on July 2, 2007.
The world has turned upside down for tax evaders in the U.K. In all the years from 1979 — when currency restrictions were lifted — through 2005, their offshore bank accounts remained well hidden from Her Majesty's Revenue and Customs. The keys to this fiscal camouflage were bank secrecy laws and the lack of cross-border information sharing.
Those protections are now crumbling. Through a series of stunning legal victories, HMRC has amassed gigabytes of information about foreign accounts owned by U.K. taxpayers. With this stick in hand, HMRC offered the carrot of a partial tax amnesty to evaders with offshore accounts. The window for registering for that amnesty closed on June 22. The result: Approximately 60,000 are taking the amnesty offer. That's far superior to the 1,300 respondents the IRS attracted in 2003 with its Offshore Voluntary Compliance Initiative (OVCI).
Finding the Problem, Funding a Solution
In February 2003 the National Audit Office — the U.K. equivalent to the U.S. Government Accountability Office — reported that fraudulent use of offshore accounts and structures was increasing, thanks to improved access to offshore funds via credit and debit cards. The National Audit Office then proposed that HMRC:
continue to work closely with the banking and credit card industry, and professional representative bodies, to tackle the problems associated with offshore accounts and structures, and realize the full benefits of new reporting requirements. They should also publicize the fact that funds concealed offshore are increasingly likely to be investigated, and back this up with better publicity of the results of successful investigations and prosecutions demonstrating the severe consequences for those found guilty.
At the time, that seemed like a tall order. Then, in April 2003, then-Chancellor of the Exchequer (now Prime Minister) Gordon Brown announced £66 million ($132 million) in funding over three years for a new compliance and enforcement initiative estimated to yield £1.6 billion of additional revenue. These funds were used in part to establish the Offshore Fraud Project Group (OFPG) in Bootle, a town in northwest England on the Irish Sea, conveniently close to the Isle of Man, a favorite location for offshore investors.
One of the first actions taken by the OFPG was to consult with the IRS. At the time the IRS had just succeeded in obtaining credit card information related to offshore bank accounts from domestic companies that process credit card transactions. Although the OFPG's initial approach was similar to that of the IRS, the British would soon surpass the Americans in the depth and scope of their offshore compliance initiative.
Making the Case
Mimicking the IRS, HMRC used domestic credit card information as its doorway into the offshore world. Its initial target was an unnamed financial institution whose customers used credit cards to access funds in offshore bank accounts, mostly in the Channel Islands (Jersey and Guernsey) and the Isle of Man. Transactions with those credit cards were processed in the U.K.
Under U.K. law (section 20(8A) of the Taxes Management Act 1970), before HMRC gets taxpayer information from a third party, the agency must get the approval of a special commissioner — a part-time magistrate specializing in tax law. On November 28, 2006, HMRC presented its arguments to Special Commissioner John Avery Jones for obtaining six years of information on 75,000 customers with offshore accounts. Among other legal requirements, HMRC had to demonstrate to the special commissioner that there were reasonable grounds for believing the cardholders had tax due and that the information sought was not readily available from another source.
In making its arguments, HMRC presented two interesting facts. First, information available to HMRC from other sources on 9,289 of the financial institution's customers showed that only 327, or 3.5 percent, had declared foreign interest on their tax returns. Second, HMRC estimated that it expected to collect revenue from 20 percent of the taxpayers in question and that the total yield from those 15,000 would be £347 million. On the basis of that information, Avery Jones opined that this was no "fishing expedition" and ruled in favor of HMRC on December 5, 2005.
It is in the next step of the process that HMRC veered from the path blazed by the IRS. While the U.S. tax collector followed up with summonses on large merchants to discover additional information — most important, mailing addresses — for cardholders, HMRC went after the U.K. banks with offshore subsidiaries. In February 2006 HMRC got approval from Avery Jones to obtain the banking records held in the U.K. of the accounts owned by U.K. residents in the financial institution's offshore subsidiaries. The financial institution was subsequently identified in press reports as U.K. banking giant Barclays. As a result of that latest action (also encompassing six years of data), HMRC estimated it would obtain £1.5 billion of additional revenue.
On December 14, 2006, HMRC presented four more "production notices" for consideration by Avery Jones. Again, the objective was onshore information about offshore accounts. HMRC estimated the tax yield from these inquiries would total £281 million. A ruling favorable to HMRC was issued on January 9, 2007. The four financial institutions were subsequently identified in the press as Halifax Bank of Scotland, Royal Bank of Scotland, HSBC, and Lloyds TSB.
The information HMRC obtained through these inquiries complements what it is getting through the EU savings directive that came into effect on July 1, 2005. The general idea behind the savings directive is that all EU members, as well as associated territories and some other European countries that voluntarily participate, will share information on all interest earned in the EU with the country where the EU account holder resides. Some countries and jurisdictions — primarily those that pride themselves on strict bank secrecy laws — opted to collect a 15 percent withholding tax in lieu of information sharing: Austria, Belgium, Luxembourg, Andorra, Liechtenstein, Monaco, San Marino, Switzerland, the British Virgin Islands, Gibraltar, the Netherlands Antilles, the Turks and Caicos Islands, and — most important for the U.K. — Guernsey, the Isle of Man, and Jersey. The withholding tax rate will increase to 20 percent on July 1, 2007, and to 35 percent on July 1, 2011.
