Should Swiss Banks Committing U.S. Tax Crimes Pay for Their Conduct? (5/7/14)

The question I ask has several levels of consideration.  I address here only one of them -- an appropriate sharing of the costs of misconduct that might fairly, at some level, be considered criminal misconduct.

A number of U.S. persons with Swiss bank accounts after 2008 have been contacted by Swiss banks seek information and/or documents establishing U.S. tax compliance that the Swiss banks can use for penalty relief under the U.S. DOJ / Swiss Bank Initiative.  (The original initiative and a subsequent clarification are here and here.)  Basically, in summary, the Swiss banks joining the U.S. DOJ Swiss Bank Initiative as Category 2 banks will have a penalty equaling the following:

A penalty base
x (times) a percentage
equals
the penalty.

The penalty base refers to U.S. person accounts at the bank during the Applicable Period, defined as "the period between August 1, 2008, and either (a) the later of December 31, 2014, or the effective date of an FFI Agreement, or (b) the date of the Non-Prosecution Agreement or Non-Target Letter, if that date is earlier than December 31, 2014, inclusive."  In part here pertinent, U.S. person accounts otherwise includible can be excluded from the penalty base if the Swiss Bank can establish to the satisfaction of the DOJ that the account either that (i) the account was not an undeclared account, (ii) was disclosed by the Swiss Bank to the IRS, or was disclosed by the U.S. person to the IRS under the OVDI/P.  The letters from the Swiss Banks seek information and documents from the U.S. persons to meet the requirement of the third category, so that the Swiss Banks can avoid penalty for their misconduct.

These letters from the Swiss Banks come in various iterations.  Apparently, as best I can discern, DOJ has not given them the a list of the precise form of proof required.  Examples of the requests I have seen include: (i) request for the OVDI/P preclearance acceptance letter; (ii) the ultimate Form 906 itself; (iii) just a U.S. person certification of U.S. tax compliance.  I gather that each Swiss Bank, in consultation with its U.S. attorneys, are determining what is required and asking for it.

Often the letter requests are not straight-forward.  They do not simply advise the U.S. person that the Swiss Banks are trying to reduce their penalty exposure and would appreciate the U.S. person providing the proof the Swiss Banks feel they need.  Often the letters are shrouded in rhetoric about the Swiss banking system, how the U.S. persons should give the banks waivers of U.S. persons' secrecy rights under Swiss law to permit the inevitable disclosures to the IRS (whether waivers or given or not), and how the U.S. persons should waive all rights they have against the Swiss banks. I don't doubt that this extra verbiage is important to the Swiss Banks and that, even if not important, the Swiss Banks would appreciate U.S. persons waiving all rights they may have against the Swiss Banks.  But it is the height of hubris for Swiss Banks to seek such waivers and not be straight-forward in advising the U.S. persons that their real goal is seeking unilateral benefits from the U.S. person that the banks have no legal right to require.

Now, I focus not on the waiver of rights but on the request for affirmative documentation as to U.S. tax compliance so that the Swiss Banks can avoid penalties for their own misconduct.  Of course, U.S. persons are not required to give that documentation.

The question I address here is whether U.S. persons should give that documentation and under what conditions should they do so.

First, let's focus on the penalty structure for which the Swiss banks seek relief:

The penalty structure is:

1. for U.S. Related Accounts that existed on August 1, 2008, an amount equal to 20% of the maximum aggregate dollar value of all such accounts during the Applicable Period;
2. for U.S. Related Accounts that were opened between August 1, 2008, and February 28, 2009, an amount equal to 30% of the maximum aggregate dollar value of all such accounts; and
3. for U.S. Related Accounts that were opened after February 28, 2009, an amount equal to 50% of the maximum aggregate value of all such accounts.

The penalty base is reduced, as noted, by proof of U.S. tax compliance in the manner indicated above.

