[Congressional Record Volume 155, Number 36 (Monday, March 2, 2009)]
[Senate]
[Pages S2624-S2638]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. LEVIN (for himself, Mr. Whitehouse, Mrs. McCaskill, and 
        Mr. Nelson of Florida):
  S. 506. A bill to restrict the use of 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, America has been knocked flat on its back 
by the current financial crisis, but the American fighting spirit 
hasn't given up. We are battling back.
  Congress recently passed an $800 billion recovery bill to jumpstart 
the economy with new jobs and investments. That $800 billion is on top 
of the $700 billion we set aside earlier to revive the credit markets 
and recapitalize the financial institutions that got us into this mess. 
Those steps weren't easy to take and represent a lot of money going out 
the door.
  That is why, today, I am introducing the Stop Tax Haven Abuse Act, 
along with Senators Whitehouse, McCaskill and Bill Nelson, to stop tax 
cheats who drain our treasury of funds needed to pay for our recovery. 
The bill's target is offshore tax abuses that rob the U.S. Treasury of 
an estimated $100 billion each year, reward tax dodgers using offshore 
secrecy laws to hide money from Uncle Sam, and offload the tax burden 
onto the backs of middle income families who play by the rules.
  It is time for Congress and this administration to take a stand 
against offshore tax evasion. It is unfair; we can't afford it; and 
there is a whole lot more we can do to stop it.
  The bill we are introducing today is an improved version of the Stop 
Tax Haven Abuse Act that I introduced in February 2007, with Senator 
Coleman and then Senator Obama, and that Congressmen Lloyd Doggett and 
Rahm Emanuel introduced in the House with the support of 47 cosponsors. 
No action was taken last Congress on either bill, even though evidence 
has continued to pour in about the extensive and serious nature of 
offshore tax dodging.
  In July 2008, for example, the Senate Permanent Subcommittee on 
Investigations, which I chair, held two days of hearings and released a 
report that broke through the wall of secrecy that normally surrounds 
banks located in tax haven jurisdictions. The Subcommittee presented 
multiple case histories exposing how two such banks, UBS AG of 
Switzerland and LGT Bank of Liechtenstein, used an array of secrecy 
tricks to help U.S. clients hide assets and dodge U.S. taxes.
  The hearing showed, for example, that UBS had opened Swiss accounts 
for an estimated 19,000 U.S. clients with nearly $18 billion in assets, 
and did not report any of those accounts to the U.S. Internal Revenue 
Service. A UBS private banker based in Switzerland pled guilty to 
conspiring to helping a U.S. billionaire hide $200 million and evade 
$7.2 million in tax, and provided sworn deposition testimony to the 
Subcommittee about how UBS Swiss bankers sought and serviced clients 
right here in the United States. A more senior UBS official asserted 
his Fifth Amendment rights at the hearing rather than answer questions 
about UBS conduct.
  The Subcommittee investigation also presented seven case histories of 
U.S. persons who had secretly stashed millions of dollars in accounts 
at LGT Bank, a private bank owned by the Liechtenstein royal family. 
These case histories unfolded like spy novels, with secret meetings, 
hidden funds, shell corporations, and complex offshore transactions 
spanning the globe from the United States to Liechtenstein, 
Switzerland, the British Virgin Islands, Australia, and Hong Kong. What 
the case histories had in common were officials from LGT Bank and its 
affiliates acting as willing partners to move a lot of money into LGT 
accounts, while obscuring the ownership and origin of the funds from 
tax authorities, creditors, and courts.
  A former LGT employee, now in hiding for disclosing LGT client 
information, provided videotaped testimony during the hearing 
describing a long list of secrecy tricks and deceptive practices used 
by LGT to conceal client assets. They included using code names for LGT 
clients; requiring bankers to use outside pay phones to call clients to 
prevent those calls from being traced back to the bank; establishing 
offshore shell corporations which clients could use to route money into 
and out of their LGT accounts without incriminating wire transfers; and 
creating elaborate offshore structures involving foundations, trusts, 
and corporations to conceal client ownership of assets. In addition, 
four U.S. persons asserted their Fifth Amendment rights at the hearing 
and declined to answer questions about their LGT accounts.
  More than 150 U.S. taxpayers are now under investigation by the IRS 
for having undeclared Liechtenstein accounts. The IRS is not labouring 
alone. Nearly a dozen countries have investigations underway into 
possible tax evasion involving Liechtenstein accounts. Germany, for 
example, is working through a list of 600 to 700 German taxpayers with 
LGT accounts, including a prominent businessman who allegedly used LGT 
accounts to evade $1.5 million in taxes.
  LGT was invited to the July Subcommittee hearings to defend its 
actions, but chose not to appear. UBS, to its credit, appeared and 
announced at the hearings that it would take responsibility for its 
actions. It apologized for past compliance failures, promised to close 
all 19,000 Swiss accounts unless the U.S. accountholder agreed to 
disclose the account to the IRS, and announced it would no longer offer 
U.S. clients the option of opening Swiss accounts that are not 
disclosed to the IRS. A few months later, Liechtenstein signed its 
first tax information exchange agreement with the United States, and 
LGT announced its intention to change its business model and begin 
cooperating with foreign tax authorities.
  The actions taken by UBS and LGT have reverberated around the tax 
haven world, raising questions about whether the game is finally up and 
the international community is ready to take action to put an end to 
offshore secrecy and tax abuses. Some banks, like Credit Suisse, 
Switzerland's largest bank after UBS, have decided to follow UBS' lead 
and stop offering hidden Swiss bank accounts to U.S. clients. But many 
other tax haven banks continue their secret ways and continue to engage 
in practices that facilitate tax evasion.
  The United States Government is continuing its efforts to combat 
offshore secrecy. In November 2008, the U.S. Department of Justice, 
DOJ, indicted a senior UBS official, then head of the UBS private bank, 
for conspiring to help other U.S. clients dodge U.S. taxes. Because 
he has refused to face the charges, he remains a fugitive from justice 
in Switzerland. In February, DOJ indicted UBS itself, again for 
conspiring to help U.S. clients dodge U.S. taxes. That criminal 
prosecution was then deferred, because UBS admitted to the underlying 
facts, paid a $780 million fine, turned over the names of at least 250 
clients with Swiss accounts,