But the information from the production orders is far more valuable to HMRC than the information from the savings directive. First of all, the production orders cover years before 2005. Second, the production orders provide information from countries not participating in the EU savings directive and from participating countries that opted for withholding instead of information exchange.
The U.K. Amnesty
On April 17, 2007, HMRC announced that U.K. residents that had not declared interest on their offshore accounts could use its Offshore Disclosure Facility program. In general, participants would be required to pay all tax and interest on undeclared offshore income for as far back as 20 years, plus a 10 percent penalty. The deadline for notifying HMRC was June 22. Following the initial notification, participants were also required to make full disclosure and pay all outstanding liabilities by November 26.
The penalty would be waived for disclosures of untaxed amounts totaling less than £2,500. Disclosures that were found to be materially incorrect would not be accepted. Disclosures from individuals already under investigation by HMRC would not be accepted. And disclosures from people suspected of being involved in serious tax crimes (like VAT carousel fraud) or other serious crimes would not be accepted.
Most important, HMRC announced that after June 22 it intended to target remaining offshore evaders by investigating mismatches between tax records and information obtained from banks and through the EU savings directive. Then, instead of the 10 percent penalty available under the disclosure facility, penalties would range from 30 percent to 100 percent.
With HMRC holding all the cards, tax experts quoted in the press strongly urged evaders to take advantage of the offer. "Taxpayers should beware of ignoring this offer, as the Revenue does now have the details of a great number of people with offshore accounts," warned Tim Gregory, a partner with the accounting firm Saffery Champness. "This is an offer that only a fool would turn down," said Noshir Avari of Avari & Associates. Registering for the facility would be a "no-brainer," commented Reg Day, national director for tax investigations at KPMG.
Nevertheless, the process got off to a slow start. More than halfway through the two-month amnesty, only 2,000 U.K. residents had registered. Information gathered from the production orders to the five banks revealed 400,000 account holders. In early June HMRC sent warning letters to 200,000 of those foreign account holders. (Account holders whose information was not solid — for example, those that had out-of-date addresses — were not sent letters.) Still, one week before the deadline, only 11,000 had registered. In the face of that lackluster result, many tax professionals criticized HMRC's handling of the amnesty. In particular, they believed HMRC had not done enough to publicize the amnesty.
Citing reports of tax amnesties from other countries, HMRC repeatedly asserted there would be a surge in filing right up to the June 22 midnight deadline. Despite widespread doubts, HMRC was correct. Three days before the deadline, the BBC reported that the total had risen to 25,000 registrations. And, as predicted by HMRC, the last few days saw a flurry of activity. Gabriel Rozenberg of The Times reported on June 23 that as the amnesty period came to a close, between 55,000 and 60,000 people had opted to register. And, at the time of the deadline, a leading U.K. financial journal reported a grand total of more than 60,000 disclosures (Kevin Reed, Accountancy Age, June 22, 2007).
Comparison to the U.S. Amnesty
In a series of actions from October 2000 to August 2002, U.S. federal courts granted authority to the IRS to serve summonses on American Express, MasterCard, and Visa International for information on U.S. holders of credit cards issued by banks in tax haven countries. In many cases the summonses provided only the names of foreign corporations and trusts that were listed as owners of the accounts. To get the names of individuals using the cards, the IRS took the additional step of seeking information from 40 big-name retailers that could identify from existing records purchasers using the credit cards. In August and October 2002, the IRS obtained authorization from federal district courts to issue summonses for those data. The IRS referred to all this data gathering as the Offshore Credit Card Program (OCCP).
On January 14, 2003, the IRS launched the OVCI with the aim of getting taxpayers with undisclosed offshore accounts into compliance with U.S. law. Under the OVCI, taxpayers who came forward would pay back taxes with interest. And for them, penalties would be reduced. Also, participants in the program had to provide details on promoters of offshore financial arrangements. Taxpayers who failed to come forward would be subject to more significant penalties and possible criminal sanctions. The OVCI registration period lasted approximately three months — until April 15, 2003.
The latest available IRS figures (from February 2004) indicate that the IRS received 1,321 applications to the OVCI. That's about 2 percent of the 60,000 received by the HMRC for its offshore amnesty. Even more disappointing, the 1,300 figure is probably too high. In 2004 the GAO reported that about 400 of those applications may be regarded as being double-counted because they were from corporations and trusts owned by individuals who were also in the program. (See the second part of "Taxpayer Information: Data Sharing and Analysis May Enhance Tax Compliance and Improve Immigration Eligibility Decisions," statement of Michael Brostek before the Senate Finance Committee, July 21, 2004, Doc 2004-14934 , 2004 TNT 141-46).) According to these figures, the HMRC's amnesty was a huge success compared with the OVCI.
