Hearing of the Select Revenue Measures Subcommittee of the House Ways and Means Committee - Banking Secrecy Practices and Wealthy American Taxpayers

Hearing of the Select Revenue Measures Subcommittee of the House Ways and Means Committee - Banking Secrecy Practices and Wealthy American Taxpayers

Hearing of the select revenue measures subcommittee of the House Ways and Means Committee, Subject: Banking secrecy practices and Wealthy American Taxpayers, Chaired by: Rep. Richard E. Neal (D-MA).

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REP. NEAL: Let me call this hearing to order. I encourage you all to take the seats. I want to welcome all of you this morning to this hearing of the Select Revenue Measures Subcommittee on the issue of bank secrecy and tax avoidance.

President Kennedy noted that "The very word 'secrecy' is repugnant in a free and open society." Fostered by today's technology, those comments are truer than ever. But bank secrecy has long held a certain charm.

In fact, mystery writers have utilized the Swiss bank as the central focus of intrigue. Where else would you think to store the secrets of the Holy Grail but in a Swiss bank account, as was the case in the novel "The Da Vinci Code."

But events of the last year have chipped away at this polished veneer to reveal some rather unseemly criminal behavior. It has been one year now since a Swiss banker admitted that he and his bank assisted wealthy U.S. taxpayers in hiding money in offshore accounts, that number somewhere between 250 and 50,000 previously hidden U.S. accounts.

The bank has not denied its part and will pay a $780 million fine. But despite the best efforts of the IRS and the Justice Department, the names of those U.S. taxpayers have not been divulged. Swiss law has prevented the bank from doing so and the treaty is of no help.

It seems that there are fewer and fewer willing to stand up for such confidentiality in the face of criminal behavior. On the eve of the gathering of leaders of the wealthiest nations, who incidentally generate 80 percent of the world's wealth, the short list of international issues to be discussed includes tax havens.

When Prime Minister Brown -- Gordon Brown addressed the Congress in a joint session earlier this month, he singled out offshore tax havens as a threat and received bipartisan applause. Secretary Geithner just last week stated that the Treasury will be launching a new initiative on tax haven, one to be underscored by the president at the G-20 meeting this week.

The international effort to pressure uncooperative tax havens will be a diplomatic battle. But Congress must be a partner in this effort. In this hearing today, we'll explore issues relating to withholding and reporting the role of foreign banks in the collection of U.S. taxes and how we can better utilize tax treaties and agreements, which I happen to think constitutes the key.

It's my hope that this hearing will provide us some guidance to enhance and strengthen the current system, the system which according to one witness today allows $50 billion of lost tax revenue per year. Following this debate, I'm hopeful that we can file bipartisan legislation to implement the recommendations we hear today.

Now, let me recognize my friend Mr. Tiberi for his opening statement.

REP. PATRICK J. TIBERI (R-OH): Thank you, Chairman Neal. Thank you for your leadership. I share many of the concerns that you outlined in your statement and look forward to working together on responsible commonsense steps that will make our efforts to crackdown on individuals who commit tax fraud more effectively.

Thank you also to our witnesses. I appreciate your willingness to join us today and look forward to your testimony.

Tax evasion to the use of undeclared offshore bank accounts or by any other means is a federal crime. I think we are all in agreement here today that criminal tax evasion should be pursued aggressively and punished.

Not going after the dishonest few who commit criminal acts to the fullest extent possible, it is unfair to honest hardworking Americans who pay their taxes and strive to comply with their country's tax laws. The ongoing events surrounding UBS AG and its admitted criminal role in helping a number of wealthy U.S. individuals invade U.S. taxes have brought a spotlight to bear on international tax enforcement and the tools that we have at our disposal to help ensure compliance.

Among those tools is the Qualified Intermediary program. And under the QI program foreign financial institutions agreed to verify the status of foreign investors and collect and remit the appropriate U.S. withholding tax, if any. Recent events have demonstrated a number of areas where the QI program may be strengthened. And I hope that we will discuss some of those today.

Additionally, the U.S. has entered into dozens of tax treaties, and bilateral, mutual, legal, assistance treaties with other nations as well as approximately 20 tax information exchange agreements. In short, the United States is not alone in the effort to ensure the compliance with our tax laws.

A number of frame works currently exist across the government and the private sector. As we proceed with this discussion, we should keep in mind that there are willing partners in the international front and continuing to improving work through our formal network of information exchanges is the responsible way to move forward.

Steps that undermine our international standing could threaten key information exchanges and invite unintended consequences that could do significant harm to our economy's capital markets. This hearing is important -- an important opportunity to examine the serious tax compliance issues we face, find out where our current enforcement regime may have fallen short, explore new tools that may help us fight tax evasion, and close the international tax gap.

As we all know, the tax gap is defined roughly as what is legally owed, but not collected. I sincerely hope our efforts today will remain focused on the issues of compliance.

The line between illegal tax evasion and legal tax practices used by U.S. taxpayers around the world is distinct. To blow that line may only make our compliance efforts that much more difficult.

Thank you again, Chairman Neal. And thank you for your leadership on this important issue.

REP. NEAL: I thank the gentleman for his good comments. And let me welcome our witnesses here today. On our first panel; the Honorable Doug Shulman, commissioner of the Internal Revenue Service.

Thank you, Commissioner for joining us today. I want to advise members that the commissioner may not be able to answer specific questions regarding pending legal matters including the UBS case. I know the members of the panel here are likely to try anyway.

(Laughter)

On our second panel, we will hear from Stephen Shay, a tax partner at Ropes & Gray in Boston, who was formerly the International Tax Counsel at the Treasury Department.

And we will also welcome back to the subcommittee Professor Avi- Yonah, the University of Michigan Law School, who is a recognized expert in international tax issues and has served as a consultant to the Treasury Department and OECD.

Finally, we will hear from Peter Blessing, a law partner at Shearman and Sterling in New York. Mr. Blessing specializes in international tax issues. And we are fortunate to have his expertise here today.

Let me note for the record that we did extend an invitation to the Swiss government and to UBS to appear before the subcommittee today; both respectfully declined. Without objection, any other members wishing to insert statements as part of the record may do so. All written statements by the witnesses will be inserted into the record as well.

I'd like to recognize Commissioner Shulman for his opening statement.

MR. SHULMAN: Thank you Mr. Chairman, Ranking Member Tiberi, and members of the subcommittee. It's a pleasure to be here today to talk to you about the unprecedented focus that the Internal Revenue Service has placed on detecting and brining to justice those who unlawfully hide assets overseas to avoid paying tax.

In today's economic environment, where the federal government is necessarily running deficits to restore economic growth, it's more important than ever that citizens feel confident that individuals and corporations are playing by the rules and paying the taxes that they owe.

When American -- when the American public is confronted with stories of financial institutions helping U.S. citizens to maintain secret overseas accounts involving sham trust to improperly avoid U.S. tax, they should be outraged as am I. But they should also know that the U.S. government is taking unprecedented measures. And there is much more in the works.

