Voluntary disclosure of income derived abroad
05.01.2011
Key aim should be to boost gov‘t revenues in short term and improve compliance levels regarding filing and paying taxes in long term.
In recent years many countries have focused on voluntary disclosure of unreported income derived by their residents abroad.
Since 2005 Israel, which is now an OECD member, has operated a Voluntary Compliance Program (VCP).
The Israeli Tax Director, Yehudah Nasardishi, announced in January 2010 that Israel is considering an expanded VCP.
Recently, there have been indications that the US IRS may soon introduce another VCP, for those that missed the boat last time in September 2009.
In September last year, the OECD published a report which includes a comparison of the terms of VCP programs in OECD countries. According to the OECD report – Offshore Voluntary Disclosure – Comparative Analysis Guidance and Policy Advice – there are several criteria for a successful VCP. In particular, the VCP‘s aims and terms should be clear.
A key aim should be to boost government revenues in the short term and improve compliance levels regarding filing and paying taxes in the long term. Often the aim is to achieve repatriation of assets, especially when they are located in a tax heaven or another country, which is not a tax treaty partner.
The terms of a VCP typically involve a limited time-offer for taxpayers to come clean on their tax liabilities and pay the tax, with the tax authority waiving penal and civil penalties or determining a different time period (statute of limitations for criminal procedures). In this regard the tax authority needs to publish clear guidance to the public. Furthermore, it should also be clear how disclosures under the program will be treated for antimoney laundering purposes.
The VCP should aim to increasing the government‘s revenues while giving some accounting of the collection results so that obedient taxpayers will recognize that the overall taxpayers‘ circle was broadened. The general filing regime will need to be amended to encourage and support the disclosure of previously undisclosed income under the VCP coupled with criminal penalties for tax evaders.
Some countries may decide to offer reduced tax on undisclosed income while others may prefer to merely reduce the interest and penalties on tax paid late. This issue is the subject of debate in certain circles in Israel. Is it right to give a ‘‘prize‘‘ (reduced tax) to people who only now come forward? Will others see this and be motivated to wait for the next VCP instead of paying tax regularly on time?
Some countries like the UK, South Africa and Italy have offered VCP‘s more than once – and the US may soon decide to so.
There should also be a clear risk for those eligible for the program but choose not to participate (by instituting criminal procedures after the window of opportunities ended) and giving a limited time limit to participate.
Many other practical considerations arise regarding VCP‘s. In Israel, a key question is how to legally introduce a VCP, should this be decided. Extrastatutory tax concessions are outlawed by Section 245 of the Income Tax Ordinance, so will the Knesset need to adopt new regulations or new legislation?
Uncertainty must be avoided, otherwise, many potential taxpayers may be discouraged from coming forward: what will happen if they make a full and accurate disclosure and what about criminal charges? Will their cases be disclosed to the public?
To minimize uncertainty, there has to be a process for voluntary disclosure – for example the establishment of a new VCP unit (as in Belgium) and determining a working process with third parties, especially banks as in Mexico.
There generally needs to be a high profile publicity campaign. There also has to be a pragmatic approach towards incomplete records. For example, there are cases where records were destroyed or not kept and/or assets held in companies and other structures, for which financial reports are unavailable.
Will disclosed information be kept confidential? In some countries, access to the disclosed information is restricted to within the tax authority. In Israel, currently, the outcome of criminal cases resolved without going to court must be published according to a recent Supreme Court case. The process is known as ‘‘Kofer‘‘.
It is important to ensuring that no further action will be taken if the request for VCP did not end successfully by limiting the access of the tax authority‘s employees to the disclosed information.
Will there be contact with third parties?
Some tax authorities promise that third parties, such as business partners, employers, banks and related parties of the taxpayer will be contacted only in limited circumstances.
Penalties, interest and the statute of limitations must be clarified. Some countries levy penalties of 100% of the unpaid tax and the interest on unpaid tax may accumulate over more than a decade. Professional tax advisors have emphasized the need to limit the period over which the interest accumulates.
In Israel, Income Tax Ordinance Section 192 currently grants the Tax Authority discretion to reduce the rate of interest or of linkage differentials and/or waive them completely, if it is proved to their satisfaction that the delay which caused the liability to pay was not caused by any act or omission that depended on the taxpayer‘s will, or that the taxpayer did not know the exact amount of tax due.
The Israeli 2005 VPC guidelines state that interest and penalties will not be reduced. In practice some assessment offices cancel the penalties and allow the taxpayer to submit an application to reduce the interest, but this rarely is allowed.
Guidance is needed regarding the circumstances under which no criminal charges will be brought. The Israeli VPC procedure is technically a criminal procedure, so care is needed.
Another key issue is whether no-name discussions are possible, and whether names must subsequently be disclosed. It is important that there is a phone line where taxpayers and tax advisers can at least receive initial answers.
Regarding anonymity, a few alternatives should be considered. One possibility is to allow a high degree of anonymity. For example, in Mexico, taxpayers could pay the tax, interest and penalties of his unreported income through the bank without his name being disclosed to the tax authority. The taxpayer received a receipt as evidence that tax was paid and if asked at a later stage by the tax authorities as to his unreported income he could show the receipt to them.
Another possibility is to allow a lower degree of anonymity. This will involve disclosing the identity of the taxpayer at an earlier stage (the practice in Israel).
Costs are another consideration. VCP‘s costs to the tax authority may be reduced by allowing an online report in the tax authority‘s website, simplifying the documentation needed, etc.
How does Israel compare?
A comparison of the principles in the OECD report with the Israeli 2005 reveals that Israel did not prescribe a clear timetable for the VCP process in contrast to other countries such as the US. The Israeli Tax Authority has not published its revenues from VCP.
The Israeli VCP 2005 procedure requires that a request is first submitted to the investigations department at the Israel Tax Authority revealing the name and identity number of the taxpayer.
Only if such details are forthcoming and the investigations department confirms that the taxpayer is not already under investigation, can the taxpayer settle with an assessment office his tax liability on unreported income – an assessment agreement.
This process discourages taxpayers from coming forward to disclose unreported income. Interest and penalties are imposed in full, although in practice there are cases where penalties are dismissed within the framework of an assessment agreement.
What‘s next?
Recently, as mentioned, the Director of the Israel Tax Authority and other tax officials have indicated that a proposed upgraded VCP procedure may soon be allowed. It is proposed that the tax authority will consider totally exempting interest in specific cases, for example, if there is evidence that the underlying principal (capital) was inherited.
It remains to be seen whether and when Israel (and the US) will initiate any new VCP procedures, and on what terms. One must hope that such new procedures will be introduced and they will increase the voluntary disclosure of unreported income derived abroad by Israeli residents.
As always, consult experienced tax advisors in each country at an early stage in specific cases.