Now, for an an analytical framework, I present a very simple example.  Suppose Swiss Bank opened a U.S. Related Account on 3/1/2009 (when it certainly knew that it was misbehaving criminally; usually the misguided notion was that they were bullet-proof because of no U.S. presence), so that account is subject to a 50% penalty unless the U.S. person joined OVDI/P and is willing to provide the documentary proof of U.S. tax compliance.  Let's suppose that the maximum aggregate in that account was $1,000,000.  The Swiss Bank penalty is $500,000. The Swiss Bank can avoid any penalty whatsoever for its misconduct by producing documentary proof of the U.S. person's U.S. tax compliance.  But, in order for the U.S. person to provide that proof, the U.S. person usually will have had incurred major U.S. tax-related costs -- income tax for 8 years and, most importantly, a penalty of 27 1/2% on its aggregate high amounts in the 8 year period, and significant costs (attorneys fees, accountants fees, etc.) of getting into compliance.  For simplicity of analysis, lets assume that, for purposes of the U.S. person's miscellaneous OVDP penalty, the high year amount is $1,000,000 for the year which the account was with the Swiss Bank seeking penalty relief.  The U.S. person's miscellaneous penalty will be $275,000.  If after incurring those substantial costs, the U.S. person simply turns over proof to the Swiss bank gratis, the Swiss bank will avoid altogether any penalty for its own misconduct with respect to that account and the U.S. person will have born all of the costs related to the joint -- let me repeat that, joint -- misconduct.

Is that a fair resolution of the joint misconduct?

In my view it is not.

I propose that, since U.S. persons are not required to provide documentation of their compliance, U.S. persons can refuse to provide the documentation and let the Swiss Banks boil in the brew they have stewed.

But, I think there is a better and fair resolution.  The U.S. banks and the Swiss banks should share the benefit of the Swiss Bank penalty reduction that the U.S. persons have paid so handsomely for.
What is a fair sharing?  I don't know.  I think that is a matter of negotiation and the perspectives of the U.S. persons and the Swiss banks with whom they negotiate.

Approaching the issue of a fair sharing, the issue may be conceptualized as simply the continuation of the sharing arrangement that caused the Swiss banks to join in U.S. tax evasion in the first place.  When U.S. persons hid their money in Swiss banks, they essentially shared the U.S. tax "savings" -- evaded tax -- with the Swiss banks who usually took out their proceeds of the crime in excess fees, costs and low returns paid to U.S. persons (which the banks leveraged to their profit).  So, in a general fairness sense, the U.S. persons should not be required to pay all of the costs of the Government having caught the Swiss banks and U.S. persons at this game.  The Swiss banks should pay something.  And not just token amounts.

I have heard from Swiss Bank representatives that the Swiss Banks feel it inappropriate that they reimburse any portion of the U.S. persons' penalties.  I am not sure that the Swiss Banks have any moral compunction about reimbursing penalties.  It is all about the money for them.  I think they simply want to pay less rather than more, whether it is nominated penalties, fair sharing, costs for documentation (what a willing seller is willing to sell the documentation for to a willing buyer), or simply because they are warmly inclined to U.S. persons.  I have heard in this regard that some Swiss Banks offer a token amount -- $1,000 or $2,000 -- or, in rare cases (not my own) -- some larger amount to be called reimbursement of the U.S. person's attorneys fees.

I think the Swiss Banks should pay substantially more.  How much more, I don't know if there is a litmus test for what is an appropriate or fair sharing of costs.  I think that is a matter of bargaining position.

I suppose one could construct an elaborate model that would exclude the U.S. person's aggregate income tax and interest on the income tax paid in OVDI/P and then include in the sharing pot the total penalties involved.  That would be the U.S. person's income tax penalties and the interest on the U.S. income tax penalties and the miscellaneous penalty and the Swiss Bank's 50% (or 20% or 30%) penalty and share according to the ratio thus derived, so that the Swiss Bank pays the amount to the U.S. person to put the cost sharing in the proper ratio.  That is a bit elaborate and highly fact intensive.  I suggest that, for negotiation purposes, the U.S. persons might just say we have something we can sell you for 50% of your savings or some other percent of the savings.

At the end of the day, however, the U.S. person should have a significant bargaining position.  The U.S. person can simply provide no documentation to the Swiss Banks and let the Swiss Banks pay for their misconduct just as the U.S. person has.

I invite the ideas and discussion from readers.