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March 20, 2023

Tax Perspectives

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Please note that these publications may not be up-to-date as taxation matters are subject to frequent changes.

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Fall 2003
Volume 3, Number 3

The information in Tax Perspectives is prepared for general interest only. Every effort has been made to ensure that the contents are accurate. However, professional advice should always be obtained before acting and TSG member firms cannot assume any liability for persons who act on the basis of information contained herein without professional advice.

U.S. Attacks Offshore Credit Cards

By Arnold Sherman, CA, CTA, TEP, FCA (England and Wales)
H. Arnold Sherman Professional Corporation (Calgary)

The United States Internal Revenue Service ("IRS") has been aware for many years that some U.S. taxpayers have been cheating on their taxes by hiding part of their income in banks in the Caribbean and elsewhere. In the year 2000, the IRS found a way to identify many of these tax evaders. The IRS was particularly interested in the so-called tax advisers, who were promoting ways in which US taxpayers could hide income from the IRS. These tax advisers, mostly based outside the U.S., relied on bank secrecy as a basic element of their promotion. All the jurisdictions used by tax evaders have strict bank secrecy rules, making it a criminal offence for a locally incorporated bank, or bank branch, to provide information about their customers.

Tax evaders who hide money offshore were always concerned about access to their funds. The promoters provided a solution. Funds were deposited offshore in the name of a tax haven corporation (or an offshore trust) set up for this purpose. The tax cheat was given an offshore credit (or debit) card, issued by the bank holding the deposit, in the name of the corporation or trust. Often these cards had very high limits on withdrawals US$1 million, for example. The bank had no risk, as the amount charged on the credit card could never exceed the deposit.

The IRS had a problem because of the offshore bank secrecy rules. They guessed that between 100.000 and 250.000 U.S. taxpayers were using offshore cards. The solution they devised was to seek U.S. Court orders, requiring credit card companies to make available to the IRS their files concerning offshore credit and debit cards. By 2002, they had the orders they needed.

When petitioning for the Court orders, a consultant to the IRS filed an affidavit estimating the cost of offshore tax evasion as US$70 billion per year.

Most cards issued outside the U.S. are either processed by U.S. based credit card companies, or by offshore subsidiaries of the U.S. companies, so the IRS could get the information, by-passing the offshore banks.

It is not illegal for a U.S. taxpayer to have an offshore card that "controls" an offshore bank account, but its existence must be disclosed on the taxpayer's annual tax return. Filing a false U.S. tax return is a felony.

There are some legitimate reasons for a U.S. (or Canadian) taxpayer to have an offshore card, but most are presumably used for doubtful purposes.

The IRS requested all the correspondence in the credit card files, because they knew that the card alone, in the name of an offshore entity, would not help. They hoped that the correspondence would identify the U.S. tax evader. They asked for information on cash withdrawals from ATMs; often a video camera records withdrawals.

The IRS planned to train 1,400 auditors for the project, and were apparently successful in obtaining useful information. However, they must have hit a roadblock, because they added a new wrinkle.

They obtained further Court orders, requiring many airlines, hotel chains, department stores and others, such as AOL Time Warner, to give them information about customers paying with offshore cards. Presumably, this was necessary because their information about a particular card did not identify the user. If, for example, there was a record of an airline ticket purchase using the card, the IRS, under a Court order, could obtain the name of the traveler by contacting the airline.

So what are the implications for cheating Canadians?

Unconfirmed reports have appeared in the press from time to time that the CCRA is conducting a similar investigation. There has been close cooperation between the CCRA and the IRS for many years. For example, the IRS provides Ottawa with annual information on interest payments made by U.S. banks and financial institutions to taxpayers with Canadian addresses. The CCRA compares this information with Canadian tax returns.

My guess (and it is only a guess) is that the IRS will accumulate information on many Canadian taxpayers through their offshore credit card program. What will they do with it? They can forward it to Ottawa if they wish, since exchange of information is permitted under Article XXVII of the Canada/United States tax treaty. The technical explanation of the treaty (prepared by the U.S. authorities) reads:

"It is contemplated that Article XXVII will be utilized by the competent authorities to exchange information upon request, routinely, and spontaneously."

Canadian taxpayers, who in the past have evaded Canadian tax using an offshore bank with an offshore credit or debit card, would be well advised to consider their position carefully, and to consult their Canadian tax adviser. A voluntary disclosure, before the CCRA begins an investigation, will tend to reduce or eliminate penalties and may avoid the risk of a criminal prosecution for tax evasion.