“Do more with less” has been the mantra of the IRS since the Tea Party wing of the Republican Party ushered in an era of tight tax enforcement budgets about a decade ago. Sometimes the mantra seems ambitious. With 31% fewer full-time employees working in enforcement functions compared to 2010, the IRS has conducted 48% fewer audits of individual income tax returns — a staggering trend that’s impacting criminal tax enforcement given the historical origin of many criminal investigations Clues uncovered during civil exams.
However, in certain areas, the IRS Criminal Investigations component has renewed and adapted, allowing cases to be investigated more efficiently. A key set of innovations is the improved coordination of IRS-CI with foreign tax authorities, recently embodied in the Joint Chiefs of Global Tax Enforcement Consortium or J5.
The J5’s work appears to have been instrumental in the recent demise of the Puerto Rico-based Euro Pacific Bank.
‘History of Non-Compliance’
Puerto Rico’s top banking regulator, the Office of Commissioner of Financial Institutions, issued an order on June 30 ordering that Euro Pacific Bank cease operations and stated its intention to revoke the bank’s license. OCIF’s injunction was based in large part on Euro Pacific’s bankruptcy.
But the regulator also detailed and strongly cited the bank’s “history of non-compliance,” claiming that it “would not permit or tolerate any financial entity with a license issued by the Puerto Rico government to operate outside of the law.” At the forefront was undoubtedly the J5’s coordinated investigation into tax evasion and money laundering violations against Euro Pacific – codenamed Operation Atlantis – which dates back at least to 2019.
The J5 is a lightly institutionalized network of five law enforcement agencies responsible for tax crimes: IRS-CI and its counterparts in Australia, Canada, the Netherlands and the UK. Founded in 2018, the goal is improved collaboration between investigators who unsurprisingly focus on cross-border tax crimes and offshore banks and other international institutions that facilitate such crimes. At the operational level, the J5’s stated goals include sharing intelligence and coordinating investigations and deterrence intelligence, ultimately disrupting the global operations of criminal actors and corporations.
In the founding myth of the J5, the landmark event is the disclosure of the Panama Papers in 2016. That document exposed a shadowy network of cross-border tax evaders, money launderers and smugglers. Within a year or so, the J5 assembled some sort of white-collared Avengers to fight them. In truth, many OECD tax authorities have a much longer history of reasonably constructive, if not perfect, cooperation. However, the J5 differs in key respects – due to its multilateral nature, its relative permanence as an institution, and the breadth and depth of coordination and information sharing among affiliates.
“Concerned about the interaction”
Much of the impetus for the Euro Pacific Bank investigation appears to have come from the US contingent keen to avoid the troubling prospect of a US jurisdiction sliding into full-fledged tax haven status. As part of a 2020 budget, the IRS was directed to “file a report … detailing the number of individuals and businesses that … relocated to Puerto Rico and were granted tax exemptions under Puerto Rico Laws 20 and 22.”
Law 22 of Puerto Rico exempts qualifying residents from Puerto Rican income tax on any passive income realized or accrued after a person becomes a resident. Individuals who qualify for Act 22 treatment are also generally entitled to an exemption from U.S. income tax on income sourced in Puerto Rico under IRC section 933.
Therefore, as the House report accompanying the Budget Bill noted, the Ways & Means Committee was “concerned about the interaction” between Puerto Rico’s 2012 Laws 20 and 22 and IRC Section 933, “which allows for tax avoidance and federal, State and territory governments, including Puerto Rico.” The IRS submitted its report to the committee, which found hundreds of millions of dollars in lost US income tax revenue as a result of Act 22 beneficiaries. The media reported that Euro Pacific founder Peter Schiff was one of those Act 22 beneficiaries.
In January 2020, the J5 unveiled Operation Atlantis and proclaimed a day of coordinated investigative activities regarding “a Central American-based international financial institution” – including search warrants, interviews, subpoenas, subpoenas and other actions conducted by each of the two J5 components .
In the aftermath, J5 chiefs said their agencies handled hundreds of civil and criminal cases in the five jurisdictions related to the financial institution, with no banking oversight procedures that were independently advanced. The media reported in October 2020 that the unnamed financial institution was Euro Pacific Bank, although the bank is located in Puerto Rico and not Central America.
Following the day of action, in September 2021, the IRS Large Business & International Division announced a campaign targeting taxpayers claiming Act 22 benefits without complying with the requirements of IRC Section 937, which sets the residency and procurement rules for determines the US income tax. LB&I stated that suspected relocators “may misreport US source income as Puerto Rico income to avoid US taxation.”
The timing of the IRS’s announcement indicated that Euro Pacific Bank account holders were in the crosshairs. In any event, as a result of the actions of the J5, the IRS is likely to have obtained a wealth of information to initiate or expedite investigations into alleged abuses of Act 22.
Congress, consider this case of the IRS doing more with less: foreign tax enforcement, international cooperation, and coordinated financial intelligence gathering — not just to raise current cases and help shut down an allegedly abusive offshore bank, but also sow the seeds for future enforcement action. We anticipate a multitude of prosecutions and investigations involving alleged abusers of Law 22.
This article does not necessarily represent the opinion of the Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Information about the author
Joseph Rillotta is a member of Miller & Chevalier’s Washington, DC litigation practice. He assists clients in all phases of regulatory investigations, with a particular focus on tax disputes. He previously served as Counsel to the IRS Commissioner and Trial Attorney for the Department of Justice Tax Division.
Andy Howlett is a member of Miller & Chevalier’s Washington DC tax practice. Focused on tax planning, he helps clients understand and plan for the state tax consequences of a variety of transactions.
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