HSBC client prosecuted after quiet disclosure of offshore account

Illustrating the government's tough approach on offshore account disclosure, the U.S. has criminally prosecuted a taxpayer that made a “quiet disclosure” of his offshore HSBC account, instead of using IRS's 2009 Offshore Voluntary Disclosure Initiative (OVDI). A plea agreement has been reached on the charge.

Background. Each U.S. person who has a financial interest in or signature or other authority over any foreign financial accounts, including bank, securities, or other types of financial accounts in a foreign country, if the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year, must report that relationship each calendar year by filing a Report of Foreign Bank and Financial Accounts (Form TD F 90-22.1 (FBAR)), with Treasury on or before June 30 of the succeeding year.

In the spring of 2009, IRS announced a settlement offer for those that voluntarily and timely disclosed unreported offshore income for 2003—2008. Those meeting the terms of the 2009 OVDI had to pay back taxes and interest for six years, and pay either an accuracy or delinquency penalty on all six years. They also had to pay a penalty of 20% of the amount in the foreign bank accounts in the year with the highest aggregate account or asset value. However, those who came forward on a timely basis did not face criminal prosecution. The original deadline of Sept. 23, 2009, was extended to Oct. 15, 2009.

In February 2011, IRS announced a second OVDI offer for taxpayers with undisclosed income from hidden offshore accounts for the 2003—2010 period. The terms of the offer are similar to those that applied for the first settlement offer, but the penalty structure is different. The general rule is that the penalty is 25% based on amounts in foreign bank accounts, but it can be as low as 12.5% or 5% for some taxpayers. (See Weekly Alert ¶  6 02/10/2011 andWeekly Alert ¶  3 03/10/2011 )

A “silent disclosure” occurs when a U.S. taxpayer with an undeclared foreign account files FBARs and amended returns and pays related taxes and interest for previously unreported offshore income without notifying IRS of the undeclared amount through the OVDI. IRS warns taxpayers that make silent disclosures instead of using the OVDI process that they risk being criminally prosecuted for applicable years.

Facts. According to a criminal information document filed in U.S. District Court for the District of Massachusetts, Michael Schiavo, a Boston bank director, failed to report his interest in offshore accounts on an FBAR for the 2003 through 2008 and tax years.

The government alleged that Schiavo hid $99,273 from a partnership that invested in medical devices, in an undeclared account at HSBC Bank Bermuda. Schiavo's partner, Peter Schober, directed the funds to HSBC in 2006 from a UBS account in Switzerland, which was also undisclosed.

The court document claimed that Schiavo willfully failed to file FBARs disclosing his financial account in Bermuda for tax years 2003—2008. Additionally, for those years, he represented on his Schedule B, 1040, that he didn't have an interest in a foreign financial account and failed to report his income from the partnership, or the interest that accrued on the Bermuda account.

On Oct. 6, 2009, following news of UBS's disclosure to IRS of undeclared accounts held by U.S. taxpayers, Schiavo made a quiet (but partial) disclosure by preparing and filing FBARs and amended tax returns for the 2003—2008 tax years. He did not participate in the 2009 OVDI, although his disclosure was made nine days prior to the end of the amnesty period. In his October 6 disclosure, he revealed to IRS that he had an interest in an HSBC account in Bermuda, but failed to report his income on his 2006 tax return from his partnership.

Subsequently, an IRS Special Agent attempted to interview Schiavo at his home on Oct. 27, 2009.

Thereafter, Schiavo prepared and executed a second amended return for the 2006 year where he reported the income he earned from his partnership that was ultimately deposited into his then-undisclosed HSBC account in Bermuda.

According to the Department of Justice (DOJ), a plea agreement has been reached under which Schiavo agreed to pay a civil money penalty of $76,283, half the value of high balance of the HSBC Bank of Bermuda account, for failing to file the FBAR. He faces up to five years in prison, followed by three years of supervised release and a $250,000 fine. He was charged separately with failing to disclose a secret UBS AG bank account and is awaiting sentencing.

Practitioner reaction. Trial attorney Jeffrey A. Neiman (who was an Assistant U.S. Attorney involved with the prosecution of the UBS AG case), said the lesson of the case was that if a taxpayer is going to make a disclosure to the IRS, they had better make a complete and truthful one. “If you are going to come in the door, you can't come partially in the door,” he said. “You need to come completely clean, otherwise you are committing another crime by filing another false tax return.”

