[Congressional Record Volume 153, Number 31 (Saturday, February 17, 2007)]
[Senate]
[Pages S2206-S2216]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. LEVIN (for himself, Mr. Coleman, and Mr. Obama):
  S. 681. A bill to restrict the use offshore tax havens and abusive 
tax shelters to inappropriately avoid Federal taxation, and for other 
purposes; to the Committee on Finance.
  Mr. LEVIN. Mr. President, offshore tax haven and tax shelter abuses 
are undermining the integrity of our tax system, robbing the Treasury 
of more than $100 billion each year, and shifting the tax burden from 
high income persons and companies onto the backs of middle income 
families. We can shut down a lot of these abuses if we have the 
political will. That's why I am introducing today, along with Senators 
Norm Coleman and Barack Obama, the Stop Tax Haven Abuse Act which 
offers powerful new tools to do just that.
  We all know there are billions of dollars in taxes that are owed but 
not paid each year. It's called the tax gap. The latest estimate is 
$345 billion in unpaid taxes each year owed by individuals, 
corporations, and other organizations willing to rob Uncle Sam and 
offload their tax burden onto the backs of honest taxpayers. We also 
estimate that, of that $345 billion annual tax gap, offshore tax haven 
abuses account for as much as $100 billion. Abusive tax shelters, both 
domestic and offshore, account for additional billions in unpaid taxes 
per year. To pay for critical needs, to avoid going even deeper into 
debt, and to protect honest taxpayers, we must shut these abuses down.

[[Page S2207]]

  The legislation we are introducing today is the product of years of 
work by the Permanent Subcommittee on Investigations. I serve as 
Chairman of that Subcommittee. Senator Coleman is the ranking 
Republican, and Senator Obama is a valued Subcommittee member. Through 
reports and hearings, the Subcommittee has worked for years to expose 
and combat abusive tax havens and tax shelters. In the last Congress, 
we confronted these twin threats to our treasury by introducing S. 
1565, the Tax Shelter and Tax Haven Reform Act. Today's bill is an 
improved version of that legislation, reflecting not only the 
Subcommittee's additional investigative work but also innovative ideas 
to end the use of tax havens and to stop unethical tax advisers from 
aiding and abetting U.S. tax evasion.
  A tax haven is a foreign jurisdiction that maintains corporate, bank, 
and tax secrecy laws and industry practices that make it very difficult 
for other countries to find out whether their citizens are using the 
tax haven to cheat on their taxes. In effect, tax havens sell secrecy 
to attract clients to their shores. They peddle secrecy the way other 
countries advertise high quality services. That secrecy is used to 
cloak tax evasion and other misconduct, and it is that offshore secrecy 
that is targeted in our bill.
  Abusive tax shelters are another target. Abusive tax shelters are 
complicated transactions promoted to provide tax benefits unintended by 
the tax code. They are very different from legitimate tax shelters, 
such as deducting the interest paid on your home mortgage or 
Congressionally approved tax deductions for building affordable 
housing. Some abusive tax shelters involve complicated domestic 
transactions; others make use of offshore shenanigans. All abusive tax 
shelters are marked by one characteristic: there is no real economic or 
business rationale other than tax avoidance. As Judge Learned Hand 
wrote in Gregory v. Helvering, they are ``entered upon for no other 
motive but to escape taxation.''
  Abusive tax shelters are usually tough to prosecute. Crimes such as 
terrorism, murder, and fraud produce instant recognition of the 
immorality involved. Abusive tax shelters, by contrast, are often 
``MEGOs,'' meaning ``My Eyes Glaze Over.'' Those who cook up these 
concoctions count on their complexity to escape scrutiny and public 
ire. But regardless of how complicated or eye-glazing, the hawking of 
abusive tax shelters by tax professionals like accountants, bankers, 
investment advisers, and lawyers to thousands of people like late-
night, cut-rate T.V. bargains is scandalous, and we need to stop it. 
Hiding tax schemes through offshore companies and bank accounts in tax 
havens with secrecy laws also needs to be stopped cold. It's up to 
Congress to do just that.
  Today, I would like to take some time to cut through the haze of 
these schemes to describe them for what they really are and explain 
what our bill would do to stop them. First, I will look at our 
investigation into offshore tax havens and discuss the provisions we 
have included in this bill to combat them. Then, I will turn to abusive 
tax shelters and our proposed remedies.
  For many years, the Permanent Subcommittee on Investigations has been 
looking at the problem of offshore corporate, bank, and tax secrecy 
laws and practices that help taxpayers dodge their U.S. tax obligations 
by preventing U.S. tax authorities from gaining access to key financial 
and beneficial ownership information. The Tax Justice Network, an 
international non-profit organization dedicated to fighting tax 
evasion, recently estimated that wealthy individuals worldwide have 
stashed $11.5 trillion of their assets in offshore tax havens. At one 
Subcommittee hearing, a former owner of an offshore bank in the Cayman 
Islands testified that he believed 100 percent of his former bank 
clients were engaged in tax evasion. He said that almost all were from 
the United States and had taken elaborate measures to avoid IRS 
detection of their money transfers. He also expressed confidence that 
the offshore government that licensed his bank would vigorously defend 
client secrecy in order to continue attracting business.
  In a hearing held in August 2006, the Subcommittee released a staff 
report with six case studies describing how U.S. individuals are using 
offshore tax havens to evade U.S. taxes. In one case, two brothers from 
Texas, Sam and Charles Wyly, established 58 offshore trusts and 
corporations, and operated them for more than 13 years without alerting 
U.S. authorities. To move funds abroad, the brothers transferred over 
$190 million in stock option compensation they had received from U.S. 
publicly traded companies to the offshore corporations. They claimed 
that they did not have to pay tax on this compensation, because, in 
exchange, the offshore corporations provided them with private 
annuities which would not begin to make payments to them until years 
later. In the meantime, the brothers directed the offshore corporations 
to cash in the stock options and start investing the money. The 
brothers failed to disclose these offshore stock transactions to the 
SEC despite their position as directors and major shareholders in the 
relevant companies.
  The Subcommittee was able to trace more than $700 million in stock 
option proceeds that the brothers invested in various ventures they 
controlled, including two hedge funds, an energy company, and an 
offshore insurance firm. They also used the offshore funds to purchase 
real estate, jewelry, and artwork for themselves and their family 
members, claiming they could use these offshore dollars to advance 
their personal and business interests without having to pay any taxes 
on the offshore income. The Wylys were able to carry on these tax 
maneuvers in large part because all of their activities were shrouded 
in offshore secrecy.
  In another of the case histories, six U.S. taxpayers relied on 
phantom stock trades between two offshore shell companies to generate 
fake stock losses which were then used to shelter billions in income. 
This offshore tax shelter scheme, known as the POINT Strategy, was 
devised by Quellos, a U.S. securities firm headquartered in Seattle; 
coordinated with a European financial firm known as Euram Advisers; and 
blessed by opinion letters issued by two prominent U.S. law firms, 
Cravath Swaine and Bryan Cave. The two offshore shell companies at the 
center of the strategy, known as Jackstones and Barneville, supposedly 
created a stock portfolio worth $9.6 billion. However, no cash or stock 
transfers ever took place. Moreover, the shell companies that conducted 
these phantom trades are so shrouded in offshore secrecy that no one 
will admit to knowing who owns them. One of the taxpayers, Haim Saban, 
used the scheme to shelter about $1.5 billion from U.S. taxes. Another, 
Robert Wood Johnson IV, sought to shelter about $145 million. Both have 
since agreed to settle with the IRS.
  The persons examined by the Subcommittee are far from the only U.S. 
taxpayers engaging in these types of offshore tax abuses. Recent 
estimates are that U.S. individuals are using offshore tax schemes to 
avoid payment of $40 to $70 billion in taxes each year.
  Corporations are also using tax havens to avoid payment of U.S. 
taxes. A recent IRS study estimates that U.S. corporations use offshore 
tax havens to avoid about $30 billion in U.S. taxes each year. A GAO 
report I released with Senator Dorgan in 2004 found that nearly two-
thirds of the top 100 companies doing business with the United States 
government had one or more subsidiaries in a tax haven. One company, 
Tyco International, had 115. Enron, in its heyday, had over 400 Cayman 
subsidiaries.
  Data released by the Commerce Department further demonstrates the 
extent of U.S. corporate use of tax havens, indicating that, as of 
200l, almost half of all foreign profits of U.S. corporations were in 
tax havens. A study released by the journal Tax Notes in September 2004 
found that American companies were able to shift $149 billion of 
profits to 18 tax haven countries in 2002, up 68 percent from $88 
billion in 1999.
  Here's just one simplified example of the gimmicks being used by 
corporations to transfer taxable income from the United States to tax 
havens to escape taxation. Suppose a profitable U.S. corporation 
establishes a shell corporation in a tax haven. The shell corporation 
has no office or employees, just a mailbox address. The U.S. parent

