The Internal Revenue Service is looking for your international tax data—that is, if the IRS doesn’t already have it. With the rollout of the Foreign Account Tax Compliance Act (FATCA) and other automatic exchange-of-information (EOI) procedures, the IRS is now receiving—and making use of—a large amount of international tax information about U.S. taxpayers.
In 2017, the Treasury Inspector General for Tax Administration (TIGTA) recommended a number of changes regarding the IRS’ use of EOI, and the IRS has begun using data analytics to make EOI information a formidable resource for identifying taxpayers and specific tax issues for examination. Currently, more IRS employees have expanded access to automatic EOI information, and IRS employees are making greater use of specific EOI requests.
U.S. borders are no longer major barriers to IRS discovery. It is now not at all uncommon to meet the IRS or DOJ in a foreign jurisdiction, particularly for interviews or testimony. Below is an overview of the major EOI techniques in use and a discussion of best practices and key defenses to EOI requests.
Information-Gathering Methods—Old Standards and New Conventions
The IRS is permitted to exchange tax information internationally through a number of different treaties, agreements, and conventions. To a greater degree, IRS employees now also use informal means to obtain international information.
Bilateral Tax Treaties and TIEAs
Still the primary ways that the IRS obtains international tax information, income tax treaties and tax information exchange agreements (TIEAs) provide mechanisms for requests for information from foreign taxing authorities. Although taxpayer-specific requests under treaties and TIEAs in audits are perhaps the most familiar, the agreements are used for other types of information exchange, including spontaneous exchanges and automatic exchange of fixed, determinable, annual, or periodic (FDAP) income information.
Furthermore, several tax treaties allow for specific requests to aid tax collection and grant collection authority. TIGTA has recommended the heightened use of such requests, known as mutual collection assistance requests.
MLATs and Other Criminal Investigation Tools
Mutual legal assistance treaties (MLATs) and other conventions authorize treaty partners to secure evidence in foreign jurisdictions for use in criminal proceedings. Not all MLATs allow for EOI in tax cases.
Also, many income tax treaties and TIEAs allow the IRS to participate in the Simultaneous Criminal Investigation Program (SCIP), which allows information-sharing in related criminal investigations. In addition, the Joint International Tax Shelter Information and Collaboration (JITSIC) Network coordinates EOI related to offshore arrangements intended to minimize tax, in both civil and criminal contexts.
Automatic Exchange of Information
As discussed above, most income tax treaties and TIEAs allow for automatic exchanges of tax information to facilitate enforcement. A number of new avenues for automatic EOI (AEOI) have recently become effective. Most significantly, FATCA has resulted in a flood of new reporting. In the fall of 2018, the first criminal convictions for failure to comply with FATCA reporting occurred.1 The Common Reporting Standard (CRS) in Europe is resulting in a similar wave of new information for those taxing authorities. Although beyond the scope of this article, the OECD’s BEPS project and related initiatives are also generating greater AEOI about multinational enterprises.
Hague Evidence Convention
The Convention on the Taking of Evidence Abroad in Civil or Commercial Matters (the Hague Evidence Convention) is a powerful tool in litigation. Under letters of request issued by a U.S. court, the parties may obtain documents or testimony by going directly to many foreign jurisdictions. This tool is available to both parties, and letters of request can be critical to building a taxpayer’s litigation defense.
Informal and Alternative Methods
With international enforcement efforts growing, the IRS is training its employees to think creatively and not to limit themselves to formal EOI methods. As a part of case development, the IRS instructs employees to search for the taxpayer’s customers in the United States and to seek information through third-party summonses. Publicly available sources such as news articles, SEC filings, and industry databases—and even YouTube—are easily accessible sources of information about a taxpayer’s international operations.
Best Practices—Making a Specific EOI Request Go Smoothly
When facing an IRS request for international information, the taxpayer can make the process less onerous. At the outset of an exam, the taxpayer should evaluate whether—and to what extent—it intends to share international information with the IRS cooperatively. Under most EOI methods, the IRS must demonstrate that the records are unavailable in the United States and that it has exhausted local remedies. Cooperation also allows the taxpayer a modicum of control—for example, a say in the timing of production and the location and duration of interviews.
