U.S. International Tax Enforcement -- Exchange of Information and Collection (6/28/14)

I often get the question of whether the U.S. can request treaty partner assistance to collect taxes from taxpayers resident in foreign country or against property in a foreign country.  The U.S. can do that by treaty, but that is not a standard provision in the bi-lateral double tax treaties that the U.S. has.  There is a multilateral treaty, called the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, sponsored by the OECD to which the U.S. is a party.  The OECD's resources on this Convention, including the Convention, are here.  The U.S. has made reservations the effect of which is to deny its obligation to collect other countries' taxes and, because reciprocal duties are required, relieve other countries from the obligation collect U.S. taxes.

Now, to the broader subject of U.S. international tax enforcement, I offer the following (footnotes omitted) from a JCT report, titled Joint Committee on Taxation, Explanation of Proposed Protocol to the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, (JCX-9-14), February 21, 2014, which may be downloaded here:

The report has a great discussion of the state of the law on international enforcement.  Here are key excepts related to international enforcement mechanisms under Current Law (footnotes omitted; I do not indent because of the length of the material copies; in some cases I have bold-face to draw readers' attention)

I. SUMMARY

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Ratification of the protocol is not intended to alter the reservation of rights or declarations of understanding that the United States made when it ratified the existing convention in 1991. In its instrument of ratification, the United States reserved the right not to provide (1) assistance for taxes imposed by possessions, political subdivisions, or local authorities of other parties to the convention; (2) tax collection assistance; or (3) assistance in serving documents (except the service of documents by mail). The reservations are reciprocal; to the same extent that the United States will not provide assistance, other parties need not assist the United States. Thus, only the provisions relating to information exchanges and service of documents by mail are in effect for the United States. Those reservations would continue to govern the effect of the treaty with respect to the United States upon ratification of the proposed protocol.

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II. OVERVIEW OF TAX ADMINISTRATION IN CROSS-BORDER CONTEXT 
A. General Background of OECD 
B. Emerging Consensus on OECD Transparency Standards 
C. Extent of Mutual Assistance Under Present Law

The difficulties one jurisdiction has in piercing the “bank secrecy” of another jurisdiction can be traced to the centuries-long tradition against expecting one jurisdiction to assist another jurisdiction with collection of its taxes. This doctrine, known as the “Revenue Rule,” is rooted in common law and sovereign immunity. It is often referred to as the Lord Mansfield Rule, in recognition of the jurist's statement, “For no country ever takes notice of the revenue laws of another.” Although its vitality and scope have been questioned, most recently in Pasquatino v. United States [544 U.S. 349 (2005), here], the doctrine remains a cornerstone of all common law jurisdictions, as well as many others. To the extent that countries have provided administrative assistance of any sort, including exchange of information, it has been a result of State-to-State negotiations, resulting in a multilateral or bilateral international agreements or treaties, ensuring that any waiver of the principle will be reciprocated.


The degree of governmental access to financial information has varied historically from country to country, ranging from the relative transparency in the United States to the traditional opacity of jurisdictions such as Switzerland or Liechtenstein. The term “bank secrecy” generally refers to a legal standard, whether judicial or statutory in origin, which prevents governmental access to the financial information necessary to ascertain beneficial ownership and enforce tax, securities and financial regulations. The limitations may apply only to certain entities operating within the jurisdiction or may apply only to the sharing of information with a foreign jurisdiction, and are often reinforced by civil or criminal penalties.

Presently, the United States is a party to more than 60 income tax conventions, more than 20 tax information exchange agreements (“TIEAs”), and more than 50 Mutual Legal Assistance Treaties (“MLATs”). In a report in 2011 to the Permanent Subcommittee on Investigations, U.S. Senate Committee on Homeland Security and Governmental Affairs, the Government Accountability Office outlined the varied bilateral agreements under which the United States exchanges tax information. In this network of agreements, exchange of information is not the sole type of assistance that has been agreed upon, but it is the principal form of assistance that the United States has been willing to provide. In its treaties with France, Canada, Sweden, Denmark, and the Netherlands, the United States has specifically agreed to provide mutual assistance in collection, and does so under its Mutual Assistance Collection Program. It also provides assistance in criminal tax matters via the MLATs. Unlike the tax treaties, MLATs designate the Department of Justice as the “Central Authority” having the role of administering the treaty on behalf of the United States. Exchange of information provisions first appeared in the late 1930s. They are included in almost all current double tax conventions to which the United States is a party. Beginning in the 1980s, the United States began entering into specific TIEAs under the authority of the Code. In contrast to the bilateral double tax conventions, TIEAs are executive agreements entered into by Treasury without the advice and consent of the Senate and are limited in scope to the mutual exchange of information. These agreements often are entered into with countries that impose little or no income tax.

