The tightening of the screws
Wealthy American citizens all over the world are a scared lot these days as the dreaded Internal Revenue Service (IRS) continues its drive to hunt for unreported wealth and wealth stashed away in tax havens.
Americans globally rushed to register under the IRS Voluntary Disclosure Initiative (VDI) to pay back taxes by last month's deadline. With a worldwide recession and a struggling US economy, it is likely the Obama administration will continue to hound well-heeled Americans in a drive to collect taxes, according to Jeff VanderWolk, a former IRS lawyer.
According to Ken Harvey, an international corporate tax partner with KPMG, 4,000 American taxpayers globally took advantage of the VDI to own up to unreported income and assets.
He says IRS estimates suggest non-filing taxpayers overseas cost the US Treasury US$25 billion a year.
'If you include under-reported income and exaggerated deductions, the actual estimates of the tax gap, or the difference between tax collection at full compliance and the amount of taxes actually being collected, is supposedly something like US$350 billion,' Harvey says. The IRS assertion, according to Harvey, is that with full compliance it would collect a total of US$2.1 trillion in taxes a year.
While the IRS would not comment on investigations on Americans living in Hong Kong, its position is resolute - that US citizens, regardless of where they are resident, are responsible for reporting their worldwide income.
'IRS commissioner Douglas Shulman has made combating international tax evasion one of his top priorities,' says Bruce Friedland, an IRS spokesman in Washington. 'He's committed to supporting ongoing offshore investigations wherever they may lead. Every day, taxpayers making voluntary disclosures and other third parties are providing us with new useful information,'
Hong Kong-based PriceWaterhouseCoopers partner Robert Keys thinks claims of US citizens using Hong Kong and Singapore for tax evasion may be overblown. So too does Harvey, who believes most US expatriates in the region will be unaffected. 'The purpose of the VDI is really to pursue criminal tax evasion. Usually the people who are caught are people who actually live in the US,' he says. 'This isn't really a matter of chasing after US citizens who just happen to live overseas.'
But Hong Kong-based Withers partner Kurt Rademacher believes IRS investigations have already had ripple effects in Asia as the body, which is an arm of the US Treasury department, locates tax evaders 'wherever they might live'.
Regarding the perennial question of when aggressive tax planning or tax avoidance becomes tax evasion, all tax professionals contacted agree it is a heavily fact-driven determination and varies case by case.
'You need a substantial authority for any tax-planning decision based on [case] law because, if that doesn't exist, you can't just rely on advice from a Big Four accounting firm,' VanderWolk says.
Therefore, legal tax avoidance is simply a matter of getting good advice and following the law. The line between aggressive tax planning and tax evasion is blurry, but comes down to whether one is honestly attempting to follow the laws and regulations or is wilfully trying to evade them, Harvey says.
As for concerns that Americans are using Hong Kong and Singapore as tax havens, the IRS is concerned that in the global economy certain taxpayers may conceal income and assets through undisclosed offshore accounts. Accordingly, it is seriously committed to combating the problem wherever such accounts are established, Friedland says. Some of the effort takes place through IRS investigations.
While press reports suggest some tax evaders have used Hong Kong, Rademacher thinks they would be more likely to use bank secrecy havens.
Harvey also thinks such concerns are exaggerated because there is nothing inherently evasive or sinister about doing business in Hong Kong or Singapore.
Rademacher thinks the VDI programme is a good idea and believes it is an attempt by the IRS 'to bring people into the system'.
He believes the penalty regime should be more flexible and penalties reduced to assist taxpayers who are not wilful tax evaders.
But Harvey believes the VDI is about the under-reporting of income and the underpayment of US income tax. 'The VDI is a means by which people who might otherwise be subject to criminal charges may be able to avoid being prosecuted, in exchange for which they would pay a maximum set penalty [generally 20 per cent of the unreported assets] in addition to the actual tax and late payment charges on the income itself,' he says.
Clearly, the IRS is trying to gather as much information as possible about US citizens' overseas financial activities. Rademacher agrees the IRS is trying to ensure potential tax evaders do not simply choose an entity or vehicle in which to hide their funds that falls outside a narrower definition.