[[Page S2625]]

and promised to no longer open Swiss accounts for U.S. clients without 
notifying the IRS. A U.S. indictment of a major bank is rare; an 
indictment of a major bank for helping clients evade U.S. taxes may be 
unprecedented.

  In addition to filing these criminal prosecutions, DOJ served UBS 
with a John Doe summons seeking the names of the other 19,000 U.S. 
clients with Swiss accounts hidden from the IRS. UBS said at the 
Subcommittee hearing in July that it was ready to cooperate, but 
virtually none of the information requested by the John Doe summons has 
been turned over, primarily because the Swiss Government has taken the 
position that turning over this client account information would 
violate Swiss secrecy laws. DOJ has asked the U.S. court that approved 
the summons to enforce it, and a trial to resolve the issue is now 
scheduled for July 2009, one year after the initial request for the 
information. The fact that the United States is having such a difficult 
time getting the client names, despite catching UBS red-handed and 
obtaining its admission of wrongdoing, shows how tough the offshore tax 
evasion problem is.
  It is worth noting that Switzerland is refusing to allow UBS to 
provide the names of potential U.S. tax cheats, while at the same time 
attempting to claim it is not a tax haven and it is not a secrecy 
jurisdiction. It is also worth noting that top Swiss government 
officials have now formed a ``strategic delegation'' charged with 
defending Swiss bank secrecy against efforts by the United States, 
European Union, and other countries to change Swiss practices.
  Right now, tax haven governments and tax haven banks often dress up 
their secrecy laws and banking practices with phrases like ``financial 
privacy'' and ``wealth management.'' Some enter into tax treaties and 
tax information exchange agreements with the United States, while 
setting up procedures that deny or delay providing information 
essential for effective tax enforcement. They also use their secrecy 
laws and practices to hide, not only the wrongdoing of the taxpayers, 
but also the actions of the tax haven participants who aid and abet the 
wrongdoing.
  Secrecy breeds tax evasion. Tax evasion eats at the fabric of 
society, not only by starving health care, education, and other needed 
government services of resources, but also by undermining trust--making 
honest folks feel like they are being taken advantage of when they pay 
their fair share.
  We can fight back against offshore secrecy jurisdictions and offshore 
tax abuses if we summon the political will. Our bill offers powerful 
new tools to tear down the tax haven secrecy walls in favour of 
transparency, cooperation, and tax compliance. To tear down those 
secrecy walls, protect honest taxpayers, and obtain the revenues 
essential for critical needs, I hope my colleagues will act during this 
Congress to enact our legislation to shut down the $100 billion in 
offshore tax abuses.
  The Stop Tax Haven Abuse Act is the product of years of work. My 
Subcommittee, through reports and hearings, has exposed numerous 
abusive practices involving offshore tax havens as well as home-grown 
abusive tax shelters. In the 109th Congress, we confronted these twin 
threats to our treasury by introducing S. 1565, the Tax Shelter and Tax 
Haven Reform Act. In the 110th Congress, we introduced an improved 
version of that legislation, S. 681, 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.
  Today's bill is very similar to S. 681, but with three new additions. 
A new Section 103 addresses the tax dodging that occurs when a business 
incorporates in a tax haven, pretending to be a foreign corporation for 
U.S. tax purposes, while, in reality, being managed and controlled from 
the United States. A new Section 108 seeks to put an end to financial 
gimmicks being used by offshore hedge funds and others to dodge payment 
of U.S. taxes on U.S. stock dividends. A new Section 109 expands 
reporting requirements for U.S. persons who benefit from a passive 
foreign investment corporation. These new sections offer powerful new 
tools to combat offshore tax abuse.
  I will now describe some of the tax abuses that need to be addressed 
and explain what our bill would do to stop them. First, I will look at 
the offshore tax problem and then at some of our home-grown abusive tax 
shelters.


                            Tax Haven Abuses

  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.
  The Tax Justice Network, an international non-profit organization 
dedicated to fighting tax evasion, has estimated that wealthy 
individuals worldwide have stashed $11.5 trillion of their assets in 
offshore tax havens. The IMF has estimated that, in 2000 alone, $1.7 
trillion in investments were sent through offshore tax havens. A series 
of 2007 Tax Notes articles estimated that over $1.5 trillion in hidden 
assets were located in just four tax havens, Guernsey, Jersey, Isle of 
Man, and Switzerland, characterizing those assets as beneficially owned 
by nonresident individuals likely avoiding tax in their home 
jurisdictions. 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 connection with a hearing held in August 2006, the Subcommittee 
released a staff report with six case studies describing how U.S. 
individuals use 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 $600 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

