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The Clock is Ticking: U.S. Government Officials Investigate Panama Papers

By Matthew L. Roberts on May 2, 2016

Panama has long been known as a favorite country for many taxpayers on account of its low tax rates and strict confidentiality laws, the latter of which serve to protect the identities of Panamanian corporate shareholders and bank account holders in the case of frivolous civil litigation. Accordingly, it should come to no one’s surprise that many non-Panamanian citizens take advantage of these low rates and confidentiality laws by creating Panamanian entities and utilizing the Panamanian banking system. Until recently, no one really knew how prolific the use of these entities was by non-Panamanian citizens or the extent to which they may be used by persons to avoid detection by taxing authorities and other governments. However, on April 3, 2016, the world got a glimpse of all of the above when a treasure trove of business records and documents relating to the formation and operation of Panamanian companies was released by hundreds of journalists from across the globe. 

Although the release of this information in itself would probably warrant significant media attention, further controversy was stoked when it was revealed that some of the individuals identified in the Panama Papers included monarchs, celebrities, and presidential leaders of non-Panamanian countries. Adding only more intrigue to an already incredible news story was that the unnamed source had secretly gathered the information—consisting of over 11 million documents—from a well-known Panamanian law firm, Mossack Fonseca. 

Shortly after the documents were released, U.S. government officials began participation in global meetings with other high-level foreign government officials regarding the contents of the Panama Papers. The IRS also participated in at least one “special project meeting” directly related to the documents and publicly encouraged those U.S. citizens with undisclosed Panamanian bank accounts and unreported Panamanian income to remediate by participating in the Offshore Voluntary Disclosure Program (“OVDP”). More recently, the U.S. attorney for the Southern District of New York indicated that he too had “opened a criminal investigation regarding matters to which the Panama Papers are relevant.” In sum, the U.S. government appears ready to use the contents of the Panama Papers to further pending criminal investigations as well as open new ones.

In light of the intense international pressure it continues to receive, the Panamanian government has publicly acknowledged that it intends to work with other governments in stopping criminal behavior that occurs within Panama. Notably, on April 16, 2016, the Panamanian government entered into a formal agreement with the United States in which Panama agreed to ensure certain information related to U.S. citizens with funds in Panamanian banks would be shared with U.S. government officials when requested. Although Panama had already entered into a similar agreement with the United States after enactment of the Foreign Account Tax Compliance Act (FATCA), the new agreement shows, at least ostensibly, that Panama fully intends to cooperate with the United States in the future.

The Panama Papers serve as yet another reminder that so-called “secret” accounts are not guaranteed to stay secret. With that backdrop, let’s take a quick look at U.S. tax obligations U.S. persons have when they conduct business overseas. Under Title 31, if a U.S. person has a financial interest in or signature authority over a “foreign financial account”—defined broadly to include brokerage accounts and mutual funds—that person is required to file FinCEN Report 114, Report of Foreign Bank and Financial Accounts (commonly referred to as an “FBAR”). Failure to file the report may subject the person to civil and even criminal liabilities. Additionally, certain U.S. persons who are shareholders, officers, or directors of foreign corporations are required to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations. A similar form, Form 8865, Return of U.S. Persons with Respect to Certain Foreign Partnerships, is required for those who have certain interests in foreign partnerships. Failure to file Forms 5471 and 8865 may also subject a person to civil and criminal penalties. Other filing obligations also exist under the Internal Revenue Code.

If a U.S. person engaged in overseas business has willfully failed to file required forms, serious thought should be given to entering into the OVDP. The stated purpose of this program is to “bring taxpayers that have used undisclosed foreign accounts and assets, including those held through undisclosed foreign entities, to avoid or evade tax into compliance with United States tax and related laws.” Although entering the OVDP requires the taxpayer to pay tax and penalties, in exchange the taxpayer receives some protection from criminal prosecution and imposition of harsher penalties if the IRS were to discover the information on its own. It should be noted that if the IRS has already initiated an examination or criminal investigation relating to the tax years at issue, the taxpayer is precluded from entering the OVDP. For those taxpayers whose non-compliance is not willful, the IRS also has streamlined procedures and a delinquent information return program which will be discussed in my next blog post.

As the IRS alluded to above, the clock is currently ticking on those U.S. persons potentially implicated in the Panama Papers if those persons have failed to comply with their U.S. filing and tax obligations. On another note, a lesson learned from the Swiss bank experience is that the IRS may look unkindly on the movement of a noncompliant taxpayer’s account and structure to another country identified to have better secrecy protections.