of the enhancement under all relevant versions of the Sentencing Guidelines. U.S.S.G. § 2T1.1 cmt. n.4. The district court properly imposed the sentencing enhancement.

8. I don't think there is enough information provided to figure out what this is about other than the Government's improper claim of work product privilege (case citations omitted, except for Hickman).

16. Defendant argues that the district court erred in ruling that the government had provided the information requested by Defendant. We review for clear error. The district court clearly erred because the government claimed work-product privilege for the material. However, the outcome would have been the same even had the district court recognized that the government had not provided the material, because no exception from the privilege applied. Hickman v. Taylor, 329 U.S. 495 (1947). Thus, the error was harmless.

Swiss - More on Damage Control

The Swiss have made a lot of money over the years helping persons hide their money from tax collectors and others. Although the Swiss are not the only players in this game, they have been perceived as the most sophisticated hiders of money. It had become almost a cliche to talk about Swiss bank accounts in virtually the same breath as secrecy and tax cheating. Until recently.

Is the gig up or do they just have to be smarter?. The most recent U.S. initiative against UBS (including a deferred prosecution agreement and agreement, under compulsion, to disclose U.S. account holders) and the related offshore account voluntary disclosure initiative have put great pressure on this Swiss franchise. The best the Swiss can hope for is to mitigate the damage.

The most recent attempt to mitigate the damage discussed in several on-line web articles today. I link to some below. As noted in my previous blogs, the Swiss Government is requesting a legislative solution consistent with the agreement with the U.S. to disclose names (and ex-post facto, legalizing the disclosures already made or promised to be made). The reports are that the Swiss Parliament was balking. New reports indicate that UBS is lobbying the Parliament to approve the Government's proposal, for other Swiss banks and the whole Swiss system could be at risk if they do not.

One prong of UBS' attempt to mitigate the damage is in the form of a letter that is quite telling. I quote from the reports about the letter from the NY Times article:

In a letter sent to several Swiss lawmakers, a copy of which was obtained Friday by The International Herald Tribune, UBS said that failure to approve the treaty could encourage United States authorities to go after other Swiss banks, further undermining the country’s all-important financial sector. “In the end, the effects of not approving the deal are multiple and will not just affect a single entity like UBS,” the bank argued.

In its letter, UBS said the Internal Revenue Service had already collected information on the cross-border activities of about 20 Swiss banks. It added that it was “very possible” that the I.R.S. was seeking information about additional American clients of the banks.

“The refusal by the Swiss to fulfill its obligations under international law could send an escalating signal for these cases,” it said.

Switzerland also risked ending up on a blacklist of uncooperative tax havens if lawmakers refused to bless the deal, the bank said.

Does any reader believe that passage of the proposal would in fact cause the IRS not to pursue other Swiss banks? If the Swiss Parliament approves an amendment to the treaty, why would the U.S. not use the UBS template, then approved by the treaty amendment, to go after the other identified banks (or even the others yet to be identified)?

I suspect the UBS and the Swiss believe that this current brouhaha, while a setback and a permanent setback, it does not take away all the tricks of the hide the money gave. They will just have to hide smarter, but better than than a permanent lost of the whole franchise.

New York Times article
USA Today

Further Relief by Deferral for Signatories and Certain Owners of Commingled Funds

On February 26, 2010, by IRS Notice 2010-23, the IRS announced further relief by deferral for U.S. persons who are signatories only of foreign accounts or have interests in certain commingled accounts. The full Notice is here, but the the key provisions are fairly short, so I just cut and paste them here:

1. Signature Authority.

Persons with signature authority over, but no financial interest in, a foreign financial account for which an FBAR would otherwise have been due on June 30, 2010, will now have until June 30, 2011, to report those foreign financial accounts. The deadline of June 30, 2011, applies to FBARs reporting foreign financial accounts over which the person has signature authority, but no financial interest, for the 2010 and prior calendar years. When completing an FBAR that is subject to the extension provided in this paragraph, persons must adhere to FBAR guidance in effect at the time the FBAR is filed.

2. Certain Foreign Commingled Funds.

Persons with a financial interest in, or signature authority over, a foreign commingled fund that is a mutual fund are required to file an FBAR unless another filing exception, as provided in the FBAR instructions or other relevant guidance, applies. The IRS will not interpret the term "commingled fund" as applying to funds other than mutual funds with respect to FBARs for calendar year 2009 and prior years. Thus, the IRS has determined that it will not apply its enforcement authority adversely in the case of persons with a financial interest in, or signature authority over, any other foreign commingled fund with respect to that account for calendar year 2009 and earlier calendar years. A financial interest in, or signature authority over, a foreign hedge fund or private equity fund is included in the administrative relief provided in the preceding sentence.

3. FBAR-Related Questions on Federal Tax Forms.

Provided the taxpayer has no other reportable foreign financial accounts for the year in question, a taxpayer who qualifies for the filing relief provided in this Notice should check the "no" box in response to FBAR-related questions found on federal tax forms for 2009 and earlier years that ask about the existence of a financial interest in, or signature authority over, a foreign financial account.

Items 1 and 3 are particularly helpful to the many family members who frequently appeared as signatories but with no ownership / financial interest in the particular account or in any other offshore financial account.   I think the message here is that the FBAR form will likely change by the extended due date, so that those persons who elect to defer filing will have to use the then current form.  These signatories can file now, since the extension is just for the final date to file.  If so, they use the current form

FBAR Penalties and Excessive Fines (3/5/10)

A commenter requested further discussion as to the possibility of an excessive fines problem for the FBAR penalties. In an earlier blog here, I had advised readers of this article on the subject: Steven Toscher and Barbara Lubin, When Penalties Are Excessive -- The Excessive Fines Clause as a Limitation on the Imposition of the Willful FBAR Penalty.. The commenter said:

Could you share your thoughts in a new thread on the third article here, Steven Toscher and Barbara Lubin, When Penalties Are Excessive -- The Excessive Fines Clause as a Limitation on the Imposition of the Willful FBAR Penalty. The article seems to conclude that the 50% FBAR penalty is an unconstitutional punishment. But no one appears to have contested the constitutionality of it in the plea deals brought so far, because those individuals could face greater criminal charges if they do not accept the proposed civil punishment. Your thoughts on the legality of the 50% FBAR penalty?