[[Page S2626]]

that conducted these phantom trades were so shrouded in offshore 
secrecy that no one would admit to knowing who owns them. One U.S. 
taxpayer used the scheme to shelter about $1.5 billion from U.S. taxes. 
Another 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. Two experts, 
Joseph Guttentag and Professor Reuven Avi-Yonah, have estimated 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. Data released by the Commerce Department indicates that, as of 
2001, 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. Professor Kimberly Clausing has estimated that 
corporate offshore abuses utilizing transfer pricing schemes resulted 
in $60 billion in lost U.S. tax revenues in 2004, and other experts 
have estimated similar amounts.
  Corporate use of tax haven jurisdictions is also widespread. In 
January 2009, Senator Dorgan and I released a report by the Government 
Accounting Office (GAO) which shows that out of the 100 largest U.S. 
publicly traded corporations, 83 have subsidiaries in tax havens. Of 
the 100 largest federal contractors, 63 have tax haven subsidiaries. 
Using data from their corporate filings with the Securities and 
Exchange Commission, GAO listed the number of tax haven subsidiaries 
for each of these corporations. GAO determined, for example, that 
Morgan Stanley has 273 tax haven subsidiaries, while Citigroup has 427, 
with 90 in the Cayman Islands alone. News Corp. has 152, while Procter 
and Gamble has 83, Pfizer has 80, Oracle has 77, and Marathon Oil has 
76. My Subcommittee is currently engaged in an effort to understand why 
so many of these corporations have so many tax haven affiliates. To do 
that we are going to have to battle secrecy laws in 50 different 
jurisdictions.
  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 
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 2008 investigation into tax haven banks and our 
2006 investigation into offshore abuses also highlight 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 has shown how U.S. 
taxpayers, with the help of offshore financial institutions, service 
providers, legal counsel, and tax professionals, set up financial 
accounts and entities in secrecy jurisdictions to hide assets and dodge 
taxes. The case studies showed how some U.S. persons created complex 
offshore structures to hide their ownership of offshore bank accounts. 
Others formed offshore entities which they claimed were independent 
but, in fact, exercised control over them through compliant offshore 
trustees, officers, directors, and corporate administrators. Because of 
offshore secrecy laws and practices, offshore businesses could and did 
take steps 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 needed to enforce U.S. tax laws.
  The extent of the offshore tax abuses documented by years of 
Subcommittee reports and hearings demonstrates the importance of 
obtaining new tools 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 providing those 
new enforcement tools. They include new legal presumptions to overcome 
offshore secrecy barriers, special measures to combat persons who 
impede U.S. tax enforcement, treatment of offshore corporations as 
domestic corporations when controlled by U.S. persons, elimination of 
the offshore dividend tax loophole, greater disclosure of offshore 
transactions, and more.


         Presumptions Related to Offshore Secrecy Jurisdictions

  The 2006 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 helped 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, the regulators 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

[[Page S2627]]

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.

     Section 101--Rebuttable evidentiary presumptions and initial 
       list of offshore secrecy jurisdictions

  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 staff 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 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 U.S. 
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 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.

[[Page S2628]]

  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--Special measures where U.S. tax enforcement is 
       impeded

  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, 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 a designated foreign jurisdiction or 
financial institution. Denying tax haven banks the 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--Deny tax benefits for foreign corporations 
       managed and controlled in the United States

  In July 2008, the Senate Finance Committee held a hearing detailing 
findings made by GAO when it went to the Cayman Islands to look at the 
infamous Ugland House, a five-story building that is the official 
address for over 18,800 registered companies. GAO's review seems to 
indicate that the Cayman Islands has more registered businesses than 
residents, with a mutual fund or hedge fund for every five residents, 
and two registered companies for every resident.
  GAO also determined that about half of the alleged Ugland House 
tenants--around 9,000 entities--have a billing address in the United 
States and were not actual occupants of the building. In fact, GAO 
determined that none of the nearly 19,000 companies registered at the 
Ugland House was an actual occupant. GAO found that the only true 
occupant of the building is a Cayman law firm, Maples and Calder. 
According to the GAO: ``Very few Ugland House registered entities have 
a significant physical presence in the Cayman Islands or carry out 
business in the Cayman Islands. According to Maples and Calder 
partners, the persons establishing these entities are typically 
referred to Maples by counsel from outside the Cayman Islands, fund 
managers, and investment banks. As of March 2008 the Cayman Islands 
Registrar reported that 18,857 entities were registered at the Ugland 
House address. Approximately 96 percent of these entities were 
classified as exempted entities under Cayman Islands law, and were thus 
generally prohibited from carrying out domestic business within the 
Cayman Islands.''
  Section 103 of the bill is a new addition to the Stop Tax Haven Abuse 
Act designed to address the Ugland House problem. It focuses on the 
situation where a corporation is incorporated in a tax haven as a mere 
shell operation with little or no physical presence or employees in the 
jurisdiction. The shell entity pretends it is operating in the tax 
haven, even though its key personnel and decisionmakers are in the 
United States. The objective of this set up is to enable the owners of 
the shell entity to take advantage of all of the benefits provided by 
U.S. legal, educational, financial, and commercial systems, and at the 
same time avoid paying U.S. taxes.
  My Subcommittee has seen numerous companies exploit this situation, 
declaring themselves to be foreign corporations, even though they 
really operate out of the United States. For example, thousands of 
hedge funds whose financial experts live in Connecticut, New York, 
Texas, or California play this game to escape taxes and avoid 
regulation. In an October 2008 Subcommittee hearing, three sizeable 
hedge funds, Angelo Gordon, Highbridge Capital, and Maverick Capital, 
admitted that, although all they claimed to be based in the Cayman 
Islands, none had an office or a single full time employee in that 
jurisdiction. Instead, their offices and key decisionmakers were 
located and did business right here in the United States.
  Section 103 will put an end to such corporate fictions and offshore 
tax dodging. It states that if a corporation is publicly traded or has 
aggregate gross assets of $50 million or more, and its management and 
control occurs primarily in the United States, that corporation will be 
treated as a U.S. domestic corporation for income tax purposes.
  To implement this provision, Treasury is directed to issue 
regulations to guide the determination of when management and control 
occur primarily in the United States, looking at whether 
``substantially all of the executive officers and senior management of 
the corporation who exercise day-to-day responsibility for making 
decisions involving strategic, financial, and operational policies of 
the corporation are located primarily within the United States.''
  This new section relies on the same principles regarding the true 
location of ownership and control of a company that underlie the 
corporate inversion rules adopted in the American Jobs Creation Act of 
2005. Those inversion rules, however, do not address the fact that some 
entities directly incorporate in foreign countries and manage their 
businesses activities from the United States. Section 103 seeks to 
level the playing field and ensure that entities which incorporate 
directly in another country are subject to a similar management and 
control test. Section 103 is also similar in concept to the substantial 
presence test in the income tax treaty between the United States and 
the Netherlands, which looks to the primary place of management and 
control to determine corporate residency.
  Section 103 also provides an exception for foreign corporations with 
U.S. parents. This exception from the $50 million gross assets test 
recognizes that, within a multinational operation, strategic, 
financial, and operational decisions are often made from a global or 
regional headquarters location and then implemented by affiliated 
foreign corporations. Where such decisions are undertaken by a parent 
corporation