Charles Chromow of Wuersch & Gering LLP (New York) agreed and opined that Schiavo did not initially make a full silent disclosure because he failed to disclose his income from the partnership on his initial 2006 amended return. Chromow also said that although the DOJ charged Schiavio with failure to file an FBAR, other criminal charges that could have been filed include the willful attempt to evade or defeat tax under Code Sec. 7201 or the willful filing of false tax return under penalties of perjury (i.e. for the taxpayer's failure to include his partnership income on his 2006 return) under Code Sec. 7206(1) .

The maximum fines for the uncharged crimes are $100,000 for an individual. Conversely, the maximum fine for willfully failing to file an FBAR is $250,000. The maximum prison sentence for a willful failure to file an FBAR or for a crime under Code Sec. 7201 is five years, while the maximum sentence for a crime under Code Sec. 7206(1) is three years.

EXP ¶72,014.15 Voluntary disclosure in tax evasion cases.

A willful attempt to evade or defeat any tax or the payment of tax is punishable under Code Sec. 7201 as a felony. The IRS will consider voluntary disclosure along with all other factors in an investigation in determining whether criminal prosecution will be recommended. This voluntary disclosure practice creates no substantive or procedural rights for taxpayers because it is simply a matter of internal IRS practice, provided solely for guidance to IRS personnel. Taxpayers cannot rely on the fact that other similarly situated taxpayers may not have been recommended for criminal prosecution. Internal Revenue Manual, Part 9, 9.5.11.9(1), 12/2/2009.

A voluntary disclosure will not automatically guarantee immunity from prosecution, but a voluntary disclosure may result in prosecution not being recommended. This practice does not apply to taxpayers with illegal source income. Internal Revenue Manual, Part 9, 9.5.11.9(2), 12/2/2009.

A disclosure is timely if it is received before the IRS has done any of the following:

(1) initiated a civil examination or criminal investigation of the taxpayer, or notified the taxpayer that it intends to begin such an examination or investigation. Internal Revenue Manual, Part 9, 9.5.11.9(4)A., 12/2/2009.

(2) received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer's noncompliance. Internal Revenue Manual, Part 9, 9.5.11.9(4)B., 12/2/2009.

(3) initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer. Internal Revenue Manual, Part 9, 9.5.11.9(4)C., 12/2/2009.

(4) acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena). Internal Revenue Manual, Part 9, 9.5.11.9(4)D., 12/2/2009.

 CAUTION: A taxpayer planning to make voluntary disclosure in any tax matter that might involve criminal charges should consult an attorney because of the attorney-client privilege. There is no similar privilege for communications with non-attorney tax practitioners in such cases. The privilege for accountants and other non-attorney practitioners under Code Sec. 7525 does not extend to criminal tax matters or proceedings, see ¶75,254 . 

The 2011 offshore voluntary disclosure initiative for disclosures made before Sept. 1, 2011.

The IRS provides a special voluntary disclosure initiative (the 2011 Offshore Voluntary Disclosure Initiative (2011 OVDI)) designed to bring offshore money back into the U.S. tax system and help people with undisclosed income from hidden offshore accounts get current with their taxes. This voluntary disclosure initiative will be available through Aug. 31, 2011. It succeeded an earlier voluntary disclosure program, discussed below, that closed with 15,000 voluntary disclosures on Oct. 15, 2009. In the period after that and before the Feb. 8, 2011 announcement of the 2011 OVDI, more than 3,000 taxpayers came forward to the IRS with bank accounts from around the world. These taxpayers are also eligible to take advantage of the 2011 OVDI. The 2011 OVDI includes several changes from the 2009 program. The overall penalty structure for 2011 is higher, meaning that people who did not come in through the 2009 voluntary disclosure program will not be rewarded for waiting. However, the 2011 OVDI does add features not found in the 2009 offshore voluntary disclosure program and has a different penalty framework from the 2009 program. Under the 2011 OVDI, individuals pay a penalty equal to 25% of the amount in the foreign bank accounts in the year with the highest aggregate account balance covering the 2003 to 2010 time period. A reduced rate of 12.5% is available for taxpayers whose offshore accounts did not exceed $75,000 during 2003-2010. Taxpayers are generally eligible for the 5% penalty if they did not open the account, had minimal contact with the account, did not withdraw more than $1000 in any year covered by the 2011 OVDI, and can establish that taxes were paid on funds deposited in the account. In addition, foreign residents who did not know they were U.S. citizens can avail themselves of the 5% reduced penalty. All 2011 OVDI participants also must pay back-taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties. Taxpayers participating in the 2011 OVDI must file all original and amended tax returns and include payment for taxes, interest and accuracy-related penalties by the Aug. 31 deadline. IR 2011-14, 2/8/2011; , 2011 Offshore Voluntary Disclosure Initiative Frequently Asked Questions and Answers. 