As you know, Mr. Chairman, federal law prohibits the disclosure of information about civil and criminal tax investigations while the subcommittee may have seen press accounts and documents entered into the public record about some recent investigations. These relate to ongoing civil litigation where the strategies, techniques, and opinions of the IRS, and I might note specifically the IRS commissioner, are central elements to the litigation. And therefore the Department of Justice has asked that I not comment on the UBS case specifically.

With all the recent publicity, the press has also been full of speculation about those who are advising U.S. taxpayers who have undeclared offshore accounts and income. My advice to those taxpayers is simple. They should come in under the IRS' voluntary disclosure program.

We've been steadily increasing pressure on offshore financial institutions that facilitate concealment of taxable income by U.S. citizens and that pressure will only increase. The IRS recently issued guidance to its exam personnel, who were addressing voluntary disclosure requests involving unreported offshore income.

We issued this guidance to make sure that our personnel had standard procedures when someone voluntarily came in. We believe that this is firm, but fair resolution of these cases. Taxpayers who come in will pay a significant price, but they will also avoid criminal prosecution if they come in voluntarily.

Mr. Chairman, there is no "silver bullet" or one strategy that will alone solve the problem of offshore tax avoidance. Rather it's an integrated approach that we've been developing. My written testimony explores a variety of elements of that approach. Let me highlight a few.

First, since becoming commissioner I've made international issues a top priority. I've both increased the number of audits in this area and prioritized stepped-up hiring of international experts and investigators. We've had some success with some high profile cases that you mentioned and we're getting some other results.

Several so-called tax haven countries had pledged to reform bank secrecy laws and in the last month have agreed to comply with the international standards for tax and data sharing. The president's 2010 budget will allow us to increase our resources in this area. And it includes robust funding for a portfolio of IRS international tax compliance initiatives.

The IRS is also looking at how to improve the Qualified Intermediary program or QI program. The QI program is an important tool for the IRS because it gives us a line of sight into the activities of U.S. taxpayers who do business with foreign banks. As with any large and complex program, we have to strive to continuously improve the program where we see weaknesses.

Several measures that we're considering now with the Treasury Department include expanding the information reporting requirements to include other income besides just the income from U.S. securities, strengthening documentation rules to ensure that beneficial owners of accounts cannot hide behind sham trusts, subjecting trusts or private corporations to U.S. withholding tax, if we don't have a clear line of sight to the beneficial owners.

And additionally, we've already proposed changes that would shore up the independent review of the Qualified Intermediary program in substantial ways. As you can see, the IRS and Treasury are considering a wide range of measures to ensure that the QI program works as intended.

But there is always going to be situations when we discover a potential of violation of tax law after the fact. In these cases, we need some other administrative and legislative changes. We're exploring increased use of and potentially more information reporting requirements around money being transferred in and out of the United States.

And we've also asked Congress in the past and we'll continue to ask for an extension of the statute of limitations when we're working on cases that involve offshore tax evasion.

Mr. Chairman, these are important steps forward, but there will be much more to come. The president's budget committed to identifying $210 billion in savings over the next decade from international enforcement and reforming other tax policies in the international arena.

The administration will have more detailed and specific announcements in the near future. We're also looking closely at a variety of legislative proposals that have been introduced by members of Congress. And we look forward to continuing dialog over the coming months.

Thank you for this opportunity to provide an update of IRS activities to combat illegal tax avoidance schemes. Because this is a global problem, it will require a closely coordinated strategy among nations dedicated to ending this evasion that deprives our country of precious resources and erodes citizen's confidence in the fairness of our tax administration system.

I'd be happy to respond to questions.

REP. NEAL: Thank you very much, Commissioner. I read your testimony last night. I thought it was really on target. And like many, as I come across data in the last few weeks, I was surprised to hear that there were 50,000 previously undisclosed bank accounts at UBS held by U.S. taxpayers. And I think some clarity here would be helpful.

It's been estimated that these accounts hold $14 billion in assets. Now, many of those accounts may be simple checking accounts for U.S. workers in Switzerland, but those accounts still are probably earning interest income.

Do you support proposals to modify the QI regime, so that QIs would report on all U.S. held bank accounts and not just those accounts which include U.S. securities?

MR. SHULMAN: As I mention, we're having discussions about a variety of issues. That is certainly one of the issues on the table.

It will be helpful for the IRS and, you know, we'll be coming out in hopefully the next month or so with the full range of pieces. But in general, I support a wider range of reporting around the bank accounts held by individuals overseas.

REP. NEAL: And a year ago, the GAO in reviewing the QI program, found a trouble that there were large sums flowing to unknown jurisdictions and unknown recipients withholding rate at about 4 percent when it should be 30 percent.

It makes us seem that as if the QI isn't complying with the know- your-customer rules if they don't know where and with whom the payment ends up, which I also think is very important.

What has the IRS done since the program audit by GAO to find an answer for this anomaly or to ensure the QIs actually know their customers and collect the tax?

MR. SHULMAN: There is a couple of things we've done, you know, combination of some of the external auditor reports as well as some of our stepped-up investigations where we've been looking closer at banks that are facilitating either legal or illegal accounts being held overseas.

One is we made a proposal in November that the external auditor that works with -- that audits the QI program for the IRS, a) has to report to the IRS if there is indicia of fraud. B, it needs to have some nexus to a U.S. audit firm, so that there can be some supervision of the work by an entity which the IRS has some authority over. Those proposals are out for comment now. We've received a lot of comments for reviewing them.

Second is, what I referred to in my testimony, which is, I think there is a real need -- in the past, we've relied on country-by- country know-your-customer rules. It's clearly the responsibility of a financial institution to look a documentation of their -- anyone opening an account with them.

We're looking at some substantially stepped-up proposals to make sure that when bank accounts are opened, by QI that have a U.S. taxpayer involved that there is more documentation around who are the real owners of those accounts, so that we can look through trusts, private corporations where there is a lot of issue.

If someone sets up a trust in a foreign jurisdiction, the bank will need to look through. If there is any indication that there is a U.S. taxpayer, either we're going to need to see that information or we'll have automatic withholding.

REP. NEAL: As promised, the nexus between secrecy and the number of people who are avoiding -- you believe are avoiding their responsibility; do you want to quantify a number for us about how much is out there?

MR. SHULMAN: You know, it's -- let me talk to you about the problems with quantification, since we -- I know you -- we had a conversation about this before.

Generally, when the IRS -- first of all, when the IRS quantifies a number, it has some weight because we put out the tax gap proposals. The most reliable way for us to quantify any sort of gap between taxes owed and taxes paid is for us to do randomly selected audits.

Usually, our audits are selected based on some criteria that targets people who we think have non-compliance. We'll also set up research programs, where we randomly select audits and we go and do audits. The problem with doing this overseas is we need to work through embassies, local law enforcement officials. And when there is accounts hidden, it's much harder to find than a U.S. citizen on the U.S. soil.

With that said, I've challenged our team to do some of the kinds of extrapolation that some of the witnesses have done on your next panel to see if we could come up with our best estimate. What I would say there was a couple of things.