[[Page S2208]]

transfers a valuable patent to the shell corporation. Then, the U.S. 
parent and all of its subsidiaries begin to pay a hefty fee to the 
shell corporation for use of the patent, reducing its U.S. income 
through deducting the patent fees and thus shifting taxable income out 
of the United States to the shell corporation. The shell corporation 
declares a portion of the fees as profit, but pays no U.S. tax since it 
is a tax haven resident. The icing on the cake is that the shell 
corporation can then ``lend'' the income it has accumulated from the 
fees back to the U.S. parent for its use. The parent, in turn, pays 
``interest'' on the ``loans'' to the shell corporation, shifting still 
more taxable income out of the United States to the tax haven. This 
example highlights just a few of the tax haven ploys being used by some 
U.S. corporations to escape paying their fair share of taxes here at 
home.
  Our Subcommittee's most recent investigation into offshore abuses 
highlighted the extent to which offshore secrecy rules make it possible 
for taxpayers to participate in illicit activity with little fear of 
getting caught. Through a series of case studies, the Subcommittee 
showed how U.S. taxpayers, with the help of offshore service providers, 
financial institutions, and sometimes highly credentialed tax 
professionals, set up entities in such secrecy jurisdictions as the 
Isle of Man, the Cayman Islands, and the island of Nevis, claimed these 
offshore entities were independent but, in fact, controlled them 
through compliant offshore trustees, officers, directors, and corporate 
administrators. Because of the offshore secrecy laws and practices, 
these offshore service providers could and did go to extraordinary 
lengths to protect their U.S. clients' identities and financial 
information from U.S. tax and regulatory authorities, making it 
extremely difficult, if not impossible, for U.S. law enforcement 
authorities to get the information they need to enforce U.S. tax laws.
  The extent of the offshore tax abuses documented by the Subcommittee 
during this last year intensified our determination to find new ways to 
combat offshore secrecy and restore the ability of U.S. tax enforcement 
to pursue offshore tax cheats. I'd now like to describe the key 
measures in the Stop Tax Havens Act being introduced today, which 
includes the use of presumptions to overcome offshore secrecy barriers, 
special measures to combat persons who impede U.S. tax enforcement, and 
greater disclosure of offshore transactions.
  Our last Subcommittee staff report provided six case histories 
detailing how U.S. taxpayers are using offshore tax havens to avoid 
payment of the taxes they owe. These case histories examined an 
Internet based company that helps persons obtain offshore entities and 
accounts; U.S. promoters that designed complex offshore structures to 
hide client assets, even providing clients with a how-to manual for 
going offshore; U.S. taxpayers who diverted business income offshore 
through phony loans and invoices; a one-time tax dodge that deducted 
phantom offshore stock losses from real U.S. stock income to shelter 
that income from U.S. taxes; and the 13-year offshore empire built by 
Sam and Charles Wyly. Each of these case histories presented the same 
fact pattern in which the U.S. taxpayer, through lawyers, banks, or 
other representatives, set up offshore trusts, corporations, or other 
entities which had all the trappings of independence but, in fact, were 
controlled by the U.S. taxpayer whose directives were implemented by 
compliant offshore personnel acting as the trustees, officers, 
directors or nominee owners of the offshore entities.
  In the case of the Wylys, the brothers and their representatives 
communicated Wyly directives to a so-called trust protector who then 
relayed the directives to the offshore trustees. In the 13 years 
examined by the Subcommittee, the offshore trustees never once rejected 
a Wyly request and never once initiated an action without Wyly 
approval. They simply did what they were told. A U.S. taxpayer in 
another case history told the Subcommittee that the offshore personnel 
who nominally owned and controlled his offshore entities, in fact, 
always followed his directions, describing himself as the ``puppet 
master'' in charge of his offshore holdings. When the Subcommittee 
discussed these case histories with financial administrators from the 
Isle of Man, they explained that none of the offshore personnel were 
engaged in any wrongdoing, because their laws permit foreign clients to 
transmit detailed, daily instructions to offshore service providers on 
how to handle offshore assets, so long as it is the offshore trustee or 
corporate officer who gives the final order to buy or sell the 
assets. They explained that, under their law, an offshore entity is 
considered legally independent from the person directing its activities 
so long as that person follows the form of transmitting ``requests'' to 
the offshore personnel who retain the formal right to make the 
decisions, even though the offshore personnel always do as they are 
asked.

  The Subcommittee case histories illustrate what the tax literature 
and law enforcement experience have shown for years: that the business 
model followed in all offshore secrecy jurisdictions is for compliant 
trustees, corporate administrators, and financial institutions to 
provide a veneer of independence while ensuring that their U.S. clients 
retain complete and unfettered control over ``their'' offshore assets. 
That's the standard operating procedure offshore. Offshore service 
providers pretend to own or control the offshore trusts, corporations, 
and accounts they help establish, but what they really do is whatever 
their clients tell them to do. In truth, the independence of offshore 
entities is a legal fiction, and it is past time to pull back the 
curtain on the reality hiding behind the legal formalities.
  The reality behind these offshore practices makes a mockery of U.S. 
laws that normally view trusts and corporations as independent 
entities. They invite game-playing and tax evasion. To combat these 
offshore abuses, our bill takes them head on in a number of ways.
  The first section of our bill, Section 101, tackles this issue by 
creating several rebuttable evidentiary presumptions that would strip 
the veneer of independence from the U.S. person involved with offshore 
entities, transactions, and accounts, unless that U.S. person presents 
clear and convincing evidence to the contrary. These presumptions would 
apply only in civil judicial or administrative tax or securities 
enforcement proceedings examining transactions, entities, or accounts 
in offshore secrecy jurisdictions. These presumptions would put the 
burden of producing evidence from the offshore secrecy jurisdiction on 
the taxpayer who chose to do business there, and who has access to the 
information, rather than on the Federal Government which has little or 
no practical ability to get the information. The creation of these 
presumptions implements a bipartisan recommendation in the August 2006 
Subcommittee report on tax haven abuses.
  The bill would establish three evidentiary presumptions that could be 
used in a civil tax enforcement proceeding: (1) a presumption that a 
U.S. taxpayer who ``formed, transferred assets to, was a beneficiary 
of, or received money or property'' from an offshore entity, such as a 
trust or corporation, is in control of that entity; (2) a presumption 
that funds or other property received from offshore are taxable income, 
and that funds or other property transferred offshore have not yet been 
taxed; and (3) a presumption that a financial account controlled by a 
U.S. taxpayer in a foreign country contains enough money--$10,000--to 
trigger an existing statutory reporting threshold and allow the IRS to 
assert the minimum penalty for nondisclosure of the account by the 
taxpayer.
  In addition, the bill would establish two evidentiary presumptions 
applicable to civil proceedings to enforce U.S. securities laws. One 
would specify that if a director, officer, or major shareholder of a 
U.S. publicly traded corporation were associated with an offshore 
entity, that person would be presumed to control that offshore entity. 
The second provides that securities nominally owned by an offshore 
entity are presumed to be beneficially owned by any U.S. person who 
controlled the offshore entity.
  These presumptions are rebuttable, which means that the U.S. person 
who is the subject of the proceeding could provide clear and convincing 
evidence

[[Page S2209]]

to show that the presumptions were factually inaccurate. To rebut the 
presumptions, a taxpayer could establish, for example, that an offshore 
corporation really was controlled by an independent third party, or 
that money sent from an offshore account really represented a 
nontaxable gift instead of taxable income. If the taxpayer wished to 
introduce evidence from a foreign person, such as an offshore banker, 
corporate officer, or trust administrator, to establish those facts, 
that foreign person would have to actually appear in the proceeding in 
a manner that would permit cross examination in order for the taxpayer 
to rebut the presumption. A simple affidavit from an offshore resident 
who refused to submit to cross examination in the United States would 
be insufficient.
  There are several limitations on these presumptions to ensure their 
operation is fair and reasonable. First, the evidentiary rules in 
criminal cases would not be affected by this bill which would apply 
only to civil proceedings. Second, because the presumptions apply only 
in enforcement ``proceedings,'' they would not directly affect, for 
example, a person's reporting obligations on a tax return or SEC 
filing. The presumptions would come into play only if the IRS or SEC 
were to challenge a matter in a formal proceeding. Third, the bill does 
not apply the presumptions to situations where either the U.S. person 
or the offshore entity is a publicly traded company, because in those 
situations, even if a transaction were abusive, IRS and SEC officials 
are generally able to obtain access to necessary information. Fourth, 
the bill recognizes that certain classes of offshore transactions, such 
as corporate reorganizations, may not present a potential for abuse, 
and accordingly authorizes Treasury and the Securities and Exchange 
Commission to issue regulations or guidance identifying such classes of 
transactions, to which the presumptions would then not apply.

