Enforcing Non-US Tax Authority Requests For Taxpayer Information

Introduction

As the world's citizens engage in more international transactions, the world's tax authorities struggle to keep up. In particular, a governmental tax authority's ability to investigate tax-related issues involving one of its corporate or individual citizens or residents may be hampered by the foreign nature of the transaction or record keeping. This is consistent with the notion that a sovereign's authority to obtain information, through compulsory processes or otherwise, is limited to its borders.

Over the years, however, the tax authorities have developed legal means to obtain information located outside their jurisdictions. To enable their tax authorities to acquire information relevant to the enforcement of their revenue laws, many countries have entered into bilateral tax treaties or information exchange agreements. Bilateral tax treaties allow tax authorities to request and acquire information from partnering foreign nations to further their own tax investigations and fight offshore tax evasion. These agreements allow a non-US tax authority to use the US Internal Revenue Service (IRS) as an agent of its investigation and extend its reach into the United States. Indeed, a non-US taxpayer may be confused to find that the IRS has served a summons on a US entity (eg, a US bank) to obtain information that will assist the non-US tax authority's investigation of him, her or it.

This update:

provides an overview of the information exchange articles under the US Model Income Tax Convention of 2006 ('US model treaty'), as well as the enforcement procedures in the US courts; reviews US case law concerning the enforcement of summonses issued on behalf of treaty partners; and provides practical considerations for non-US taxpayers that find that the IRS has issued a summons on behalf of a non-US tax authority. Bilateral tax treaties and enforcement process

In general, bilateral income tax treaties include provisions for both the prevention of double taxation and information exchange. The US Treasury Department has developed a model income tax treaty, the US Model Income Tax Convention of 2006, which is used as the starting point for bilateral treaty negotiations with other countries.1 Article 26 of the US model treaty provides the basis for information exchange. Paragraph 1 of Article 26 imposes an obligation on the competent authority2 of each contracting state to exchange such information as is necessary to carry out the treaty provisions. Paragraph 4 provides that "[i]f information is requested by a Contracting State... the Contracting State shall use its information gathering measures to obtain the requested information" Thus, the bilateral treaty does not provide a compulsory process for information exchange;3 instead, it authorises the treaty partners to use each other's administrative processes to access information about their respective taxpayers. For example, if a treaty partner requests information from the United States4 under the treaty,5 Paragraph 4 of Article 26 authorises the United States to use its administrative processes, including the issuance of a summons under Section 76026 of the Internal Revenue Code,7 to acquire such information. In pursuing the request for information on behalf of the treaty partner, the United States must follow its statutory requirements, which includes providing notice to the taxpayer when a summons is issued to a third-party record keeper. It is irrelevant that the treaty partner may not need the information for its own purposes, and a treaty partner cannot decline to supply information solely because it has no domestic interest in the information.

Once the IRS issues a summons on behalf of a foreign treaty partner, the non-US taxpayer is entitled to file a petition to quash the summons in the US district court in the district within which the person to be summoned resides or is found within 20 days after it has received notice of the summons.8 If the summons has been issued to a third party (eg, a US bank) with regard to the non-US taxpayer, the non-US taxpayer has the right to intervene in a summons enforcement proceeding commenced by the United States and has a right to file a motion to quash.9 In most instances, when a taxpayer files a petition to quash a summons, the IRS will counterclaim for enforcement of the summons.10

The IRS must satisfy a number of requirements to enforce a summons in a US court. The prima facie case for the enforcement of any IRS summons was established by the US Supreme Court in United States v Powell11. Under Powell, the government bears the burden of showing that:

the summons was issued for a legitimate purpose; the material sought is relevant to that purpose; the information sought is not already within the possession of the commissioner; and the administrative steps required by the code have been followed.12 Considering the IRS's broad authority to issue a summons under Section 7602, the Powell factors are relatively easy to satisfy.

Once the IRS has made the requisite showing, the burden shifts to the taxpayer (US or non-US) to disprove one of the Powell factors or otherwise show that the IRS is attempting to abuse the court's process. Such an abuse would take place if the summons had been issued for an improper purpose, such as to harass the taxpayer or to put pressure on it to settle a collateral dispute, or for any other purpose reflecting on the propriety of the particular investigation.13 For the taxpayer challenging an IRS enforcement order on behalf of a foreign tax authority, only evidence of the IRS's abuse of process, not that of the non-US government, is relevant.

In addition to the Powell factors, courts consider the specific treaty in question in determining the enforceability of the summons. Paragraph 3 of Article 26 of the US model treaty provides that information exchange articles shall not require a contracting state "to carry out administrative measures at variance with the laws and administrative...