Any enforcement program and especially this kind of enforcement program that sends a message -- when there is somebody who has the means to hide assets offshore, sends a message to average U.S. citizens, a teacher, a fireman, a policeman, who are paying their taxes that there is some sort of inequity, that they are paying their taxes because it's reported on a W-2 and someone is hiding their assets offshore. I think it's a matter of, a) fundamental fairness that we have rigorous enforcement programs and we go after people hiding assets offshore.

It's also about protecting the 2.5 trillion revenue base and having U.S. citizens feel that there is fundamental fairness in the system so that they'll continue to voluntarily come forward and pay taxes. And so, you know, whether the number is 2 billion, or 5 billion, or 10 billion, I think we will continue to have a focus in this area, because it protects the overall revenues for the U.S. government.

REP. NEAL: The other witnesses are invited to speculate at the right moment as well. And with that I'd like to acknowledge Mr. Tiberi.

REP. TIBERI: Thank you, Mr. Chairman.

Commissioner, it appears to me that if a U.S. taxpayer was intent on evading taxes; and tell me if I'm wrong on this, the best way to do it would be to find a foreign bank that's not a QI, that doesn't have a U.S. presence somewhere in the world. How do we -- how do you together with us prevent that scenario from happening?

MR. SHULMAN: Yeah. Clearly, if we're going to have a comprehensive approach to the problem of offshore tax evasion, we need to focus on strengthening the QI program and also encouraging people to come into the QI program.

And so one is, we need to have the QI program work. And make sure that people who are participating through the QI program we have information on them and they pay the proper amount of taxes. I think we also need to encourage other institutions to become QIs.

Some of the items under discussion are looking at some disincentives around not being a QI. For instance, more withholding if funds are being transferred to a non-QI versus a QI, information reporting to the U.S. government about those kinds of wire transfers that are going out to non-QI, so there needs to be a comprehensive approach that includes both.

I think you're absolutely right on that. And I would agree with you.

REP. TIBERI: I mentioned in my opening statement, the corporations that is out there that currently exist. Are you working through those channels as well with other foreign counterparts?

MR. SHULMAN: Yeah, absolutely. I would agree with you whole heartedly that we need to have bilateral discussions, multilateral discussions. This is not just a U.S. issue. You know, a lot of countries are focused and worried about illegal offshore tax avoidance.

Clearly, the Treasury participates in a variety of forums. As you know, the secretary went a few weeks ago to the G-20 and the president will be at the G-20. There is a forum of tax administrators in the OECD, which I'm an active participant in.

We also have a smaller group called the Leads Castle Group, where just commissioners come together and discuss these issues. And we have something called the Joint International Tax Shelter Information Center called JITSIC, which was originally formed by the IRS and several other countries to co-locate staff to have more open dialog around tax shelter issues.

We've recently expanded that to look at some other issues including offshore tax avoidance.

And so I'm a big fan that this is not a go-it-alone strategy; that we need to be actively engaging other countries and, this is part of a diplomatic and dialog among nations.

REP. TIBERI: Can you expand upon the issue of the tax -- the statute of limitations that you talked about extending for how long and why?

MR. SHULMAN: Yeah, there is a few proposals out there and a number of them would work pretty well for us. The proposal we have on the table is just simply to extend from three years to six years, the statute of limitations.

REP. TIBERI: And why is that important?

MR. SHULMAN: The reason it's important is when we were conducting investigation in the U.S., we have all the authorities of the U.S. and people, you know, understand our, you know, our ability to go and do an audit, do an investigation. We know how to find people, we have agency who could go out and see them.

And generally, once you cross the border, a) it's harder to find folks; b) when we're doing exchanges of information to try to get an information, it can take longer. People who are operating in the international arena generally have very sophisticated legal counsel and other advisors who know exactly where the statute of limitations end, and can play run out the clock with us.

And it's just harder to find information. It takes longer to do investigations. We sometimes have to work through law enforcement agencies in other countries, which can take time to go through the administrative process to get it done.

And so, it's really a matter of us having reasonable amount of time to follow the trail, which can be harder to follow once you cross the border.

REP. TIBERI: So just to summarize, Commissioner, do you believe that together with some tools that we can give you along with some things that you can do with some of your counterparts, and foreign governments, and financial services companies around the world that we can get at this better?

MR. SHULMAN: Yes.

REP. TIBERI: Thank you.

I yield back.

REP. NEAL: Thank you, gentleman.

The gentleman from New York, Mr. Crowley is recognized.

REP. JOSEPH CROWLEY (D-NY): Thank you, Mr. Chairman.

Thank you, Commissioner Shulman, for being here today to discuss these issues -- excuse me. Along with Chairman Neal, I recognize the need to address the tax gap and ensure all appropriate old taxes are paid and welcome the hearing today on QI.

But that brings me to what I'd like to discuss with you today. And let me start by saying that my office is not getting -- really had the opportunity to fully get this with you and your staff, as this is relatively new to our office as well.

But this looks like an issue that I would like to work with you and your office on. And you can agree or disagree depending on where we go with this question.

I understand that Americans investing abroad for the most part of tax that the maximum withheld rate in most foreign countries is a first, as those tax collection agencies are not familiar with the identity of the investor, the American overseas.

Meaning, if an American invested in U.K., the U.K. tax authority would withhold the maximum on any dividends earned regardless of any tax treaties, as the U.K. wouldn't know at first what the nationality of the foreign investor was.

Then, the American taxpayer can file a tax reclamation form in that foreign country to reclaim any taxes withheld above the limits of any tax treaty between the two nations. Afterwards, that American can then file an IRS Form 1116 to claim a U.S. tax credit for any foreign taxes that were legally paid abroad.

The Form 1099, dividend form, is the form issued by brokerage houses to U.S. taxpayers that lists the amount of foreign tax paid and is the basis for the American taxpayer to claim the U.S. tax credit on Form 1116 for foreign taxes paid.

My question is this form, Form 1099-DIV issued by the IRS only asks the amount of foreign tax paid, not the actual amount of foreign taxes legally owed and paid, not taking into account taxes paid and then reclaimed by the taxpayer.

Therefore, I could be investing in a foreign country, have the maximum withheld, reclaim a fair amount of due to a U.S. tax treaty. But on the 1099-DIV form, I can still report the total amount of taxes paid before reclaiming what was owed to me, and collect a credit based on that total amount paid before reclamation.

I'm not saying that this is tax fraud by brokerage houses or U.S. investors individually, but rather maybe the need for an updated 1099 dividend form to reflect the actual taxes legally paid. This could help us better tailor this U.S. tax credit to apply only to those foreign taxes actually paid for taxes actually owed and not reclaimed.

Could you give us your thoughts on this issue as a possible candidate to help us narrow the tax gap without increasing taxes or scaring away investors, both for individual investors and for hedge funds and other entities as such?

MR. SHULMAN: Well, you know, as -- I think as you noted, foreign tax credits -- the intent of a foreign tax credit is to make sure that people aren't subject to double taxation, that they're not paying the same tax --

REP. CROWLEY: Right.