  An even more fundamental limitation on the presumptions is that they 
would apply only to transactions, accounts, or entities in offshore 
jurisdictions with secrecy laws or practices that unreasonably restrict 
the ability of the U.S. government to get needed information and which 
do not have effective information exchange programs with U.S. law 
enforcement. The bill requires the Secretary of the Treasury to 
identify those offshore secrecy jurisdictions, based upon the practical 
experience of the IRS in obtaining needed information from the relevant 
country.
  To provide a starting point for Treasury, the bill presents an 
initial list of 34 offshore secrecy jurisdictions. This list is taken 
from actual IRS court filings in numerous, recent court proceedings in 
which the IRS sought permission to obtain information about U.S. 
taxpayers active in the named jurisdictions. The bill thus identifies 
the same jurisdictions that the IRS has already named publicly as 
probable locations for U.S. tax evasion. Federal courts all over the 
country have consistently found, when presented with the IRS list and 
supporting evidence, that the IRS had a reasonable basis for concluding 
that U.S. taxpayers with financial accounts in those countries 
presented a risk of tax noncompliance. In every case, the courts 
allowed the IRS to collect information about accounts and transactions 
in the listed offshore jurisdictions.
  The bill also provides Treasury with the authority to add or remove 
jurisdictions from the initial list so that the list can change over 
time and reflect the actual record of experience of the United States 
in its dealings with specific jurisdictions around the world. The bill 
provides two tests for Treasury to use in determining whether a 
jurisdiction should be identified as an ``offshore secrecy 
jurisdiction'' triggering the evidentiary presumptions: (1) whether the 
jurisdiction's secrecy laws and practices unreasonably restrict U.S. 
access to information, and (2) whether the jurisdiction maintains a tax 
information exchange process with the United States that is effective 
in practice.
  If offshore jurisdictions make a decision to enact secrecy laws and 
support industry practices furthering corporate, financial, and tax 
secrecy, that's their business. But when U.S. taxpayers start using 
those offshore secrecy laws and practices to evade U.S. taxes to the 
tune of $100 billion per year, that's our business. We have a right to 
enforce our tax laws and to expect that other countries will not help 
U.S. tax cheats achieve their ends.
  The aim of the presumptions created by the bill is to eliminate the 
unfair advantage provided by offshore secrecy laws that for too long 
have enabled U.S. persons to conceal their misconduct offshore and game 
U.S. law enforcement. These presumptions would allow U.S. law 
enforcement to establish what we all know from experience is normally 
the case in an offshore jurisdiction--that a U.S. person associated 
with an offshore entity controls that entity; that money and property 
sent to or from an offshore entity involves taxable income; and that an 
offshore account that wasn't disclosed to U.S. authorities should have 
been. U.S. law enforcement can establish these facts presumptively, 
without having to pierce the secrecy veil. At the same time, U.S. 
persons who chose to transact their affairs through an offshore secrecy 
jurisdiction are given the opportunity to lift the veil of secrecy and 
demonstrate that the presumptions are factually wrong.
  We believe these evidentiary presumptions will provide U.S. tax and 
securities law enforcement with powerful new tools to shut down tax 
haven abuses.
  Section 102 of the bill is another innovative approach to combating 
tax haven abuses. This section would build upon existing Treasury 
authority to apply an array of sanctions to counter specific foreign 
money laundering threats by extending that same authority to counter 
specific foreign tax administration threats.
  In 2001, the PATRIOT Act gave Treasury the authority under 31 U.S.C. 
5318A to require domestic financial institutions and agencies to take 
special measures with respect to foreign jurisdictions, financial 
institutions, or transactions found to be of ``primary money laundering 
concern.'' Once Treasury designates a foreign jurisdiction or financial 
institution to be of primary money laundering concern, Section 5318A 
allows Treasury to impose a range of requirements on U.S. financial 
institutions in their dealings with the designated entity--from 
requiring U.S. financial institutions, for example, to provide greater 
information than normal about transactions involving the designated 
entity, to prohibiting U.S. financial institutions from opening 
accounts for that foreign entity.

  This PATRIOT Act authority has been used sparingly, but to telling 
effect. In some instances Treasury has employed special measures 
against an entire country, such as Burma, to stop its financial 
institutions from laundering funds through the U.S. financial system. 
More often, however, Treasury has used the authority surgically, 
against a single problem financial institution, to stop laundered funds 
from entering the United States. The provision has clearly succeeded in 
giving Treasury a powerful tool to protect the U.S. financial system 
from money laundering abuses.
  The bill would authorize Treasury to use that same tool to require 
U.S. financial institutions to take the same special measures against 
foreign jurisdictions or financial institutions found by Treasury to be 
``impeding U.S. tax enforcement.'' Treasury could, for example, in 
consultation with the IRS, Secretary of State, and the Attorney 
General, require U.S. financial institutions that have correspondent 
accounts for a designated foreign bank to produce information on all of 
that foreign bank's customers. Alternatively, Treasury could prohibit 
U.S. financial institutions from opening accounts for a designated 
foreign bank, thereby cutting off that foreign bank's access to the 
U.S. financial system. These types of sanctions could be as effective 
in ending the worst tax haven abuses as they have been in curbing money 
laundering.
  In addition to extending Treasury's ability to impose special 
measures against foreign entities impeding U.S. tax enforcement, the 
bill would add one new measure to the list of possible sanctions that 
could be applied to foreign entities: it would allow Treasury to 
instruct U.S. financial institutions not to authorize or accept credit 
card transactions involving the designated foreign jurisdiction or 
financial institution. Denying tax haven banks the

[[Page S2210]]

ability to issue credit cards for use in the United States, for 
example, would be a powerful new way to stop U.S. tax cheats from 
obtaining access to funds hidden offshore.
  Section 103 of the bill addresses another problem faced by the IRS in 
cases involving offshore jurisdictions--completing audits in a timely 
fashion when the evidence needed is located in a jurisdiction with 
strict secrecy laws. Currently, in the absence of fraud or some other 
exception, the IRS has 3 years from the date a return is filed to 
complete an audit and assess any additional tax. Because offshore 
secrecy laws slow down, and sometimes impede, efforts by the United 
States to obtain offshore financial and beneficial ownership 
information, the bill gives the IRS an extra 3 years to complete an 
audit and assess a tax on transactions involving an offshore secrecy 
jurisdiction. Of course, in the event that a case turns out to involve 
actual fraud, this provision of the bill is not intended to limit the 
rule giving the IRS unlimited time to assess tax in such cases.
  Tax haven abuses are shrouded in secrecy. Section 104 attempts to 
pierce that secrecy by creating two new disclosure mechanisms requiring 
third parties to report on offshore transactions undertaken by U.S. 
persons.
  The first disclosure mechanism focuses on U.S. financial institutions 
that open a U.S. account in the name of an offshore entity, such as an 
offshore trust or corporation, and learn from an anti-money laundering 
due diligence review, that a U.S. person is the beneficial owner behind 
that offshore entity. In the Wyly case history examined by the 
Subcommittee, for example, three major U.S. financial institutions 
opened dozens of accounts for offshore trusts and corporations which 
they knew were associated with the Wyly family.
  Under current anti-money laundering law, all U.S. financial 
institutions are supposed to know who is behind an account opened in 
the name of, for example, an offshore shell corporation or trust. They 
are supposed to obtain this information to safeguard the U.S. financial 
system against misuse by terrorists, money launderers, and other 
criminals.
  Under current tax law, a bank or securities broker that opens an 
account for a U.S. person is also required to give the IRS a 1099 form 
reporting any capital gains earned on the account. However, the bank or 
securities broker need not file a 1099 form if the account is owned by 
a foreign entity not subject to U.S. tax law. Problems arise when an 
account is opened in the name of an offshore entity that the bank or 
broker knows, from its anti-money laundering review, is owned or 
controlled by a U.S. person. The U.S. person should be filing a tax 
return with the IRS reporting the income of the ``controlled foreign 
corporation.'' However, since he or she knows it is difficult for the 
IRS to connect an offshore accountholder to a particular taxpayer, he 
or she may feel safe in not reporting that income. That complacency 
might change, however, if the U.S. person knew that the bank or broker 
who opened the account and learned of the connection had a legal 
obligation to report any account income to the IRS.
  Under current law, the way the regulations are written and typically 
interpreted, the bank or broker can treat the foreign account holder as 
an independent entity separate from the U.S. person, even if it knows 
that the foreign corporation is merely holding title to the account for 
the U.S. person, who exercises complete authority over the corporation 
and benefits from any capital gains earned on the account. Current law 
thus arguably imposes no duty on the bank or broker to file a 1099 form 
disclosing the account to the IRS.
  The bill would strengthen current law by expressly requiring a bank 
or broker that knows, as a result of its anti-money laundering due 
diligence or otherwise, that a U.S. person is the beneficial owner of a 
foreign entity that opened the account, to disclose that account to the 
IRS by filing a 1099 form reporting account income. This reporting 
obligation would not require banks or brokers to gather any new 
information--financial institutions are already required to perform 
anti-money laundering due diligence for accounts opened by offshore 
shell entities. The bill would instead require U.S. financial 
institutions to act on what they already know by filing a 1099 form 
with the IRS.
  The second disclosure mechanism created by Section 104 targets U.S. 
financial institutions that open foreign bank accounts or set up 
offshore corporations, trusts, or other entities for their U.S. 
clients. Our investigations have shown that it is common for private 
bankers and brokers in the United States to provide these services to 
their wealthy clients, so that the clients do not even need to leave 
home to set up an offshore structure. The offshore entities can then 
open both offshore and U.S. accounts and supposedly be treated as 
foreign account holders for tax purposes.
  A Subcommittee investigation learned, for example, that Citibank 
Private Bank routinely offered to its clients private banking services 
which included establishing one or more offshore shell corporations--
which it called Private Investment Corporations or PICs--in 
jurisdictions like the Cayman Islands. The paperwork to form the PIC 
was typically completed by a Citibank affiliate located in the 
jurisdiction, such as Cititrust, which is a Cayman trust company. 
Cititrust could then help the PIC open offshore accounts, while 
Citibank could help the PIC open U.S. accounts.
  Section 104 would require any U.S. financial institution that 
directly or indirectly opens a foreign bank account or establishes a 
foreign corporation or other entity for a U.S. customer to report that 
action to the IRS. The bill authorizes the regulators of banks and 
securities firms, as well as the IRS, to enforce this filing 
requirement. Existing tax law already requires U.S. taxpayers that take 
such actions to report them to the IRS, but many fail to do so, secure 
in the knowledge that offshore secrecy laws limit the ability of the 
IRS to find out about the establishment of new offshore accounts and 
entities. That's why our bill turns to a third party--the financial 
institution--to disclose the information. Placing this third party 
reporting requirement on the private banks and brokers will make it 
more difficult for U.S. clients to hide these transactions.
  Section 105 of our bill strengthens the ability of the IRS to stop 
offshore trust abuses by making narrow but important changes to the 
Revenue Code provisions dealing with taxation of foreign trusts. The 
rules on foreign trust taxation have been significantly strengthened 
over the past 30 years to the point where they now appear adequate to 
prevent or punish many of the more serious abuses. However, the 
Subcommittee's 2006 investigation found a few loopholes that are still 
being exploited by tax cheats and that need to be shut down.
  The bill would make several changes to close these loopholes. First, 
our investigation showed that U.S. taxpayers exercising control over a 
supposedly independent foreign trust commonly used the services of a 
liaison, called a trust ``protector'' or ``enforcer,'' to convey their 
directives to the supposedly independent offshore trustees. A trust 
protector is typically authorized to replace a foreign trustee at will 
and to advise the trustees on a wide range of trust matters, including 
the handling of trust assets and the naming of trust beneficiaries. In 
cases examined by the Subcommittee, the trust protector was often a 
friend, business associate, or employee of the U.S. person exercising 
control over the foreign trust. Section 105 provides that, for tax 
purposes, any powers held by a trust protector shall be attributed to 
the trust grantor.
  A second problem addressed by our bill involves U.S. taxpayers who 
establish foreign trusts for the benefit of their families in an effort 
to escape U.S. tax on the accumulation of trust income. Foreign trusts 
can accumulate income tax free for many years. Previous amendments to 
the foreign trust rules have addressed the taxation problem by 
basically disregarding such trusts and taxing the trust income to the 
grantors as it is earned. However, as currently written, this taxation 
rule applies only to years in which the foreign trust has a named 
``U.S. beneficiary.'' In response, to avoid the reach of the rule, some 
taxpayers have begun structuring their foreign trusts so that they 
operate with no named U.S. beneficiaries.

