How the ‘Shell Bank’ FATCA Loophole Hides Tax Evasion

How the ‘Shell Bank’ FATCA Loophole Hides Tax Evasion

How the Shell Bank FATCA Loophole Hides Tax Evasion

Recently, the United States Senate Committee on Finance issued a press release summarizing its findings regarding a major FATCA loophole (Foreign Account Tax Compliance Act) that may be costing the US Government billions. In general, the purpose of FATCA is to reduce offshore tax evasion and other international tax fraud by requiring Foreign Financial Institutions (FFI) to report US account holder information to the US government. Recently, and as a result of a $2 billion tax evasion scheme that involved Robert Brockman, the IRS is very concerned that they are losing billions of dollars each year as a result of the Shell Bank Loophole. Let’s take a brief look at this offshore accounting reporting loophole  by referring to portions of the Senate’s report:

FATCA Loophole In General

• • • Brockman and his associates used offshore shell companies in FATCA partner jurisdictions like Bermuda and Nevis and then registered them with the IRS as financial institutions.9 Those entities then made large capital commitments to private equity funds registered in the Cayman Islands managed by Vista Equity Partners. These Vista private equity funds were be used to buy and sell software companies in the United States, and then wire Brockman’s share of the profits to bank accounts in Switzerland.

Converting Shell Companies to Shell Banks

• • • Because the account holders of these accounts in Switzerland were Bermudan and Nevisian entities with IRS issued GIIN numbers, the Swiss banks determined that they were not required by FATCA to independently investigate whether these accounts were held by U.S. persons.10 By converting these shell companies into shell banks, Swiss financial institutions were able to accept more than $1 billion from a U.S. client without having to independently determine whether those funds belonged to a U.S. person. The Swiss banks were also not required to report the beneficial owners of these accounts to the IRS because the accounts were held by offshore entities that had registered as financial institutions and as a result could self-certify that they have accurately reported accounts held by U.S. persons to the IRS. This lack of bank reporting heightens the risk that wealthy taxpayers can exploit this loophole to underreport or fail to report offshore income.

Obtaining the GIIN is Deemed “Too Easy”

• • • The committee engaged in discussions with the IRS Large Business & International Division  and Chief Counsel’s Office regarding the process for obtaining a GIIN number from the IRS. The committee found this process to be shockingly easy. An entity must simply fill out a Form 8957 with the IRS, or register via an online portal. Applications are almost always approved without meaningful investigation or due diligence from IRS personnel.

    • Additional structural problems at the IRS have also contributed to lax FATCA enforcement. According to a recent report by the Treasury Inspector General for Tax Administration (TIGTA), the IRS “has not come close” to building out its original FATCA compliance roadmap and has instead taken “limited or no action” on a majority of planned activities due to significant IRS budget cuts following enactment of the law.

Proposed Actions

• • • Congress and Treasury should consider imposing additional due-diligence requirements on transfers between foreign financial institutions (FFIs) in situations involving large transfers of funds into relatively-small, closely held FFIs that pose an increased risk of tax evasion.

    • Congress and Treasury should consider requiring more rigorous screening of applications for GIIN numbers in situations where there is increased risk of tax evasion, potentially including GIIN number issuances to entities in jurisdictions widely considered tax havens, or entities that appear to be relatively closely-held. For example, the recentlypassed U.S. anti-money laundering law, the Corporate Transparency Act, focuses on disclosure by entities with fewer than 20 employees in the United States or that lack a physical operating presence in the United States, which represent an increased risk of noncompliance with anti-money laundering laws.

    • Congress and Treasury should strengthen the IRS Whistleblower Office and better utilize incentives available for whistleblowers to come forward with information to detect offshore tax evasion. The IRS has lost thousands of revenue officers and examiners, and whistleblowers can serve as effective partners for the federal government to unpack sophisticated tax evasion schemes used by wealthy taxpayers and large corporations. However, the number of criminal tax investigations opened by the IRS CI division from whistleblower claims has declined from 43 in FY14 to six in FY20.18 Awards to whistleblowers and the amounts collected by the IRS have also dropped sharply over the last four years, particularly for major cases.

    •  Congress should increase IRS enforcement resources to ensure it has the manpower and infrastructure sufficient to audit complex financial structures involving high-net worth individuals, including undeclared offshore accounts. According to a recent GAO report, the IRS employs 40 percent fewer revenue agents than it did in 2011, severely crippling its ability to conduct complex audits of wealthy taxpayers.20 The IRS funding in the IRA is a significant step forward in this regard.

    • The steep decline in IRS audits of partnerships, combined with the sharp increase in the number of partnerships and weak FATCA enforcement have created a permissive environment which allows the wealthy to conceal investment income using these entities.21 A core component of the alleged scheme carried out by Robert Brockman and Robert Smith was the use of foreign partnerships managed by Vista Equity Partners. The two American billionaires used these partnerships to generate billions in investment income in the United States and then wire it offshore without IRS detection for over a decade. The IRS needs additional resources to increase audits of large partnerships and reverse the last decade’s decline.

    • Congress should explore efforts to increase disclosure of high-value financial accounts domestically, similar to proposals advanced in the Biden Administration’s FY 2022 Budget Request. Congress should also explore opportunities to increase information sharing and coordination between partner jurisdictions and more closely align reporting regimes with the Organization for Economic Cooperation and Development’s (OECD) Consistent Reporting Standards, similar to proposals advanced in the Biden Administration’s FY 2023 Budget Request.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the pension tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to streamlined procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead of the Streamlined Procedures. But, if a willful Taxpayer submits an intentionally false narrative under the streamlined procedures (and gets caught), they may become subject to significant fines and penalties. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

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