USA — Disclosure of Foreign Accounts and Offshore Voluntary Disclosure Program (OVDP)

Background

According to
the provisions of the Internal Revenue Code of 1986 (IRC) as amended, of
the USA, all U.S. residents, green-card holders and citizens must file
their tax returns in the U.S. on their global income and pay taxes on
that income in the U.S. The penalties for failure to pay tax on global
income in the U.S. can be quite severe. This includes penalty for
failure to file return of income in time, failure to pay the taxes by
the due dates and levy of interest for delay in payment of taxes.

In
order to ensure that all the U.S. taxpayers comply with the provisions
of the IRC, the followings additional reporting requirements for
offshore income have been prescribed:

(b) Accordingly, U.S. residents or persons in and
doing business in the U.S. must file a report with the government if
they have a financial account in a foreign country with a value
exceeding INR614,567 at any time during the calendar year. Taxpayers
comply with this law by reporting the account on their income tax return
and by filing Form TD F 90–22.1, the Report of Foreign Banks and
Financial Accounts (FBAR). The FBAR must be received by the Department
of the Treasury on or before June 30th of the year immediately following
the calendar year being reported. The June 30th filing date may not be
extended. Willfully failing to file a FBAR can be subject to both
criminal sanctions (i.e., imprisonment) and civil penalties equivalent
to the greater of INR6,145,675 or 50% of the balance in an unreported
foreign account — for each year since 2004 for which an FBAR was not
filed.

B. Statement of Specified Foreign Financial Assets under the Foreign Account Tax Compliance Act (FATCA) — Form 8938

(a)
The FATCA, enacted in 2010 as part of the Hiring Incentives to Restore
Employment (HIRE) Act, is an important development in U.S. efforts to
combat tax evasion by U.S. persons holding investments in offshore
accounts.

Under FATCA, certain U.S. taxpayers holding financial
assets outside the United States must report those assets to the IRS. In
addition, FATCA will require foreign financial institutions to report
directly to the IRS certain information about financial accounts held by
U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a
substantial ownership interest.

(b) Reporting by U.S. Taxpayers Holding Foreign Financial Assets

FATCA
requires certain U.S. taxpayers holding foreign financial assets with
an aggregate value exceeding INR3,072,837 to report certain information
about those assets on a new form (Form 8938 — Statement of Specified
Foreign Financial Assets) that must be attached to the taxpayer’s annual
tax return. Reporting applies for assets held in taxable years
beginning after March 18, 2010. For most taxpayers this will be the 2011
tax return they file during the 2012 tax filing season. Failure to
report foreign financial assets on Form 8938 will result in a penalty of
INR614,567 (and a penalty up to INR3,072,837 for continued failure
after IRS notification). Further, underpayments of tax attributable to
non-disclosed foreign financial assets will be subject to an additional
substantial understatement penalty of 40 percent.

(c) Reporting by Foreign Financial Institutions

FATCA
will also require foreign financial institutions (‘FFIs’) to report
directly to the IRS certain information about financial accounts held by
U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a
substantial ownership interest. To properly comply with these new
reporting requirements, an FFI will have to enter into a special
agreement with the IRS by June 30, 2013. Under this agreement a
‘participating’ FFI will be obligated to:

(i) undertake certain identification and due diligence procedures with respect to its accountholders;

(ii)
report annually to the IRS on its accountholders who are U.S. persons
or foreign entities with substantial U.S. ownership; and

(iii)
withhold and pay over to the IRS 30% of any payments of U.S. source
income, as well as gross proceeds from the sale of securities that
generate U.S. source income, made to

(a) non-participating FFIs,

(b) individual ac-countholders failing to provide sufficient information to determine whether or not they are a U.S. person, or

(c) foreign entity accountholders failing to provide sufficient information about the identity of its substantial U.S. owners.

(d)
Form 8938 is and will be a significant tool for the IRS to identify the
scope of international tax non-compliance of a given U.S. taxpayer. The
reason why Form 8938 is so useful for the IRS is that Form 8938 now
requires a taxpayer to disclose more information, which connects various
parts of a taxpayer’s international tax compliance including the
information that escaped disclosure on other forms earlier.

(e)
Form 8938, allows the IRS to effectively identify the overall scope of a
taxpayer’s noncompliance. Form 8938 may lay the foundation (and road
map) for an IRS investigation of whether the taxpayer has been in
compliance previously. For example, Question 3a of Form 8938 indirectly
asks a problematic question: it requires the taxpayer to tick the box
‘account opened during tax year’, if the account is opened during the
tax year.

(f) For older accounts, this is a dangerous question.
Answering that the account was not opened in the tax year, implicitly
(and affirmatively by omission) states that account was opened in a
prior year. As a result, prior years FBARs should have been filed. The
answer to question 3a could provide incriminating evidence to the IRS.

