Related-Statute IRC §6103(h) Violation As a Defense Against FBAR Audit

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International tax lawyers should focus not only on substantive, but also on procedural defenses against the results of an FBAR audit. One such potential defense against FBAR audit is a related-statute IRC §6103(h) violation.

Related-Statute IRC §6103(h) Violation: Background Information

In a previous article, I already discussed the fact that IRC §6103(a) limits somewhat the ability of the IRS to use tax returns in an IRS FBAR Audit, because IRC §6103(a) designates all tax return information as confidential. However, IRC §6103(h) provides a limited exception to IRC §6103(a) by allowing IRS employees the disclosure of tax return information for the purposes of tax administration.

Under IRC §6103(b)(4), tax administration is interpreted broadly to cover administration, management and supervision of the Internal Revenue Code and “related statutes”. This means that, if the IRS determines that the Bank Secrecy Act (“BSA”) is a related statute for the purposes of a particular FBAR audit, it can release the tax return information to be used against the taxpayer.

The IRS will deem the BSA as a related statute only if there is a good-faith determination that a BSA violation was committed in furtherance of a Title 26 violation or if such a violation was part of a pattern of conduct that violated Title 26. See IRM 4.26.14.2.3 (07-24-2012). In other words, the tax violation and the FBAR violation has to be related in order for the IRS to disclose tax return information to be utilized in an IRS FBAR Audit.

Related-Statute IRC §6103(h) Violation: Procedural Aspects of Related-Statute Determination

The Internal Revenue Manual (“IRM”) sets forth very specific procedures for making a related-statute determination in the preparation of an IRS FBAR Audit. Generally, this is a two-step process.

First, the examiners are required to prepare a Form 13535, Foreign Bank and Financial Accounts Report Related Statute Memorandum, to establish why the IRS believes that an apparent FBAR violation was in furtherance of a Title 26 violation. Form 13535 must describe tangible objective factors and provide adequate documentation.

Then, Form 13535 goes to the examiner’s Territory Manager. The Territory manager should make his decision at that point. If he believes that the related-statute test was not met, tax returns and return information may not be disclosed for the purposes of starting an IRS FBAR Audit. On the other hand, if the Territory Manager determines that the apparent FBAR violation was in furtherance of a Title 26 violation, then all of the tax returns and tax return information will be released to the IRS agent who conducts the audit.

Can Related-Statute IRC §6103(h) Violation Be Utilized as a Defense in FBAR Audit?

We are now about to answer the question that is at the center of this article: if the IRS fails to follow the IRM procedures for related-party determination pursuant to IRC §6103(h), can it be used as a defense in FBAR Audit? Perhaps, the best way to answer the question above is to look at an analogy of whether the failure to follow IRM procedures for related-party determination under IRC §6103(h) can be utilized to support a claim for damages for unauthorized disclosure under IRC §7431.

Generally, the failure by the IRS to follow IRM procedures and make a related-party determination is likely to be insufficient to support a claim under IRC §7431. In Hom v. United States, 2013 U.S. Dist. LEXIS 142818, 2013-2 U.S. Tax Cas. (CCH) P50,529, 112 A.F.T.R.2d (RIA) 6271, 2013 WL 5442960 (N.D. Cal. 2013), aff’d, 645 Fed. Appx. 583, 2016 U.S. App. LEXIS 5528, 117 A.F.T.R.2d (RIA) 1119, 2016 WL 1161577 (9th Cir. Cal. 2016), the court held that the failure of the IRS to make a related-statute determination as required by the IRM did not provide the plaintiff with a claim for damages under IRC §7431. Rather, a plaintiff would have to prove that the failure to file an FBAR was clearly not in furtherance of a Title 26 violation – i.e. the plaintiff would have to prove that BSA was not a related statute in his case.

If we use this analogy, then it seems that the procedural failures by the IRS to follow the related-party determination under IRC §6103(h) would not be sufficient to be used as a defense in an IRS FBAR Audit. There is a possibility, however, that if the FBAR violation was clearly not related to Title 26, then it may be used as a defense to exclude evidence.