The information exchange procedures followed by the United States under its network of international agreements are described below. The goals of the U.S. tax information exchange program are (a) assuring the accurate assessment and collection of taxes, (b) preventing fiscal fraud and tax evasion, and (c) developing improved information sources for tax matters in general. With respect to the United States, taxes covered generally are limited to national taxes, such that state and local taxes are not covered. The objective of a TIEA is to promote international cooperation in tax matters (civil and criminal) through exchange of information. A party to the TIEA must have adequate process for obtaining information; if the party is required to enact measures providing such process, then the entry into force of the TIEA may be delayed until such requirements have been met. The requirements of the TIEA often require a jurisdiction to override its domestic laws and practices pertaining to disclosure of information regarding taxes.

To administer its obligations under the network of bilateral treaties, the Secretary of the Treasury has delegated the role of U.S. Competent Authority for the treaties to the Deputy Commissioner, Large Business & International, IRS. The Competent Authority is responsible for resolving disputes with the other contracting State about the scope or interpretation of the treaty. With respect to exchange of information articles, the Competent Authority determines whether the agency should present a request for information to a treaty partner as well as how to respond to any requests that it receives from the treaty partner.

All information exchanged flows through the offices of the Competent Authorities, and is safeguarded by the domestic laws of each State as well as the secrecy clause in the exchange of information article. In the United States, the information received from a treaty partner is within the scope of “tax convention information” and, if it is taxpayer-specific, is also treated as “return information” for purposes of protecting it from disclosure. Non taxpayer-specific information received from a partner is considered tax convention information as is also protected from disclosure if such disclosure would harm tax administration, as determined by the Competent Authority in consultation with his counterpart.32 Since the entry into force of the first treaty to include an exchange of information article, the United States has exchanged information with its partners in a variety of ways.

The principal types of information exchanges are generally referred to as routine or automatic, spontaneous, or specific exchanges. In addition, there are industry-wide exchanges with certain treaty partners, and simultaneous examinations or criminal investigations with other partners. The IRS reports the number of total disclosures under the exchange of information program in an annual report, but does not provide a breakdown of the type of exchange involved.

A “routine exchange of information” is one in which the contracting States have agreed that a category of information will be shared with one another on an ongoing basis, without the need for a specific request because it is of a type that is consistently relevant to the tax administration of the receiving jurisdiction. Information that is automatically shared under this jurisdiction to override its domestic laws and practices pertaining to disclosure of information regarding taxes.

The treaty partners may also work together to gain expertise about specific industries and to facilitate sharing of information when there is a common interest in the information. In those instances, they may arrange a meeting of agents or officials familiar with a particular industry or economic sector to share experiences, know-how, investigative techniques, and observations about trends in that industry. These discussions do not generally address the cases of specific taxpayers. Both the industry-wide meetings and the simultaneous examinations occur under the auspices of the exchange of information program; they are not in lieu of formal exchanges. They establish a process by which extensive exchanges of information can occur, with the assistance of an Exchange of Information analyst or Tax Attache.

As part of its obligations under its treaties, the United States has successfully defended its efforts to honor its treaty obligations against a variety of challenges. These challenges have included suits seeking to obtain publication of information received under treaty exchanges, objections to enforcement of administrative summonses and finally, an attempt to claim that the disclosure to another tax administrator was negligent. The United States successfully protected the secrecy of certain information in internal memoranda, including the identity of the treaty partner that had communicated with the IRS.38 The need to safeguard the secrecy of the information to protect the working relationship of the treaty partners was sufficient reason to sustain the government position that documents from meetings of Competent Authorities are entitled to treaty protection.

D. Cross-Border Enforcement Actions

Because the United States taxes its citizens and residents on their worldwide income, U.S. tax administrators frequently need foreign-based financial information to verify the accuracy of reporting by U.S. taxpayers. The United States generally has three options for accessing information located in other jurisdictions: information reported by the taxpayer in compliance with U.S. domestic requirements; third-party information reporting to the IRS; and information obtained from other jurisdictions through an exchange of information under a bilateral agreement, as described in the preceding section.

