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The IRS Can Share Your Tax Information with Foreign Governments

The recent Zhang v. United States case, Docket No. 21-17093 (9th Cir. Oct. 18, 2022), serves as a reminder that the Internal Revenue Service (IRS) can force you to disclose and share your tax information with foreign governments. The taxpayers in Zhang appealed the decision from the US District Court for the Northern District of California denying their petition to quash an IRS summons for information. The summons was at the request of the Canadian tax authority pursuant to a bilateral tax treaty between the United States and Canada. The US Court of Appeals for the Ninth Circuit reaffirmed that the IRS can seek information for, and on behalf of, a foreign government as long as the request satisfies the accepted guidelines of requesting information in the United States—for example, the “good faith” requirement announced in United States v. Powell, 379 U.S. 48, 57-58 (1964).

So why do we highlight Zhang for you? In this ever-increasing world of tax information transparency, taxpayers need to be mindful of the ability of tax authorities to share information with each other and adjust their taxes accordingly. During a tax audit, it’s a strategic decision as to what tax information to share and what not to share with each tax authority. Telling different stories to different tax authorities could lead to more intrusive audits/scrutiny and higher overall tax bills and could even lead to criminal prosecution. Below are some basic principles to keep in mind:

  • There are three primary methods as to how countries share tax information with each other:
    • Automatic Exchanges
    • Spontaneous Exchanges
    • Targeted Requests
  • Automatic exchanges are becoming increasingly used by countries (g., BEPS Action 5 and the Foreign Account Tax Compliance Act) because they are automatic and routine and usually associated with standardized financial/bank transactions.
  • A spontaneous exchange occurs when one country sees something of interest and alerts another country about a potential tax issue or as part of a joint audit by the countries.
    • These exchanges are usually facilitated by provisions in bilateral tax treaties.
    • The IRS’s Internal Revenue Manual (g., IRM 4.60.1.3) has detailed instructions for IRS employees on how to handle these treaty exchanges.
  • Targeted requests (like in Zhang) are typically initiated by one country that is a party to an information exchange treaty to seek information needed by that country in its tax investigation of its resident or citizen.
    • In such a case where a foreign government makes a request of the US government through a treaty, the IRS Office of the Competent Authority on the US side handles the request. (See, e.g., IRM 4.60.1.2.2.4.)
    • If the US taxpayer does not comply with the IRS request for information made by the foreign government (usually in the form of an “Information Document Request”), the IRS can use its administrative summons power to enforce the summons in court (which is what happened in Zhang).

Practice Point: It is crucial to be strategic [...]

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Ninth Circuit Interprets Summons Notice Rules Strictly Against IRS

The Internal Revenue Service (IRS) had broad examination authority to determine the correct amount of tax owed by taxpayers. In addition to seeking information directly from a taxpayer, the IRS is also authorized to seek information from third parties. However, Internal Revenue Code (Code) Section 7602(c)(1) requires that the IRS provide “reasonable notice in advance to the taxpayer” before contacting a third party. The US Court of Appeals for the Ninth Circuit recently addressed what constitutes “reasonable notice” for this purpose.

In J.B. v. United States, the taxpayer sought to quash an IRS summons for insufficient notice. The taxpayers were selected for a compliance research examination as part of the IRS’s National Research Program, which involves in-depth audits of random taxpayers to improve the government’s access to compliance information and ensure that the IRS is auditing the right taxpayers. The IRS notified the taxpayers of the audit by mail and enclosed a copy of Publication 1, Your Rights as a Taxpayer. Publication 1 states, in relevant part, that the IRS may sometimes talk to other persons if the taxpayers are unable to provide or verify information received from the taxpayer. In J.B., the IRS summonsed the California Supreme Court for copies of billing statements, invoices and other documents relating to payments to the taxpayer-husband, who was a lawyer who accepted appointments to represent indigent criminal defendants in capital cases. The taxpayers did not learn of the summons until after it had been issued, and therefore moved to quash the summons for insufficient notice. The district court held in favor of the taxpayers.

The Ninth Circuit affirmed, albeit on different grounds. After explaining that “reasonable notice” is a fact-sensitive determination and that advance notice is intended to provide taxpayers the right to avoid potential embarrassment caused by IRS contact with third parties, the court discussed the Internal Revenue Manual and the IRS’s prior practice of providing taxpayer-specific notice. In particular, the predecessor IRS letter had more than 20 iterations tailored to meet different functional requirements. The court ultimately held that the IRS must provide notice “reasonably calculated under all relevant circumstances to apprise interested parties of the possibility that the IRS may contact third parties and that affords interested parties a meaningful opportunity to resolve issues and volunteer information before those third-party contacts are made.”

The Ninth Circuit was particularly troubled by the facts that: (1) the IRS had reason to know that the billing records at issue might have been subject to attorney-client privilege and (2) the taxpayers would have had access to those documents and would have been able to provide redacted copies of the pertinent records. Moreover, the court noted that Publication 1 was “divorced from any specific request for documents.” The court concluded that “[a]lthough we limit our holding to the facts of this case, we are doubtful that Publication 1 alone will ever suffice to provide reasonable notice in advance to the taxpayer, as [...]

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Law360: US District Court To French Tax Authorities: Pas De Probleme

Robin Greenhouse and Kevin Spencer recently authored, “US District Court To French Tax Authorities: Pas De Probleme” for Law360. The article discusses a case involving IRS summons and taxpayers’ rights in context of the US-France Treaty.

Read the full coverage on Law360.




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