On April 3, 2016, the International Consortium of Investigative Journalists (ICIJ) indicated that it acquired sensitive documents that belonged to the Panamanian law firm, Mossack Fonseca & Co., about the offshore holdings of some of the world’s most prominent and wealthy individuals. The leak has received substantial mainstream media coverage due to the identity of the individuals named.
To date, the ICIJ has not released the identities of all of the hundreds of thousands of offshore entities or the persons related to those entities, which were referenced in the leaked documents. The ICIJ indicated that it would wait until May 2016 to release the full list. By waiting to May, the ICIJ is putting certain US persons on notice that they should consider starting the process to disclose previously undisclosed foreign assets to the Internal Revenue Service (IRS).
The United States subjects US persons to worldwide income taxation. As part of this taxing system, the IRS requires US persons to fulfill certain information reporting obligations related to foreign assets. For example, US persons must report a financial interest or signature authority over a foreign financial account on FinCEN Form 114, Report of Foreign Bank and Financial Account (FBAR). Non-compliance may result in a penalty of up to 50 percent of the highest aggregate value of the foreign financial account as well as criminal sanctions if done so willfully.
The IRS has implemented programs to encourage previously non-compliant US persons to disclose foreign assets and become compliant. One such program is the Offshore Voluntary Disclosure Program (OVDP). OVDP is designed for taxpayers who may have willfully failed to disclose foreign assets to the IRS. The primary benefits of participating in the OVDP are that the IRS will not recommend criminal prosecution to the Department of Justice (DOJ) for non-compliance up to the date of the disclosure and the taxpayer will no longer be subject to civil examination for the years covered by the OVDP disclosure.
Non-compliant US persons who may be named in the Panama Papers leak risk OVDP ineligibility if they wait until May to enroll. Specifically, US persons who are under civil or criminal investigation by the IRS are ineligible to participate in OVDP. US persons who are identified in the Panama Papers leak will be prime targets for examinations by the IRS. Thus, to the extent the IRS commences a civil or criminal investigation following the release, the US person would be ineligible to enroll in OVDP. Accordingly, the ICIJ has kept OVDP eligibility open for at least another month for those that may be affected.
Further, US persons who enroll in OVDP generally are subject to, among other things, a Title 26 miscellaneous offshore penalty equal to 27.5 percent of the highest aggregate value of OVDP assets during the OVDP covered period (OVDP Penalty). The OVDP Penalty increases from 27.5 percent to 50 percent if, at the time the taxpayer submits the preclearance letter to the IRS, an event has already occurred that constitutes a public disclosure that the foreign financial institution where the account is held, or another facilitator who assisted in establishing or maintaining the taxpayer’s offshore arrangement, is or has been under investigation by the IRS or the DOJ in connection with accounts that are beneficially owned by a US person. The IRS publishes a list of those foreign financial institutions where the 50 percent penalty will apply within OVDP and updates it frequently as it concludes agreements and actions against foreign facilitator banks.
The ICIJ has already identified certain banks (e.g., Credit Suisse, Deutsche Bank and UBS) as part of the Panama Papers leak that have been subject to a public disclosure that will automatically increase the OVDP Penalty to 50 percent. Nevertheless, there may be other financial institutions or facilitators that will be exposed in May and become subjects of investigation by the IRS or DOJ. As more of these banks and facilitators are investigated, the number of foreign facilitators on the IRS’s “bad bank” list will undoubtedly grow. As that list grows, so does the potential that persons banking with these institutions will be subject to the higher 50 percent OVDP penalty.
Accordingly, non-compliant US persons who may be exposed as part of the Panama Papers leak may want to consider enrolling in OVDP before the ICIJ releases its entire trove of information in May in order to limit their exposure to a 27.5 percent OVDP Penalty rather than risk being subject to a 50 percent OVDP Penalty. This is also critical, because if even one of the banks that a US person that enters the OVDP program with is a “bad bank” and on the IRS’s list, then all of their undisclosed foreign financial accounts are subject to the increased 50 percent penalty amount. This could be crippling for these individuals, and thus is an additional incentive for those potential clients to enter the OVDP program as quickly as practicable.
In short, non-compliant US persons who believe they may be exposed as part of the Panama Papers leak may want to contact their tax advisors to determine whether immediate action should be taken before any IRS investigation is commenced that could render them ineligible for OVDP. This may include considering whether to submit an OVDP preclearance letter this month to avoid risking OVDP ineligibility and/or a substantially larger OVDP Penalty.