There
seems to be an abundance of U.S.
persons and corporations that are perfectly willing to commit tax
evasion if
there is a reasonable chance they can get away with it. They are
therefore
agreeable to an assortment of schemes and scams that attempt to hide or
to
disguise the true ownership or the income of a foreign corporation.
And
because most of the major countries of the world do not treat tax
evasion as a
crime, the financial and legal professionals in other countries are
often
willing to cooperate with such schemes or even to help devise them and
to then
promote their use to U.S.
persons.
The
following are some of the schemes and scams we have encountered, along
with
links to the IRS web site where there are brief descriptions of various
offshore tax schemes the IRS is challenging when they encounter
taxpayers who
have been using these arrangements but primarily from targeting
offshore tax
shelter promoters, followed by subpoenaing the records and auditing the
promoter’s clients.
The August 17, 2001 issue
of Business Week describes a “tax
scheme” that was promoted by a broker with Paine Webber; but,
apparently,
without the knowledge of Paine Webber. This broker recommended a
Bahamian IBC
for Americans to avoid current income taxation on their investment
income. An
IBC is generally formed in a no-tax jurisdiction by non-residents (such
as
Americans). The scheme apparently worked for a while because the
Bahamian IBCs
are not required to disclose who owns the company. Thus, Paine Webber
allegedly
thought they were dealing with a foreign corporation that is allowed to
invest
in certain kinds of U.S.
securities, tax-free.
The thrust of the article was
that the broker should have known better and was promoting a tax
evasion
scheme. U.S.
citizens and
residents are required to pay taxes on their worldwide income and, if a
U.S.
person controls a foreign corporation, that U.S.
person is required to pay income taxes on certain (subpart F) income of
the
foreign corporation. Generally, any investment type income is subject
to tax by
the U.S.
shareholders of the foreign corporation who own 10% or more of the
corporate
stock.
Due
to changes in withholding and reporting procedures for payments to
foreign
financial intermediaries as of January 1, 2001, this scheme is no
longer
possible.
Some of the stuff we see on
the Internet and in some popular books about saving taxes offshore is
so
blatantly false, we have to believe the people making these claims are
not
smart enough to be real con artists. Here’s an example of a portion of
a letter
we received in the mail. The writer is promoting a newsletter that
promises to
show subscribers how to secure high returns of from 50% to 100% a year
from
offshore investments and says:
“One advantage in setting
up your own offshore corporation is that your investment profits can be
accumulated on a tax-free basis since there is no reporting of profits
and no
withholdings.”
Obviously, if someone is
going to claim his newsletter can help you to make from 50% to 100% a
year on
your investments, he is not likely to be honest about the tax rules for
offshore investing through a foreign corporation.
An offshore corporation is
not subject to the taxing jurisdiction of the U.S. However, the U.S. shareholders or deemed
shareholders of an
offshore corporation are subject to the taxing jurisdiction of the U.S.
The promoter apparently
believes that because no information return is sent to the IRS, the
income is
not taxable. All income
is
taxable to U.S.
persons, regardless of whether an information return is sent to the
IRS. Those
who fail to report all of their income are risking the chance of very
punitive
interest and penalties at some future date. And, any tax return with
omitted income
may remain open to an audit for an unlimited time.
There are some legal ways
to save taxes offshore,
just as there are legal ways to save taxes in the U.S. But forming a foreign
corporation in the attempt to hide investment income from the IRS is
not one of
them.
A non-resident alien
(including a non-resident foreign corporation) can invest in U.S. stocks and any gains are not
subject to U.S.
taxes. A non-resident alien is not taxed on interest on investments in U.S.
government securities or certain kinds of U.S. bank or S&L
obligations. In
addition, any income or gains derived from investing in any non-U.S.
investments is tax-free if the corporation is domiciled in a tax haven.
A great many U.S.
taxpayers want to be the owner of a foreign corporation that can
generate
tax-free income from investments, but they clearly are not aware of the
complicated obstacles that Congress has put in their path.