Cooperation with the foreign taxing authority, if allowed, is beneficial as well. For example, specific EOI requests related to foreign tax credits may produce more thorough documentation than the taxpayer possesses. The taxpayer’s local representative may have a good working relationship with foreign taxing agents and may be actively involved in the EOI response.
Advance preparation and knowledge of relevant corporate records are also key. Understanding what supportive records exist and making reasoned determinations regarding privilege are essential tasks in responding to a specific EOI request.
Common Defenses—When Full Cooperation Isn’t an Option
Of course, voluntary participation in the EOI request is not always possible or desirable. The request may be burdensome and overbroad. It may seek documents covered by privilege or other protections. The request may seek nonexistent records or interviews with unavailable former employees. There are, however, a number of potentially effective defenses.
How to Object?
There are no set procedures for objections. Notice by the IRS is not required, and the IRS does not consider an EOI request to be a “third-party contact” subject to disclosures under Internal Revenue Code Section 7602(c).2 The foreign taxing authority may notify the taxpayer locally to assist in gathering the information, and this can provide an avenue to raise objections. Most income tax treaties and TIEAs allow rejection of a request, so objections to the foreign taxing authority are a good line of defense. If the information is held by third parties abroad, the taxpayer should notify them of any possible objections the taxpayer would raise (e.g., privilege).
Overbreadth and Burden
An IRS International Practice Unit provides that EOI-requesting examiners “should only request the appropriate and relevant amount of information that will help develop issues in their case.” Relevance, overbreadth, and burden are valid objections to EOI requests, and the objections typically carry weight with the foreign taxing authority, which may be reluctant to comply with a burdensome request.
Availability of Records in the United States and Exhaustion of Remedies
A key provision of most TIEAs requires the requesting state to certify that it has pursued all means available in its own jurisdiction to obtain the information, and IRS examiners must seek information within the United States first, before resorting to EOI procedures.3 Thus, a key objection to an EOI request is that the records at issue exist in the United States, either with the taxpayer or with third parties. Further, a taxpayer’s claim of privilege or work-product protection to withhold documents should not render them “unavailable” for the purposes of EOI requests.
Limits on Discovery Available in Foreign Jurisdiction
The foreign jurisdiction is generally under no obligation to provide information that is contrary to the laws of, or not obtainable in, the foreign jurisdiction. Access to privileged information, trade secrets, and some types of financial information may be limited in foreign jurisdictions. Taxpayers would do well to gain the assistance of local counsel when evaluating whether an EOI request complies with foreign laws.
Limits on discovery are particularly important under the Hague Evidence Convention. The availability of pretrial discovery can vary widely, and generally U.S. litigants are bound to follow local procedures. Some jurisdictions may allow greater discovery for criminal or quasi-criminal purposes than for civil cases (and vice versa), and foreign jurisdictions will evaluate the allegations under their own legal standards. Testimony must generally be taken by local process, and American-style depositions are frequently unavailable.
Confidentiality Restrictions (Data Privacy and IRS Statutes)
The advent of data privacy laws in Europe and elsewhere complicates IRS EOI requests, particularly when employee or third-party information is at issue. When possible, the taxpayer should raise these objections with the relevant foreign taxing jurisdiction.
Information exchanged under EOI requests is subject to confidentiality restrictions under IRC Section 6105. “Tax convention information” exchanged on a confidential basis is protected, subject to exceptions for ongoing administrative and judicial proceedings. Information exchanged under an EOI request is also subject to the default confidentiality restrictions of IRC Section 6103.
The rapid exchange of tax information among jurisdictions and its heightened ease of use undoubtedly will change the course of IRS examinations in coming years. Taxpayer preparation is crucial, and new EOI methods are not necessarily bad news—especially to the extent that they may lead to greater transparency, fewer misunderstandings, and more efficient IRS audits. Understanding the new landscape may allow taxpayers to tell the IRS “bonne chance!” when the next EOI request comes their way.
Laura L. Gavioli is a partner at McDermott Will & Emery
- See United States v. Kyriacou, No. 18-cr-102 (E.D.N.Y.).
- See Internal Revenue Manual 18.104.22.168.
- See Internal Revenue Manual 4.60.1.