Prior law.

Before Feb. 8, 2011, the 2011 OVDI had not been announced. IR 2011-14, 2/8/2011. However, the 2011 OVDI has retroactive effect. Thus taxpayers who made voluntary disclosure after Oct. 15, 2009 (i.e., after the 2009 VDP closed) may apply to participate in the 2011 OVDI. IR 2011-14, 02/08/2011. 

IRS offshore disclosure program for voluntary disclosures made in the period from Mar. 23, 2009 until Oct. 15, 2009.

In 2009, the IRS centralized the civil processing of offshore voluntary disclosures and offered a uniform penalty structure for taxpayers who voluntarily came forward. , FAQs on Voluntary Disclosure Process and Undisclosed Offshore Account, Q&A 1, May 6, 2009. Taxpayers had until Oct. 15, 2009 to make voluntary disclosure under these rules. IR 2009-84, 9/21/2009. Taxpayers with undisclosed foreign accounts or entities could make a voluntary disclosure that enabled them to become compliant, avoid substantial civil penalties, generally eliminate the risk of criminal prosecution and calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues. , FAQs on Voluntary Disclosure Process and Undisclosed Offshore Account, Q&A 3, May 6, 2009. Participating taxpayers paid back-taxes and interest for six years and either an accuracy related or delinquency penalty. But, in lieu of all other penalties that may apply, including FBAR and information return penalties, the IRS assessed a penalty equal to 20% of the amount in foreign bank accounts or entities in the year with the highest aggregate account or asset value. , Authorization to Apply Penalty Framework to Voluntary Disclosure Requests Regarding Unreported Offshore Accounts and Entities, Mar. 23, 2009. An alternative to statutory passive foreign investment company computations was offered in connection with this program. , Offshore Voluntary Disclosure Initiative: Passive Foreign Investment Computations, September, 2010. 

Prior law.

Before March 23, 2009, the 2009 offshore voluntary disclosure program did not apply. , FAQs on Voluntary Disclosure Process and Undisclosed Offshore Account, Q&A 16, May 6, 2009.

Any person who willfully attempts in any manner to evade or defeat any tax imposed under the Internal Revenue Code or the payment of such a tax will be guilty of a felony and, on conviction, will be fined or will be imprisoned up to five years, or both, together with the costs of prosecution. The maximum amount of the fine is $100,000 ($500,000 for corporations). Code Sec. 7201 .
A person includes an individual, trust, estate, partnership, association, company or corporation. Code Sec. 7701(a)(1) . A person, for purposes of the criminal provisions of the Code includes an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform the act in respect of which the violation occurs, see ¶73,434 . Code Sec. 7343 .
 OBSERVATION: Although most evasion prosecutions involve income taxes, Code Sec. 7201 applies also to evasion of transfer taxes (estate and gift taxes) and excise taxes.
The Supreme Court has said that the elements of the crime of tax evasion under Code Sec. 7201 are willfulness, the existence of a tax deficiency, and an affirmative act constituting an evasion or attempted evasion of the tax.
The Supreme Court held that a controlling shareholder (S) accused of criminal tax evasion could argue for nontaxable return-of-capital treatment for corporate distributions without producing evidence that when the distributions occurred, either he or the corporation intended a return of capital. The could held that if the corporation had no earnings and profits (E&P) the distributions did not give rise to a deficiency, with the result that there was no tax evasion. The Supreme Court rejected the Ninth Circuit's view that evidence of contemporaneous intent was required in order for a distribution to be treated as a return of capital.
The Eighth Circuit held that judicial statements that there must be a tax deficiency in evasion cases do not mean that there must be a “deficiency” in the technical sense (i.e., an excess of tax imposed over the tax shown on the return) since there is no such requirement in Code Sec. 7201 . Such statements are judicial shorthand signifying that there must be a tax due and owing. Thus, a taxpayer's filing of accurate returns did not preclude prosecution for his later willful acts of attempting to evade payment of taxes on those returns in the Schoppert case, cited at ¶72,015.11(25) .
The crime of a conspiracy to commit tax evasion is an offense distinct from the commission of tax evasion, see ¶72,014.03 .
A taxpayer's good faith reliance on the expert advice of an attorney or accountant may negate the element of willfulness necessary for a tax evasion conviction.
The burden of proof in a criminal tax prosecution is on the government to establish, beyond a reasonable doubt, the guilt of the defendant, see ¶72,014.11. The IRS will consider voluntary disclosure along with all other factors in an investigation in determining whether criminal prosecution will be recommended, see ¶72,014.15 . Assessment of a criminal penalty without conviction has been held improper. For included offenses in tax evasion cases.
In a criminal prosecution for tax evasion, the government can establish willful failure to report income through various methods in order to prove the taxpayer's guilt. The government may rely on the taxpayer's increased net worth to prove unreported income. The use of the increase-in-net-worth method to prove tax evasion has been approved by the Supreme Court, see ¶72,014.12 .