[[Page S2211]]

  For example, the Subcommittee's investigation into the Wyly trusts 
discovered that the foreign trust agreements had only two named 
beneficiaries, both of which were foreign charities, but also gave the 
offshore trustees ``discretion'' to name beneficiaries in the future. 
The offshore trustees had been informed in a letter of wishes from the 
Wyly brothers that the trust assets were to go to their children after 
death. The trustees also knew that the trust protector selected by the 
Wylys had the power to replace them if they did not comply with the 
Wylys' instructions. In addition, during the life of the Wyly brothers, 
and in accordance with instructions supplied by the trust protector, 
the offshore trustees authorized millions of dollars in trust income to 
be invested in Wyly business ventures and spent on real estate, 
jewelry, artwork, and other goods and services used by the Wylys and 
their families. The Wylys plainly thought they had found a legal 
loophole that would let them enjoy and direct the foreign trust assets 
without any obligation to pay taxes on the money they used.
  To stop such foreign trust abuses, the bill would make it impossible 
to pretend that this type of foreign trust has no U.S. beneficiaries. 
The bill would shut down the loophole by providing that: (1) any U.S. 
person actually benefiting from a foreign trust is treated as a trust 
beneficiary, even if they are not named in the trust instrument; (2) 
future or contingent U.S. beneficiaries are treated the same as current 
beneficiaries; and (3) loans of foreign trust assets or property such 
as real estate, jewelry and artwork (in addition to loans of cash or 
securities already covered by current law) are treated as trust 
distributions for tax purposes.
  Section 106 of the bill takes aim at legal opinions that are used to 
try to immunize taxpayers against penalties for tax shelter 
transactions with offshore elements. The Subcommittee investigations 
have found that tax practitioners sometimes tell potential clients that 
they can invest in an offshore tax scheme without fear of penalty, 
because they will be given a legal opinion that will shield the 
taxpayer from any imposition of the 20 percent accuracy related 
penalties in the tax code. Current law does, in fact, allow taxpayers 
to escape these penalties if they can produce a legal opinion letter 
stating that the tax arrangement in question is ``more likely than 
not'' to survive challenge by the IRS. The problem with such opinions 
where part of the transaction occurs in an offshore secrecy 
jurisdiction is that critical assumptions of the opinions are often 
based on offshore events, transactions and facts that are hidden and 
cannot be easily ascertained by the IRS. Legal opinions based on such 
assumptions should be understood by any reasonable person to be 
inherently unreliable.
  The bill therefore provides that, for any transaction involving an 
offshore secrecy jurisdiction, the taxpayer would need to have some 
other basis, independent of the legal opinion, to show that there was 
reasonable cause to claim the tax benefit. The ``more likely than not'' 
opinion would no longer be sufficient in and of itself to shield a 
taxpayer from all penalties if an offshore secrecy jurisdiction is 
involved. This provision, which is based upon a suggestion made by IRS 
Commissioner Mark Everson at our August hearing, is intended to force 
taxpayers to think twice about entering into an offshore scheme and to 
stop thinking that an opinion by a lawyer is all they need to escape 
any penalty for nonpayment of taxes owed. By making this change, we 
would also provide an incentive for taxpayers to understand and 
document the complete facts of the offshore aspects of a transaction 
before claiming favorable tax treatment.

  To ensure that this section does not impede legitimate business 
arrangements in offshore secrecy jurisdictions, the bill authorizes the 
Treasury Secretary to issue regulations exempting two types of legal 
opinions from the application of this section. First, the Treasury 
Secretary could exempt all legal opinions that have a confidence level 
substantially above the more-likely-than-not level, such as opinions 
which express confidence that a proposed tax arrangement ``should'' 
withstand an IRS challenge. ``More-likely-than-not'' opinion letters 
are normally viewed as expressing confidence that a tax arrangement has 
at least a 50 percent chance of surviving IRS review, while a 
``should'' opinion is normally viewed as expressing a confidence level 
of 70 to 75 percent. This first exemption is intended to ensure that 
legal opinions on arrangements that are highly likely to survive IRS 
review would continue to shield taxpayers from the 20 percent penalty. 
Second, the Treasury Secretary could exempt legal opinions addressing 
classes of transactions, such as corporate reorganizations, that do not 
present the potential for abuse. These exemptions would ensure that 
taxpayers who obtain legal opinions for these classes of transactions 
would also be protected from tax code penalties.
  In addition to tax abuses, last year's Subcommittee investigation of 
the Wyly case history uncovered a host of troubling transactions 
involving U.S. securities held by the 58 offshore trusts and 
corporations associated with the two Wyly brothers. The offshore 
entities had obtained these securities by exercising about $190 million 
in stock options provided to them by the Wylys. The Wylys had obtained 
these stock options as compensation from three U.S. publicly traded 
corporations at which they were directors and major shareholders.
  The investigation found that the Wylys generally did not report the 
offshore entities' stock holdings or transactions in their SEC filings, 
on the ground that the 58 offshore trusts and corporations functioned 
as independent entities, even though the Wylys continued to direct the 
entities' investment activities. The public companies where the Wylys 
were corporate insiders also failed to include in their SEC filings 
information about the company shares held by the offshore entities, 
even though the companies knew of their close relationship to the 
Wylys, that the Wylys had provided the offshore entities with 
significant stock options, and that the offshore entities held large 
blocks of the company stock. On other occasions, the public companies 
and various financial institutions failed to treat the shares held by 
the offshore entities as affiliated stock, even though they were aware 
of the offshore entities' close association with the Wylys. The 
investigation also found that, because both the Wylys and the public 
companies had failed to disclose the holdings of the offshore entities, 
for l3 years federal regulators were unaware of those holdings and the 
relationships between the offshore entities and the Wyly brothers.
  Corporate insiders and public companies are already obligated by 
current law to disclose share holdings and transactions of offshore 
entities affiliated with a company director, officer, or major 
shareholder. Current penalties, however, appear insufficient to ensure 
compliance in light of the low likelihood that U.S. authorities will 
learn what went on in an offshore jurisdiction. To address this 
problem, our bill would establish a new monetary penalty of up to $1 
million for persons who knowingly fail to disclose offshore holdings 
and transactions in violation of U.S. securities laws.
  The Subcommittee's August 2006 investigation showed that the Wyly 
brothers used two hedge funds and a private equity fund controlled by 
them to funnel millions of untaxed offshore dollars into U.S. 
investments. In addition, that and earlier investigations provide 
extensive evidence on the role played by U.S. company formation agents 
in assisting U.S. persons to set up offshore structures. Moreover, a 
Subcommittee hearing in November 2006 disclosed that U.S. company 
formation agents are forming U.S. shell companies for numerous 
unidentified foreign clients. Some of those U.S. shell companies were 
later used in illicit activities, including money laundering, terrorist 
financing, drug crimes, tax evasion, and other misconduct. Because 
hedge funds, private equity funds, and company formation agents are as 
vulnerable as other financial institutions to money launderers seeking 
entry into the U.S. financial system, the bill contains two provisions 
aimed at ensuring that these groups know their clients and do not 
accept or transmit suspect funds into the U.S. financial system.