[[Page S2629]]

that is actively engaged in a U.S. trade or business and is organized 
in the United States--and is, therefore, already a domestic 
corporation--the bill generally will not override existing U.S. 
taxation of international operations. At the same time, this exception 
makes it clear that the mere existence of a U.S. parent corporation is 
not sufficient to shield a foreign corporation from also being treated 
as a domestic corporation under this section. The section also creates 
an exception for private companies that once met the section's test for 
treatment as a domestic corporation but, during a later tax year, fell 
below the $50 million gross assets test, do not expect to exceed that 
threshold again, and are granted a waiver by the Treasury Secretary.

  Section 103 is intended to stop, in particular, the outrageous tax 
dodging that now goes on by too many hedge funds and investment 
management businesses that structure themselves to appear to be foreign 
entities, even though their key decisionmakers--the folks who exercise 
control of the company, its assets, and investment decisions--live and 
work right here in the United States. Too many hedge funds establish a 
structure of offshore entities, often including master and feeder 
funds, that make it appear as if the hedge fund's assets and investment 
decisions are offshore, when, in fact, the funds are being managed and 
controlled by investment experts located in the United States. It is 
unacceptable that such companies utilize U.S. offices, personnel, laws, 
and markets to make their money, but then stiff Uncle Sam and offload 
their tax burden onto competitors who play by the rules.
  To put an end to this charade, Section 103 specifically directs 
Treasury regulations to specify that, when corporate assets are being 
managed primarily on behalf of investors and the investment decisions 
are being made in the United States, the management and control of that 
corporation shall be treated as occurring primarily in the United 
States, and that corporation shall be subject to U.S. taxes in the same 
manner as any other U.S. corporation.
  If enacted into law, Section 103, the Ugland House provision, would 
put an end to the unfair situation where some U.S.-based companies pay 
their fair share of taxes, while others who set up a shell corporation 
in a tax haven are able to defer or escape taxation, despite the fact 
that their foreign status is nothing more than a paper fiction.

     Section 104--Extension of time for offshore audits

  Section 104 of the bill addresses a key 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 
secrecy laws. Currently, in the absence of fraud or some other 
exception, the IRS has three years from the date a tax 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 three 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.

     Section 105--Increased disclosure of offshore accounts and 
       entities

  Offshore tax abuses thrive in secrecy. Section 105 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 or other reportable income 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 is nominally not subject to tax, but which the 
bank or broker knows, from its anti-money laundering review, is owned 
or controlled by a U.S. person who is subject to tax. 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 an account opened in the name 
of a foreign corporation as an account that is held by an independent 
entity that is 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 income earned on the account. Many banks and brokers 
contend that the current regulations impose no duty on them to file a 
1099 or other form disclosing that type of 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 an account, to disclose that account to the 
IRS by filing a 1099 or equivalent form reporting the 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 the relevant 
form with the IRS.