Now, usually, someone does not have to ask for my thoughts. I usually give them before someone asks for them (and, sometimes, before I even think them). My thoughts are not really different and certainly not better that Steve's and Barbara's. But here goes, since you asked:

1. We need to keep in mind that the framework for this discussion is the Bajakajian case discussed in the article. In that case, the 100% penalty on the amount that should have been reported in the CMIR was deemed excessive under the facts of the case (just a footfault, albeit intentional and important, as to reporting, but no other illegality involved). By contrast the fines we are talking about here are 50% fines per incident, rather than the 100% fine per incident involved in Bajakajian and other illegality (income tax misconduct) is involved. That does not mean the Eight Amendment concerns are not involved, but the facts and amounts are materially different.

2. The conduct punished in the extant criminal cases is multiple incidents (years in the case of the FBARs) with the 50% applying to a single year, albeit the highest year. The Government could have gotten to the same number by applying a lesser penalty rate to each of the years.

3. For this reason, the effective penalty rate over all incidents (years) is much less than 50% unless you assume the unlikely case that only one year was involved. Let me illustrate, assume that 6 years are involved, with the highest year being $1,000,000 and all others years having $500,000 each and that the penalty is thus 50% of the highest year or $500,000. The penalty is thus 14%, hardly an excessive penalty in my mind. (I must resist the temptation to think that the The framers of the constitution (or Bible or what have you) must have had my mind in mind when drafting the respective tome.)

4. While I have not gone through all possible iterations, my gut (perhaps the same as my mind, but in any event also not the framer's gauge) tells me that conceivable iterations where the Government would make its discretionary call to prosecute are unlikely to dramatically affect the conclusion, at least in terms of the Eighth Amendment's Excessive Fines Clause as discussed in Bajakajian. Where it would dramatically affect the percentage forfeited because one of the years (the highest year) is dramatically out of sync with the other years or only 1 or 2 years are involved, then I question whether DOJ Tax would prosecute or insist on an out of whack penalty.

5. And, beyond that, the 50% penalty for the highest year is being extracted as a plea agreement in which the Government is giving up a number of other criminal charges that even could affect sentencing in some of the cases. It is just a deal that the defendants find acceptable regardless of whether they might have some outlier argument to make against any particular term of the deal considered in isolation.

6. I cannot wholly discount the possibility that DOJ Tax would prosecute a single year. Maybe the Government believes a drug dealer is involved and can't nail the defendant for that, so it takes what it can. But, in the run of the mine tax motivated FBAR failure to file case, one year is unlikely to make the prosecutorial discretion cut. And even then, to go back to Bajakajian, the penalty is one-half (50% rather than 100%) and other illegality is involved (at least one tax offense since, as of now, the Government is not prosecuting except where there is a tax crime and the hypothesized drug dealer will have almost certainly committed a tax crime). My same gut tells me that this may not offend the sensibilities of the Supreme Court in the same way the Bajakajian facts did.

To paraphrase the saying, my gut is often wrong but never in doubt (or turmoil). There you have it for what it is worth.

Addendum 3/5/10

After preparing the foregoing discussion, I read the following article:  Courtney J. Linn, Redefining the Bank Secrecy Act, Currency Reporting and the Crime of Structuring, 50 Santa Clara L. Rev. 407 (2010).  The author at pp. 501 - 507 discusses the implications of Bajakajian to BSA reporting requirements and related criminal provisions for structuring in the context of United States v. Ahmad, 213 F.3d 805, 815 (4th Cir. 2000), a structuring case.   In Ahmad, the court determined that the $85,000 was subject to civil forfeiture and then turned to whether the forfeiture of the entire amount subject to civil forfeiture was an excessive fine under Bajakajian concepts.  The Ahmad court found Bajakajian distinguishable because it involved a single incident whereas the violations in Ahmad involved more than one incident.  Further, "Ahmad's structuring constituted part of a complicated larger scheme related to customs fraud violations."  Whereas Bajakajian involved only the loss of information to the Government, "Ahmad's deposit structuring activities not only caused the government to lose information, but also implicated an intermediary actor ... and affected its legal duty to report certain transactions [to Customs]."  In praising this aspect of Ahmad, the author reasons (footnotes omitted and emphasis supplied):

More compelling was the fact that Ahmad's structuring conduct related to a larger scheme involving the evasion of custom tax duties. In Bajakajian, the defendant did not "fit into the class of persons for whom the statute was principally designed: He is not a money launderer, a drug trafficker, or a tax evader." The funds were lawfully derived and the defendant intended to use the money to repay a legitimate debt. In contrast, Ahmad acknowledged that he transferred some of the funds from his illegally structured deposits into an account used to further a customs fraud scheme. Congress enacted the CTR requirement precisely out of concern that large unreported currency transactions enabled tax evasion and similar crimes. This fact, more than the other marshaled by the Ahmad court, distinguishes Ahmad from Bajakajian. Indeed, the handful of post-Bajakajian decisions involving forfeitures for reporting violations can largely be synthesized on this ground. Courts tend to uphold the forfeiture against excessive fines challenges when the reporting violation relates to a central purpose of the BSA and tend to mitigate it when it does not.

Hope this helps move the discussion forward.