Contact Sherayzen Law Office for Help with Your FBAR Audit

If your FBARs are being audited by the IRS, contact Sherayzen Law Office for professional help. Sherayzen Law Office is an international tax law firm that is dedicated to helping businesses and individuals with their US international tax obligations, including FBARs. We have helped hundreds of US taxpayers around the world and we can help you!

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Guilty Pleas for Secret Swiss-Israeli Bank Accounts | FATCA Lawyer

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On January 18, 2017, three US taxpayers pleaded guilty for hiding millions of dollars in their secret Swiss and Israeli bank accounts (hereinafter “Swiss-Israeli Bank Accounts”) and failing to report these Swiss-Israeli Bank Accounts on their FBARs.

Facts of the Case Involving Secret Swiss-Israeli Bank Accounts

All three defendants are relatives – Mr. Dan Farhad Kalili and Mr. David Ramin Kalili are brothers while Mr. David Shahrokh Azarian is their brother-in-law. They are all residents of Newport Coast, California.

According to the documents filed with the court and statements made in connection with the defendants’ guilty pleas, between May 1996 and 2009, Mr. Dan Kalili opened and maintained several undeclared offshore bank accounts at Credit Suisse and UBS in Switzerland. Similarly, Mr. David Kalili opened and maintained several undeclared accounts at Credit Suisse from February 1999 through at least 2009. He also owned several undeclared accounts at UBS from October 1993 through at least 2008. The brothers also maintained joint undeclared Swiss bank accounts at both UBS and Credit Suisse beginning in 2003 and 2004, respectively.

At the same time, Mr. Azarian opened and maintained several undeclared accounts at Credit Suisse from May 1994 through at least 2009. He also owned several accounts at UBS in Switzerland from April 1997 through at least 2008.

In 2006, we had the appearance of the now famous Ms. Beda Singenberger, a Swiss citizen who owned and operated a financial advisory firm called Sinco Truehand AG. She was indicted in New York on July 21, 2011. The charges were: conspiring to defraud the United States, evade U.S. income taxes, and file false U.S. tax returns. Ms. Singenberger remains a fugitive as of the time of this writing.

In July of 2006, Mr. Dan Kalili, with the assistance of Ms. Singenberger, opened an undeclared account at UBS in the name of the Colsa Foundation, a Liechtenstein entity. As of May 2008, the Colsa Foundation account at UBS held approximately $4,927,500 in assets.

In light of the increased IRS tax enforcement and the UBS case, all three defendants attempted to partially hide their prior ownership of Swiss accounts by moving the assets from one account to another. At the same time, they also tried to legitimize partial ownership of their assets.

Mr. Dan Kalili opened an undeclared account at Swiss Bank A in the name of the Colsa Foundation and in May 2008 and transferred his assets from the UBS Colsa Foundation account to Swiss Bank A. He then made partial disclosure of the Swiss Bank A Colsa account on his individual income tax returns. In 2009, Mr. Dan Kalili opened undeclared accounts at Israeli Bank A and at Bank Leumi, both in Israel. He then closed his joint (with his brother) Credit Suisse account and his own undeclared account and transferred all funds to Israel.

At that time of its closure, the undeclared joint account of Dan and David Kalili at Credit Suisse held approximately $2,561,508 in assets. As of December 2009, Dan Kalili’s undeclared account at Israeli Bank A had the approximate value of $1,569,973 and his undeclared account at Bank Leumi was valued at approximately $2,497,931.

Mr. David Kalili followed almost the same pattern. In August of 2008, he opened an account at Israeli Bank A in Israel and transferred to this account all of his funds from his UBS accounts. He later partially declared the Israeli Bank A account on his individual income tax returns. As of August 2009, Mr. David Kalili’s undeclared account at Israeli Bank A held assets valued at approximately $1,369,489.

Finally, Mr. Azarian also opened an account at Israeli Bank A in Israel in August of 2008. In May of 2009, he closed his Credit Suisse account and transferred all funds to his Israeli account. At the time of its closure, Mr. Azarian’s undeclared account at Credit Suisse held assets valued at approximately $1,903,214.

