Cross-Border Audits: When Foreign Tax Authorities Sic the IRS on You

International audits often involve examinations conducted by the Internal Revenue Service (“IRS’) on individuals and companies that have financial activities, businesses, or assets outside of the United States. These audits aim to ensure compliance with U.S. tax laws. International audits can also involve foreign tax authorities investigating American individuals or companies for violations of foreign tax laws. In cases of cross-border audits involving U.S. individuals or companies, foreign tax authorities may make a treaty request with the IRS to obtain records to build a criminal tax case against a U.S. person. The records sought by foreign tax authorities are typically financial account or credit card information, loan applications, and copies of safe deposit box rental agreements. Once the IRS receives a tax treaty request for records from a treaty partner, the IRS will typically issue a summons to obtain the records sought by a foreign tax agency. Any information received by the IRS through a summons can be utilized as evidence in a domestic and foreign criminal tax proceeding. Any U.S. person that has been put on notice by the IRS in regards to an IRS summons to obtain their financial information from third parties should consider challenging the IRS’s summons. This article discusses the IRS’s ability to obtain information on behalf of a foreign tax agency through a summons and how such a summons may be judicially challenged in court.

IRS’s Summons Power

If a U.S. person is suspected of committing a tax crime in a foreign country and evidence of the tax crime can be found in the United States, the foreign tax authority makes a treaty request to the United States to obtain evidence that is located domestically. Most treaty requests are made pursuant to a mutual legal assistance treaty (“MLAT”), which has the force of law. The MLAT will define the obligation to provide assistance, the scope of assistance, and the contents of the request. It may also contain evidentiary provisions that vary from the Federal Rules of Evidence. MLATs are not, however, the only treaties that provide a foreign tax authority with assistance: some extradition treaties and many tax treaties contain such provisions.

After a foreign tax authority makes a proper request for assistance, it will typically be up to the IRS to obtain the requested evidence. The IRS generally will use its summons power to obtain the information sought by a foreign tax authority. Section 7602 of the Internal Revenue Code gives the IRS broad authority to issue a summons to “any person the Secretary of Treasury may deem proper to appear before the Secretary of Treasury at a time and place named in the summons and to produce such books, papers, or other data, and to give such testimony, under oath, as may be relevant or material to determine “the liability of any person for any internal revenue tax.” Section 7602 extends to requests made to the IRS by tax treaty partners. See United States v. Stuart, 489 U.S. 353 (1989); Verges v. United States, No. 18-cv-60235, 2018 WL 3423965 (S.D. Fla. June 27, 2018) (finding good cause where IRS issued summons pursuant to Spanish tax authorities’ request).

Once the IRS issues a summons to third parties such as financial institutions or credit card companies to obtain records on behalf of foreign tax authority, the IRS must serve a copy of the summons to the individual being investigated. An individual affected by the summons is entitled to contest it in an enforcement proceeding. See United States v. Clarke, 573 U.S. 248, 254 (2014). An individual affected by the summons may file a motion to quash with a federal district court that has proper venue.

A motion to quash is a formal request to a federal district court to declare the summons issued by the IRS invalid or void. The purpose of a motion to quash is also to challenge the validity of an IRS summons. A federal district court will review the arguments and evidence presented by the party filing the motion. In summons enforcement proceedings, “courts may ask only whether the IRS issued a summons in good faith and must eschew any broader role of ‘overseeing the IRS’s determination to investigate.” See United States v. Powell, 379 U.S. 48. 56 (1964). The IRS can make its prima facie showing of good faith through a four-factor test discussed in United States v. Powell, 379 U.S. 48, 56 (1964). Specifically, the IRS must show 1) that the investigation will be conducted pursuant to a legitimate purpose; 2) that the inquiry will be relevant to that purpose; 3) that the information sought is not already in the IRS’ possession and; 4) that it has the administrative steps necessary issuance of a summons. The IRS can satisfy this burden merely by presenting the sworn affidavit of the agent who issued the summons attesting to these facts. See La Mura v. United States, 765 F.2d 974, 979 (11th Cir. 1985). The burden then “shifts to the party contesting the summons to disprove one of the four elements of the IRS’s prima facie showing or convince the court that enforcement of the summons would constitute an abuse of the court’s process.

Depending on the facts and circumstances of the particular case, some reasons for filing a motion to quash may include:

1) The scope of the summons is so broad, indefinite, or burdensome as to constitute an unreasonable search or invasion of privacy;

2) The documents sought by the summons are protected under the Fourth and Fifth Amendments to the United States Constitution;

3) The summons request are subject to a privilege;

4) The treaty or treaty provisions relied upon by the foreign tax authority is inapplicable;

5) Internal Revenue Code Section 7202(c) forbids the IRS from issuing a domestic summons when a Justice Department criminal referral is in effect. Under this reasoning, the IRS should also not issue a summons to assist a treaty partner’s criminal tax investigation. See United States v. Stuart, 489 U.S. at 357, 363.

Conclusion

If you are under investigation by the foreign tax authority and the IRS has issued a summons to obtain records on behalf of a foreign country, you should immediately consult with qualified attorneys both in the foreign country conducting the investigation and the United States. On the U.S. side, you will generally only have 20 days from the date of the issuance of the summons by the IRS to file a motion to quash challenging the legality of the summons. Timely filing a motion to quash an IRS summons will likely have a significant impact on criminal tax investigation being conducted by a foreign government and potentially even the IRS. Being the subject of a cross-border criminal tax investigation is a very serious matter. The sooner you reach out to a qualified tax attorney, the more time your attorney will have to develop a defense strategy.

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi & Liu, LLP. Anthony has assisted clients accused of tax crimes in the United States and in foreign countries. Anthony has also represented clients in cases involving IRS summons seeking records on behalf of foreign tax authorities.

Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.