  Currently, unregistered investment companies, such as hedge funds and 
private equity funds, are the only class of financial institutions 
under the Bank Secrecy Act that transmit substantial offshore funds 
into the United

[[Page S2212]]

States, yet are not required by law to have anti-money laundering 
programs, including Know Your Customer, due diligence procedures. There 
is no reason why this growing sector of our financial services industry 
should continue to serve as a gateway into the U.S. financial system 
for monies of unknown origin. The Treasury Department proposed anti-
money laundering regulations for these groups in 2002, but has not yet 
finalized them, even though the principal hedge fund trade association 
supports the issuance of federal anti-money laundering regulations. Our 
bill would require Treasury to issue final regulations within 180 days 
of the enactment of the bill. Treasury would be free to work from its 
existing proposal, but the bill would also require the final 
regulations to direct hedge funds and private equity funds to exercise 
due diligence before accepting offshore funds and to comply with the 
same procedures as other financial institutions if asked by federal 
regulators to produce records kept offshore.
  In addition, the bill would add company formation agents to the list 
of persons subject to the anti-money laundering obligations of the Bank 
Secrecy Act. For the first time, those engaged in the business of 
forming corporations and other entities, both offshore and in the 50 
States, would be responsible for knowing the identity of the person for 
whom they are forming the entity. The bill also directs Treasury to 
develop anti-money laundering regulations for this group. Treasury's 
key anti-money laundering agency, the Financial Crimes Enforcement 
Network, testified before the Subcommittee that it was considering 
drafting such regulations.
  We expect and intend that, as in the case of all other entities 
covered by the Bank Secrecy Act, the regulations issued in response to 
this bill would instruct hedge funds, private equity funds, and company 
formation agents to adopt risk-based procedures that would concentrate 
their due diligence efforts on clients that pose the highest risk of 
money laundering.
  Section 204 of the bill focuses on one tool used by the IRS in recent 
years to uncover taxpayers involved in offshore tax schemes, known as 
John Doe summonses. The bill would make three technical changes to IRS 
rules governing the issuance of these summonses to make their use more 
effective in offshore and other complex investigations.
  A John Doe summons is an administrative IRS summons used to request 
information in cases where the identity of a taxpayer is unknown. In 
cases involving known taxpayers, the IRS may issue a summons to a third 
party to obtain information about a U.S. taxpayer, but must also notify 
the taxpayer who then has 20 days to petition a court to quash the 
summons to the third party. With a John Doe summons, however, IRS does 
not have the taxpayer's name and does not know where to send the 
taxpayer notice, so the statute substitutes a procedure in which the 
IRS must apply to a court for advance permission to serve the summons 
on the third party. To obtain approval of the summons, the IRS must 
show the court, in public filings to be resolved in open court, that: 
(1) the summons relates to a particular person or ascertainable class 
of persons, (2) there is a reasonable basis for concluding that there 
is a tax compliance issue involving that person or class of persons, 
and (3) the information sought is not readily available from other 
sources.
  In recent years, the IRS has used John Doe summonses to obtain 
information about taxpayers operating in offshore secrecy 
jurisdictions. For example, the IRS has obtained court approval to 
issue John Doe summonses to credit card associations, credit card 
processors, and credit card merchants, to obtain information about 
taxpayers using credit cards issued by offshore banks. This information 
has led to many successful cases in which the IRS identified funds 
hidden offshore and recovered unpaid taxes.
  Use of the John Doe summons process, however, has proved 
unnecessarily time consuming and expensive. For each John Doe summons 
involving an offshore secrecy jurisdiction, the IRS has had to 
establish in court that the involvement of accounts and transactions in 
offshore secrecy jurisdictions meant there was a significant likelihood 
of tax compliance problems. To relieve the IRS of the need to make this 
same proof over and over, the bill would provide that, in any John Doe 
summons proceeding involving a class defined in terms of accounts or 
transactions in an offshore secrecy jurisdiction, the court may presume 
that the case raises tax compliance issues. This presumption would then 
eliminate the need for the IRS to repeatedly establish in court the 
obvious fact that accounts, entities, and transactions involving 
offshore secrecy jurisdictions raise tax compliance issues.

  Second, for a smaller subset of John Doe cases, where the only 
records sought by the IRS are offshore bank account records held by a 
U.S. financial institution where the offshore bank has an account, the 
bill would relieve the IRS of the obligation to get prior court 
approval to serve the summons. Again, the justification is that 
offshore bank records are highly likely to involve accounts that raise 
tax compliance issues so no prior court approval should be required. 
Even in this instance, however, if a U.S. financial. institution were 
to decline to produce the requested records, the IRS would have to 
obtain a court order to enforce the summons.
  Finally, the bill would streamline the John Doe summons approval 
process in large ``project'' investigations where the IRS anticipates 
issuing multiple summonses to definable classes of third parties, such 
as banks or credit card associations, to obtain information related to 
particular taxpayers. Right now, for each summons issued in connection 
with a project, the IRS has to obtain the approval of a court, often 
having to repeatedly establish the same facts before multiple judges in 
multiple courts. This repetitive exercise wastes IRS, Justice 
Department, and court resources, and fragments oversight of the overall 
IRS investigative effort.
  To streamline this process and strengthen court oversight of IRS use 
of John Doe summons, the bill would authorize the IRS to present an 
investigative project, as a whole, to a single judge to obtain approval 
for issuing multiple summons related to that project. In such cases, 
the court would retain jurisdiction over the case after approval is 
granted, to exercise ongoing oversight of IRS issuance of summonses 
under the project. To further strengthen court oversight, the IRS would 
be required to file a publicly available report with the court on at 
least an annual basis describing the summonses issued under the 
project. The court would retain authority to restrict the use of 
further summonses at any point during the project. To evaluate the 
effectiveness of this approach, the bill would also direct the 
Government Accountability Office to report on the use of the provision 
after five years.
  Finally, Section 205 of the bill would make several changes to Title 
31 of the U.S. Code needed to reflect the IRS's new responsibility for 
enforcing the Foreign Bank Account Report (FBAR) requirements and to 
clarify the right of access to Suspicious Activity Reports by IRS civil 
enforcement authorities.
  Under present law, a person controlling a foreign financial account 
with over $10,000 is required to check a box on his or her income tax 
return and, under Title 31, also file an FBAR form with the IRS. 
Treasury's Financial Crimes Enforcement Network (FinCEN), which 
normally enforces Title 31 provisions, recently delegated to the IRS 
the responsibility for investigating FBAR violations and assessing FBAR 
penalties. Because the FBAR enforcement jurisdiction derives from Title 
31, however, and most of the information available to the IRS is tax 
return information, IRS routinely encounters difficulties in using 
available tax information to fulfill its new role as FBAR enforcer. The 
tax disclosure law permits the use of tax information only for the 
administration of the internal revenue laws or ``related statutes.'' 
This rule is presently understood to require the IRS to determine, at a 
managerial level and on a case by case basis, that the Title 31 FBAR 
law is a ``related statute.'' Not only does this necessitate repetitive 
determinations in every FBAR case investigated by the IRS before each 
agent can look at the potential non-filer's income tax return, but it 
prevents the use by IRS

[[Page S2213]]

of bulk data on foreign accounts received from tax treaty partners to 
compare to FBAR filing records to find non-filers.
  One of the stated purposes for the FBAR filing requirement is that 
such reports ``have a high degree of usefulness in . . . tax . . . 
investigations or proceedings.'' 31 U. S. C 5311. If one of the reasons 
for requiring taxpayers to file FBARs is to use the information for tax 
purposes, and if IRS is to be charged with FBAR enforcement because of 
the FBARs' connection to taxes, common sense dictates that the FBAR 
statute should be considered a related statute for tax disclosure 
purposes, and the bill changes the related statute rule to say that.
  The second change made by Section 205 is a technical amendment to the 
wording of the penalty provision. Currently the penalty is determined 
in part by the balance in the foreign bank account at the time of the 
``violation.'' The violation is interpreted to have occurred on the due 
date of the FBAR return, which is June 30 of the year following the 
year to which the report relates. The statute's use of this specific 
June 30th date can lead to strange results if money is withdrawn from 
the foreign account after the reporting period closed but before the 
return due date. To eliminate this unintended problem, the bill would 
instead gauge the penalty by using the highest balance in the account 
during the reporting period.