(g)
The IRS is tracking foreign accounts in all countries, but thanks to
recent indictments of account-holders in countries like Switzerland and
India (several HSBC India account-holders have been indicted), there
could be increased focus on these countries.

(h) For Basic
Questions and Answers on Form 8938, the interested reader can refer to
the IRS website link at www.irs.gov/businesses/
corporations/article/0,,id=255061,00.html.

Offshore Voluntary Disclosure Program (OVDP)

For years, the IRS has been pursuing the disclosure of information regarding undeclared interests of U.S. taxpayers (or those who ought to be U.S. taxpayers) in foreign financial accounts. On January 9, 2012, the IRS announced yet another Offshore Voluntary Disclosure Program (the 2012 OVDP) following the success of the 2009 Offshore Voluntary Disclosure Program (the 2009 OVDP) and the 2011 Offshore Voluntary Disclosure Initiative (the 2011 OVDI), which were announced many years after the 2003 Offshore Voluntary Compliance Initiative (OVCI) and the 2003 Offshore Credit Card Program (OCCP).

The OVDP programs basically eliminate the risk of criminal prosecution for taxpayers that are accepted into the program, and provide for reduced civil penalties than would apply if the IRS were to discover the taxpayer’s non-compliance in this area. In part, the success of such initiatives often depends on the perception that strong government tax enforcement efforts will follow.

2012 OVDP — Salient features

(a)    The IRS on 9th January, 2012 reopened the OVDP to help people hiding offshore accounts get current with their taxes.

(b)    The program is similar to the 2011 OVDI program in many ways, but with a few key differences. Unlike 2011 OVDI, there is no set deadline for people to apply. However, the terms of the program could change at any time going forward. For example, the IRS may increase penalties in the program for all or some taxpayers or defined classes of taxpayers — or decide to end the program entirely at any point.

(c)    The overall penalty structure for the 2012 OVDP is the same as was for 2011 OVDI, except for taxpayers in the highest penalty category. For the 2012 OVDP, the penalty framework requires individuals to pay a penalty of 27.5% of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the eight full tax years prior to the disclosure. That is up from 25% in the 2011 OVDI. Some taxpayers will be eligible for 5 or 12.5% penalties; these remain the same in the 2012 OVDP as in 2011 OVDI. Smaller offshore accounts will face a 12.5% penalty. People whose offshore accounts or assets did not surpass $75,000 in any calendar year covered by the 2012 OVDP will qualify for this lower rate. As under the prior programs, taxpayers who feel that the penalty is disproportionate may opt instead to be examined.

(d)    Participants must file all original and amended tax returns and include payment for back-taxes and interest for up to eight years as well as pay accuracy-related and/or delinquency penalties.

Who should take advantage of the OVDP?

Taxpayers who have undisclosed offshore accounts or assets are eligible to apply for the 2012 OVDP penalty regime.

Taxpayers who reported and paid tax on all their taxable income but did not file FBARs, should not participate in the 2012 OVDI but should merely file the delinquent FBARs with the Department of Treasury, Post Office Box 32621, Detroit, MI 48232-0621 and attach a statement explaining why the reports are filed late. Under the 2011 OVDI, the IRS agreed not to impose a penalty for the failure to file the delinquent FBARs if there were no underreported tax liabilities and taxpayers filed the FBARs by September 9, 2011 (FAQ 17). Presumably, the IRS will follow the same course under the 2012 OVDP since those with no underreported tax liabilities are not truly within the range of taxpayers the IRS is trying to identify.

However, those taxpayers who have failed to report their foreign income altogether, might consider taking the advantage of 2012 OVDP. The ability of a U.S. taxpayer to maintain an undisclosed, ‘secret’ foreign financial account is fast becoming impossible. Foreign account information is flowing into the IRS under tax treaties, through submissions by whistleblowers, from others who participated in the 2009 OVDP and the 2011 OVDP who have been required to identify their bankers and advisors.

It does not matter if the failure to report foreign income or tax evasion was unintentional. For many years the IRS has, as part of the tax return in Schedule B of the Form 1040 — U.S. Individual Income Tax Return, had asked for information on foreign bank accounts and hence a taxpayer is expected to be aware of this.

Additional information will become available as the FATCA and new mandatory IRS Form 8938 — Statement of Specified Foreign Financial Assets has become effective. Under such circumstances, the decision to apply for 2012 OVDP involves fair bit of risk management. Although the 2012 OVDP penalty regime may seem overly harsh for many, the decision to participate should include an economic analysis of the taxpayer’s projected future earnings that could be generated from the foreign funds. It is important to note that if a taxpayer is discovered before any voluntary disclosure submission, there could be harsh criminal (in addition to civil) penalties. The risks may outweigh the benefits.

For those taxpayers at substantial risk of being treated as willful non-filers by the IRS, the OVDP’s fixed civil penalties, generally, are substantially lower than the potential maximum willful penalties. Therefore, filing under the OVDP generally should be a good deal for such taxpayers.