  This section would require such reports to the IRS from two sets of 
financial institutions. The first set are financial institutions which 
are located and do business in the United States, supply 1099 and other 
forms to the IRS, and open U.S. accounts for foreign entities which the 
financial institution knows are beneficially owned by U.S. persons. The 
second set are foreign financial institutions which are located and do 
business outside of the United States, but are voluntary participants 
in the Qualified Intermediary Program, and have agreed to provide 
information to the IRS about certain accounts. Under this section, if a 
foreign financial institution has an account under the QI Program, and 
the accountholder is a non-U.S. entity that is controlled or 
beneficially owned by a U.S. person, then that foreign financial 
institution would have to report to the IRS any U.S. securities or 
other reportable assets or income in that account.
  The second disclosure mechanism created by Section 105 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

[[Page S2630]]

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 105 would require any U.S. financial institution that 
directly or indirectly opens a foreign 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 their offshore transactions.
     Section 106--Closing foreign trust loopholes
  Section 106 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.
  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 10--Legal opinion protection from penalties

  Section 107 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 2006 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

[[Page S2631]]

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.
  Finally, in drafting such regulations, it is intended that the 
Secretary of the Treasury take into account the function of the ``more 
likely than not'' standard in the context of corporations that are 
independently audited and subject to accounting rules requiring 
disclosure of uncertain tax positions. It is intended that the 
regulations issued under this bill provision be coordinated with the 
objectives of those accounting rules to ensure consistent guidance for 
detecting and stopping abusive transactions without disrupting the 
financial accounting of legitimate transactions.

     Section 108--Closing the dividend tax loophole

  Section 108 of this bill is the second new addition to the Stop Tax 
Haven Abuse Act. It is aimed at closing down a tax loophole that has 
enabled offshore hedge funds and others to use complex financial 
gimmicks, including transactions involving equity swaps and offshore 
stock loans, to dodge billions of dollars in U.S. taxes over the last 
ten years. This loophole contributes to the estimated $100 billion in 
unpaid taxes that Uncle Sam loses each year from offshore tax abuses. 
With financial disasters hitting this country from every direction, we 
can no longer afford to ignore this offshore tax dodge. It is time to 
shut it down.
  The section is straightforward. It amends the Internal Revenue Code 
to make it clear that non-U.S. persons cannot escape payment of U.S. 
taxes on U.S. stock dividends by participating in structured financial 
transactions that recast taxable stock dividend payments as allegedly 
tax-free ``dividend equivalent'' or ``substitute dividend'' payments. 
The bill eliminates this offshore tax dodge by requiring that dividend, 
dividend equivalent, and substitute dividend payments made to non-U.S. 
persons all receive the same tax treatment--as taxable income subject 
to withholding.
  Right now, foreigners who invest in the United States enjoy a minimal 
tax burden. For example, non-U.S. persons who deposit money with a U.S. 
bank or securities firm pay no U.S. taxes on the interest earned. They 
pay no U.S. taxes on capital gains. U.S. citizens do pay taxes on that 
income, but the tax code lets foreign investors operate without tax in 
an effort to attract foreign investment.
  But there is one tax on the books that even foreign investors are 
supposed to pay. If they buy stock in a U.S. company, and that stock 
pays a dividend, the non-U.S. stockholder is supposed to pay a tax on 
the dividend. The general tax rate is 30%, unless their country of 
residence has negotiated a lower rate with the United States, typically 
15%.
  In addition, to make sure those dividend taxes are paid, U.S. law 
requires the person or entity paying a stock dividend to a non-U.S. 
person to withhold the tax owed Uncle Sam before any part of the 
dividend leaves the United States. If the ``withholding agent'' fails 
to retain and remit the dividend tax to the IRS, and the tax is not 
paid by the dividend recipient, the tax code makes the withholding 
agent equally liable for the unpaid taxes. That's the law. But the 
reality is that many non-U.S. stockholders never pay the dividend taxes 
they owe.
  An investigation conducted by the Permanent Subcommittee on 
Investigations, which I chair, resulted in a staff report and hearing 
in September 2008, which showed that foreign entities, primarily 
offshore hedge funds and foreign financial institutions, use two 
common schemes to dodge their dividend tax obligations to the U.S. 
government--equity swaps and stock loans.