Neither of the three defendants ever filed an FBAR for their secret Swiss-Israeli Bank Accounts on their FBARs during any of the years 2006-2009.

Criminal and Civil Penalties Imposed For Failure to Declare Foreign Income and Swiss-Israeli Bank Accounts

According to the plea agreements, the criminal and civil penalties were severe. Mr. Dan Kalili, Mr. David Kalili and Mr. Azarian each face a statutory maximum sentence of five years in prison, a period of supervised release and restitution for 2003-2009 tax loss and monetary penalties. The defendants also admitted to committing civil fraud, which exposes them to additional civil fraud penalty.

In addition, each defendant agreed to pay a willful FBAR civil penalty in the amount of 50% of the highest balances of their undeclared Swiss-Israeli Bank Accounts. Mr. Dan Kalili agreed to pay the FBAR penalty of $2,674,329, Mr. David Kalili agreed to pay the FBAR penalty of $1,325,121 and Mr. Azarian agreed to pay the FBAR penalty of $951,607.

Lessons to Be Learned from the Defendants’ Handling of Their Undeclared Swiss-Israeli Bank Accounts

This case is a classical example of what not to do if one wishes to avoid criminal prosecution. Let’s point out five main mistakes which exposed the taxpayers to the IRS criminal prosecution.

The first mistake is obvious – the defendants willfully failed to declare their Swiss-Israeli bank accounts on their FBARs and the income generated by these accounts on their US tax returns.

The deleterious impact of the first mistake was magnified by the usage of an offshore shell corporation to hide the ownership of the Swiss-Israeli bank accounts (while the entity was concerned mostly with Swiss accounts, it was also used to hide the source of funds on the defendants’ Israeli bank accounts).

Third, the defendants engaged in the evasive pattern of opening and closing foreign accounts in various banks in order to hide them from the IRS. The defendants obviously underestimated the IRS ability to track these accounts and ended up giving the IRS additional powerful indirect evidence of intent to evade taxes and the willfulness of their failures to file FBARs.

Fourth, the taxpayers engaged in partial voluntary disclosure outside of any actual voluntary disclosure program. By doing partial disclosure, the taxpayers provided additional evidence to the IRS of their knowledge of the requirement to report foreign income and properly complete Schedule B. At the same time, the fact that their disclosure was only partial further emphasized the willfulness of their prior failure to disclosure foreign income and foreign assets. The readers should remember that a voluntary disclosure must always be accurate and complete; otherwise, the taxpayers simply give the IRS more evidence of willfulness of their tax noncompliance.

Finally, it does not appear that the taxpayers ever considered doing a true voluntary disclosure which could have limited their penalties and prevented the IRS criminal prosecution. One of the first thing that the taxpayers should always consider once they find out about their noncompliance or the possibility of the IRS detection of such noncompliance is to retain an international tax lawyer to review their voluntary disclosure options. The taxpayers failed to do so in this case and paid a very high price.

Contact Sherayzen Law Office for Professional Help with the Voluntary Disclosure of Your Foreign Income and Foreign Assets, including Swiss-Israeli Bank Accounts

If you have undisclosed foreign income and foreign assets, you should contact Sherayzen Law Office for professional help as soon as possible. Our international tax law firm has successfully helped hundreds of US taxpayers around the world to bring their tax affairs into full compliance with US laws and we can help you!

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Taxation of Royalties Ceases Under Estonia-UK Tax Treaty | MN Tax Lawyer

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On January 18, 2017, the HM Revenue & Customs announced that the withholding tax on royalties under the 1994 Estonia-UK tax treaty has been eliminated retroactively as of October 16, 2015.

Under the original Estonia-UK tax treaty, the rates had been 5 percent for industrial, commercial, and scientific equipment royalties and 10 percent in other cases. However, paragraph 7 of the Exchange Notes to the Treaty contains the Most Favoured Nation” (MFN) provision relating to royalties (Article 12). Under the MFN provision, UK tax residents only need to pay the lowest tax withholding rate ever agreed by Estonia in a Double-Taxation Treaty (DTA) it later agrees with an OECD member country that was a member when the UK-Estonia tax treaty was signed in 1994.