MR. SHULMAN: -- in a foreign country and here. Clearly, there is opportunity and I haven't explored this issue and would be happy to explore it with your office. You know, we've talked a lot about foreign tax credit generators in the business context where kind of some of the intent of foreign tax credits and the confusion around it can have people not just get rid of double taxation, but actually end up with some sort of tax benefit.

So in general, what I would say is, the QI program gives us a way to work with foreign banks, when people invest overseas, and allows us to set up a set of rules around them doing proper reporting and withholding. And so I think strengthening the QI program and the avenue you're going down should help with that.

Clearly, if people are, you know, claiming a credit for foreign taxes paid, but then they get money back in not doing that, that's an issue. It's not one that I've explored, you know, fully --

REP. CROWLEY: We'd like to work with you and your office.

MR. SHULMAN: I'd be happy to work with you on that.

REP. CROWLEY: Thank you, Commissioner.

REP. NEAL: Thank you very much.

The gentleman from Nevada, Mr. Heller.

REP. DEAN HELLER (R-NV): Thank you, Mr. Chairman. Thank you. And thank you for the opportunity for the committee to look into an issue related to international tax compliance, specifically the recent stories that have come to light regarding bank secrecy practices in Switzerland.

I share the serious concerns nearly all members have that the practices that occurred must come to a halt. To do that, some changes certainly need to be made. Those of us, those who broke the law need to be brought to justice.

However, I do have some concerns that this particular issue is being used to advance another agenda, an agenda that is not really about compliance with the law, more about international tax policy. While our committee has jurisdiction and every reason to look into issues of international tax competition, I think that some might be trying to use this one example to dramatically alter international tax policy.

We do have a problem. And our government along with the Swiss government, financial institutions are in the process of correcting that problem. Again, those who broke the law should face the penalties clearly, but this example should not be the springboard to massive new regulations.

The banking secrecy practices being examined today, already against the law, should not be a platform to creating new blacklist and financial enemies right at the time when international financial cooperation is so desperately needed to do -- to address our economy to continue fighting the drug war that is creeping across our borders and to continue our fight in the global war on terror.

Commissioner, thank you very much for being here. I just want to raise the concerns that have -- that had been raised about this blacklisting approach. There are some that threatened -- that believe that it threatens critical information exchanges with other countries, undermines our international standing and advise retaliation that could do harm to U.S. capital markets.

Would you care to give us your opinion and thoughts on this issue?

MR. SHULMAN: Yeah, I mean, I think the U.S. is not, you know, there is a broad discussion happening at the G-20 about the so-called blacklist. I don't think you've seen anybody, you know, certainly my officer in the U.S. endorse or not endorse it.

My personal opinion is that where we need to focus is not around necessarily names of countries, but on characteristics that could help facilitate evasion. And so bank secrecy, lower tax rates, the QI program where there is not incentives, not having good information exchange agreements, and so we are very focused on finding places where there is evasion, and going after them.

We haven't been focused on necessarily naming countries. And I fully recognize, you know, I've got a view as an IRS commissioner, but when you want to get into putting names of country on list, you need to -- it's a much broader diplomatic discussion involving the State Department, Treasury, ultimately the White House and others.

REP. HELLER: Would you discuss these kind of changing directions here a little bit, the voluntary disclosure guidance program that you issued on March 26?

MR. SHULMAN: Yeah. We issued direction to our field about how to handle cases of voluntary disclosure where people are coming in with offshore bank accounts. I mean, clearly we've been seeing some results as we've been stepping up the pressure, people have been availing themselves.

We wanted to have a consistent approach. So there are agents in the field who worked these cases, you know, had -- knew exactly what to do and what would support it in getting a resolution. We also wanted to have predictability for taxpayers. We -- the way this works is taxpayers who come in truly voluntarily, not taxpayers that we've contacted or who are under criminal investigation, will have to pay six years in back taxes, plus interest.

They'll have to pay either a delinquency or an accuracy penalty depending which applies, and then they'll have to pay a penalty in lieu of all other penalties of 20 percent of the highest account balance in their bank account, or their investment or bank account, over in the last six months.

We also issued guidance, and again, we think this is firm. We think it's fair. I mean, at any time you're doing the voluntary disclosure program, what you want to do is make sure the people aren't getting away scot-free, and that regular citizens who've actually been paying their taxes all along don't feel that they've been short- changed, and that we're giving somebody a sweat-heart deal. So it needs to be tough. But it also needs to be attractive enough that we bring people in, because ultimately our goal is to get people into the system.

The other thing we issued in this guidance is that this is a six- month guidance, after which we will reevaluate. And people who we find, who don't come in voluntarily, we've instructed our agents to fully work those cases and explore all criminal and civil pursuits and investigations that they can.

REP. HELLER: Thank you.

Chairman, I yield back.

REP. NEAL: I thank the gentleman. Mr. Doggett, the gentleman from Texas is recognized to inquire.

REP. LLOYD DOGGETT (D-TX): Mr. Chairman, thank you very much and thank you especially for holding this hearing. It deals with a very important topic to every American taxpayer, business, or individual, who is playing by the rules and paying their fair share of taxes. When other people, as the commissioner has pointed out in his testimony, the firefighter, the police officer doing their fair share, and some individual or corporation goes offshore to avoid doing their fair share.

This hearing, as the questions from our colleague just indicated, also provides us the first opportunity to look more closely at the tools to address this issue that are advanced in the Stop Tax Haven legislation that I introduced last session with Senator Levin.

At that time, Senator Barack Obama was one of our cosponsors, as was Rahm Emmanuel, and you, Mr. Chairman, here on this committee. We've refiled that legislation joined by Chairman Neal, and sitting commissioner in the same chair you are, Treasury Secretary Geithner endorsed the legislation when he was here testifying to us a few weeks ago.

That would, of course, be consistent with your own testimony when you testified earlier this month in front of Senator Levin's Subcommittee on Permanent Investigations. And I believe your testimony, sir, was that it would be good news for the IRS to have the enforcement tools available that are included in the Stop Tax Haven legislation. Is that correct?

MR. SHULMAN: That's correct.

REP. DOGGETT: And you believe it would be good for the IRS to have Stop Tax Havens adopted?

MR. SHULMAN: It certainly would give us a variety of more tools. And as I mentioned before, that bills out there, Senator Baucus has just introduced a bill. And we're working pretty aggressively now to make sure that the administration is going to come forward with the full package.

REP. DOGGETT: Since --

MR. SHULMAN: So we very much welcome.

REP. DOGGETT: Since little or nothing had been done in the prior administration, I'm delighted to hear that you are -- I believe, the approach Senator Baucus has is far different than Stop Tax Havens, but it is important for us to work together to try to get the strongest tools possible.

I applaud your comments about fundamental fairness, and inequity to American taxpayers, and the way this jeopardizes our system when some individuals and some multinational corporations engage in these kinds of shenanigans.

As it relates specifically to the inquiry that you just received about the so-called blacklist, I want to explore with you, as you know, the original countries that are listed in the Stop Tax Haven legislation, grow out of enforcement actions by the IRS, by your office.

