Canada: Non-wilful conduct and IRS compliance
25 August 2014
Posted by: Author: Sunita Doobay
Author: Sunita Doobay (TaxChambers LLP)
On June 18, 2014, the IRS announced changes to its 2012 streamlined filing compliance procedures for offshore disclosure (News Release IR-2014-73). The changes apply to a US taxpayer who resides outside or in the United States. The enhanced streamlined procedures are attractive for a US non-resident, who is now not subject to a failure-to-file and failure-to-pay penalty, an accuracy-related penalty, an information return penalty, or an FBAR penalty unless the non-compliance was fraudulent or the FBAR violation was wilful. (Previously assessed penalties for those years are not reduced.)
In its publication "Streamlined Foreign Offshore Procedures,” the IRS clarified that "[n]on-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.” Treasury officials said that no guidance on "willful conduct” is forthcoming and that a US taxpayer should seek assistance from a US tax adviser to determine whether the relevant conduct was wilful or not.
Existing tax law provides only limited guidance on what constitutes a wilful violation of FBAR filing requirements. Two relatively recent court cases shed some light on whether a taxpayer wilfully violated his or her obligations.
In Williams (no. 10-2230 (4th Cir. 2012)), the Fourth Circuit court upheld civil penalties imposed for the taxpayer’s failure to report interest earned in two foreign bank accounts in 2000 on information return TD F 90-22.1 (FBAR); the court overturned the District Court’s decision that the taxpayer had not wilfully failed to file his FBAR.
The FBAR must be filed by June 30 of each calendar year with respect to foreign financial accounts maintained in the previous calendar year. A person who wilfully fails to file the FBAR is exposed to a penalty of up to $100,000 or 50 percent of the maximum balance in the account when the penalty can be imposed. Williams is one of the few cases that discuss the meaning of the word "willfully.” The lower court found that the taxpayer had not wilfully failed to file the FBAR: the court accepted the taxpayer’s testimony that he was unaware of the FBAR requirement at the 2001 filing date and had focused only on the numerical portion of his tax return. The District Court concluded that in 2001 the taxpayer had no reason to conceal his offshore accounts: at that time, he was aware that the US government had uncovered the accounts and had also requested that they be frozen. The District Court said that it was reasonable for the taxpayer to believe that the accounts were already disclosed and that he did not need to file the FBAR.
The Fourth Circuit disagreed and concluded that the taxpayer wilfully chose to not file his FBAR.
"Willfulness may be proven through inference from conduct meant to conceal or mislead sources of income or other financial information,” and it "can be inferred from a conscious effort to avoid learning about reporting requirements.” . . . Similarly, "willful blindness” may be inferred where "a defendant was subjectively aware of a high probability of the existence of a tax liability, and purposefully avoided learning the facts point to such liability.” . . . [But] "where willfulness is a statutory condition of civil liability, [courts] have generally taken it to cover not only knowing violations of a standard, but reckless ones as well.” . . . "[The] question of willfulness is essentially a finding of fact.”
The taxpayer wilfully chose not to file the FBAR when it was due—when he signed his 2000 federal tax return—and the taxpayer declared under penalty of perjury that he had
"examined this return and accompanying schedules and statements” and that, to the best of his knowledge, the return was "true, accurate, and complete.” "A taxpayer who signs a tax return will not be heard to claim innocence for not having actually read the return, as he or she is charged with constructive knowledge of its contents.” . . . Williams’s signature is prima facie evidence that he knew the contents of the return . . . and at a minimum line 7a’s directions to "[s]ee instructions for exceptions and filing requirements for Form TD F 90-22.1” put Williams on inquiry notice of the FBAR requirement.
Nothing in the record indicates that Williams ever consulted Form TD F 90-22.1 or its instructions. In fact, Williams testified that he did not read line 7a and "never paid any attention to any of the written words” on his federal tax return. . . . Thus, Williams made a "conscious effort to avoid learning about reporting requirements” . . . and his false answers on both the tax organizer and his federal tax return evidence conduct that was "meant to conceal or mislead sources of income or other financial information.”
The court also noted that the form instructions specified that
"[e]vidence of acts to conceal income and financial information, combined with the defendant’s failure to pursue knowledge of further reporting requirements as suggested on Schedule B, provide a sufficient basis to establish willfulness on the part of the defendant.” This conduct constitutes willful blindness to the FBAR requirement.
The court in McBride (no. 2:09-cv-00378 (D UT 2012)) essentially followed Williams.
In the recent jury-decided case of Zwerner (no. 1:13-cv-22082, SD FL (Miami)), the taxpayer was found to have wilfully failed to report his interest in a Swiss account for the taxation years 2004 to 2006. According to the May 28, 2014 Department of Justice press release,
Even though he filled out a tax organizer provided by his accountant, every year, [the taxpayer] answered "no” to questions asking whether "you have an interest in or signature authority over a financial account in a foreign country, such as a bank account, securities account or other financial account” and whether "you have any foreign income or pay any foreign taxes.”
The jury agreed with the IRS that the taxpayer was subject to a penalty of 50 percent of his account balance at the time of each violation for each of 2004, 2005, and 2006; the total penalty was $2,241,809, even though the highest account balance in the years at issue was $1,691,054. On June 9, 2014, the IRS announced a settlement under which the taxpayer agreed to pay about $1.8 million. The taxpayer’s lawyer had sought a no-name disclosure to spare the taxpayer from criminal but not civil penalties. Once the taxpayer filed, he was audited and thus could not participate in the OVDI program.
If the wilfulness standard for the streamlined procedures is based on Williams, McBride, and Zwerner, many US taxpayers residing in Canada will be challenged to qualify if they filed US returns but failed to file FBARs. Those taxpayers may have limited procedural alternatives by which to resolve their US tax issues and become tax-compliant, but they may have no other option: hiding from the IRS is no longer an easy feat, and the stakes are high.
This article first appeared on ctf.ca.