1. U.S. information gathering ability in tax administration

The administration and enforcement of the Internal Revenue Code is generally governed by the provisions of Subtitle F of the Code. The broad powers granted to the IRS include the ability to compel production of information in the form of filing returns or response to summonses, the implementation of a system of third-party information reports on various specific subjects and the ability to impose and collect penalties for failure to comply with the measures.

Information gathering ability

Summons authority of the IRS

The IRS has broad statutory authority to require production of information in the course of an examination. A request for information in the form of an administrative summons is enforceable if the IRS establishes its good faith, as evidenced by the four factors enunciated by the Supreme Court in United States v. Powell [379 U.S. 48 (1964), here].  The Powell factors require that the information (1) is sought for a legitimate law enforcement purpose, (2) is of a type that will shed light on the subject of the examination, (3) is not already in the possession of the IRS, and (4) that the IRS has complied with all applicable statutory requirements, such as service of process. Subsequent to United States v. Powell, the legitimacy of using an administrative summons in furtherance of an investigation into criminal violations was validated in United States v. LaSalle National Bank [437 U.S. 298 (1978), here], in which the Supreme Court determined that the dual civil and criminal purpose was legitimate, so long as there had not yet been a commitment to refer the case for prosecution.

The use of this summons authority to obtain information from third parties is subject to greater procedural safeguards, but otherwise the same good faith elements are analyzed to determine whether the summons should be enforced. When the existence of a possibly noncompliant taxpayer is known but not his identity, as in the case of holders of offshore bank accounts or investors in particular abusive transactions, the IRS is able to issue a summons to learn the identity of the taxpayer, but must first meet greater statutory requirements, to guard against fishing expeditions.

An effort to learn the identity of unnamed “John Does” requires that the United States seek judicial review in an ex parte proceeding prior to issuance of the summons. In its application and supporting documents, the United States must establish that the information sought pertains to an ascertainable group of persons, that there is a reasonable basis to believe that taxes have been avoided, and that the information is not otherwise available. The reviewing court does not determine whether the summons will ultimately be enforceable. Once a court has determined that the predicate for issuance of a summons is met, the summons is served, and the summoned party served may challenge enforcement of the summons, based on the Powell factors. It is not entitled to judicial review of the ex parte ruling that permitted issuance of the summons.

If a taxpayer whose liability is the subject of the summons either initiates or intervenes in a proceeding to challenge the  enforcement of the summons, the limitations period for the tax year under investigation is suspended during the pendency of the proceeding. The taxpayer whose identity is at issue in a John Doe summons would not initiate or intervene in a proceeding, and may not know of the proceeding. Nevertheless, enforcement of a John Doe summons is likely to be subject to time-consuming challenges, possibly warranting an extension of the limitations period. Thus, under current law, the limitations period for the tax year under investigation is suspended beginning six months after the service of a John Doe summons and ends with the final resolution of the response to the summons.

Information reporting requirements

A variety of information reporting requirements apply under present law. The primary provision governing information reporting by payors requires an information return by every person engaged in a trade or business who makes payments to any one payee aggregating $600 or more in any taxable year in the course of that payor’s trade or business. Reportable payments include compensation for both goods and services, and may include gross proceeds. Certain enumerated types of payments that are subject to other specific reporting requirements are carved out of reporting under this general rule by regulation. Another carveout excepts payments to corporations from reporting requirements. Additionally, the requirement that businesses report certain payments is generally not applicable to payments by persons engaged in a passive investment activity.

Detailed rules are provided for the reporting of various types of investment income, including interest, dividends, and gross proceeds from brokered transactions (such as a sale of stock). In general, the requirement to file Form 1099 applies with respect to amounts paid to U.S. persons and is linked to the backup withholding rules of section 3406. Thus, a payor of interest, dividends or gross proceeds generally must request that a U.S. payee (other than certain exempt recipients) furnish a Form W-9 providing that person’s name and taxpayer identification number.54 That information is then used to complete the Form 1099.

Failure to comply with the information reporting requirements results in penalties, which may include a penalty for failure to file the information return, a penalty for failure to furnish payee statements, or failure to comply with other various reporting requirements.