What circumstances, generally, cause you to go in and question a -- the use of an offshore account in a place like the Cayman Islands or Panama or some other tax dodging place?

MR. SHULMAN: Well, the list that you mentioned came out of a initiative that we did where we issued a John Doe summons?

REP. DOGGETT: What is that?

MR. SHULMAN: I'm sorry. John Doe summons is, when we think there is a class of taxpayers, we have no other way to get at it, and we have some evidence that there is a class of taxpayers. And rather than naming a taxpayer by name, you know, Mr. Doggett, we're looking for your information; we have an identifiable class of taxpayers.

And so we've actually recently issued a John Doe summons on a class of taxpayers in the case that was mentioned before, just saying we think there's a bunch of people. We don't have their names, but we're looking for a bank to come forward with that information.

The list was really never intended -- that list was never intended to say these countries have problems all the way across the board. I mean, whether they do it or not, it was intended for a very specific credit card initiative where we had evidence there were credit cards being issued from those jurisdictions. And we're looking in general for all the names of the credit card holders.

REP. DOGGETT: As you know, the Stop Tax Haven legislation that Secretary Geithner endorsed authorizes the Treasury to take countries on and off that list. Are there any of those John Doe summonses that involve countries where you have subsequently seen improvement in their bank secrecy laws and John Doe summons would no longer be necessary?

MR. SHULMAN: Well, those John Doe summons are closed. We don't have any kind of broad open John Doe summons around with countries' name that are open right now. You know, I guess what I'd say is I think the world has paid attention to both the legislative interest in this issue, the international focus on this issue, and the IRS' stepped-up enforcement in this issue.

In the last month, you've seen a number of tax -- jurisdictions that had either bank secrecy or didn't have good information exchange agreements step forward and say that they are going to start working on information exchange agreements.

And so I'm quite hopeful with some of the progress. That progress alone isn't going to solve this problem. But it's certainly a step in the right direction.

REP. DOGGETT: Mr. Chairman, may I pose just one more question about qualified intermediaries. Under the program, I'd like to know if any institution has ever been kicked out of the program, what the procedures are for expelling someone from the program, and specifically given all that we know that has occurred, why UBS has not been kicked out of the program.

MR. SHULMAN: Yeah, as I mentioned in my opening statement, I can't speak specifically about UBS, but let me answer the rest of your questions. Institutions can't be kicked out if there is a -- and the two criteria are material failure and no remedy.

My goal is to actually protect the integrity of the system, keep people in the system, because once you've kicked them out of the system, then those -- we don't have necessarily a line of sight and agreement between the IRS and that institution.

We have terminated a number of QIs close to a 100 in the past. The -- in the specific question you asked about UBS, I just would refer you to the deferred prosecution agreement with the Justice Department that actually has a number of issues around the QI program in there.

But again, we will look when there is a material failure and there is no remedy. We will kick people out. The goal though is actually to get remediation, keep people in the system. So we keep the line of sight on U.S. taxpayers.

REP. DOGGETT: Thank you, Mr. Chairman.

Thank you, Commissioner.

REP. NEAL: Thank you, Mr. Doggett. The gentleman from Illinois, Mr. Roskam.

REP. PETER ROSKAM (R-IL): Thank you, Mr. Chairman.

Commissioner, could you just elaborate a little bit more. I sensed sort of healthy honest tension in that exchange, and I don't want to overinterpret it. But can I give you a couple of minutes to highlight for us what some of the concerns may be about what some people are characterizing as a blacklist for company -- for countries. And how that takes a -- how that has an impact on your job as a commissioner that's interacting with other nations seeking cooperation? Can you speak to that, generally?

MR. SHULMAN: Well, I mean, sure. I think, you know, the issue of blacklist has been played out pretty accurately and well in the press. I mean, some will tell you a blacklist is right, because it shames a country into compliance. Some will tell you that a blacklist is horrible because it -- you know, there is a lot of other diplomatic issues, there is a lot of cooperation. You don't want to put countries on list.

My view is that what's important is that we need to have a whole integrated set of tools to combat offshore tax avoidance. I mean, the first most important one is, I've said, this is a priority for the IRS, and the President said, it's a priority for the administration. People take note.

Second is we're in the process of stepping up and hiring more examiners, more lawyers, more agents, more special agents for criminal investigators, placing more people in other countries. We need to use data better, both data exchanges from other government agencies, third party data, as well as data from other government agencies.

We need to strengthen the QI program. We need to look at legislation and there is a variety of legislative proposals on the table. We need better coordination amongst nations both kind of formal dialogue, but also increased informal dialogue and discussions. So we're seeing trends that are happening. And we need to keep focused on our litigated -- our litigation and our enforcement efforts that have been having some fruit.

And so I guess what I'd say is I think this will continue to be a discussion, clearly there is a discussion at the G-20. It's a discussion that's, you know, happening now at the level of the president.

It doesn't need to happen at the level of the IRS commissioner, but regardless with the outcome of that discussion, there is really a whole suite of things that we need to do to tighten the net around those using the international capital markets to hide assets overseas.

REP. ROSKAM: Fair enough, thank you. You mentioned earlier that part of the approach here is in the voluntary program, the imposition of a special penalty, and so forth. Can you walk us through sort of the IRS thinking about penalties?

Now, this is in the interest of disclosure. I asked Secretary Geithner about his own tax situation, and he told this committee that he was encouraged by the IRS to seek a waiver of the penalty. I'm not asking you to comment on the secretary's individual situation, because I know you can't.

But can you give us a glimpse into the decision-making at the IRS about generally how you make decisions about imposing penalties and not imposing penalties as it relates to other policy questions or other compliance issues?

MR. SHULMAN: Yeah, I mean, at the end of the day, we, for instance, in the offshore case, this is kind of a broader initiative. And I'm a big fan of -- you know, we have limited resources. We have to triage those resources. We need to decide where we're focusing both on our service agenda, on our technology agenda, on our enforcement agenda.

I'm a big believer that when we can set up a unified program with a group of taxpayers that brings them back into the system and has them be compliant taxpayers in the future, that settlement initiatives are a good idea. What you're seeing now in this offshore case isn't really a public settlement initiative. It's guidance to the field that was then made public.

There what we're doing is we're trying to say, come in, it'll be predictable, and you'll avoid criminal prosecution. And that's the kind of thing you'll see when we're doing broad initiatives through sets of taxpayers. For penalties in general, obviously Congress sets the penalties but the IRS is given administrative discretion.

I'm a believer that each individual taxpayer that comes in, needs to be looked at individually. We have no discretion about waiving necessarily taxes of our interest. But when it comes to penalty, our agents and it's the -- the discretion is put in the hands of individual agents who are looking at those cases, have the ability to look at facts and circumstance, look at whether actions were willful or not willful, whether they were honest mistakes, or whether someone was trying to evade taxes.

And they have the ability to abate penalties in individual circumstances. They can abate or not abate. There's avenues for appeals both within the chain of command of the agent as well as to go to our appeals function, and then there is obviously tax court in litigation where these issues can get played out.

