Application of Offshore Penalty to Business Ownership Interests

In another essay, I previously discussed the possible inclusion of the business ownership interests in the calculation of the OVDP (2012 Offshore Voluntary Disclosure Program) Offshore Penalty.  In this article, I would like to explore in more depth the application of the Offshore Penalty to ownership of business interests.

OVDP Offshore Penalty

It is a requirement of the OVDP that the taxpayers who enter the program pay the Offshore Penalty. This penalty is imposed in lieu of all other penalties that may apply to the taxpayer’s undisclosed foreign assets and entities, including FBAR and offshore-related information return penalties and tax liabilities for years prior to the voluntary disclosure period. The default penalty rate is 27.5% (in limited cases, the penalty is reduced to 12.5% or 5%) of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the period covered by the voluntary disclosure.

The Offshore Penalty calculation includes business ownership interests related to tax noncompliance. Tax noncompliance includes failure to report income from the assets, as well as failure to pay U.S. tax that was due with respect to the funds used to acquire the asset.

Business Ownership Interests Are Included in the Offshore Penalty; Limited Exceptions

As I previously discussed, the Offshore Penalty is much broader than simply the FBAR penalty. Among other items, the Offshore Penalty encompasses ownership interest in businesses related to income tax non-compliance or acquired by tainted funds (i.e. funds that were subject to U.S. tax but on which no such tax was paid; the definition also includes funds derived from illegal sources such as criminal and terrorist activities).

There are exceptions to this rule, however. Two most prominent exceptions deserve to be emphasized here. First, where a business interest was not obtained by tainted funds and there are no under-reported U.S. tax liabilities, the taxpayer is likely to be able to exclude the business interest from the Offshore Penalty.

Second, the OVDP rules carve out a limited exception for U.S. taxpayers who are foreign residents and quality for the third category of 5% penalty rate. For these taxpayers only, the IRS stated that the offshore penalty will not apply to non-financial assets, such as real property, business interests, or artworks, purchased with funds for which the taxpayer can establish that all applicable taxes have been paid, either in the U.S. or in the country of residence. This exception only applies if the income tax returns filed with the foreign tax authority included the offshore-related taxable income that was not reported on the U.S. tax return.

Obviously, the determination of whether either of these two exceptions (or any other exception) applies in your individual case should only be determined by an international tax attorney experienced in the area of offshore voluntary disclosures.

Major Types of Business Ownership Interests Covered by the Offshore Penalty

The biggest category of business ownership interests covered by the Offshore Penalty includes ownership of foreign entities for which information returns, such as Forms 5471, 8865, 8858, 926 and so on, should have been filed by the non-compliant taxpayer. Most often, this category includes ownership of closely-held foreign corporation, interest in the controlled foreign partnership and contribution of property to a foreign corporation.

Notice that, even if the business entity controlled by the taxpayer is not itself tax non-compliant, but it holds the assets which are non-compliant (usually because they were purchased by using tainted funds), the entire ownership interest in the business entity may be exposed to the Offshore Penalty.

Another type of business interest that is often subject to Offshore Penalty involves business entities that are virtually indistinguishable from its owners. In situations where a business entity is an alter ego or nominee of the taxpayer, the IRS may determine that the Offshore Penalty should be applied to the underlying assets of the entity.

The most spectacular reach of the OVDP, however, is the possibility of involving domestic entities. In spite of having “Offshore” in its name, the Offshore Penalty can actually apply to ownership of U.S. businesses acquired with tainted funds. This is a critically-important consideration for non-compliant U.S. taxpayers who repatriated tainted funds back to the United States and invested them into U.S. businesses.

Contact Sherayzen Law Office for Help With Your Voluntary Disclosure of Offshore and Domestic Business Ownership Interests

Sherayzen Law Office can help you with the disclosure of any of your foreign assets, including Offshore and Domestic business ownership interests. Our international tax law firm is highly experienced in conducting offshore voluntary disclosures of business interests. We will thoroughly analyze your case, assess your tax liability as well as the liability that you would face under the OVDP, determine the available disclosure options and implement the disclosure strategy (including preparation of all legal and tax documents as well as IRS representation).

Contact Sherayzen Law Office to schedule your consultation!