U.S. Department of Justice & Swiss Federal Department of Finance Enter into Historic Agreement Regarding Tax Evasion Investigations

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Continuing its mission to eradicate offshore tax evasion, on August 29, 2013, the United States Department of Justice Tax Division (the “DOJ”) and the Swiss Federal Department of Finance issued a Joint Statement regarding the establishment of the “Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Banks” (the “Program”).

As previously discussed in this blog’s coverage of the United States government’s protracted investigation into offshore tax evasion, the Department of Justice and Internal Revenue Service (“IRS”) have used a variety of tactics in their fight against illegal offshore activity. The Foreign Account Tax Compliance Act (“FATCA”), for example, requires foreign institutions to report information regarding its U.S. account holders to the IRS or pay a substantial (30%) withholding tax for all of its accounts held by U.S. persons. The IRS’s Offshore Voluntary Disclosure Program (“OVDP”) incentivizes U.S. taxpayers to report undisclosed foreign accounts and holdings to the IRS to eliminate substantial civil penalties and eliminate the risk of criminal prosecution.

The latest Program re-crafts the DOJ’s approach to investigating Swiss banks in a manner that closely resembles the IRS’s OVDP. Unlike the OVDP however, the Program offers amnesty to banks rather than individual accountholders. This agreement is the first program of this kind, and if successful, is likely to be the first of several future agreements between the DOJ and other countries’ finance departments.

The Program’s Framework

The Program’s structure is based on a four-tiered ranking system that categorizes each Swiss bank’s exposure to illegal activity.  Category 1 banks consist of the fifteen Swiss banks currently under criminal investigation. These institutions are excluded from the Program altogether along with insurance companies, asset managers and others such as fiduciaries, financial advisers, and lawyers (whether under investigation or not).

Category 2 banks consist of institutions which “have reason to believe” they may have committed tax-related offenses or monetary transaction offenses under U.S. law in connection with undeclared U.S. taxpayer accounts. Category 2 institutions are only allowed to request a Non-Prosecution Agreement, which if obtained would shield them from criminal charges.

The window for compliance with the Program is narrow. The DOJ must receive a letter of intent to enter into the Program no later than December 31, 2013. In addition to requesting the Non-Prosecution Agreement, Category 2 institutions seeking protection under this Agreement will have 120 days after submission to come into full compliance. Category 2 institutions must also name and identify an independent examiner to audit the respective bank’s cross-borders business for US accounts and present his or her findings regarding the bank’s structure, business operations, marketing, and management to the DOJ.

While the DOJ is willing to forego criminally prosecuting institutions, the potential penalties for Category 2 institutions are significant. Penalties are assessed based on the amount held in the account, with a respective 20% penalty being charged against amounts held on August 1, 2008; 30% penalties on the aggregate amount on accounts opened between this date and February 28, 2009; and 50% penalties of the aggregate amounts opened thereafter. The DOJ based this timeline for calculating penalties on the timing of the United Bank of Switzerland fallout in late 2008. The DOJ reasoned that once that occurred, Swiss banks were on notice that handling undeclared accounts for U.S. taxpayers was a violation of U.S. law.

Category 3 institutions are those which have not assisted U.S. taxpayers with undeclared accounts. Category 4 banks consist of institutions that are purely local in nature, do not have U.S. or other non-Swiss customers, and are otherwise “Compliant Financial Institution” under the definition promulgated under the Agreement between the U.S. and Switzerland for the Cooperation to Facilitate the Implementation of FATCA. Under the program, both Category 3 and 4 banks can request a Non-Target Letter by submitting a letter of intent to the DOJ between July 1, 2014 and October 31, 2014.

Along with these conditions, Category 2, 3, and 4 institutions must retain records for 10 years following the signing of a respective Non-Prosecution Agreement or Non-Target Letter. Participants in the program must also waive any statute of limitation defenses, with the DOJ retaining sole discretion to decline to enter into an Agreement with an institution for any reason.

The Program So Far & Identification of New Category 1 Banks

The DOJ estimates that the Program will be applicable to approximately 100 Category 2 Swiss banks, which will be forced to disclose information about previously undisclosed U.S. accounts and incur significant penalties. Credit Suisse, Julius Baer, and state-backed regional bank Zuercher Kantonalbank account for just a few of the banks that are already being investigated by the U.S. (see here).

Most recently, on September 10, 2013, Rahn & Bodmer Co., one of the oldest private banks in Zurich, announced that it too was among the group of Category 1 banks under investigation. Rahn & Bodmer Co. partner, Christian Rahn, expressed his belief that his bank would fall within Category 2 stating “the bank discontinued its dealing in untaxed funds in 2008, and has encouraged its American clients to cooperate with the DOJ through voluntary offshore-disclosure programs offered by U.S. authorities.” Rahn went on to state that he believed that “client use of those disclosure programs, which have drawn thousands of participants, likely caused his bank to come under investigation” (see here).

Ultimately, the DOJ expects the Program to unearth a significant amount of data, while affording institutions free of wrongdoing assurances that they can provide information to the DOJ without fear of being targets of criminal investigations. As this Program continues to develop, it will be interesting to see how effective it actually is.