And so the penalty regime is an important part of tax administration. We've got some discretion and taxpayers have a variety of avenues they can go to if they think that discretion isn't being used properly.

REP. ROSKAM: Thank you, Mr. Chairman. I yield back.

REP. NEAL: Thank you.

The gentleman from Florida, Mr. Meek is recognized to inquire.

REP. KENDRICK B. MEEK (D-FL): Thank you, Mr. Chairman, and Commissioner, good to see you again. I enjoyed our discussion we had last week on this topic. And I know that just by this hearing today that we will be able to zero-in more on those individuals who are putting us in this room at this particular time to talk about this issue.

You know, in 2003, some $293 billion were sent to individuals and businesses residing abroad. And I think that's something that -- especially in these very hard times, when we have companies that are here in the United States of America that are paying their share of taxes by U.S. law that we make sure that we level that playing field.

I just want to change the channel here, not too far, but on a recent action that you were able to take and as it relates to the theft loss of those that have been victim of these Ponzi schemes that have been going on, especially brought to light in recent days.

We know that there has been some confusion because we know that there's been a lot of action in the stock market. Many investors lost great sums of money based on the stock market and the reaction that it has had to this economy.

But as it relates to some 13,000-plus Americans that found themselves in a situation, not only in the well-known case, the Madoff case, but several other Ponzi schemes that have been uncovered, since the regulators have been looking at these individuals a little closer now, have lost their entire life savings in many cases, given the statements that they had a certain amount of money, paid taxes on those dollars. And many of those individuals reside in Florida and throughout the country.

I know that you have taken action recently, and I had an opportunity to read your testimony from the March 17th hearing that took place over in the Senate. And you addressed some of the issues there that you found that were wrong and that needed to be dealt with. And you've dealt with them, I believe with the five year theft loss, which I think that, looking at that is a step in a right direction, but there is still work that's undone.

The reason why I'm homing in on this is because 2000 of these individuals reside in Florida and 562 of them reside in the two counties that I represent in South Florida. And we have a number of seniors, Commissioner, and I don't need to tell you.

We have a number of seniors, even with the five-year theft -- theft loss that IRS has ruled on, that's in play in this particular case. But we have a number and number of seniors at 85, 90 years old finding themselves in a situation they are having to move out of their homes.

I have legislation, that is H.R. 1195 -- 1159 is going to set it back by 10 years to allow them to be able to claim theft loss on those dollars that they have paid taxes on. They thought they had, but was not necessarily there. Also, there are issues as it relates to foundations, and that were not addressed in the ruling that are providing services to many of these seniors that found themselves in a very bad situation.

I was hoping, if you could elaborate and clarify a little further on the action that you took, and as it relates to the seniors, will the 10 year. And that's an act that the Congress is going to have to move on which I'm pushing the legislative hearing on soon, and also talking with the administration on. How would it assist seniors to five versus 10? I guess that's my question.

MR. SHULMAN: Yeah, you know, the actions we took were really making sure that the Treasury and the IRS lawyers gave clear interpretation of the current loss on the books around investment theft losses. We thought this was important because when you're having a declining stock market, when you are in economic -- serious economic slump, that's when Ponzi schemes come to light. Because there is no longer money flowing in, so they can't be paying out money to old investors.

You know, what we did was just interpret the law, said it is an investment theft loss. Once you have an investment theft loss, you go into the typical NOL carryback language, which is three years generally. The American Recovery Act actually provided for five year carryback if you have less than ($)15 million of income.

And so our interpretation said that that was the case. We also put out a revenue procedure that put a safe harbor in place, because a lot of times it takes many years to litigate these cases and to find out how much you're going to actually recover from the trustees, and et cetera. And really the place people will be getting money back is from CEPIC and from the IRS.

And so our safe harbor said that you could take 95 percent of your losses minus CEPIC in reasonable -- and what you reasonably expected to regain. And so ours was pure interpretation. As we had a chance to talk about, we'll obviously follow whatever law Congress puts in place, and you know, I can't really opine on, you know, we don't have the authority to do a 10-year carryback. We have an authority just to interpret the laws as they are on the books.

REP. MEEK: Well, if I can, Mr. Chairman -- basically, Commissioner, what I'm trying to get to, the 10-year carryback will assist seniors at a greater level to be able to recover, because if you are in your 50s and 40s you have an opportunity to do so is -- will that be -- will I be correct in saying that?

MR. SHULMAN: I mean, I would think so. I mean, obviously a 10- year carryback can go back from 10 years instead of 5. All I'm saying is it's kind of not in my bailiwick to make the call on.

REP. MEEK: I understand. I understand. Mr. Chairman -- thank you so very much, Commissioner.

Mr. Chairman, I -- as you know, this is an issue in concern of many of us that represent people of age. And I'm hoping that we can work with the administration and work with others, but I would like to commend the commissioner and IRS for making the ruling that they have under this situation.

And I look forward to, Mr. Chairman, at working with you on the reason why we're here today in getting to the bottom of some of this offshore business.

Thank you, sir.

REP. NEAL: Thank you, gentleman, and part of this hearing today was scheduled based on Mr. Meek's prompting. So the gentleman from Kentucky, Mr. Louis, is recognized to inquire.

REP. GEOFF DAVIS (R-KY): Mr. Davis.

REP. NEAL: There used to be a fellow from Kentucky named Louis on this committee.

REP. DAVIS: We just call it the Kentucky seat now.

(Laughter)

Thanks, Mr. Chairman.

Commissioner, I appreciate you coming in and the time you've invested in getting the net loss, as well as talking about a number of issues. I think as my colleague from Illinois said, there is occasionally a bit of creative tension on the committee on a variety of issues and certainly on this one.

But I think there is unanimity across the board on really dealing with tax evasion and effective compliance mechanism so the agency can function in legitimate -- and revenue can be gotten into the agency. To the extent that you agree that international exchange of information, in particular, are key elements of the ongoing efforts to fight tax evasion.

Do you feel it's reasonable for us to be concerned about a blacklist in the sense that it might make listed countries willing or less willing to provide the IRS with information that you need to combat this evasion effectively?

MR. SHULMAN: You know, I guess I don't have a lot to add to what I said in general about blacklist. I mean, I'm -- I always focus on characteristics of company -- of jurisdictions where we might see tax evasion rather than listing those jurisdictions, things like bank secrecy, things like lack of information exchange, things like non- transparent laws, and cooperation with the U.S.

And so clearly there's pieces of the blacklist that could be quite useful to the IRS, because you could then change some presumptions and target specific rules around there. And I fully understand the diplomatic issues around the blacklist which are pretty large.

REP. DAVIS: I guess the reason that I was asking is I was wondering if you could confirm for the record. The U.S. currently has a tax information exchange agreements with several countries that are included on the Levin-Doggett proposal, or proposed blacklist, including the Cayman Islands and New Jersey.

And I guess, taking this just one step further, could you also confirm for the record in that same vein that our nation actually has full-fledged tax treaties with at least three countries that are on that proposed blacklist, Switzerland, Luxembourg, and Cyprus.

