The Panama Papers And The Voluntary Disclosure Conundrum

This article was published on June 9, 2016 in Global Tax Weekly, Wolters Kluwer.

On June 26, 2016, a widened Panama Canal will open for business after a ten-year, USD5.3bn expansion project is completed. The new locks will allow bigger ships to pass through the 102-yearold waterway. The canal has been a source of great pride to America, who built the canal, and Panama, who possesses and operates the great locks. But the recently leaked 11.5 million documents from the Panama-based law firm Mossack Fonseca & Co., known as the "Panama Papers," shows another, darker side of our Pan-American relationship, which has been largely ignored until now.

The Panama Papers present the US government with a vast amount of highly confidential information on the secretive world of tax havens, offshore accounts, their underlying beneficial owners and possible tax evasion, which will take years to investigate and unravel. Already, in response to the release of the Panama Papers, the US Attorney's Office for the Southern District of New York has opened a formal criminal investigation into potentially widespread tax evasion and other criminal activity, and the New York State Department of Financial Services has asked 13 foreign banks to turn over information about their respective New York branches' contact with the Mossack Fonseca law firm. The United States is not alone. Similar inquires have been launched in the UK, Germany, France, Austria, Sweden, the Netherlands and elsewhere. The person who leaked the information to the International Consortium of Investigative Journalists ("ICIJ") remains anonymous, but he issued a manifesto on May 6, describing his reasons for exposing what he called "massive, pervasive corruption." In response, Panama has stated that it is "fully and immediately" committed to providing an exchange of tax information. It is a certainty that the IRS and US Department of Justice will soon issue a treaty request to Panama that seeks additional account information.1

Having a foreign account in the name of an offshore company is not per se illegal (although see below for a caveat to this) and may be accompanied by full compliance with the tax laws. There are no restrictions in the United States against having a bank or securities account in a foreign jurisdiction. Many Americans maintain foreign accounts for legitimate reasons. Thus, the fact that a name may appear on a client list of the Panamanian law firm, Mossack Fonseca, does not mean tax evasion has been committed. However, it is a tax crime to willfully conceal foreign accounts and income, and to use offshore structures to hide such accounts and evade US taxes.

US citizens are taxed annually on their world-wide income and are required to report income from all offshore accounts. A US citizen must disclose on their annual income tax returns any financial interest in or signatory authority over a financial account located in a foreign country and report all income from the offshore account. This must be done regardless of the account balance or whether income was earned from the foreign account. US citizens are also required to file a Report of Foreign Bank and Financial Account (FBAR) to reveal all foreign accounts if more than USD10,000 is held in their offshore accounts in total.

The FBAR is an informational return and does not require the payment of any tax. The annual FBAR must be filed with the IRS whenever a taxpayer has an interest in, or signature authority over, a foreign financial account with a value over USD10,000 at any time during the calendar year. It makes no difference if the average amount in the account during the year is less than USD10,000 or if all of the money is withdrawn by the end of the year. If the account held more than USD10,000 at any time during the year, the FBAR must be filed. The USD10,000 threshold is based on the cumulative balance of all your foreign accounts. You are also required to file the FBAR if a foreign account has non-monetary assets of more than USD10,000. For example, the cash surrender value of a life insurance policy is such a nonmonetary asset. In addition to the annual FBAR, the US taxpayer must also report the income earned from each foreign account on schedule B, Form 1040, as well as complete the IRS Form 8938, Statement of Specified Foreign Financial Assets.

The FBAR must contain the name and address of each...