Offshore structures have become one of the preferred business vehicle for investments in the United States due to its discretion and tax advantages although, if erroneously applied, could subject its owner(s) to heavy sanctions and criminal liabilities.
In order to prevent tax evasion and money laundering, the Internal Revenue Service (“IRS”) introduced the Offshore Voluntary Disclosure Program (“OVDP”), which has been revised over the years. In June 2014, the IRS announced the latest version of the OVDP. The program was initially created after the U.S. Department of Justice (“DOJ”) discovered international tax evasion by U.S. taxpayers using hidden offshore bank accounts.
A renowned case of tax fraud in the U.S. is the Birkenfeld case, in which the DOJ investigated Swiss bank UBS after Bradley Birkenfeld, a former employee, had divulged details of how the bank facilitated U.S. taxpayers to conceal income and assets not reporting them to U.S. authorities. The DOJ entered into a deferred prosecution agreement with UBS imposing a $780 million fine to be paid by the bank, which also agreed to disclose account information for more than 4,500 clients.
Similarly, Credit Suisse had to pay $2.6 billion dollar fine for conspiring to aid tax evasion. To date, there are about 100 Swiss banks negotiating their cases with the DOJ to prevent facing felony tax charges. Equally, Deutsche Bank AG was accused of aiding tax evasion and agreed to pay $554 million to avoid prosecution.
Presently, U.S. taxpayers holding foreign financial accounts must report their interest when the aggregate value of those accountsexceeds $10,000 U.S. dollars at any time during the calendar year, by filing a Report of Foreign Bank and Financial Accounts (“FBAR”); otherwise, they may be subject to civil and/or criminal sanctions.
The OVDP was introduced in 2009 for taxpayers who intentionally failed to report offshore income and failed to file the FBAR. Accordingly, taxpayers who amended their tax returns and filed FBARs for the years 2003 to 2008, had an opportunity to avoid criminal prosecution and were to pay the equivalent of 20% of the highest aggregate value of the unreported offshore accounts during the six-year period as penalty. Later in 2011, the offshore penalty increased from 20% to 25% and the disclosure period was extended from six to eight years (2003 to 2010). In 2012, the penalty increased to 27.5%.
The 2011 reform also included the opt-out procedure where taxpayers could avoid criminal prosecution although remaining subject to all penalties as mitigated by the program; so the taxpayer would opt out the ODVP, so long as the IRS proved the voluntary non-compliance.
The latest changes to the OVDP were announced in June 18, 2014. The new rules are stricter due to the awareness and efforts in preventing tax evasion. Many offshore financial institutions have been requiring U.S. taxpayers to assure they are reporting the offshore income to U.S. authorities.
Due to the publicity surrounding the voluntary disclosure initiatives, U.S. taxpayers with offshore financial accounts should know of their duty to report the income; accordingly, undeclared offshore income would be treated as a willful non-compliance with U.S. tax law. For delinquent FBARs, a 50% penalty will be applied when a financial institution (where the taxpayer has or had an account) has been publicly identified as being under investigation or as cooperating with an investigation.
In 2012, the IRS also created streamlined offshore procedures for U.S. taxpayers living abroad or dual citizens with delinquent tax returns. They were required to file the returns for the previous three years and to file FBARs for a six year-period, along with the penalty fee. Low compliance risk taxpayers (i.e., less that $1,500 in tax due each year) were not subject to penalties or follow-up actions. Nonetheless, the risk level could increased based on the following factors:
- There were indications of tax planning or avoidance;
- There was material economic activity in the U.S.;
- Any of the tax returns claimed a refund;
- The taxpayer did not report the income in the country of residence;
- The taxpayer was under investigation by the IRS;
- FBAR penalties had been previously imposed;
- The taxpayer had a financial interest over any financial account located outside his or her country of residence;
- There was U.S. source income.
In the 2014 reform, this procedure was maintained and modified. Now procedures are available to both U.S. individual taxpayers residing in and outside the U.S. who certify that the failure resulted from non-willful conduct. Accordingly, taxpayers may follow Streamlined Foreign Offshore Procedures (“SFOP”), or Streamlined Domestic Offshore Procedures (“SDOP”). Eligibility for one or other procedure depends on whether the taxpayer, for the three most recent years for which the tax return is due, did not have a U.S. abode and was physically abroad for at least 330 full days, or is not a U.S. citizen or legal permanent resident. In such case, the SFOP apply.
To comply with the SFOP, the taxpayer must submit a delinquent tax return or amend the one previously filed, for each of the most recent 3 years for which the U.S. tax return is due. Additionally, the taxpayer must submit delinquent FBARs for each of the most recent 6 years for which the FBAR due date has passed, along with payment of all tax due and all applicable statutory interest with respect to each of the late payment amounts. Taxpayer will be exempt from late fees.
Additionally, the taxpayer will have to certify the submission of all the FBARs and that failure to file tax returns, report income, pay tax, and file information returns, resulted from non-willful conduct.
To comply with the SDOP the requirements are similar but the offshore penalty is equal to 5% of the highest aggregate balance of the foreign financial assets for each of the years in the covered tax return period.
As explained, it is mandatory to know and understand the foregoing rules since the authorities are putting a big effort to collect from delinquent taxpayers and the ignorance of the law is no longer an excuse.
Cav. Piero Salussolia,Esq.;
Lizet Cardozo, Abg. (admitted in Colombia only);
Monica Tirado, Abg. (admitted in Colombia only).
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