MR. SHULMAN: You know I don't want to get this wrong. So if you'd let me just come back to you, and I'll give you the list of the all countries that we have and submit it for the record, I'd be happy to do that.

REP. DAVIS: Okay, thank you, Mr. Chairman. I yield back.

REP. NEAL: Thank you, Mr. Davis. I want to thank the commissioner for the time that he spent with us and also the time that he spent preparing for the hearing today, and we look forward to working with you on these issues.

You can see that there was pretty good attendance this morning. There is a lot of interest, media accounts I think day after day, indicate the nature of the problem, and we hope to -- you will continue to be part of the narrative as we seek to solve it. And with that, I'd like to call our second panel.

MR. SHULMAN: Thanks for your leadership on this, Mr. Chairman.

REP. NEAL: Thank you.

Let me thank our second panel and the chair recognizes Mr. Shay.

MR. SHAY: Thank you, Mr. Chairman, Ranking Member Tiberi, and the members of the committee. My name is Stephen Shay. I am a partner at the law firm Ropes and Gray in Boston.

With the Chairman's permission, I submit my testimony for the record and I would just summarize my principal observations. I also want to make clear I'm appearing in individual capacity, and what I'm going to say does not represent the views of my law firm and my clients.

The key points I'd like to make are -- with respect to the focus of this hearing are that in order to attract foreign capital and for historic administrative reasons, the United States taxes are very little U.S.-source investment income paid to foreigners, foreign persons.

We exempt from withholding tax, most capital gains of non- residents on sales and securities, and U.S. insurance paid to unrelated to non-resident lenders. Our source-withholding tax principally imposes tax on payments of dividends to non-residents.

We do not impose U.S. withholding tax on payments of foreign source income to foreign persons. Our source-withholding regime for a U.S. source income payment is designed to determine whether the owner of the income is a foreign person, and if so, what withholding rate should apply.

Generally, the United States does not have enforcement jurisdiction over foreign financial institutions that is not owned by U.S. person and that does not carry on business itself and the entity in the United States.

The QI system was developed to overcome these jurisdictional limitations and allow a U.S. withholding agent. And again, it's a U.S. institution making a payment to what it thinks is a foreign person to rely on documentation received from foreign banks that are acting as qualified intermediaries.

The QI system relies on the foreign bank that has a direct relationship with the foreign customer to exercise normal banking, know your customer disciplines in assuring that the documentation it received and that it provides the U.S. withholding agent in turn was correct.

The QI regime prescribes audits by the bank's external auditors to confirm that its processes are being used appropriately. Because some of the income that we exempt is exempted on a unilateral basis, not just to residents in other treaty countries that have given reciprocal exemptions, it is not possible to rely on the other country's governmental audits to check the QI system.

So this is a feature of the extent of our unilateral exemption, particularly, portfolio interest at source. As noted by others the Qualified Intermediary regime is an opt-in system and allows where the foreign bank elects to participate, and it applies to accounts that are designated as QI accounts.

Accordingly, under current law rules, it is possible for a QI to act as a QI and also have accounts that are not covered by the QI requirements including accounts for U.S. persons.

The cross-border withholding system for payments to foreign persons is not designed itself to provide information reporting on U.S. persons. It is just designed to screen for and apply the appropriate withholding tax rate to foreign persons.

In this regard, one of the key decisions made in implementing these rules was to follow traditional tax rules and respect a foreign corporation rights and the U.S. principles as a nontransparent beneficial owner of income without regard to whether it was owned by U.S. persons.

When a payor of these payments is within the U.S. tax jurisdiction, payments of interest, dividends, and gross proceeds from sales of securities to a U.S. person are subject to domestic information reporting and backup withholding rules.

These have become a very important part of our compliance system. It is possible, however, for a U.S. person to have an account at a foreign financial institution that is not subject to third-party information reporting.

Under the structure of the rules just described briefly, some U.S. persons are able to masquerade as foreign persons or hide behind foreign corporations without reporting this income. As a jurisdictional matter, the United States can only obtain information on U.S. persons, foreign accounts, and foreign financial institutions if the foreign financial institution agrees to participate, for example, through a QI system or through information requests on a bilateral basis with other countries.

In my testimony, I have set out a series of proposals some of which have been made by others -- many of which have been made by others that I think would be feasible ways to overcome the limitations I have described. In the interest of time, I'll be happy to answer any questions on those.

Thank you, Mr. Chairman.

REP. NEAL: Thank you. In fact, during the question period I'll have an opportunity to raise that with you.

Professor.

MR. AVI-YONAH: Chairman Neal, Ranking Member Tiberi, and other members of the committee and the staff, thank you very much for inviting me today to testify before you again on this issue.

I think the UBS methods shows that there are serious problems with the QI initiative as it is currently drafted. Basically, you know, as we all know, UBS enabled American citizens to hide behind sham corporations in various other secrecy jurisdictions other than Switzerland.

And thereby, for a while escape the notice of the IRS and to some extent still because they claim that under Swiss bank secrecy law they can't disclose the identity of the other American account holders even when specifically requested by the IRS to do so.

Now, stepping back from a moment, what is the basic problem with the QI program from my perspective? The QI program was set up in order to enable foreigners to invest in the U.S. through the QI without the U.S. withholding agents knowing the identity of those foreigners.

If a foreign person invests directly in the United States then the -- in principle, the U.S. withholding agent has the ability to collect information about that foreign person. The U.S. -- in the end, the payments come from the United States.

There is a U.S. withholding agent, and when the U.S. withholding agent makes a payment, even if payment that is exempt, let's say, under the portfolio interest exemption there is a potential of collecting information about and from W-8BEN from that person to know the identity of that person whether or not there is a treaty.

And then if there is a treaty, then there is a potential for the IRS to get that information from the American financial institution and exchanging out of the treaty information exchange.

Now, the QI program was essentially set up so that this would not happen. Under regulations proposed by the Clinton administration, but not yet finalized, American banks were supposed to collect information about payments that are exempt under the portfolio interest exemption.

And under the version proposed by the Bush administration, that would still apply but only to 16 designated countries. I think it should apply to every country and that these regulations should be finalized.

But under the QI agreement, once you go with the QI, the once -- once a foreigner goes with the QI, then the QI only reports to the American withholding agents essentially a summary or pooled information about all the beneficiaries that it knows are eligible for let's say the reviews, withholding types of dividends, and the American withholding agents knows only that. Only the pooled information and therefore there is no information available for treaty information exchange.

And I think that this is a problem and what it enables is essentially for Americans to pretend that they are foreigners, submit from W-8BEN to the QI. Now, here is the issue that Mr. Shay identifies the QI is not supposed to look behind this corporation to see whether there is an American behind it.

Now, there are some debates in the background material about when -- if the QI has actual knowledge that the corporation is owned by an American, whether they should be able -- my view is that if QI has actual knowledge that there is an American then it should treat it as an American and do back up with all the information reported.

But it's not entirely clear that under the current regulations and the model QI agreement they have the obligation to do that. May be they can just accept the corporate form as hiding the American sufficiently and I think to that extent that should be changed.

