With a global increase in tax enforcement, US companies may be seeing more document requests from the IRS on behalf of foreign taxing authorities. Anthony Pastore of Mayer Brown explains what companies should do if such a request arrives at their door.
Consider this scenario: A US company receives a request from the IRS for tax documents on behalf of a foreign government. It comes as a shock—while the company routinely shares information with the IRS in audits, it has never seen a request like this. Complying will be a headache, since many of the documents are sensitive or privileged, and the company is worried about how the foreign government plans to use them.
This scenario isn't as uncommon as you might imagine. Foreign governments seem to be leaning on these types of requests more heavily. Though it would appear as if the IRS doesn't have a dog in the fight, we've seen cases where the US government aggressively pursues these "specific exchange of information" requests, even filing federal lawsuits to compel production.
Exchange of Information Requests
The IRS' right to pursue these types of requests is well established. Bilateral tax treaties allow foreign governments to ask the IRS for information from US taxpayers for purposes of foreign audits. (Article 26 of the US Model Treaty is a good example.) The Internal Revenue Code's confidentiality provisions contain an exception allowing the IRS to share information pursuant to a treaty. And there's ample case law treating such requests like any other type of IRS request for purposes of enforcement.
Many types of US companies can receive these requests. In some cases, the recipient is a US company with no ownership relationship to the taxpayer being audited in a foreign country. The recipient could be a US bank, crypto exchange, or other financial institution with whom a foreign taxpayer under audit does business. Or the recipient could be a tech company that provides email or web services to the foreign taxpayer. In other cases, the request is perhaps less of a surprise; the recipient could be the US parent of a foreign subsidiary or affiliate being audited abroad.
The IRS has developed detailed procedures for how to handle these requests. An IRS agent first typically issues an Information Document Request, which often repeats verbatim the foreign competent authority's request. If the US company doesn't sufficiently respond, the IRS issues a summons and eventually initiates an enforcement case in federal court.
When Push Comes to Shove
Recipients have little to no ability to push back. If the US government pursues a plain-vanilla IDR through a summons, the judge would apply the so-called "Powell" factors (named after a US Supreme Court case) to determine whether the taxpayer must turn over the documents. These factors establish a surprisingly low bar for the government to meet to obtain the documents. "But it's burdensome!" is usually not a sufficient defense.
Litigants have argued that a different or higher standard should apply when the request is coming on behalf of a foreign government via a treaty. For example, companies have argued that the US government must establish that the foreign taxing authority is pursuing the audit abroad in good faith or that the documents will be used in a US audit. While these arguments might sound reasonable, the courts have rejected them.
In its internal guidance, the IRS takes an even more expansive view of its ability to pursue treaty requests. It believes that it's obligated to request information on behalf of foreign country even when the US statute of limitations is closed for the year under audit. If a treaty is in place, the IRS also believes it must seek responsive documents created in years predating the treaty's execution.
That said, there are some limits. The bilateral treaties give the IRS no more power to seek documents than they would have if they'd sought the documents for a US audit. Companies wouldn't need to produce documents subject to a bona fide claim of privilege, for example. The treaties also typically provide some protection for trade-secret information.
Although each request is different, there are a few lessons that broadly apply to most treaty requests.
The language in the request matters. The IRS often issues IDRs that seek large—sometimes massive—piles of information. While far from perfect, it tries to target requests to a set of readily identifiable documents. In some cases, foreign taxing authorities have less of a history with "litigation-style" requests, and a treaty request might reflect that. The IDR might be shockingly broad or may poorly define what the foreign auditors actually want. It's worth analyzing the request's language closely, because the recipient isn't required to respond to anything other than that specific language.
There's a reasonableness standard. If the foreign taxing authority seeks an identified set of documents (such as bank statements for certain months for certain accounts), it won't be hard to identify which ones are subject to the request. But if the IDR contains a request for "all documents related to topics A, B, and C," it won't be so easy. The search can and should be bound by a reasonableness standard. Heroic efforts to find every shred of paper generally aren't required, but if the response doesn't provide all requested documents, it might need a caveat.
Consider privilege, trade secrets, and data privacy. Generally, documents need not be produced if they're subject to legitimate claims of privilege, such as the attorney-client privilege or the work-product doctrine. This general rule doesn't change simply because the request originated from a foreign country where privilege laws might differ (and are often less protective). It's also worth considering whether a document request involves protected trade secrets. And it's always necessary to consider data-privacy laws, particularly if documents sit on servers in jurisdictions with such laws—such as Europe's GDPR.
Don't forget the US audit impact. The IRS doesn't believe tax treaty requests constitute an examination for purposes of the statute governing multiple audits of the same taxable year. Even so, documents subject to a treaty request could be useful to the IRS in a future US audit of the same issue that's under audit abroad.
With a global increase in tax enforcement, one can assume that US companies will see more document requests from the IRS on behalf of foreign taxing authorities. Companies that have no prior experience with such requests should get familiar with the IRS' policies and procedures and consider how to respond if and when an IDR arrives.
Originally published by Bloomberg Tax
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