Second UBS Tax Investigation Shows the Continuing Allure of Whistleblower Law

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News leaked late last week that Swiss banking giant UBS is again under DOJ investigation for aiding tax fraud by U.S. clients. In 2009, UBS pled guilty to a criminal tax conspiracy charge, and received a deferred prosecution agreement. UBS admitted that thousands of unreported and untaxed accounts at the bank were controlled by U.S. taxpayers, not the shell companies that its clients set up to avoid IRS reporting requirements, sometimes with encouragement from UBS employees. Public reports about the new UBS investigation, although short on detail, suggest that it concerns the use of bearer bonds. Bearer-share securities have long been part of the tax fraud toolkit, and bearer bonds in particular are useful for concealing the beneficial ownership of interest income. If UBS bankers were encouraging U.S. clients to use bearer securities to avoid U.S. tax reporting requirements, that would indeed be a repeat of the practices that landed the bank in trouble just a few years ago.

Notably, the new UBS investigation apparently began with a tip from a whistleblower. The IRS’s whistleblower law, 26 U.S.C. § 7263(b), requires the agency to pay informants up to 30% of any taxes ultimately collected, depending on the usefulness of their information and the amount at issue. A highly publicized nine-figure payout, and a prospective second one, brought this law into temporary prominence. If a second criminal charge against UBS is forthcoming, that will do so again.

The first UBS investigation began with information provided by a former UBS banker, Bradley Birkenfeld. To much fanfare, Birkenfeld later received the largest known award to date under the IRS whistleblower law, a cool $104 million – but only after serving 40 months in federal prison for tax fraud, a longer sentence than any of the UBS clients or bankers that were subsequently prosecuted.

Birkenfeld’s large payout may be exceeded by a still-pending IRS whistleblower claim against mutual fund giant Vanguard concerning the rates its affiliates charged one another for management services. David Danon, a former in-house tax lawyer at Vanguard, filed a series of very public whistleblower claims and a qui tam lawsuit against the company, claiming that it underpaid billions in state and federal taxes. Would-be whistleblowers who are involved in the underpayment can see their award reduced or eliminated, but Danon apparently objected internally to Vanguard’s tax strategy and claims he was fired as a result. If successful, Danon will likely walk away with a nine-figure payout exceeding Birkenfeld’s.

The Vanguard case illustrates the irony of the IRS’s whistleblower provision: those with the knowledge and experience to best recognize a questionable tax position, and the access to documents to back it up, are often under a legal duty to not disclose it. An attorney or accountant making a whistleblower disclosure is all but committing professional suicide if his actions ever become public knowledge, as the Code’s whistleblower law creates no exceptions to otherwise-applicable duties of loyalty and confidentiality. Senior executives making whistleblower disclosures would become similarly unemployable. Plus, if a professional is involved in “planning or initiating” an aggressive tax strategy, he runs the risk of a reduced award, compounding the disincentive to coming forward.

The IRS does its best to mitigate these financial and professional risks to whistleblowers. It promises whistleblowers confidentiality to the degree possible. It even requires auditors to excise references to informants from the audit file, to prevent disclosure in discovery or a FOIA lawsuit. So the chance of a seven-, eight-, or nine-figure payout keeps would-be whistleblowers coming in the IRS’s door: the Whistleblower Office receives about 9,000 claims per year and has collected billions in taxes since the program began. Because awards are pegged to the total amount of taxes and penalties at issue, and are paid only if and when the disputed taxes are collected, the law effectively encourages high-dollar claims against well-established companies in particular.

As the Vanguard and UBS cases illustrate, the IRS’s whistleblower law makes it more likely that aggressive tax practices will eventually come to light – whether that practice is a position the taxpayer itself takes, as alleged in Vangaurd, or one it markets, as UBS is accused of doing. The chances of a whistleblower claim, meritorious or not, increase if there are high tax savings from a position, and if many people are involved in the underlying transaction or in return preparation. In all likelihood, tax whistleblower claims will only proliferate in the future, as a few well-publicized multi-million dollar payouts will keep the IRS’s pipeline full.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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