H. Jacob Lager

Archive for the ‘Court decisions’ Category

Iraq reconstruction legacy: Kickback conspiracies and tax crimes

In Court decisions, Tax Crime on October 12, 2012 at 7:49 am

This past Wednesday, Assistant Attorney General Lanny A. Breuer of the Criminal Division and U.S. Attorney for the Northern District of Alabama Joyce White Vance announced the sentencing of two former Parsons Company employees for their participation in a kickback conspiracy in Iraq and related tax crimes.

According to court documents, Gaines R. Newell Jr and Billy Joe Hunt worked for Parsons in Iraq as program managers to support the U.S. Army Corps of Engineers in its efforts to keep abandoned munitions from insurgents and unfriendly forces.  In their plea agreements, the Defendants admitted to taking over $1 million in kickbacks from certain (shall we say “more friendly”) subcontractors, in return for awarding them valuable munitions clearance program contracts.

Newell and Hunt also admitted to filing false federal income tax returns by not disclosing the kickback income.  If that last part sounds familiar to you – yes, “that’s how they got Capone.”

In what’s becoming a tax crime tradition here at TSF, lets run down what $1 million of illegal income cost our perps:

Billy Joe Hunt (age 57) received:

  • 15 months in prison:
  • 3 years of supervised release;
  • A tax restitution bill for $66,212; and
  • Forfeiture of $236,472.

Gaines R. Newell Jr. (age 53) received:

  • 27 months in prison;
  • 3 years of supervised release;
  • A tax restitution bill for $241,088; and
  • Forfeiture of $861,027 to the U.S. Army Corps of Engineers.

I would ever advise a client to engage in an illegal business activity. BUT, I would advise him to, at the very least, pay his taxes on the income.

Read the official presser here.

Flag image provided by cudmore.


Planning on “pleading the Fifth”? Not when it comes to offshore banking

In Court decisions, Offshore Accounts, Uncategorized on September 7, 2012 at 12:45 pm

I have never actually heard someone take the Fifth.  Not as an advocate.  Not as opposing counsel.  Heck, not even as a juror.

Three years of law school and nearly 15 years of practice and I’ve never actually heard those magic words: “on advice of counsel, I respectfully refuse to answer on the grounds that to do so might incriminate myself.”

See.  I even know them by heart.

Sadly, On August 27, the Seventh Circuit made it even more unlikely that I’d hear them anytime soon.  The panel ruled that the Fifth Amendment privilege against self-incrimination does not apply to a taxpayer’s offshore banking records and that the taxpayer may not invoke the privilege to resist compliance with a subpoena seeking records kept pursuant to the Bank Secrecy Act.

In so ruling, the Seventh Circuit joined the Ninth Circuit in holding that the so-called “required records” exception to the Fifth Amendment privilege against self-incrimination applies to records of foreign bank accounts.

So, what is this exception and why haven’t they mentioned it on Law & Order?  According to the Ninth Circuit, the doctrine exists because “the Supreme Court has recognized that . . . the privilege does not extend to records required to be kept as a result of an individual’s voluntary participation in a regulated activity.”

What this essentially means is that if you voluntarily (remember that word – it’s important later) enter into a regulated activity that requires you to keep records, you can’t later prevent those records from being disclosed.

So how does this exception work?

Under the required records doctrine, a government inquiry does not impact your Fifth Amendment rights if:

(1) The government’s inquiry is essentially regulatory; [hmm… ok, but aren’t they all?]

(2) The information is a preserved record of a kind customarily retained; and

(3) The records have taken on public aspects making them analogous to a public document.

Ok, wait a minute!  If you’re wondering why your banking records are considered analogous to a “public document,” then you’ve been paying attention.  According to the Ninth Circuit, where “personal information is compelled in furtherance of a valid regulatory scheme, as is the case here, that information assumes a public aspect….  Similarly, disclosure of basic account information is an ‘essentially neutral’ act necessary for effective regulation of offshore banking.”

