Supervision of Offshore Transactions – Part II

tax detectiveTaxpayer’s Defenses

It is in the context of summons and subpoenas that contestable issues occur promoting the need for the government in its supervisory role to utilize what is referred to as a Formal Document Request procedure and the use of treaty agreements. In understanding Formal Document Requests and treaty agreements, it is advantageous to first understand the glitches and defenses to the process available in the international context regarding summons and subpoenas.

There are two (2) basic taxpayer’s defenses asserted in resistance to summons and subpoenas. One such defense is that the taxpayer lacks the necessary control of the information sought to verify in satisfaction of the reporting requirements. The second basic defense is that to comply with the issued summons or subpoena would violate blocking statutes of a particular country. It is the success of the taxpayer with these basic defenses that create the necessity of the government to utilize Formal Document Requests and treaty agreements.

The crux of a taxpayer’s posture in its effort to avoid compliance with a summons or a subpoena is sometimes based on the lack of United States or other country’s jurisdiction, premised upon a lack of due process. The issue is raised as to the question of proper in personam jurisdiction in the service of summons and subpoenas on a foreign taxpayer. In determining a due process issue, the government is asserting judicial jurisdiction, in personam, based on due process of law. In this jurisdictional sense, due process arises when a statutory provision or constitutional authorization purports to provide a United States court a jurisdictional basis, and the assertion complies with due process notions.

Due process is a constitutional concept that has evolved with various judicial decisions over a series of judiciary interpretations. It is a determination of whether a United States court may entertain jurisdiction over a matter within boundaries of a notion of due process and the Fourteenth and Fifth Amendments of the United States Constitution. That is, the jurisdiction of the court cannot deprive an objecting party of life, liberty or property without due process of law.  The underpinning of due process is that it must be an exercise of jurisdiction over a matter in a manner fair and reasonable via a common sense way of reasoning.

In this respect, the Service has been successful in asserting in personam jurisdiction over a foreign parent corporation based on the jurisdictional reach of Sections 7402 (b) and section 7604 (a) of the Code. In obtaining jurisdiction, the government has overcome the defense of lack of jurisdiction contention regarding the necessary statutory authority and due process, satisfying the court’s notions of due process in the quest for records and books in possession of a foreign parent corporation. The defense used to refute this type of summons to obtain records located abroad is grounded in the concept that such records are not within the control of the person subject to the summons. The control issue is argued from a jurisdictional notion and lack of due process.

The other taxpayer defense to the enforcement arsenal of the government’s summons and subpoena power is grounded in what are referred to as blocking statutes. These statutes are designed by many foreign countries to prohibit, as a matter of international law, compliance with United States discovery orders for the production of evidence located within the blocking states’ territory. The most common of these blocking statutes are bank secrecy laws. The bank secrecy law of Switzerland is the model statute from which many other sovereigns have designed their statutes.

The United States by use of summons and subpoenas has sought unilateral extraterritorial discovery. Blocking statutes have been enacted in many foreign situs to specifically thwart this unilateral, extraterritorial discovery deemed to infringe upon that of a sovereign territorial right. In addition to the blanket type, these statutes often are drafted to prohibit disclosure of information pertaining to particular industries, with the banking industry the largest benefactor. These prohibitive blocking statutes are often accompanied by criminal sanctions for violation. It is the very severity of the criminal sanction that encompasses the essence of their due process principle.

Summons issued to produce books and records of subsidiary corporations in Switzerland to determine Subpart F Income have brought courts to an analysis of distinctions between the degrees of criminal sanctions imposed pursuant to blocking statutes. A contrast is drawn between sanctions deemed significant and those appearing more heavily enforced. A blocking statute prohibiting a merchant from disclosing the books of account for use in a legal action abroad enabled a defendant to successfully quash a subpoena. There is a distinction also made part of a court’s analysis as to those cases which have civil sanctions. There is an attempt by United States courts to try to balance interests and affect a heightened standard of materiality in discovery.

The United States government has become creative when denied access to bank records by virtue of the blocking statute bolstered by the criminal sanction of local foreign law. Where a particular statute could be overcome by the consent signature of the account records otherwise subject to criminal penalty, the Supreme Court has upheld a contempt holding for a party refusing to consent to access to foreign bank records. The court did have in personam jurisdiction of the person in its court.

The government, having exhausted the summons and subpoena arsenal, utilizes either independently or conjunctively, the Formal Document Request tool. A Formal Document Request is a request made after the normal request procedures have failed to produce the requested documentation. It is a request for foreign-based documentation sent by United States registered or certified mail to the taxpayer at his or its last known address. It sets forth four essential elements.

First, it states the time and place for the production of the requested documents. Second, it states the reason the documentation previously produced, if any, is not sufficient. Third, it describes precisely the documentation sought under the Formal Document Request. Last, it states what the consequences to the taxpayer shall be by failing to comply with production of the sought items.

A Formal Document Request is not bound by the fact that a foreign jurisdiction would impose a civil or criminal penalty for disclosing the requested documentation and therefore is not a reasonable cause. A taxpayer who fails to comply with a Formal Document Request within ninety (90) days subsequent to the date of the mailing of the request, on motion, shall be prohibited from the introduction of such requested information in a civil proceeding in which the tax treatment of the examined item is an issue. Therefore, failure of a taxpayer to comply with a Formal Document Request unilaterally precludes the taxpayer from defending a tax assessment based upon the item requested but not produced.

The basic final tool to implement the supervisory role of the United States government is through the use of treaty agreements. The case of Transworld Airlines, Inc. v. Franklin Mint Corp., underscores this principle and its application. An international treaty by its very nature is a contract between nations and interpreted as such. The general rules of contract construction are applicable. It is appropriate to start with the text of the treaty and the context in which its written words are used. The treaty’s history, aspects of the negotiation, and basic practical construction of it as adopted by the parties may be relevant.

The detailing of tax treaties is beyond the scope of this text. The United States has approximately thirty-nine bilateral treaties pertaining to income tax issues, sixteen bilateral treaties incorporating estate or gift taxation issues, and a number of bilateral treaties that serve as Tax Information Exchange Agreements. These treaty agreements allow the United States government to gain some access and cooperation relating to the enforcement of their supervisory role of the regulation and examination of foreign enterprises. The purpose of these agreements is summarized in the Tax Information Exchange Agreements (TIEAS), which states the exchange of information is affected in a manner that may be necessary and appropriate to apply and enforce the tax laws of the United States and the beneficiary country. That application is with respect to criminal or civil proceedings and includes information that may otherwise be subject to nondisclosure provisions of the local law of the beneficiary, country that would include provisions respecting bank secrecy and bearer corporate shares.

Continued from Part I

In accordance with Circular 230 Disclosure

William Richards is a Sole Practitioner in Orlando, Florida, USA 32626. Attorney at Law, Legal Advisor. 1978 – Present

PUBLICATIONS: International Financial Centers, Adell Financial Series, AD Adell Publishing, Copyright 2012, 378 pages. The Handbook of Offshore Financial Centers, Adell Financial Series, AD Adell Publishing, Copyright 2004, 266 pages; Offshore Financial Centers and Tax Havens, Archives of Tulane Law Library, Tulane Law School, Tulane University, New Orleans, Louisiana, Copyright, 1996, 512 Pages.

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