The 2011 Offshore Voluntary Disclosure
Initiative was announced by the Internal Revenue Service on 8 February 2011 to
combat offshore tax evasion and to set the historical significance of the OVDI
as part of larger efforts by the IRS.
The IRS has maintained an institutional voluntary disclosure program as part of
its longstanding practice to encourage taxpayers to come forward and become
compliant with their United States federal income tax and informational
reporting obligations while facing a substantially reduced risk of criminal
The programme not only allows the IRS to
collect back taxes and interest, but also accomplishes bringing the undisclosed
accounts and entities back into the United States tax system for future years.
Prior to calendar year 2009, the IRS received relatively few voluntary disclosure
submissions each year. Many taxpayers simply filed what has been referred to as
“quiet disclosures”, a process in which the taxpayer would merely amend the
last six years of United States federal income tax and informational returns to
include the additional income and information without actually participating in
the IRS voluntary disclosure process.
The 2009 Offshore Voluntary Disclosure
The IRS announced the 2009 Offshore
Voluntary Disclosure Programme on 23 March 2009. The OVDP was originally
scheduled to expire on 23 September 2009; however, the deadline was later
extended until 15 October 2009. The unique feature of the OVDP was that it
provided taxpayers with a set penalty framework within which to disclose their
offshore accounts and entities in a manner which would avoid criminal
Participants in the OVDP were required to pay all back taxes
interest on the tax due, an accuracy related penalty of 20 per cent of the tax
due or a delinquency penalty (if applicable) and a miscellaneous penalty of 20
per cent of the aggregate highest balance during the last six years on the
offshore accounts and/or entities1. This 20 per cent penalty was to be assessed
in lieu of all additional penalties which could be assessed against the taxpayer
in connection with the offshore accounts and entities. Examiners did not have
the capacity to negotiate the penalty framework or mitigate penalties on the
basis of reasonable cause.
It has been reported that approximately
15,000 taxpayers participated in the OVDP, far exceeding the IRS expectations.
The IRS was not initially prepared to process so many voluntary disclosure
applications, and numerous taxpayers initially experienced substantial delays
in processing their applications. At the time this article is being written, a
number of the applications from the OVDP remain outstanding and await having
their cases finalised. Through the overwhelming success of the OVDP, which is
largely attributed to the certainty of a set penalty structure for all participants,
the IRS gained valuable information thus expanding its capacity to combat
offshore tax evasion.
Throughout the OVDP (and later the
OVDI), the IRS has repeatedly warned against taxpayers continuing to file
“quiet disclosures” with the taxpayer’s IRS Service Center. The IRS has
repeatedly warned that such taxpayers may be examined and that there is a risk
of being potentially criminally prosecuted for all applicable years. Perhaps
because of this warning, as well as the broader IRS approach against offshore
tax evasion, approximately 3,000 additional taxpayers came forward after the
OVDP formally ended. During this time period, the IRS considered announcing
another voluntary disclosure programme, and stated that the terms of any new
programme would not be as favourable as the OVDP.
The 2011 Offshore Voluntary Disclosure
On 8 February 2011, the IRS announced
the new 2011 OVDI. The OVDI, which will be available through 31 August 2011 and
which will require the taxpayer to report unreported income for all calendar
years from 2003 through 2010, contains several significant changes from the
2009 Offshore Voluntary Disclosure Programme.
Notably, the miscellaneous
penalty has been increased from 20 per cent to 25 per cent of the amount in the
foreign bank accounts in the year with the highest aggregate account balance
covering the 2003 through 2010 time period. The IRS also created a separate
12.5 per cent miscellaneous penalty alternative for taxpayers whose highest
aggregate account balance (including the fair market value of assets in
undisclosed offshore entities and the fair market value of any foreign assets
that were either acquired with improperly untaxed funds or produced improperly
untaxed income) in each of the years covered by the OVDI is less than $75,000.
The 5 per cent miscellaneous penalty which was available during the OVDP was
expanded so that taxpayers who otherwise met the requirements under the OVDP
would still be eligible even if they withdrew no more than $1,000 during the account
during any calendar year covered by the OVDI. The 5 per cent miscellaneous
penalty also applies to taxpayers who are foreign residents who were unaware
that they were United States citizens.
In addition to paying the unreported tax
and interest, as well as the miscellaneous penalty discussed above, the
taxpayer will also be required to pay (1) a 20 per cent accuracy-related
penalty under IRC § 6662(a) on the full amount of the taxpayer’s underpayments
for all years, (2) a failure to file penalty under IRC § 6651(a)(1), if
applicable, and (3) a failure to pay penalty under IRC § 6651(a)(2), if
applicable. The OVDI also allows for the alternative mark-to-market calculation
of income from investments in passive foreign investment companies (such as offshore
mutual funds, offshore hedge funds or similarly structured offshore products),
a feature which was belatedly added to the OVDP.
As was the case with the OVDP, examiners
do not have the authority to negotiate the tax and penalty structure, nor do
examiners have the ability to mitigate penalties on the basis of reasonable
cause. The IRS will, however, allow participants in the previous OVDP who now
qualify for a reduced 5 per cent or 12.5 per cent miscellaneous penalty to
readjust their previous penalty paid and seek a refund for the difference.
OVDI continues to allow taxpayers to “sham out” certain entities in connection
with the voluntary disclosure in certain circumstances, a practice which was
allowed to participants in the OVDP. The OVDI also continues to allow the
“pre-clearance” of taxpayers prior to formally making an offshore voluntary
disclosure, and even streamlines the process through a central office which
will provide pre-clearance to taxpayer representatives.
Foreign Account Tax Compliance Act
enacted in February 2010, has provided the IRS with the information and tools
to effectively detect and combat offshore tax evasion. The IRS has adopted an
aggressive stance toward combating offshore tax evasion and is becoming much
more sophisticated in its ability to detect and pursue offshore tax evasion.
Taxpayers with undisclosed foreign accounts and entities are advised to apply
for voluntary disclosure rather than risk the IRS discovering the taxpayer.
The IRS intends that this OVDI be more
streamlined than the previous OVDP. The IRS has therefore indicated that it
will require a completed package (including complete and accurate amended
United States federal income tax and informational returns) by the 31 August
2011 deadline. It is therefore important that taxpayers with undisclosed
offshore accounts or income begin the application to make a voluntary
disclosure as soon as possible, in order to ensure that their application will
be completed by the 31 August 2011 deadline.