It turns that Switzerland was an OECD member country in 1994. In 2002, Estonia signed a tax treaty with Switzerland, but the treaty did not impact the UK withholding tax rate at that time. In 2014, however, Estonia and Switzerland signed an amending protocal to the 2002 Estonia-Switzerland tax treaty. Under the protocol, the treaty was revised to provide for only resident state taxation of royalties.

It was this provision in the 2014 protocol to the Estonia-Switzerland tax treaty that triggered the 1994 MFN provision of the Estonia-UK tax treaty. Therefore, when the 2014 protocol entered into force on October 16, 2015, it effectively eliminated tax withholding on royalties not only in Switzerland (wth respect to Estonia), but also in the United Kingdom. While the taxation of royalties under the Estonia-UK tax treaty ceased on October 16, 2015, the HM Revenue & Customs waited for more than a year to announce it on January 18, 2017.

It should be pointed out that MFN provisions, such as the one in Estonia-UK tax treaty, quite often have an important impact throughout the treaty network of a country. This ripple effect of the MFN provisions creates enormous opportunities for international tax planning that is often utilized by international tax lawyers, including US international tax law firms such as Sherayzen Law Office, Ltd.

Belarus-Hong Kong Tax Treaty Signed | MN International Tax Attorney

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On January 16, 2017, the Belarus-Hong Kong Tax Treaty was signed by government officials from both countries – K.C. Chan, Hong Kong’s secretary for financial services and the treasury, and Sergei Nalivaiko, Belarusian minister of taxes and duties. Let’s explore the most important provisions of the new Belarus-Hong Kong Tax Treaty.

Elimination of Double-Taxation Under the Belarus-Hong Kong Tax Treaty

The new tax treaty will provide real benefits to businesses and individuals in both countries. In the absence of the treaty, the profits of Hong Kong companies earned through a permanent establishment in Belarus would be taxed in Belarus and Hong Kong. Similarly, prior to the treaty, the income earned by Belarusian companies in Hong Kong would be subject to both, Belarusian and Hong Kong taxation.

The Belarus-Hong Kong Tax Treaty will now eliminate the risk of double taxation by allowing Belarusian companies to claim a tax credit for taxes paid in Hong Kong. Similarly, Hong Kong companies will be able to claim tax credit for taxes paid in Belarus.

Belarus-Hong Kong Tax Treaty: Taxation of Dividends, Interest and Royalties

The new treaty establishes a 5% maximum tax rate for dividends and interest payments. This is a large reduction from the current highest rate of 13%. Moreover, in certain cases (mainly Hong Kong or Belarusian government-owned entities), dividends and interest are entirely exempt from taxation.

Additionally, under the new treaty, the royalties will generally be taxed also at 5%. However, if the royalties are paid for the use of (or the right to use) aircraft, then the tax withholding rate is further reduced to 3%. Again, this is a major reduction from the current highest rate of 15%.

Belarus-Hong Kong Tax Treaty: Concessions to Hong Kong Airlines

The special reduction for aircraft-related royalties is a major concession to Hong Kong Airlines, but it is not the only one. Additionally, Belarus agreed that Hong Kong Airlines operating flights to Belarus will be taxed at Hong Kong’s corporation tax rate. Furthermore, the profits from international shipping transport earned by Hong Kong residents that arise in Belarus (and which are currently taxed in Belarus) will now fully escape Belarusian taxation.

Belarus-Hong Kong Tax Treaty: Other Provisions and Entry into Force

The new treaty contains a number of other provisions regulating taxation of capital gains, pensions, government salaries and other income. Additionally, Article 25 of the treaty provides for exchange of tax-related information between Belarus and Hong Kong. This provision may have an unintended consequence for US tax residents who operate in Belarus and Hong Kong, because some information exchanged between Belarus and Hong Kong may be further provided to the United States under Hong Kong’s FATCA tax information exchange obligations.

The Belarus-Hong Kong Tax Treaty will enter into force once both sides complete their own ratification procedures.