For those few taxpayers, however, who have credible and strong reasonable cause arguments to avoid penalties completely, the fixed penalties of the OVDP program generally do not appear to be an attractive option.

For the vast majority of taxpayers who fall somewhere in between (i.e., clearly not a willful non-filer, but also no credible reasonable cause arguments), the decision becomes a difficult one of number-crunching and comparing all possible outcomes, followed by risk-tolerance and risk-aversion based choices from amongst those possible outcomes in deciding which course to follow. Anyone considering an OVDP submission must carefully examine all potential civil penalties and evaluate the risk of criminal prosecution.

Options available to taxpayers

Taxpayers who have not disclosed their foreign assets and wishing to come into compliance, have the following two options:

(a)    a formal disclosure through the IRS’s standard voluntary disclosure program (a ‘noisy disclosure’) or

(b)    simply trying to file prior year original or amended returns and hope they slip through the cracks and don’t get audited (a ‘silent disclosure’).

Taxpayers must be clearly aware that the IRS is getting more aggressive in auditing ‘silent disclosures’ of offshore accounts and, therefore, this option remains highly risky and is not advisable for most taxpayers. However, a silent disclosure could be a preferred option for some taxpayers, depending on their specific circumstances and that the IRS will never be able to succeed in forcing all taxpayers into a noisy disclosure, which is their stated goal. It is strongly advisable to consult one’s tax advisor for his specific situation. An individual’s situation maybe different from the facts of a generic article of this type and hence it’s better to look at getting the right advice.

Risks of non-reporting and IRS initiatives to seek Foreign Accounts Information

There are rumors regarding ongoing ‘John Doe’ summons (A John Doe summons is any summons where the name of the taxpayer under investigation is unknown and therefore not specifically identified) activity seeking to force foreign financial institutions to deliver account-holder information to the U.S. government as well as possible indictments of foreign financial institutions. Recently, several foreign institutions have advised their account-holders to consult U.S. tax advisers regarding the IRS voluntary disclosure program and their U.S. tax reporting relating to their foreign financial accounts. It is reasonable to assume that such institutions will take whatever action is necessary to avoid being indicted, beginning with the delivery of information regarding account-holders to the U.S. government.

It is likely that the U.S. will require foreign financial institutions doing business in the United States to disclose account-holders having relatively small accounts and earnings. There have been rumors of discussions regarding accounts having a high balance of the equivalent of $50,000 at any time between 2002 and 2010. U.S. persons having interests in foreign financial accounts should not find comfort in a belief that their foreign financial institution will somehow refrain from disclosing very small accounts in the current enforcement environment. Those who think too long may be sorely surprised at the high level of ultimate cooperation of their institution with the U.S. government.

The U.S. government is establishing special disclosure pacts with France, Germany, Italy, Spain and the United Kingdom. Under this approach, foreign banks would disclose data on U.S. account-holders to their own governments, which would then provide information to the IRS. The U.S. government is looking to expand these pacts to other countries as well.

It is important to keep in mind that the U.S. government has prosecuted taxpayers in many cases who did not report their foreign accounts and foreign income. The list of some of such cases is given below:

(a)    U.S. v. Mauricio Cohen Assor (Florida, 2011) got 120 months jail time — his son was also convicted and received the same jail time.

(b)    U.S. v. Diana Hojsak (San Francisco, CA, 2007) got 27 months jail time.

(c)    U.S. v. Igor Olenicoff (Orange County, CA, 2007) got 2 years probation and 120 hours community service.

(d)    U.S. v. Monty D. Hundley (New York, 2005) got 96 months jail time.

(e)    U.S. v. Brett G. Tollman (New York, 2004) got 33 months jail time — his mother and other relatives were also convicted.

Conclusion

Taxpayers having undisclosed interests in foreign financial accounts must consult competent tax professionals before deciding to participate in the 2012 OVDI. Others may decide to risk detection by the IRS and the imposition of substantial penalties, including the civil fraud penalty, numerous foreign information return penalties, and the potential risk of criminal prosecution. If discovered before any voluntary disclosure submission, the results can be devastating. Waiting may not be a viable option.

In view of the above discussion, the NRIs, PIOs and green-card holders living in the USA would be well advised to plan investments in India in a manner that they are able to obtain full credit for Indian taxes paid/withheld at source against their U.S. Tax liability on such Indian income. Further, planning to have the tax-free/low-taxed income in India may not be very prudent in many cases, in view of tax liability of such income in the USA.

The purpose of this article is to bring awareness about the 2012 OVDP of U.S. IRS and the potential risks of non-reporting of foreign financial accounts. This article is based on the information given on U.S. IRS website and views, experiences of earlier OVDPs and articles of U.S. tax experts, available in public domain. The reader is advised to consult U.S. Tax Expert(s) before taking advantage of 2012 OVDP.