  The third part of section 205 relates to Suspicious Activity Reports, 
which financial institutions are required to file with FinCEN whenever 
they encounter suspicious transactions. FinCEN is required to share 
this information with law enforcement, but currently does not permit 
IRS civil investigators access to the information. However, if the 
information that is gathered and transmitted to Treasury by the 
financial institutions at great expense is to be effectively utilized, 
its use should not be limited to the relatively small number of 
criminal investigators, who can barely scratch the surface of the large 
number of reports. In addition, sharing the information with civil tax 
investigators would not increase the risk of disclosure, because they 
operate under the same tough disclosure rules as the criminal 
investigators. In some cases, IRS civil agents are now issuing an IRS 
summons to a financial institution to get access, for a production fee, 
to the very same information the financial institution has already 
filed with Treasury in a SAR. The bill changes those anomalous results 
by making it clear that ``law enforcement'' includes civil tax law 
enforcement.
  Overall, our bill includes a host of innovative measures to 
strengthen the ability of Federal regulators to combat offshore tax 
haven abuses. We believe these new tools merit Congressional attention 
and enactment this year if we are going to begin to make a serious dent 
in the $100 billion in annual lost tax revenue from offshore tax abuses 
that forces honest taxpayers to shoulder a greater tax burden than they 
would otherwise have to bear.
  Until now, I've been talking about what the bill would do to combat 
offshore tax abuses. Now I want to turn to what the bill would do to 
combat abusive tax shelters and their promoters who use both domestic 
and offshore means to achieve their ends. Most of these provisions 
appeared in the Levin-Coleman-Obama bill from the last Congress. Some 
provisions from that bill have been dropped or modified in light of 
those that were enacted into law.
  For five years, the Permanent Subcommittee on Investigations has been 
conducting investigations into the design, sale, and implementation of 
abusive tax shelters. Our first hearing on this topic in recent years 
was held in January 2002, when the Subcommittee examined an abusive tax 
shelter purchased by Enron. In November 2003, the Subcommittee held two 
days of hearings and released a staff report that pulled back the 
curtain on how even some respected accounting firms, banks, investment 
advisors, and law firms had become engines pushing the design and sale 
of abusive tax shelters to corporations and individuals across this 
country. In February 2005, the Subcommittee issued a bipartisan report 
that provided further details on the role these professional firms 
played in the proliferation of these abusive shelters. Our Subcommittee 
report was endorsed by the full Committee on Homeland Security and 
Governmental Affairs in April 2005. Most recently, a 2006 Subcommittee 
staff report entitled, ``Tax Haven Abuses: The Enablers, the Tools, and 
Secrecy,'' disclosed how financial and legal professionals designed and 
sold yet another abusive tax shelter known as the POINT Strategy, which 
depended on secrecy laws and practices in the Isle of Man to conceal 
the phantom nature of securities trades that lay at the center of this 
tax shelter transaction.
  The Subcommittee investigations have found that many abusive tax 
shelters are not dreamed up by the taxpayers who use them. Instead, 
most are devised by tax professionals, such as accountants, bankers, 
investment advisors, and lawyers, who then sell the tax shelter to 
clients for a fee. In fact, as our 2003 investigation widened, we found 
a large number of tax advisors cooking up one complex scheme after 
another, packaging them up as generic ``tax products'' with boiler-
plate legal and tax opinion letters, and then undertaking elaborate 
marketing schemes to peddle these products to literally thousands of 
persons across the country. In return, these tax shelter promoters were 
getting hundreds of millions of dollars in fees, while diverting 
billions of dollars in tax revenues from the U.S. Treasury each year.
  For example, one shelter investigated by the Subcommittee and 
featured in the 2003 hearings has since become part of an IRS effort to 
settle cases involving a set of abusive tax shelters known as ``Son of 
Boss.'' Following our hearing, more than 1,200 taxpayers have admitted 
wrongdoing and agreed to pay back taxes, interest and penalties 
totaling more than $3.7 billion. That's billions of dollars the IRS has 
collected on just one type of tax shelter, demonstrating both the depth 
of the problem and the potential for progress. The POINT shelter 
featured in our 2006 hearing involved another $300 million in tax loss 
on transactions conducted by just six taxpayers.

  The bill we are introducing today contains a number of measures to 
curb abusive tax shelters. First, it would strengthen the penalties 
imposed on those who aid or abet tax evasion. Second, it would prohibit 
the issuance of tax shelter patents. Several provisions would deter 
bank participation in abusive tax shelter activities by requiring 
regulators to develop new examination procedures to detect and stop 
such activities. Others would end outdated communication barriers 
between the IRS and other enforcement agencies such as the SEC, bank 
regulators, and the Public Company Accounting Oversight Board, to allow 
the exchange of information relating to tax evasion cases. The bill 
also provides for increased disclosure of tax shelter information to 
Congress.
  In addition, the bill would simplify and clarify an existing 
prohibition on the payment of fees linked to tax benefits; and 
authorize Treasury to issue tougher standards for tax shelter opinion 
letters. Finally, the bill would codify and strengthen the economic 
substance doctrine, which eliminates tax benefits for transactions that 
have no real business purpose apart from avoiding taxes.
  Let me be more specific about these key provisions to curb abusive 
tax shelters.
  Title III of the bill strengthens two very important penalties that 
the IRS can use in its fight against the professionals who make complex 
abusive shelters possible. Three years ago, the penalty for promoting 
an abusive tax shelter, as set forth in Section 6700 of the tax code, 
was the lesser of $1,000 or 100 percent of the promoter's gross income 
derived from the prohibited activity. That meant in most cases the 
maximum fine was just $1,000.
  Many abusive tax shelters sell for $100,000 or $250,000 apiece. Our 
investigation uncovered some tax shelters that were sold for as much as 
$2 million or even $5 million apiece, as well as instances in which the 
same cookie-cutter tax opinion letter was sold to 100 or even 200 
clients. There are huge profits to be made in this business, and a 
$1,000 fine is laughable.
  The Senate acknowledged that in 2004 when it adopted the Levin-
Coleman amendment to the JOBS Act, S. 1637, raising the Section 6700 
penalty

[[Page S2214]]

on abusive tax shelter promoters to 100 percent of the fees earned by 
the promoter from the abusive shelter. A 100 percent penalty would have 
ensured that the abusive tax shelter hucksters would not get to keep a 
single penny of their ill-gotten gains. That figure, however, was cut 
in half in the conference report, setting the penalty at 50 percent of 
the fees earned and allowing the promoters of abusive shelters to keep 
half of their illicit profits.
  While a 50 percent penalty is an obvious improvement over $1000, this 
penalty still is inadequate and makes no sense. Why should anyone who 
pushes an illegal tax shelter that robs our Treasury of needed revenues 
get to keep half of his ill-gotten gains? What deterrent effect is 
created by a penalty that allows promoters to keep half of their fees 
if caught, and of course, all of their fees if they are not caught?
  Effective penalties should make sure that the peddler of an abusive 
tax shelter is deprived of every penny of profit earned from selling or 
implementing the shelter and then is fined on top of that. Section 301 
of this bill would do just that by increasing the penalty on tax 
shelter promoters to an amount equal to up to 150 percent of the 
promoters' gross income from the prohibited activity.
  A second penalty provision in the bill addresses what our 
investigations have found to be a key problem: the knowing assistance 
of accounting firms, law firms, banks, and others to help taxpayers 
understate their taxes. In addition to those who meet the definition of 
``promoters'' of abusive shelters, there are professional firms that 
aid and abet the use of abusive tax shelters and enable taxpayers to 
carry out the abusive tax schemes. For example, law firms are often 
asked to write ``opinion letters'' to help taxpayers head off IRS 
questioning and fines that they might otherwise confront for using an 
abusive shelter. Currently, under Section 6701 of the tax code, these 
aiders and abettors face a maximum penalty of only $1,000, or $10,000 
if the offender is a corporation. This penalty, too, is a joke. When 
law firms are getting $50,000 for each of these cookie-cutter 
opinion letters, it provides no deterrent whatsoever. A $1,000 fine is 
like a jaywalking ticket for robbing a bank.