A popular foreign tax
scheme is the formation of a foreign corporation (usually called an IBC
with
bearer shares or with an unsigned agreement with the person who is
acting on
your behalf. An “off-the-shelf” IBC can be purchased in most foreign
jurisdictions that is formed by a local attorney (or other professional
person)
who merely hands you the shares to this standby corporation for a fee.
The
promoter/lawyer may act as the agent for the company. However, this
strategy
does not avoid pertinent tax laws.
The U.S. courts have often
disregarded
the legal formalities of an ownership arrangement that is inconsistent
with the
facts. The substance of the arrangement, not the formalities,
determines the taxation
consequences. If another person acts as your agent, a nominee or an
intermediary, you are treated as the principal. A principal
"controls" his agent and is treated as the owner for tax purposes.
A U.S. person who funds a
foreign
trust or entity with cash may believe a secret account can then be
created. However,
transfers of small sums are not adequate to offset the fees to create,
maintain
the entity and pay the money manager. Larger secret accounts or
investments may
be detected in a number of ways. Telephone calls, faxes, mail and
travel to
visit with money managers of the assets for the foreign trust or
foreign entity
leave a trail.
Often family members are
unaware of the so-called secret account. Typically, the children are
unaware of
the secret account. Circumstances, such as aging or bad health, raise
the ugly
question of how the secret account will be transferred to or used for
the
benefit of the children. One has grave concerns, even shame, in
informing his
children about the secret account during his lifetime. If the children
learn of
the secret accounts during the parent’s lifetime, they have grave
concerns of
how this will be handled after death. But if the secret account is
disclosed to
the children after his death, they are faced with a serious dilemma.
The children learn that
their parent’s death tax return must be signed by the executor under
penalties
of perjury and that failing to report the secret account as a part of
the
estate constitutes a crime and that receipt of income from the secret
account
by the children constitutes criminal conspiracy for failure to report
the prior
existence of the secret account. Even if the children decide not to
receive one
penny from the secret account, they are participating in a conspiracy
to commit
a crime against the U.S.
under both the U.S. Code and the IRC. To be blunt, the children do
not have
one single good solution.
The U.S. tax law imposes severe
penalties for not filing various reports for this kind of arrangement.
A
corporation is more visible than a bank account, and is more likely to
be
noticed by an inquisitive auditor. Or, the corporation may be reported
to the
IRS by an angry former partner, former spouse, former lover or another
person.
Also, foreign money
managers can mismanage the assets in the secret account or
misappropriate the
money for their own benefit. This leaves one in a serious situation.
Should he
file suit in a foreign jurisdiction against the money manager? If suit
is filed
against the money manager, it may become public knowledge in this
particular
jurisdiction and spread, even to the U.S. and possibly to the
IRS. Again,
the point is that so-called secret accounts can result in serious
problems.
We understand from our
contacts in the international tax community that the IRS has agents who
live in
low tax or zero tax countries that are popular tax havens and they
spend their
time looking for Americans who willing to talk with a stranger about
their
clever ways of beating the IRS. After all, if you have done something
really
clever, it’s no fun unless you brag about it.
Are you willing to trust a
promoter who helps you break U.S.
laws? If he is dishonest in one area, why do you believe he will be
honest in
dealing with you?
One of the more widely
promoted methods of transferring assets into a foreign corporation or
foreign
trust on a tax-favored basis is through a private annuity contract.
This has
become a major target of the IRS and they have announced that they will
no
longer apply some long standing rulings to permit taxpayers to defer
capital
gain taxes with a private annuity.
Effective after October 18,
2006, the IRS has rescinded their long standing regulation that
permitted
property owners to defer capital gains taxes on the transfer of
appreciated
property in exchange for a private annuity.
This
proposed notice of rule making effectively eliminates most of the
appeal of
using a private annuity in combination with a foreign corporation as a
way to
defer taxes on the transfer of appreciated property in exchange for a
private
annuity.