Does this mean if there is a regulation requiring that you maintain information, that information is automatically exempt from Fifth Amendment protection?  Doesn’t that exception swallow the entire rule?  Not exactly.

The trick here is that you must voluntarily enter into the activity itself in the first place.  Your individual tax returns remain protected in most respects because simply being a taxpayer does not involve a voluntary choice.  However, according to the Ninth Circuit, “no one is required to participate in the activity of offshore banking.”  Thus, the required records doctrine applies to offshore banking records because the taxpayer “enters upon a regulated activity knowing that the maintenance of extensive records available for inspection by the regulatory agency is one of the conditions of engaging in the activity….”

In short, if you bank offshore, you cede any Fifth Amendment protections related to that account.

Bet you didn’t see that in the application.

International sales and state and local taxation: Closer than you may think

In Business tax rate, Business tax rates, Court decisions on August 3, 2012 at 6:38 am

Michigan allows domestic corporation to aggregate with foreign entity

The mainstream media (first time I’ve ever used that term this election cycle!) often portrays the use of foreign business entities as an arcane, indecipherable tax-dodging practice available only to huge corporations and the very wealthy.

The truth is far more mundane and, therefore, relevant to growing middle-market and closely-held businesses.

Take, for example, this past Tuesday’s re-issuance of a May 15, 2012 decision by the Michigan Court of Appeals.   In Wheeler v. MI Dept. of Treasury,  the court held that the shareholders of a domestic S-corporation were entitled to combine that corporation’s income with that of its subsidiary foreign partnerships when determining how to properly apportion state income tax liability.

So what does all that mean?

How Multi-State Allocation Works

Like many states, Michigan relies on statutory rules of allocation to determine which income from out-of-state activities are not subject to Michigan income taxes.  Some taxpayers can easily identify out-of-state activities and thereby allocate their income to specific geographic areas.  Others often encounter difficulties attempting to make such an allocation.  States are allowed to tax these multi-state operators on an apportionable share of their multistate business attributable to their jurisdiction.  This is known as the “Unitary Business Principle” (or “UBP”) and is often expressed within a state’s revenue statutes in the form of a formula that accounts for factors such as the taxpayer’s in-state property, payroll and sales.

In Wheeler, the taxpayers were the individual owners of a Michigan S Corporation with underlying foreign subsidiaries that were also transparent for tax purposes.  The owners treated their income from all their domestic and foreign pass-through entities as a unitary business and included in their UBP apportionment calculation the factors attributable to their foreign entities, resulting in a lower Michigan tax bill.  Michigan argued that UBP did not allow consideration of the foreign entities’ activities.

The Decision

In holding for the taxpayers, the court noted that “the plain language of the [statute] requires unitary, international businesses to apportion their income, and the plain language of the [statute] in effect during the years at issue required unitary, international businesses to include international apportionment factors in the calculation of property, payroll, and sales factors. . . . [T]herefore, we enforce the statute as written and follow the plain meaning of the statutory language.”

The Takeaway

When you or your clients plan for next year’s anticipated total tax obligations, don’t automatically assume that international operations are entirely separate from domestic.  You might be leaving money on the table if you don’t examine a full unitary approach for all your operations.

Debt or equity? HP case sheds new light on old issue

In Court decisions, Debt v. equity on June 28, 2012 at 10:46 am

Hewlett-Packard was handed a recent loss in Tax Court when its preferred equity in a foreign corporate special purpose vehicle (SPV) was recast as debt.  Consequently, HP was denied an indirect foreign tax credit as well as a capital loss on the equity when sold.

So, what exactly happened here?

Historically speaking, HP fell into a classic tax question: was the subject investment debt or equity?  The answer is not always so easy to discern.  Believe it or not, The Internal Revenue Code itself does not contain a general definition of the term “indebtedness” or “equity.”  Instead, courts that have considered the debt versus equity issue have repeatedly stated that the question whether an advance of funds is debt or equity is a question of fact to be decided on the basis of all the facts and circumstances.  Courts typically consider a list of factors that are to be taken into account in resolving this issue.