2. Access to cross-border information

Judicial process

Foreign-based information may be obtained using judicial process. It requires a balancing of the U.S. interest in tax enforcement with the interests of the other state in maintaining confidentiality. In Société Internationale v. Rogers, 357 U.S. 197 (1958) [here], the Supreme Court articulated a basic rule of comity, holding unanimously that a U.S. district court could not ignore the interests of the foreign state in determining whether it would compel production of foreign based documents. Since then, courts balancing these conflicting U.S. and foreign interests have tended to give greater weight to the U.S. interests in cases involving money laundering or drug dealing than in cases involving tax compliance. In United States v. Bank of Nova Scotia, 487 U.S. 250 (1988) [here], the court enforced a grand jury subpoena served in the United States for records maintained in the Cayman Islands, despite claims that the bank secrecy laws of that jurisdiction would not permit production. In that case, the records were sought in connection with prosecution of money laundering and possible drug dealing.

Foreign Account Tax Compliance Act (“FATCA”)

In response to the difficulties in compelling production of information across-borders, the United States has enacted a variety of statutory measures to require greater enhanced information reporting and encourage voluntary disclosure, at the risk of incurring penalties. One of the most significant is the separate reporting and withholding regime for outbound payments in order to police tax compliance of U.S. persons. Although other measures provide narrowly targeted tools that assist in securing cooperation in later stages of controversies, such measures do not assist during the examination portion of a controversy.

Commonly referred to as the Foreign Account Tax Compliance Act, the new regime imposes a withholding tax of 30 percent of the gross amount of certain payments to foreign financial institutions (“FFIs”) unless the FFI establishes that it is compliant with FATCA. The information reporting requires identification by third parties of certain U.S. accounts held in an FFI. An FFI must report with respect to a U.S. account (1) the name, address, and taxpayer identification number of each U.S. person holding an account or a foreign entity with one or more substantial U.S. owners holding an account, (2) the account number, (3) the account
balance or value, and (4) except as provided by the Secretary, the gross receipts and gross withdrawals or payments from the account.

Final regulations published in 2013 provide guidance on how FFIs may comply with FATCA. An FFI may become a participating FFI by completing the IRS FATCA registration process, obtaining a Global Intermediary Identification Number (GIIN), and agreeing to the terms of an FFI Agreement. A list of FATCA compliant institutions is to be published electronically by the IRS. The list can be relied upon by withholding agents in determining the status of a payee. To be included on the list, an FFI applies to the IRS for issuance of a GIIN through the IRS FATCA registration process. If approved, the applicant and GIIN will be included in the published list. The registration process and access to the list may be done electronically.

The process for complying with FATCA is expected to be further streamlined for FFIs resident in jurisdictions that are parties to an intergovernmental agreement (“IGA”) with the United States. In 2012, the United States began negotiations for a series of bilateral IGAs, on the authority of its various tax treaties and agreements to exchange information, with the intention of forming a partnership with another jurisdiction (FATCA partner) to facilitate the implementation of FATCA and obviate any legal impediments that FFIs that are resident in a FATCA partner may otherwise have faced in complying with the terms of FATCA. Since then, the United States has signed intergovernmental agreements with 22 countries. In addition, it has completed negotiations with several others.

All bilateral IGAs conform to models published in 2012. The Model 1 bilateral agreement provides a framework in which an FFI provides information to the tax authorities of the FATCA partner rather than to the IRS. The FATCA partner then provides information to the United States under an automatic exchange of information. In a variation on Model 1 referred to as the reciprocal version, the agreements include a reciprocal commitment for automatic exchange of information, under which the United States agrees to provide automatic exchange of certain information identified in the IGA and collected under U.S. information reporting requirements with respect to residents of the FATCA partner. Model 2 creates a framework under which the FATCA partner agrees to waive domestic restrictions, if any, which would prevent FFIs from reporting directly to the IRS and to require these FFIs to comply with the terms of an FFI Agreement. The FATCA partner also agrees to honor U.S. requests for requests for exchange of information as needed. The FFIs provide the requisite information directly to the IRS.

Third-party reporting is not the only means by which compliance of U.S. persons with foreign financial holdings is encouraged. Reporting by taxpayers about their foreign holdings was also enacted contemporaneously with FATCA. Effective for tax years beginning after the date of enactment (March 18, 2010), individuals are required to disclose with their annual Federal income tax return any interest in foreign accounts and certain foreign securities if the aggregate value of such assets is in excess of the greater of $50,000 or an amount determined by the Secretary in regulations. Failure to do so is punishable by a penalty of $10,000, which may increase for each 30 day period during which the failure continues after notification by the IRS, up to a maximum penalty of $50,000.68 In addition, U.S. persons with foreign holdings may be required to file an annual form TD F 90-22.1, Foreign Bank Account Report (“FBAR”). The FBAR includes information about foreign financial accounts held or controlled, as provided under regulations implementing the Bank Secrecy Act.