A private annuity arrangement
is an unsecured contract
entered into between an annuitant and by someone who is NOT in the
business of issuing annuity contracts. Thus, a private annuity
arrangement is
not with an insurance company. Private annuity arrangements are
primarily used
for estate tax planning and secondarily for deferral of income taxes.
Until
late 2006, they were also a popular way to defer capital gains taxes.
The
assets sold under a private annuity arrangement are excluded from the
annuitant’s gross estate for federal estate tax purposes. Capital gains
property could previously be sold under a private annuity arrangement
with each
payment being a return of part basis, part capital gains, and part
income
(interest must be included in a private annuity arrangement).
A U.S. person often assumes
that he
can enter into a valid private annuity arrangement with an IBC that he
owns. He
apparently assumes that the IBC is not a CFC. This is rarely true. Even
if the
CFC has bearer shares and is technically owned by a foreign nominee,
the U.S.
person is deemed by the IRS to be the shareholder of this IBC. As the
sole
shareholder of the IBC (that is classified as a CFC), the U.S.
person has entered into a
private annuity arrangement with himself. This causes the private
annuity
arrangement to be invalid.
In most cases, the
corporation is a CFC, FPHC or PFIC and the annuitant is deemed as being
on both
ends of the annuity transaction and “doing business with himself.” The
CFC/FPHC
and PFIC rules remove the tax advantages otherwise available with a
private
annuity arrangement. In fact, the costs of establishing and maintaining
such an
arrangement are prohibitive in relation to the tax benefits, even if
the U.S.
annuitant is not doing business with himself.
Can a family member form
the foreign corporation and avoid the problem? Family members, as
related
parties, are subject to the same adverse tax treatment, so the answer
is “no.” In
addition, due to attribution of ownership among relatives for stock in
a CFC,
the parent is deemed to own the stock of a child.
What if the foreign
corporation is owned 50% by a foreign person? Does this alter the
results? Yes,
if the foreign owner is a real owner and is treated as such. The
foreign
corporation would not be a CFC. However, at the death of the annuitant,
the
foreign corporation is the owner of the acquired property with the
foreign
person owning half of the company and the decedent’s heirs owning the
other
half. This structure may be considered if a child or other heir resides
in a foreign
jurisdiction and is not a U.S.
citizen. However, it is generally recommended that a direct annuity
contract
between the U.S.
annuitant and the child or other heir be entered into. The constructive
ownership rules of IRC Section 318 do not apply with respect to a
non-resident
alien individual.
A proposed structure
purports to avoid U.S.
taxation on the income of a foreign corporation by having the
corporation form
a trust, which then becomes a beneficiary of the trust.
If a nominee or
accommodation party forms the IBC for a U.S. person, this does not
avoid
the CFC rules or the PFIC rules. The U.S. person who is the
beneficial
owner of the structure is deemed to have transferred his assets to the
IBC, and
the accommodation party is ignored for tax purposes.
The U.S. person is required to
file a
Form 926 and Form 5471 with respect to the creation, transfer, and the
operations of the foreign corporation. Thus, the use of an
accommodation party
to form this structure does not alter the tax reporting and obligations
of a U.S.
person.
Based on the proposal,
there are numerous IRC provisions that cause this structure to fail
with
respect to income tax planning.
If a U.S. person transfers
assets out of
this country, directly or indirectly, he is generally required to file
some
form. If the transfer is directly or indirectly to a trust, a Form
3520, 3520-A
and the TD F 90-22.1, as well as other returns, are due. If the
transfer is
directly or indirectly to a foreign corporation, a Form 926 is
required. Use of
an accommodation party to form a trust or corporation does not legally
avoid
these filing requirements. Transfers to a foreign partnership are
reported on
Form 8865 and transfers to a foreign disregarded entity are reported on
Form
8858.
There are serious penalties
for failure to file these tax information returns.
