United States: Pennies From Havens: Obama Pledges Crackdown On Offshore Banking Jurisdictions

President-elect Barack Obama has previously pledged to crack down on abusive 'tax havens,' targeting the activities of US persons in more than 30 jurisdictions that "peddle secrecy" and "cloak tax evasion and other misconduct."

The Stop Tax Haven Abuse Act (the 'STHAA' or the 'Proposal'), with then-Senator Obama as a cosponsor, was introduced in the Senate on 17 February 2007 with a mirror bill simultaneously introduced in the House. Although no action was taken on either proposal, Obama's aides have indicated that similar legislation will be considered in the early stages of the new administration.

The Proposal was bolstered by a report released over the summer by the Senate Permanent Subcommittee on Investigations, which was the culmination of an investigation into alleged abuses by a large international financial institution and a multi-year review of suspected tax evasion through offshore entities. The high-profile report specifically recommended implementation of the STHAA. If similar legislation is enacted, it could have significant implications for US individuals with connections to offshore financial centers.

Further pressure mounted in the UK as Chancellor Alastair Darling announced in the Pre-Budget Report that the UK will commission an independent review of British offshore financial centers. The review will focus on the role of those financial centers in the global economy and their long-term business strategies. While the precise scope and purpose of the UK review remains unclear, it seems likely that the review will focus at least in part on the tax practices of those offshore centres as well.

As it remains unclear in the US whether legislation will be enacted directly affecting offshore financial centers and, if so, what provisions will be included, this note outlines key provisions contained in the previously proposed STHAA.


The STHAA would restrict the use of offshore financial centers by US persons by (i) imposing a rebuttable presumption that certain transactions between US persons and entities located in certain offshore jurisdictions are taxable, (ii) raising reporting and withholding requirements on financial institutions and fiduciaries dealing with offshore jurisdictions, and (iii) increasing penalties for tax avoidance through offshore jurisdictions.

It has been estimated that the Proposal would generate up to $50 billion of additional tax revenue annually. This anticipated tax revenue could be used to offset the costs of proposed tax breaks for middle-income Americans and a wide array of new spending programs, which Obama has promised to champion over the first few months of his presidency.

Guilty until proven innocent

The centrepiece of the STHAA is a provision that would force taxpayers to prove that they do not have control over any offshore entities with which they contract. Under this 'guilty until proven innocent' approach, the STHAA presumes that a US person has control of an entity (which includes trusts, corporations, limited liability companies and partnerships) created or domiciled in a so-called Offshore Secrecy Jurisdiction if the US person directly or indirectly formed, transferred, received assets or is a beneficiary of that entity.

The STHAA also creates a presumption of taxable income for any transfer from an offshore entity to a US person, and a presumption of unreported taxable income for any transfer from a US person to an offshore jurisdiction. Taxpayers could only rebut these presumptions by providing direct evidence that all tax owed on such amounts had been paid.

Tax havens???

The initial list of 34 'Offshore Secrecy Jurisdictions' is surprisingly broad and includes Jersey, Guernsey, the Isle of Man, Switzerland, Singapore, the Cayman Islands, the British Virgin Islands, Bermuda, the Bahamas, Hong Kong, Costa Rica and Belize. Designation as a 'tax haven' would result if the Treasury Department determines that the jurisdiction has rules in place that "unreasonably restrict the ability of the US to obtain information relevant to the enforcement" of its tax laws.

Many practitioners have expressed concern that the initial list of jurisdictions fails to separate those jurisdictions operating in conformity with widely accepted international standards from other 'rogue' jurisdictions. For example, several listed jurisdictions have signed Tax Information Exchange Agreements with the US (some very recently) and are nevertheless included on the list. Should this legislation be enacted, it is uncertain which jurisdictions ultimately may be targeted, but it appears that additional consideration should be given to what triggers inclusion on the STHAA blacklist.

Heightened reporting requirements

In an effort to ferret out potential tax abuses, the STHAA would create a presumption that any account with a financial institution formed, domiciled or operating in an Offshore Secrecy Jurisdiction has sufficient funds to trigger reporting to the IRS. The STHAA also would require financial institutions that open accounts for US persons or create nonpublicly- traded entities in Offshore Secrecy Jurisdictions to report such transactions to the IRS.

The reporting of such transactions is already required of the individual taxpayers involved, but the Proposal would place this burden on intermediaries as well and would apply to US and foreign financial institutions, fiduciaries and corporate directors.

Grantor trust rules

The STHAA expressly targets offshore trusts. The Proposal would further expand the already broad rules setting out when a US person establishing an 'offshore' trust is treated as the tax owner of the trust's income and gains. This would be accomplished by amending Section 672 of the Internal Revenue Code (the 'Code') by attributing to the grantor of a trust any power held by a trust protector and amending Section 679 of the Code to treat any US person receiving cash or other property from a foreign trust as a beneficiary of such trust.

Personal use property and loans

With respect to personal use property, the Proposal would amend Section 643(i) of the Code to treat cash, marketable securities, artwork, jewellery or other personal property loaned by a foreign trust to a US person as a taxable distribution. Such a loan would be deemed taxable on the value of the use of such property, although it is unclear how the amount of these taxes would be calculated.

Penalties and deterrents

The STHAA is clearly not intended to be a paper tiger, as evidenced by several provisions that give this tiger teeth. Senator Carl Levin, the principal sponsor of the STHAA, announced when introducing the legislation that some of the current penalties for tax evasion are "like a jaywalking ticket for robbing a bank."

The Proposal would give the IRS six years instead of three to complete audits, combating the perceived sluggishness of offshore jurisdictions to respond to audit requests. It would also broaden the use of socalled 'John Doe' summonses that are used to obtain information from offshore jurisdictions in tax investigations. Both provisions would give the IRS a decided advantage in the audit process.

Financial institutions and fiduciaries would not escape penalty for failing to comply with the STHAA. The US Department of Treasury could prohibit US banks from opening accounts for noncompliant foreign financial institutions and could prohibit US financial institutions from accepting credit card transactions involving noncompliant foreign banks.

The Proposal also calls for the codification of the 'economic substance' doctrine. This doctrine requires that transactions not only satisfy all relevant legal requirements but also must have a real economic purpose other than the creation of tax benefits. Courts have used the economic substance doctrine in the past to combat what they perceived to be 'sham' transactions. The STHAA would codify this doctrine and levy a 40 percent penalty on underpayments of tax resulting from transactions that lack economic substance.

Political situation and timing

Obama has shown little interest in backing away from plans to crack down on tax havens, despite the economic downturn. It appears that Obama will proceed with his proposed middle-class tax cuts as part of an economic stimulus package, and a bill similar to the STHAA could be seen as a useful revenue raiser to offset this cost. In the week after his historic election, Obama did admit that tax increases on the nation's top earners could be delayed. However, it is not clear whether a crackdown on offshore financial centers will be delayed as well. A key period to monitor will be the first 100 days of the presidency, as Obama may try to make significant and visible policy decisions, which could include tax cuts for the middle class funded a proposal like the STHAA.

At the time of this writing, there are still two Senate races yet to be decided, but it is certain that Democrats will have comfortable margins in both Houses of Congress. The STHAA had bipartisan support in the Senate (although Republican co-sponsor Norm Coleman is currently facing a recount in his Senate re-election bid). Threats against offshore financial centers have been made in the past by both Democrats and Republicans, but have not amounted to concrete action. However, as was seen this summer with the enactment of the exit tax aimed at individuals who expatriate, it is entirely possible that Congress will take action on this potential source of revenue. Accordingly, it would be prudent for intermediaries to consider what effect these proposals could have if enacted.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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