  Swaps sound complicated, but they are essentially a financial bet--in 
the case of equity swaps a bet on the future of a stock price. Under 
the swap, a financial institution promises to pay, say, a hedge fund an 
amount equal to any price appreciation in the stock price and the 
amount of any dividend paid during the term of the swap. The payment 
reflecting the dividend is referred to as a ``dividend equivalent.'' In 
return, the hedge fund agrees to pay the financial institution an 
amount equal to any price depreciation in the stock price. The 
financial institution hedges its risk by holding the physical shares of 
stock that were ``sold'' to it by the hedge fund. It also charges a 
fee, which usually includes a portion of the tax savings that the hedge 
fund will obtain by dodging the withholding tax.
  The swap gives the hedge fund the same economic risks and rewards 
that it had when it owned the physical shares of the stock. So why hold 
a swap instead of the stock inself? Because under the tax code, 
dividend payments are taxed, but dividend equivalent payments made 
under a swap are not.
  Dividend equivalent payments made under a swap are tax free, because, 
in 1991, the IRS issued a series of regulations to determine what types 
of income will be treated as coming from the United States and 
therefore taxable. These so-called ``source'' rules treat U.S. stock 
dividends as U.S. source income, because the money comes from a U.S. 
corporation. But the 1991 regulation takes the opposite approach with 
respect to swaps. It deems swap agreements to be ``notional principal 
contracts'' and says that the ``source'' of any payment made under that 
contract is to be determined, not by where the money came from, but by 
where it ends up. In other words, the payment's source is the country 
where the payment recipient resides.
  That approach turns the usual meaning of the word, ``source,'' on its 
head. Instead of looking to the origin of the payment to determine its 
``source,'' the IRS swap rule looks to its end point--who receives it. 
That ``source'' is not really a ``source'' by any known definition of 
the word. It is the opposite--not the point of origin but the end 
point.
  The result is that when a financial institution makes a dividend 
equivalent payment to an offshore client under a swap agreement, the 
tax code provides that the payment is from an offshore ``source.'' So 
the swap payment is free of any U.S. tax. In our example, the U.S. 
financial institution makes the swap payment to the offshore hedge 
fund, minus its fee, and stiffs Uncle Sam for the amount of taxes that 
should have been sent to the IRS. The swap is then terminated, and the 
stock is ``sold'' back to the hedge fund. Under this gimmick, the hedge 
fund ends up in the same position as before the swap, as a stockholder, 
except it has pocketed a dividend payment without paying any U.S. tax.
  Stock loans are also used to dodge dividend taxes. These transactions 
pile a stock loan on top of a swap to achieve the same allegedly tax-
free result.
  The first step is that the client with an upcoming dividend lends its 
stock to an offshore corporation controlled by the financial 
institution. This offshore corporation promises, as part of the loan 
agreement, to forward any dividend payments back to the client.
  The next step is that offshore corporation enters into a swap with 
the financial institution that controls it, referencing the same type 
of stock and number of shares that is the subject of the stock loan. 
Essentially, two related parties are placing a bet on the stock, which 
makes no economic sense except, once that stock pays the dividend, the 
swap arrangement allows the financial institution to send it as an 
allegedly tax-free dividend equivalent payment to the offshore 
corporation it controls. The offshore corporation then forwards the 
same amount to the client. Because the payment is sent to the client as 
part of a stock loan agreement, it is called a ``substitute dividend.'' 
The tax code treats substitute dividends in the same way as the 
underlying dividend. So if the underlying dividend came from a U.S. 
corporation, the substitute dividend would normally be taxed as U.S. 
source income.
  But in this transaction, the parties claim the substitute dividend is 
tax-free by invoking the wording of an obscure IRS Notice 97-66 never 
intended to be applied to this situation. That notice says that when 
two parties in a stock loan are outside of the United States and 
subject to the same dividend tax rate, they don't have to pay the 
dividend tax when passing on a substitute dividend. The assumption is 
that the tax was already paid by another party in the lending 
transaction. Some tax lawyers have seized on the wording to claim that 
this IRS Notice, which was intended to prevent over-withholding, could 
be used to eliminate

[[Page S2632]]

dividend withholding entirely, so long as one offshore party passes on 
a substitute dividend to another offshore party subject to the same 
dividend tax rate. The IRS testified at the Subcommittee hearing that 
Notice 97-66 was never intended to be interpreted that way, but in the 
ten years since it was issued and abusive stock loans have exploded, 
the IRS has never put that in writing.
  The end result in our example is that the client pockets a substitute 
dividend payment--minus the financial institution's fee--without paying 
any tax. The stock loan is terminated, and the stock is returned to the 
client. The big advantage of this approach over a swap is that the 
client doesn't have to explain why he got his stock back after the 
transaction. The stock was, after all, only on loan.
  Tax dodging was clearly the economic purpose of the two transactions 
just described. While there are many types of legitimate swap and stock 
loan transactions, the Subcommittee investigation found that in these 
cases, such transactions were conducted primarily to dodge U.S. taxes 
and not for legitimate business purposes. In some of the most extreme 
examples, the client owned U.S. stock both before and after each 
transaction. Neither the swap nor the stock loan altered the client's 
market risk. The only risk involved in either transaction was that 
Uncle Sam would catch on and assess the dividend taxes that should have 
been paid but weren't.
  To make it harder for Uncle Sam to catch on and prove what is going 
on, financial institutions have added more complexity, more bells and 
whistles, to these so-called ``dividend enhancement'' transactions. But 
the purpose of the transactions remains the same--to enable clients to 
escape paying the taxes they owe.
  In the September 2008 hearing and report released by the 
Subcommittee, we described how specific financial institutions and 
hedge funds used swaps and stock loans to duck U.S. stock dividend 
taxes. We disclosed, for example, that Morgan Stanley helped clients, 
from 2000 to 2007, dodge payment of U.S. dividend taxes of over $300 
million. Lehman Brothers estimated that in one year alone, 2004, it 
helped clients dodge U.S. dividend taxes amounting to perhaps $115 
million. UBS enabled clients, from 2004 to 2007, dodge $62 million in 
dividend taxes, but last year stopped offering the Cayman stock loans 
that produced that figure. Maverick Capital, which runs several 
offshore hedge funds, disclosed that its offshore hedge funds used 
dividend enhancement products sold by multiple firms to escape dividend 
taxes from 2000 to 2007, totaling nearly $95 million. Citigroup even 
admitted to the IRS that it had failed to withhold dividend taxes on 
certain swap transactions from 2003 to 2005, and voluntarily paid 
missing taxes totaling $24 million. The Subcommittee investigation 
documented, in short, a whole swath of unpaid dividend taxes from just 
a handful of firms.
  Section 108, if enacted into law, would prevent non-U.S. persons from 
avoiding their U.S. dividend tax obligations by recasting dividend 
payments as allegedly tax-free dividend equivalent or substitute 
dividend payments. Instead, all payments of dividend-based amounts 
would be treated consistently.
  The section also authorizes the Treasury Secretary to issue 
regulations addressing several related issues. Treasury is directed, 
for example, to issue regulations to reduce possible over-withholding 
on dividend equivalents or substitute dividends, but only where the 
taxpayer can establish that the tax was previously withheld from an 
earlier payment. Treasury is also directed to issue regulations to 
impose withholding when dividend equivalent payments are netted with 
other payments under a swap contract, when dividend equivalent payments 
are made under other financial instruments, such as an option or 
forward contract, or when a substitute dividend is netted with fees and 
other payments. Finally, the section makes it clear that nothing in the 
legislation should be construed to limit the authority of the IRS 
Commissioner to collect taxes, interest, and penalties on dividend 
equivalent or substitute dividend payments made prior to the date of 
enactment of the bill.
  Let me be clear. I do not oppose structured finance transactions used 
for legitimate purposes, including swaps and stock loans that 
facilitate capital flows, reduce capital needs, or spread risk. What I 
oppose, and what Section 108 would stop is the misuse of financial 
transactions to undermine the tax code, rob the U.S. treasury, and 
force honest Americans who play by the rules to shoulder the country's 
tax burden. What this section is intended to stop are dividend-based 
transactions whose economic purpose is nothing more than tax dodging.