'Casting such a wide net has the inadvertent consequence of making compliance much more difficult for the vast majority of US taxpayers who actually pay their taxes,' Rademacher says.
The original purpose of the Report of Foreign Bank and Financial Accounts (FBAR) was mainly to combat money laundering. However, FBAR filing requirements also give the US a way to fight tax evasion.
'Offshore accounts are a hot-button issue for the IRS because the US has a reasonably good system of withholding and reporting for most types of income earned in the US, which makes tax evasion more difficult domestically,' Harvey says. But a person with money or income outside the US potentially falls outside the US tax reporting net and the government is dependent on self-reporting of such income and the assets that generate that income.'
In Hong Kong, it is rumoured that hundreds of US citizens have either renounced their passports and green cards or contemplate doing so. While the precise number is hard to verify, perhaps to deflect such speculation, Matthew Dolbow, spokesman and deputy for public affairs at the US consulate in Hong Kong, asserts that '3,800 Hong Kong residents successfully applied to immigrate to the US last year and that illustrates the US is an attractive destination for Hong Kong people'.
But VanderWolk believes heavy-handed US tax policy and enforcement tactics might have compelled some to relinquish their citizenship. 'Some people renounce citizenship simply because they prefer not to file and pay tax in a place where they don't live,' says VanderWolk. He adds that some Americans have spent decades in Hong Kong building their careers and wealth and 'would prefer to surrender their passports than pay into a system they no longer benefit from'.
Rademacher, too, suspects some have renounced their citizenship because of dissatisfaction with US tax policy.
'Congress could go a long way to alleviate these issues if it would raise the thresholds that US citizens living abroad can earn [US$91,400] without having to pay US federal income taxes under the foreign-earned income exclusion,' he says. 'But there has been no move in Congress to make taxes any less onerous for non-US resident Americans.'
Similarly, Harvey has assisted a few high-net-worth individuals with tax issues involved in surrendering US citizenship, but says they were born in the US but had spent most of their lives overseas. 'However, the motivation for giving up citizenship was certainly, to some extent, tax-related, as the US system of worldwide taxation and reporting is quite burdensome and expensive to individuals living outside the US, irrespective of the actual tax liability involved,' Harvey says. The US is isolated in terms of the worldwide taxation of its citizens and green card holders.
'No other developed country does that. In other places, when citizens live abroad for a year or more, they don't pay taxes [to their country of citizenship] on income earned abroad,' VanderWolk says.
Although Harvey agrees that US worldwide taxation is burdensome to expatriates, he does not think its enforcement tactics are what's causing concern but rather, tax rates. 'If you are following the law and reporting your taxable income, it may be a hassle, but you don't have much to worry about,' he says.
Harvey's clients renounced their citizenship before changes to the revenue code in 1995 that imposed an exit tax on them doing so.
High-net-worth individuals surrendering their US citizenship or long-term permanent residence status may have to sell all their assets on the day of renunciation. They then have to pay US tax on any gains on property they own. There is generally an exemption of US$600,000. The expatriate must pay tax on the gains but receives no benefit for any losses incurred.
Furthermore, a person who relinquishes their citizenship or green card may be treated as a US resident again for tax purposes if, with some exceptions, they spend more than 30 days in the US in any given year of the succeeding 10 years, Harvey says. 'So, as a general matter, if you renounce your citizenship, you want to be fairly sure that you don't plan on coming back.'
'We have had some clients ask about the implications of giving up their citizenship,' Keys says. 'We don't necessarily promote giving up citizenship for tax planning, as there are myriad other issues that need to be considered rather than it being simply about the tax savings.'
For example, one must consider what other citizenship they can take up. They are also giving up the opportunity to work in and travel to the US and any consular protections associated with citizenship. Moreover, since US passports are globally accepted and often cut through the bureaucratic rigmarole associated with obtaining visas other nationals often endure, relinquishing US citizenship may not be prudent.
Rademacher believes that while clients frequently inquire about giving up their citizenship, it is usually not contemplated to avoid taxation. 'Deciding to give up US citizenship is usually much more of a personal issue than it is a financial or tax issue - though there certainly are tax consequences,' he says.