BANK DIRECTOR CHARGED WITH HIDING FOREIGN ASSETS

Used Offshore Account to Conceal Income from IRS

THURSDAY, MAY 19, 2011

BOSTON, Mass. - A Boston venture capitalist and director at Boston Private Bank and Trust Company was charged with failing

to report his foreign bank account and income to the Department of the Treasury. 

According to the criminal information and plea agreement filed today, from 2003 to 2008, Michael Schiavo, 53, of Westford,

Mass., held an account in his name at HSBC Bank Bermuda (formerly the Bank of Bermuda). In 2006, with the assistance of his

business partner Peter Schober, Schiavo arranged to have income from a venture capital investment directed to Schober’s secret

account at UBS AG in Switzerland. From there, Schiavo’s share of the investment, $99,273, was wired to his HSBC Bank

Bermuda account. Schiavo knew that this payment was taxable income in the United States, but deliberately chose not to report

it, or the interest income that accrued in the HSBC Bank Bermuda account, to the IRS. In so doing, Schiavo deprived the IRS out

of $40,624 in taxes. 

U.S. citizens and resident aliens have an obligation to report to the IRS on the Schedule B of a U.S. Individual Income Tax

Return, Form 1040, whether that individual has a financial interest in, or signature authority over, a financial account in a

foreign country in a particular year by checking “Yes” or “No” in the appropriate box and identifying the country where the

account was maintained. U.S. citizens and resident aliens have an obligation to report all income earned from foreign bank

accounts on the tax return and to pay the taxes due on that income. These same taxpayers who have a financial interest in, or

signature authority over, one or more financial accounts in a foreign country with an aggregate value of more than $10,000 at

any time during a particular year are required to file with the Department of the Treasury a Report of Foreign Bank and

Financial Accounts, Form TD F 90-22.1 (the FBAR). The FBAR for the applicable year is due by June 30 of the following year. 

According to the criminal information and plea agreement, in October 2009, following widespread media coverage of UBS’s

disclosure to the IRS of account records for undeclared accounts held by U.S. taxpayers and the IRS’s Voluntary Disclosure

Program, Schiavo made a “silent disclosure” by preparing and filing FBARs and amended Forms 1040 for tax years 2003 to

2008, in which he reported the existence of his previously undeclared account at HSBC Bank Bermuda. He made such filings

notwithstanding the availability of the IRS’s Offshore Voluntary Disclosure Program. The Offshore Voluntary Disclosure

Program was a program administered by the IRS that was intended to serve as a vehicle for U.S. taxpayers to attempt to avoid

criminal prosecution by disclosing their previously undeclared offshore accounts and paying tax on the income earned in those

accounts. On its website, the IRS strongly encourages taxpayers to come forward under the Offshore Voluntary Disclosure

Program and warns them that taxpayers who instead make silent disclosures risk being criminally prosecuted for all applicable

years. 

As referenced in court documents, Schiavo admitted that for tax years 2003 through 2008, he willfully failed to file FBARs with

the Department of the Treasury and failed to disclose that he had an interest in a financial account in HSBC Bank Bermuda. He

further admitted that for tax years 2003 through 2008, he prepared, signed under penalties of perjury, and filed false individual

income tax returns with the IRS that falsely represented that he did not have an interest in any foreign financial accounts.

According to the plea agreement, Schiavo agreed to pay a civil money penalty of $76,283, half the value of high balance of the

HSBC Bank of Bermuda account, for failing to file the FBAR.

Schiavo faces up to five years in prison to be followed by three years of supervised release and a $250,000 fine. Schober was

charged separately with failing to disclose his secret UBS AG bank account and is awaiting sentencing. 

U.S. Attorney Carmen M. Ortiz, John A. DiCicco, Principal Deputy Assistant Attorney General of the Department of Justice’s Tax

Division, and William P. Offord, Special Agent in Charge of the Internal Revenue Service (IRS) Criminal Investigation, Boston

Field Division made the announcement today. The case is being prosecuted by Assistant U.S. Attorney Andrew E. Lelling Ortiz’s Economic Crimes Unit and Trial Attorney Mark Daly of the Tax Division of the Department of Justice

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