     Section 109--PFIC Reporting Requirement

  Section 109 is the third and final new addition to the Stop Tax Haven 
Abuse Act. The purpose of this provision to strengthen disclosure 
requirements for foreign corporations used as the personal investment 
vehicles of U.S. individuals. These corporations are sometimes 
established in offshore secrecy jurisdictions, making it particularly 
difficult for the IRS to detect them and establish links to the U.S. 
beneficiaries.
  The tax obligations of these corporations, known as passive foreign 
investment corporations or PFICs, are set out in Sections 1291-1298 of 
the tax code. U.S. persons who are direct or indirect shareholders of a 
PFIC are currently required to complete a Form 8621 providing certain 
information about the PFIC to the IRS. While the IRS has issued 
proposed regulations governing PFIC reporting, they have not yet been 
finalized.
  Section 109 of the bill would codify the PFIC reporting requirements 
set out in the proposed regulations, with one additional requirement. 
Specifically, PFIC reporting would be required not only by U.S. persons 
who have an ownership interest in a PFIC, but also by any U.S. person 
who, directly or indirectly, causes the PFIC to be formed, or who sent 
assets to or received assets from the PFIC during the relevant tax 
year.
  The need for expanded reporting obligations was highlighted during 
the Subcommittee's investigative work which showed that, in too many 
cases, ownership requirements were not enough to trigger reporting 
obligations for offshore corporations. For example, the Subcommittee 
found numerous instances in which a U.S. person asked an offshore 
service provider to form an offshore corporation, lodge ownership of 
the new corporation in one or more offshore shell companies under the 
provider's control, and then operate the new corporation as the U.S. 
person directed, despite the absence of any direct ownership interest. 
This arrangement, which may have been designed to evade tax or other 
legal obligations that attach to corporations directly or indirectly 
owned by a U.S. person, nevertheless provided U.S. persons with 
beneficial interests in offshore corporations that effectively operated 
at their discretion.
  To ensure that such offshore corporations are subject to the same 
reporting requirements as PFICs in which a U.S. person is a direct or 
indirect shareholder, the new Section 109 would require Forms 8621 to 
be filed by any U.S. person who formed a PFIC, sent assets to it, 
received assets from it, was a beneficial owner of it, or had 
beneficial interests in it. This expanded reporting requirement is 
intended to prevent any U.S. person who established, capitalized, or 
profited from a beneficial interest in a PFIC--whether or not that 
beneficial interest was evidenced by legal documentation--from arguing 
that they had no reporting obligation for that PFIC, because they 
lacked a formal ownership interest in it.
  Finally, Section 109 is intended to require reporting by U.S. persons 
who have a beneficial interest in a PFIC; it is not intended to impose 
reporting requirements on persons who perform ministerial tasks 
associated with a PFIC, including tasks associated with a PFIC's 
formation, management, contributions or distributions.

     Section 201--Stronger penalty for failure to make required 
       securities disclosures

  In addition to tax abuses, the 2006 Subcommittee investigation into 
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. Over the course of 
a number of years, the Wylys had obtained about $190 million in stock 
options as compensation from three U.S. publicly traded corporations at 
which

[[Page S2633]]

they were directors and major shareholders. Over time, the Wylys 
transferred these stock options to the network of offshore entities 
they had established.
  The investigation found that, for years, the Wylys had generally 
failed to report the offshore entities' stock holdings or transactions 
in their filings with the Securities and Exchange Commission (SEC). 
They did not report these stock holdings 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 found 
that, because both the Wylys and the public companies had failed to 
disclose the holdings of the offshore entities, for 13 years federal 
regulators had been unaware of those stock 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 stock 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 of transactions that take place in an offshore jurisdiction. To 
address this problem, Section 201 of our bill would establish a new 
monetary penalty of up to $1 million for persons who knowingly fail to 
disclose offshore stock holdings and transactions in violation of U.S. 
securities laws.