Here, the court held that HP’s preferred equity of a foreign corporation was debt because there was a high level of economic and legal certainty that HP would receive a prescribed dividend and that HP’s investment would be as safe as a bank deposit.  The court also noted that HP held a right to put the stock to its fellow shareholder in the seventh year of the investment, which the court treated as a put to the issuer.

The alarming thing about this case is that the court’s ruling relied so very much on the very aspects that typically make SVPs attractive to investors: namely, the investment’s safety and security.  SPVs are often specifically designed to constrict both their investment options and their ability to incur debt.  But according to the court’s ruling the fact that “HP was essentially assured of the return on its investment” took its SPV interest out of the world of equity.

Going forward, international issuers and investors will need to particularly mind the economic security and exit certainty elements of a planned SPV.  When combined, these two aspects, meant to cater to conservative investors, may in fact prove too good to be true.


Circuit Split Alert! – Fifth Circuit Diverges from Third in Holding UK Windfall Tax Creditable

In Court decisions, Foreign taxes on June 12, 2012 at 8:59 am

It’s a tax blogger’s dream.  In Entergy Corp. v. Commissioner, The Fifth Circuit just held on June 5 that a US company’s UK windfall tax payment qualifies as a creditable foreign tax and creates a circuit split after the Third Circuit recently held otherwise.

What’s a Windfall Tax?

In 1997 the United Kingdom enacted a windfall tax on the excess profits of certain recently privatized utility companies.  The tax was meant to address public backlash against what was perceived as bargain sales of the utilities.

The tax imposed on each of the utilities a 23 percent assessment on the difference between: (1) a company’s “profit-making value” (its average annual per day profit multiplied by nine) and (2) its “flotation value” (the price for which it was acquired).

Here, the US taxpayer who owned a UK subsidiary that operated a privatized utility paid the windfall tax and sought a US income tax credit based on that payment.  The IRS disallowed the credit.  As the Eighth Circuit noted, the parties “essentially disagreed on whether the Windfall Tax . . . constituted a tax on excess profits, creditable under I.R.C. § 901, or a tax on unrealized value” for which no credit would be allowed.

What this Means – Foreign Tax Credit Defined

In general, regulation 1.901-2(a) allows a credit only for foreign taxes the “predominant character” of which is an income tax in the US sense. To have that character, the tax must:  (1) reach only realized income, (2) be imposed on the basis of gross receipts, and (3) target only net income.

Third Circuit/IRS Position

In a previous case, the Third Circuit held that the windfall tax did not meet the second requirement – that it be imposed on gross receipts, or an amount not greater than gross receipts. According to this argument, the windfall tax statute focuses on “profit-making value,” an average profits calculation based on a particular time period, not “gross receipts,” even though gross receipts may impact the tax indirectly.

Fifth Circuit/Taxpayer Position

The Fifth Circuit court rejected the Third Circuit’s approach and, more pointedly, the notion that it must only examine the windfall statute’s text in reaching its conclusion.  Instead the panel examined the tax’s history and actual effect of the foreign tax on taxpayers.  Noting that “both the design and effect of the windfall tax was to tax an amount that, under US tax principles, may be considered excess profits realized by the vast majority of the windfall tax companies,” the panel ruled that the tax was designed to reach net gain under normal circumstances.  In practice, the taxpayer demonstrated that the windfall tax’s application would be based on “either actual income or an imputed value not intended to reach more than actual gross receipts.”  Consequently, the tax’s “predominant character” was that of the US income tax and that it was a creditable foreign tax under section 901.

At the moment, it’s unclear whether the split will reach the Supreme Court for final determination.  The essence of the clash lies in how an unconventional foreign tax might satisfy the three-prong test for US credit-worthiness.  While the issue may not be headline-grabbing like a civil rights or due process dispute, the US tax response to more exotic foreign taxes that are not easily categorized represents a real cost to US-based multinationals (this case involved a credit of $243 million).  I would guess we’ll see this up for certiorari sooner than later.