  Section 302 of the bill would strengthen Section 6701 significantly, 
subjecting aiders and abettors to a maximum fine up to 150 percent of 
the aider and abettor's gross income from the prohibited activity. This 
penalty would apply to all aiders and abettors, not just tax return 
preparers.
  Again, the Senate has recognized the need to toughen this critical 
penalty. In the 2004 JOBS Act, Sen. Coleman and I successfully 
increased this fine to 100 percent of the gross income derived from the 
prohibited activity. Unfortunately, the conference report completely 
omitted this change, allowing aiders and abettors to continue to profit 
without penalty from their wrongdoing.
  If further justification for toughening these penalties is needed, 
one document uncovered by our investigation shows the cold calculation 
engaged in by a tax advisor facing low fines. A senior tax professional 
at accounting giant KPMG compared possible tax shelter fees with 
possible tax shelter penalties if the firm were caught promoting an 
illegal tax shelter. This senior tax professional wrote the following: 
``[O]ur average deal would result in KPMG fees of $360,000 with a 
maximum penalty exposure of only $31,000.'' He then recommended the 
obvious: going forward with sales of the abusive tax shelter on a cost-
benefit basis.
  Section 303 of our bill addresses the growing problem of tax shelter 
patents, which has the potential for significantly increasing abusive 
tax shelter activities.
  In 1998, a Federal appeals court ruled for the first time that 
business methods can be patented and, since then, various tax 
practitioners have filed applications to patent a variety of tax 
strategies. The U.S. Patent Office has apparently issued 49 tax 
strategy patents to date, with more on the way. These patents were 
issued by patent officers who, by statute, have a background in science 
and technology, not tax law, and know little to nothing about abusive 
tax shelters.
  Issuing these types of patents raises multiple public policy 
concerns. Patents issued for aggressive tax strategies, for example, 
may enable unscrupulous promoters to claim the patent represents an 
official endorsement of the strategy and evidence that it would 
withstand IRS challenge. Patents could be issued for blatantly illegal 
tax shelters, yet remain in place for years, producing revenue for the 
wrongdoers while the IRS battles the promoters in court. Patents for 
tax shelters found to be illegal by a court would nevertheless remain 
in place, creating confusion among users and possibly producing illicit 
income for the patent holder.
  Another set of policy concerns relates to the patenting of more 
routine tax strategies. If a single tax practitioner is the first to 
discover an advantage granted by the law and secures a patent for it, 
that person could then effectively charge a toll for all other 
taxpayers to use the same strategy, even though as a matter of public 
policy all persons ought to be able to take advantage of the law to 
minimize their taxes. Companies could even patent a legal method to 
minimize their taxes and then refuse to license that patent to their 
competitors in order to prevent them from lowering their operating 
costs. Tax patents could be used to hinder productivity and competition 
rather than foster it.
  The primary rationale for granting patents is to encourage 
innovation, which is normally perceived to be a sufficient public 
benefit to justify granting a temporary monopoly to the patent holder. 
In the tax arena, however, there has historically been ample incentive 
for innovation in the form of the tax savings alone. The last thing we 
need is a further incentive for aggressive tax shelters. That's why 
Section 303 would prohibit the patenting of any ``invention designed to 
minimize, avoid, defer, or otherwise affect the liability for Federal, 
State, local, or foreign tax.''
  Another finding of the Subcommittee investigations is that some tax 
practitioners are circumventing current state and federal constraints 
on charging tax service fees that are dependent on the amount of 
promised tax benefits. Traditionally, accounting firms charged flat 
fees or hourly fees for their tax services. In the 1990s, however, they 
began charging ``value added'' fees based on, in the words of one 
accounting firm's manual, ``the value of the services provided, as 
opposed to the time required to perform the services.'' In addition, 
some firms began charging ``contingent fees'' that were calculated 
according to the size of the paper ``loss'' that could be produced for 
a client and used to offset the client's other taxable income the 
greater the so-called loss, the greater the fee.

  In response, many states prohibited accounting firms from charging 
contingent fees for tax work to avoid creating incentives for these 
firms to devise ways to shelter substantial sums. The SEC and the 
American Institute of Certified Public Accountants also issued rules 
restricting contingent fees, allowing them in only limited 
circumstances. Recently, the Public Company Accounting Oversight Board 
issued a similar rule prohibiting public accounting firms from charging 
contingent fees for tax services provided to the public companies they 
audit. Each of these federal, state, and professional ethics rules 
seeks to limit the use of contingent fees under certain, limited 
circumstances.
  The Subcommittee investigation found that tax shelter fees, which are 
typically substantial and sometimes exceed $1 million, are often linked 
to the amount of a taxpayer's projected paper losses which can be used 
to shelter income from taxation. For example, in four tax shelters 
examined by the Subcommittee in 2003, documents show that the fees were 
equal to a percentage of the paper loss to be generated by the 
transaction. In one case, the fees were typically set at 7 percent of 
the transaction's generated ``tax loss'' that clients could use to 
reduce other taxable income. In another, the fee was only 3.5 percent 
of the loss, but the losses were large enough to generate a fee of over 
$53 million on a single transaction. In other words, the greater the 
loss that could be concocted for the taxpayer or ``investor,'' the 
greater the profit for the tax promoter. Think about that--greater the 
loss, the greater the profit. How's that for turning capitalism on its 
head!
  In addition, evidence indicated that, in at least one instance, a tax 
advisor

[[Page S2215]]

was willing to deliberately manipulate the way it handled certain tax 
products to circumvent contingent fee prohibitions. An internal 
document at an accounting firm related to a specific tax shelter, for 
example, identified the states that prohibited contingent fees. Then, 
rather than prohibit the tax shelter transactions in those states or 
require an alternative fee structure, the memorandum directed the 
firm's tax professionals to make sure the engagement letter was signed, 
the engagement was managed, and the bulk of services was performed ``in 
a jurisdiction that does not prohibit contingency fees.''

  Right now, the prohibitions on contingent fees are complex and must 
be evaluated in the context of a patchwork of federal, state, and 
professional ethics rules. Section 304 of the bill would establish a 
single enforceable rule, applicable nationwide, that would prohibit tax 
practitioners from charging fees calculated according to a projected or 
actual amount of tax savings or paper losses.
  The bill would also help fight abusive tax shelters that are 
disguised as complex investment opportunities and use financing or 
securities transactions provided by financial institutions. In reality, 
tax shelter schemes lack the economic risks and rewards associated with 
a true investment. These phony transactions instead often rely on the 
temporary use of significant amounts of money in low risk schemes 
mischaracterized as real investments. The financing or securities 
transactions called for by these schemes are often supplied by a bank, 
securities firm, or other financial institution.
  Currently the tax code prohibits financial institutions from 
providing products or services that aid or abet tax evasion or that 
promote or implement abusive tax shelters. The agencies that oversee 
these financial institutions on a daily basis, however, are experts in 
banking and securities law and generally lack the expertise to spot tax 
issues. Section 305 would crack down on financial institutions' illegal 
tax shelter activities by requiring federal bank regulators and the SEC 
to work with the IRS to develop examination techniques to detect such 
abusive activities and put an end to them.
  These examination techniques would be used regularly, preferably in 
combination with routine regulatory examinations, and the regulators 
would report potential violations to the IRS. The agencies would also 
be required to prepare joint reports to Congress in 2009 and 2012 on 
preventing the participation of financial institutions in tax evasion 
or tax shelter activities.
  During hearings before the Permanent Subcommittee on Investigations 
on tax shelters in November 2003, IRS Commissioner Everson testified 
that his agency was barred by Section 6103 of the tax code from 
communicating information to other federal agencies that would assist 
those agencies in their law enforcement duties. He pointed out that the 
IRS was barred from providing tax return information to the SEC, 
federal bank regulators, and the Public Company Accounting Oversight 
Board (PCAOB)--even, for example, when that information might assist 
the SEC in evaluating whether an abusive tax shelter resulted in 
deceptive accounting in a public company's financial statements, might 
help the Federal Reserve determine whether a bank selling tax products 
to its clients had violated the law against promoting abusive tax 
shelters, or help the PCAOB judge whether an accounting firm had 
impaired its independence by selling tax shelters to its audit clients.
  A recent example demonstrates how harmful these information barriers 
are to legitimate law enforcement efforts. In 2004, the IRS offered a 
settlement initiative to companies and corporate executives who 
participated in an abusive tax shelter involving the transfer of stock 
options to family-controlled entities. Over a hundred corporations and 
executives responded with admissions of wrongdoing. In addition to tax 
violations, their misconduct may be linked to securities law violations 
and improprieties by corporate auditors or banks, but the IRS has 
informed the Subcommittee that it is currently barred by law from 
sharing the names of the wrongdoers with the SEC, banking regulators, 
or PCAOB.
  These communication barriers are outdated, inefficient, and ill-
suited to stopping the torrent of tax shelter abuses now affecting or 
being promoted by so many public companies, banks, and accounting 
firms. To address this problem, Section 306 of this bill would 
authorize the Treasury Secretary, with appropriate privacy safeguards, 
to disclose to the SEC, federal banking agencies, and the PCAOB, upon 
request, tax return information related to abusive tax shelters, 
inappropriate tax avoidance, or tax evasion. The agencies could then 
use this information only for law enforcement purposes, such as 
preventing accounting firms or banks from promoting abusive tax 
shelters, or detecting accounting fraud in the financial statements of 
public companies.
  The bill would also provide for increased disclosure of tax shelter 
information to Congress. Section 307 would make it clear that companies 
providing tax return preparation services to taxpayers cannot refuse to 
comply with a Congressional document subpoena by citing Section 7216, 
which prohibits tax return preparers from disclosing taxpayer 
information to third parties. Several accounting and law firms raised 
this claim in response to document subpoenas issued by the Permanent 
Subcommittee on Investigations, contending they were barred by the 
nondisclosure provision in Section 7216 from producing documents 
related to the sale of abusive tax shelters to clients for a fee.
  The accounting and law firms maintained this position despite an 
analysis provided by the Senate legal counsel showing that the 
nondisclosure provision was never intended to create a privilege or to 
override a Senate subpoena, as demonstrated in federal regulations 
interpreting the provision. This bill would codify the existing 
regulations interpreting Section 7216 and make it clear that 
Congressional document subpoenas must be honored.
  Section 307 would also ensure Congress has access to information 
about decisions by the Treasury related to an organization's tax exempt 
status. A 2003 decision by the D.C. Circuit Court of Appeals, Tax 
Analysts v. IRS, struck down certain IRS regulations and held that the 
IRS must disclose letters denying or revoking an organization's tax 
exempt status. The IRS has been reluctant to disclose such information, 
not only to the public, but also to Congress, including in response to 
requests by the Subcommittee.
  For example, in 2005, the IRS revoked the tax exempt status of four 
credit counseling firms, and, despite the Tax Analysts case, claimed 
that it could not disclose to the Subcommittee the names of the four 
firms or the reasons for revoking their tax exemption. Our bill would 
make it clear that, upon receipt of a request from a Congressional 
committee or subcommittee, the IRS must disclose documents, other than 
a tax return, related to the agency's determination to grant, deny, 
revoke or restore an organization's exemption from taxation.
  The Treasury Department recently issued new standards for tax 
practitioners issuing opinion letters on the tax implications of 
potential tax shelters as part of Circular 230. Section 308 of the bill 
would provide express statutory authority for these and even clearer 
regulations.
  The public has traditionally relied on tax opinion letters to obtain 
informed and trustworthy advice about whether a tax-motivated 
transaction meets the requirements of the law. The Permanent 
Subcommittee on Investigations has found that, in too many cases, tax 
opinion letters no longer contain disinterested and reliable tax 
advice, even when issued by supposedly reputable accounting or law 
firms. Instead, some tax opinion letters have become marketing tools 
used by tax shelter promoters and their allies to sell clients on their 
latest tax products. In many of these cases, financial interests and 
biases were concealed, unreasonable factual assumptions were used to 
justify dubious legal conclusions, and taxpayers were misled about the 
risk that the proposed transaction would later be designated an illegal 
tax shelter. Reforms are essential to address these abuses and restore 
the integrity of tax opinion letters.
  The Treasury Department recently adopted standards that address a 
number of the abuses affecting tax shelter opinion letters; however, 
the standards