     Sections 202 and 203--Anti-money laundering programs for 
       hedge funds and company formation agents

  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, multiple Subcommittee 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 States, yet are not required by law to have anti-money 
laundering programs, including Know Your Customer, due diligence 
procedures, and procedures to file suspicious activity reports. There 
is no reason why this sector of our financial services industry should 
continue to serve as a gateway into the U.S. financial system for 
substantial funds of unknown origin.
  Seven years ago, in 2002, the Treasury Department proposed anti-money 
laundering regulations for these companies, but never finalized them. 
In 2008, the Department withdrew them with no explanation. Section 202 
of the bill would require Treasury to issue final anti-money laundering 
regulations for unregistered investment companies within 180 days of 
the enactment of the bill. Treasury would be free to draw upon its 2002 
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, Section 203 of the bill would add company formation 
agents to the list of persons subject to anti-money laundering 
obligations. 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 in 2006, that it was 
considering drafting such regulations but has yet to do so.
  We expect and intend that, as in the case of all other entities 
required to institute anti-money laundering programs, 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--IRS John Doe summons

  Section 204 of the bill focuses on an important tool used by the IRS 
in recent years to uncover taxpayers involved in offshore tax schemes, 
known as the John Doe summons. Section 204 would make three technical 
changes to make the use of John Doe summons 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 a known taxpayer, the IRS may issue a summons to a 
third party to obtain information about the 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 instead 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 try to obtain 
information about taxpayers operating in offshore secrecy 
jurisdictions. For example, as indicated earlier, the IRS obtained 
court approval to serve a John Doe summons on the Swiss bank, UBS, to 
obtain the names of an estimated 19,000 U.S. clients who opened UBS 
accounts in Switzerland without disclosing those accounts to the IRS. 
This is a landmark effort to try to overcome Swiss secrecy laws. In 
earlier years, the IRS obtained court approval to issue John Doe 
summonses to credit card associations, credit card processors, and 
credit card merchants, to collect 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.
  Currently, however, use of the John Doe summons process is 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 in court after court, 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

[[Page S2634]]

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 that 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 summonses 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.

     Section 205--FBAR investigations and suspicious activity 
       reports

  Section 205 of the bill would make several changes to Title 31 of the 
U.S. Code needed to reflect the IRS' 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 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, Titles I and II of our bill include 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 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.


                          Abusive Tax Shelters

  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 a 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

[[Page S2635]]

thousands of people like late-night, cut-rate T.V. bargains is 
scandalous, and we need to stop it.
  My Subcommittee has spent years examining 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.
  In 2006, the Subcommittee released a staff report entitled, ``Tax 
Haven Abuses: The Enablers, the Tools, and Secrecy,'' which 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. Most recently, in 2008, the Subcommittee released a staff 
report and held a hearing on how financial firms have designed and sold 
complex financial transactions, referred to as dividend enhancement 
transactions, to help offshore hedge funds and others escape payment of 
U.S. taxes on U.S. stock dividends.
  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 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 offshore dividend 
tax scams we examined in 2008 meant additional billions of dollars in 
unpaid taxes over a ten year period.
  Titles III and IV of the bill we are introducing today contain a 
number of measures to curb abusive tax shelters. First, they would 
strengthen the penalties imposed on those who aid or abet tax evasion. 
Second, they 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.

     Sections 301 and 302--Strengthening tax shelter penalties

  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 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 $1,000, 
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 their 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, investment 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 many 
other types of 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 of the tax code 
by 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, Senator 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

[[Page S2636]]

many 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--Prohibition on tax shelter patents

  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 over 70 tax 
strategy patents to date, up from 49 in 2007, and with many 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 ``tax planning 
invention'' that is ``designed to reduce, minimize, determine, avoid or 
defer ? tax liability.'' The wording of this section has been updated 
since the Stop Tax Haven Abuse Act of 2007, to reflect the bipartisan 
consensus that was reached on this provision in S. 2369, a Baucus-
Grassley-Levin bill to bar tax patents, introduced but not acted upon 
in the 110th Congress.

     Section 304--Fees contingent upon obtaining tax benefits

  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 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.

     Section 305--Deterring financial institution participation in 
       abusive tax shelter activities

  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

[[Page S2637]]

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 2010 and 2013 on 
preventing the participation of financial institutions in tax evasion 
or tax shelter activities.

     Section 306--Ending communication barriers between 
       enforcement agencies

  During hearings before the Permanent Subcommittee on Investigations 
on tax shelters in November 2003, IRS Commissioner Mark 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.
  Another 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. The same is true for the offshore dividend tax shelters 
exposed in the Subcommittee's 2008 hearing. The IRS knows who the 
offending banks and investment firms are that designed and sold 
questionable dividend enhancement transactions to offshore hedge funds 
and others, but it is barred by Section 6103 of the tax code from 
providing detailed information or documents to the SEC or banking 
regulators who oversee the relevant financial institutions.
  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, investment firms, 
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, investment firms, or banks from 
promoting abusive tax shelters, or detecting accounting fraud in the 
financial statements of public companies.

     Section 307--Increased disclosure of tax shelter information 
       to Congress

  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 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.

     Section 308--Tax shelter opinion letters

  As part of Circular 230, the Treasury Department has issued standards 
for tax practitioners who provide opinion letters on the tax 
implications of potential tax shelters. 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 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.


                      Title IV--Economic Substance

  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

[[Page S2638]]

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 the economic 
substance doctrine 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.


                               Conclusion

  The eyes of some people may glaze over when tax shelters and tax 
havens are discussed, but unscrupulous taxpayers and tax professionals 
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 tools to end offshore tax haven and tax 
shelter abuses. Offshore tax abuses alone contribute nearly $100 
billion to the $345 billion annual tax gap, which represents taxes owed 
but not paid. With the financial crisis facing our country today and 
the long list of expenses we're incurring to try to end that crisis, it 
is past time for taxes owing to the people's Treasury to be collected. 
And it is long past time for Congress to stop tax cheats from shifting 
their taxes onto the shoulders of honest Americans.
  I am optimistic that under the leadership of the new Obama 
Administration and with the support of the Senate Finance Committee 
that we can finally tackle this massive problem.
                                 ______