Of course, an amnesty program cannot be judged solely by the number of takers. The IRS points out that the OVCI over time yielded more than $250 million in taxes, interest, and penalties to the U.S. treasury. In addition, the effort led to obtaining the names of 479 scheme and scam promoters. Nearly half of those promoters were previously unknown to IRS investigators. Comparable information about the direct and indirect benefits of the U.K. amnesty is not yet available.
In June 2003 the IRS initiated the Last Chance Compliance Initiative, similar to the OVCI, and as part of that program it mailed letters to taxpayers who were identified as having offshore credit cards but who did not participate in OVCI. Since 2004 the IRS has greatly ramped down the amount of publicity it gives to offshore compliance. Little further information is available about either the OVCI or the Last Chance Compliance Initiative. The latest entry on the IRS's Web page devoted to offshore compliance (entitled "Offshore Tax-Avoidance Schemes and IRS Compliance Efforts," at http://www.irs.gov/newsroom) is dated February 2004. Given that press coverage about catching tax cheats is a basic tactic used by tax collectors around the world, we may deduce from this lack of information that the news — from the IRS's perspective — is not good.
There are a couple of exceptions to this deafening silence. On October 6, 2006, Paul Butler of the IRS chief counsel's office said the OCCP compliance initiative "is still going strong today" (Lisa M. Nadal, "IRS Official Discusses Enforcement Initiatives," Tax Notes, Oct. 16, 2006, p. 200, Doc 2006-20909 , or 2006 TNT 195-6 ). Butler added that approximately 1,200 revenue agents were trained to participate in the OCCP and that there were about 1,500 investigations still pending as a result of summonses related to offshore credit cards.
In August 2006 Senate testimony, then-IRS Commissioner Mark Everson compared the OVCI unfavorably with the IRS initiative, announced in June 2004, to rein in taxpayers using a tax shelter known as son-of-BOSS (see Doc 2006-14493 or 2006 TNT 148- 37 ). More than 1,200 taxpayers — about two-thirds of those eligible — participated in that program. The total revenue collected in the form of tax, penalties, and interest topped $3.7 billion. The key factor in that program's success was information. Everson emphasized that the IRS had a "known population of taxpayers," and so "all non-electing taxpayers involved in these transactions were identified and are the subject of current examinations." The relative lack of success of the OVCI was due to a lack of information. Everson told the senators:
In reality, we did not have a good idea of the potential universe of individuals covered by this initiative. As a result, the incentive for taxpayers to come forward and take advantage of this initiative was diminished due to the fact that we did not have the ability to identify immediately and begin examinations for all non-participating individuals.
So it appears that until the IRS gets data on offshore accounts as good as the HMRC is getting from U.K. banks (as a result of production orders) and from EU banks (as a result of the savings directive), the U.S. effort to curtail offshore tax evasion is in a state of limbo.
To stimulate discussion on what might be done to remedy the IRS problem with offshore compliance, here are some preliminary suggestions:
Increase information exchange. The U.S. has had a tax information exchange agreement with the Cayman Islands since late 2001. The Cayman Islands is probably the number one location for U.S. taxpayers that want to hide money offshore for tax purposes. The Cayman TIEA provides for only limited information exchange. In effect, U.S. authorities must already have a strong suspicion that a specific crime has been committed before they can make a request. If the agreement were renegotiated so that information exchange was large-scale and automatic, as it is with many other jurisdictions, there would be a tremendous expansion of IRS knowledge of offshore activity.
Participate in the EU savings directive. A sovereign nation does not have to be a member of the EU to join the EU savings directive. Lichtenstein and Switzerland are examples. By allying itself with EU tax evasion efforts, the U.S. could significantly reduce the advantages to its taxpayers of not reporting interest on accounts in such favorite tax havens as Switzerland, Lichtenstein, Austria, Jersey, Guernsey, and the Isle of Man.
Require registration by offshore promoters. The prime targets of the OVCI were promoters of offshore investments and their client lists. If a practical definition of offshore promoter could be devised and those individuals or companies were required to register with the government, it would give the IRS an easy access point into the offshore world. Under some conditions, that could have the additional benefit of reducing scams in which funds are stolen from offshore investors.
Offer rewards. The IRS could pay people for information about clandestine offshore investments. Good prospects for this financial incentive would include former employees of an offshore promoter or a former spouse of an offshore investor.
Increase IRS funding for investigations. There is a backlog of IRS investigations into offshore noncompliance, and tax evaders know it. If funding for investigators were increased, taxpayers calculating the odds for and against noncompliance would be less likely to opt for evasion.
Market more effectively. Taxpayers who neglect paying tax on offshore income out of ignorance must be educated. Taxpayers who do it on purpose need to be scared. In conjunction with the above efforts, the IRS should target advertising to each group.
Editor's note: Please e-mail your comments on these proposals or your own suggestions for curbing offshore evasion to firstname.lastname@example.org.