[[Page S2216]]

could be stronger yet. Our bill would authorize Treasury to issue 
standards addressing a wider spectrum of tax shelter opinion letter 
problems, including: preventing concealed collaboration among 
supposedly independent letter writers; avoiding conflicts of interest 
that would impair auditor independence; ensuring appropriate fee 
charges; preventing practitioners and firms from aiding and abetting 
the understatement of tax liability by clients; and banning the 
promotion of potentially abusive tax shelters. By addressing each of 
these areas, a beefed-up Circular 230 could help reduce the ongoing 
abusive practices related to tax shelter opinion letters.
  Finally, Title IV of the bill incorporates a Baucus-Grassley proposal 
which would strengthen legal prohibitions against abusive tax shelters 
by codifying in Federal tax statutes for the first time what is known 
as the economic substance doctrine. This anti-tax abuse doctrine was 
fashioned by federal courts evaluating transactions that appeared to 
have little or no business purpose or economic substance apart from tax 
avoidance. It has become a powerful analytical tool used by courts to 
invalidate abusive tax shelters. At the same time, because there is no 
statute underlying this doctrine and the courts have developed and 
applied it differently in different judicial districts, the existing 
case law has many ambiguities and conflicting interpretations.
  This language was developed under the leadership of Senators Baucus 
and Grassley, the Chairman and Ranking Member of the Finance Committee. 
The Senate has voted on multiple occasions to enact it into law, but 
House conferees have rejected it each time. Since no tax shelter 
legislation would be complete without addressing this issue, Title IV 
of this comprehensive bill proposes once more to include the economic 
substance doctrine in the tax code.
  The eyes of some people may glaze over when tax shelters and tax 
havens are discussed, but unscrupulous taxpayers and tax professionals 
clearly see illicit dollar signs. Our commitment to crack down on their 
tax abuses must be as strong as their determination to get away with 
ripping off America and American taxpayers.
  Our bill provides powerful new tools to end the tax haven and tax 
shelter abuses. Tax haven and tax shelter abuses contribute nearly $100 
billion to the $345 billion annual tax gap, which represents taxes owed 
but not paid. It's long past time for taxes owing to the people's 
Treasury to be collected. And it's long past time for Congress to end 
the shifting of a disproportionate tax burden onto the shoulders of 
honest Americans.
  Mr. OBAMA. Mr. President, I rise today to speak about the Stop Tax 
Haven Abuse Act, which I am proud to cosponsor with Senators Levin and 
Coleman. This bill seeks to improve the fairness of our tax system by 
deterring the abuse of secret tax havens and unacceptable tax avoidance 
strategies. It is a serious solution to a serious problem.
  An investigation by the Senate Permanent Subcommittee on 
Investigations found that offshore tax havens and secrecy jurisdictions 
hold trillions of dollars in assets and are often used as havens for 
tax evasion, financial fraud, and money laundering. Experts estimate 
that abusive tax shelters and tax havens cost this country between $40 
billion and $70 billion every year, and the burden of filling this gap 
is borne unfairly by taxpayers who follow the rules and can't afford 
high-priced lawyers and accountants to help them game the system.
  The problem is not new, but we need a new solution. Several years 
ago, the subcommittee heard testimony from the owner of a Cayman Island 
offshore bank who estimated that all of his clients--100 percent--were 
engaged in tax evasion, and 95 percent were U.S. citizens. In 2000, the 
Enron Corporation--remember Enron?--established over 441 offshore 
entities in the Cayman Islands. A 2004 report found that U.S. 
multinational corporations are increasingly attributing their profits 
to offshore jurisdictions. A 2005 study of high-net-worth individuals 
worldwide estimated that their offshore assets now total $11.5 
trillion. The IRS has estimated that more than half a million U.S. 
taxpayers have offshore bank accounts and access those funds with 
offshore credit cards.
  Unfortunately, the tax, corporate, or bank secrecy laws and practices 
of about 50 countries make it nearly impossible for American 
authorities to gain access to necessary information about U.S. 
taxpayers in order to enforce U.S. tax laws. Today, the Government has 
the burden of proving that a taxpayer has control of the tax haven 
entity and is the beneficial owner. This allows taxpayers to rely on 
the secrecy protections of tax havens to deceive Federal tax 
authorities and evade taxes.
  This is not a political issue of how low or high taxes ought to be. 
This is a basic issue of fairness and integrity. Corporate and 
individual taxpayers alike must have confidence that those who 
disregard the law will be identified and adequately punished. Those who 
defy the law or game the system must face consequences. Those who 
enforce the law need the tools and resources to do so. We cannot sit 
idly by while tax secrecy jurisdictions impede the enforcement of U.S. 
law.
  Under this bill, if you create a trust or corporation in a tax haven 
jurisdiction, send it assets, or benefit from its actions, the Federal 
Government will presume in civil judicial and administrative 
proceedings that you control the entity and that any income generated 
by it is your income for tax, securities, and money-laundering 
purposes. The burden of proof shifts to the corporation or the 
individual, who may rebut these presumptions by clear and convincing 
evidence.
  This bill provides an initial list of offshore secrecy jurisdictions 
where these evidentiary presumptions will apply. Taxpayers with foreign 
financial accounts in Anguilla, Bermuda, the Cayman Islands, or 
Dominica, for example, should be prepared to report their accounts to 
the IRS. And this bill will make it easier for the IRS to find such 
taxpayers if they do not.
  The Treasury Secretary may add to or subtract from the list of 
offshore secrecy jurisdictions. The list does not reflect a 
determination that a country is necessarily uncooperative but merely 
that it is difficult to obtain adequate financial and beneficial 
ownership information from that country and it is ripe for tax abuse. 
If an offshore jurisdiction is in fact uncooperative and impedes U.S. 
tax enforcement, however, this bill gives Treasury the authority to 
impose sanctions, including the denial of the right to issue credit 
cards for use in the United States.
  This bill also establishes a $1 million penalty on public companies 
or their officers who fail to disclose foreign holdings and requires 
hedge funds and private equity funds to establish anti-money laundering 
programs and to submit suspicious activity reports. Importantly, this 
bill clarifies that the sole purpose of a transaction cannot 
legitimately be to evade tax liability. Transactions must have 
meaningful ``economic substance'' or a business purpose apart from tax 
avoidance or evasion.
  There is no such thing as a free lunch--someone always has to pay. 
And when a crooked business or shameless individual does not pay its 
fair share, the burden gets shifted to others, usually to ordinary 
taxpayers and working Americans without access to sophisticated tax 
preparers or corporate loopholes.
  This bill strengthens our ability to stop shifting the tax burden to 
working families. All of us must pay our fair share of the cost of 
securing and running this country. There is no excuse for benefiting 
from the laws and services, institutions, and economic structure of our 
Nation, while evading your responsibility to do your part. I believe it 
is our job to keep the system fair, and that is what this bill seeks to 
do.
  I commend Senator Levin and Senator Coleman for their leadership on 
this important issue. I am proud to be a cosponsor of this bill and 
urge my colleagues to support it.
                                 ______