Now, the fundamental issue though is that I think that we're doing this wrong in the sense that -- the reason that we're doing it the way we're doing it is that we want to essentially enable residents of other countries to evade those countries' taxes.

And that's how the QI agreement is set up. And the idea is they will not invest in the United States if they are subject to residence based taxation. And I think that the solution to this and in general to the issue of source based withholding is that we will prevent people -- capital from flying away from the United States if we're willing to cooperate with other residents' country and they're willing to cooperate with us.

We should have, under the G-20, let's say, full information exchange with other countries. We should not try to cooperate with tax evasion by residents of other countries. We should expect other countries that have income taxes to cooperate with the information exchange with us.

Fundamentally, the whole tax haven and secrecy jurisdiction issues is about cooperation by the rich countries in the world. It is not really about the tax havens themselves.

Thank you very much.

REP. NEAL: Mr. Blessing.

MR. BLESSING: Chairman Neal, Ranking Member Tiberi, and members of the subcommittee, thank you for asking me to testify today.

I will focus on two issues in respect of detecting unreported investment income and overseas accounts. In particular, tax treaty information exchange agreements and the Qualified Intermediary procedures.

There are two principle types of bilateral agreements that are chiefly used by the tax authorities for information exchange. These are the comprehensive income tax treaties and secondly, the tax information exchange agreements, which are standalone agreements.

However, under each of these typically the information that's required to be exchanged is limited to what's available in the normal course of the tax administration of the requested country as a matter of sovereignty and domestic law, but this can include bank secrecy provisions.

Very recently in response to the pending G-20 blacklist of uncooperative countries and pressure from particular countries, including the United States and France and Germany, a number of countries that previously had relied on their bank secrecy provisions have announced to override their domestic limitations and not claim bank secrecy as preventing production subject to implementing this in new agreements.

This experience shows that used carefully multilateral action by countries including blacklist or threatened blacklist can be an effective tool to convince certain countries that information exchange is in their best interests.

I'm not suggesting that every blacklist necessarily is helpful. The Stop Tax Haven Abuse Act contains a proposed unilateral blacklist of 34 countries for very different purposes. One concern is that the safeguards be there for designating countries.

Furthermore, the act would be -- the act would represent a substantial shift in enforcement burden on to financial institutions, which would be required to report voluminous information covering virtually all financial transactions involving an offshore secrecy jurisdiction. The benefits of the provision must be weighed against the compliance cost.

Turning now to the QI program, of great interest is a report on withholding procedures released in January of this year, which was prepared by the informal consultative group established by the OECD Committee on Fiscal Affairs.

Notably, the group's report recommends a system that looks very much like the U.S. QI system, and that system of foreign financial institution enters into an agreement with the IRS pursuant to which it may accept primary withholding and documentation obligations subject to external audit in exchange for a simplified pooled reporting and non-disclosure of client identities to the IRS.

And to, most importantly, to it's competitors down -- upstream in the chain of information. A significant difference from the QI system is that the identities of beneficial lenders of payments would be disclosed to the source countries.

Something Professor Avi-Yonah was just suggesting would be a good thing. This would address the flip side of information exchange, namely the needs of a country to obtain information about its residents. The United States would benefit from another country affirmatively apprising the U.S. tax authorities of accounts beneficially owned by U.S. residents and citizens.

The United States, in turn, would be expected to do the converse. However, there is a problem here, for example, the IRS W-8BEN is not currently required to be filed with the IRS under the QI program, so the IRS has no -- or otherwise for that matter, so the IRS has no record of the identity of payees to the QI system.

For non-QI payments, there is reporting to the IRS in 1042-S, but as the GAO report noted the IRS is not currently able to process that effectively for use. The U.S. Government Accounting Office reported in the QI program in December 2007, while it concluded that the QI program contains features that give the IRS some assurance that QIs are more likely to properly withhold and report tax and U.S. source income than other withholding agents it suggested that the audit standards be enhanced by requiring the external auditor to report any indications of fraud or illegal activity that could significantly affect the results of the review.

In response, the IRS issued proposed changes to the model QI agreement and the audit procedures in November of 2008 as Commissioner Shulman noted. To broaden the requirement and the required self- reporting by the QI and increase the procedures required to be performed and documentation required to be examined by the auditor.

The IRS has received comments on the proposal from certain audit firms and QIs. Clearly, a balance will be needed to be struck between the interests of a viable review and audit procedures and the increased costs associated with the proposed procedures which may be helped -- may be beyond the ability of smaller QIs to meet.

In conclusion, I believe that the QI program, overall, is well conceived, plays a key role in the U.S. withholding tax system and should be supported including with adequate funding.

Attention is appropriately being paid to strengthening the external review process. A particular limiting factor is that external, quote, "audits" are required only to be in accordance with the agreed upon procedure or standard which means that they do not constitute an audit or review, and therefore are not an expression of an opinion by the auditor.

I'll be happy to take any questions. Thank you very much.

REP. NEAL: Okay. I thank the panelists.

Mr. Shay, you and others have suggested the QIs need to know more about the beneficial owners of foreign corporations than is currently required, which results in QIs basically accepting it at face value. What exactly would you require of QIs in order to be in compliance with this additional mandate?

MR. SHAY: I think, Mr. Chairman, that in fact QIs often do know a fair amount about beneficial owners of corporations, because of the know your customer rules when they are closely held.

But for purposes of this discussion, I think, what I would recommend is subject to working through with the IRS fairly carefully is consideration of having requiring a QI to provide information about threshold U.S. owners of foreign corporations.

And we, in our testimony, we said 10 percent or more owners of U.S. corporations, for a couple of reasons. If that information is provided to the IRS they can go and cross check and be sure that those U.S. persons have complied with their income tax obligations with respect to those corporations.

If those corporations were either closely controlled or hold primarily passive assets under our existing U.S. rules, they should have included income currently in their U.S. taxable income. So this would be an effective check.

There may be circumstances where it would make sense to go beyond that. One other comment I would make, in my testimony I've highlighted the important role that QIs play in the withholding system.

This would be an additional burden for a foreign corporation that's participating. It is a judgment call, but my judgment is that being a Qualified Intermediary for important foreign banks, now it's sufficiently important to be a participant in the international capital markets that they would be willing to take on some additional burden.

I urge the committee to give the IRS flexibility to workout the details so that this system doesn't cause QIs to leave the system.

REP. NEAL: Thank you, Mr. Shay.

Mr. Blessing, you nuanced a part of this -- in your testimony you nuanced a part of this question I'm about to raise. I'm interested in the EU savings directive that is explained in your testimony and you did speak to this issue.

Do you think that the U.S. could participate in such an automatic reporting regime, or would it overwhelm our banks and financial institutions so that it would be deemed over burdensome?

MR. BLESSING: The EU savings directive is a very different type of system, which requires the reporting of interest to EU, by EU participants to external parties, non-EU parties.

In the U.S. reporting system, I don't think that there is anything quite comparable. We do require reporting of most payments. We have declined to require a reporting of bank payments by domestic banks that was not -- at the time there was some concern that that was -- would be a burden on the systems.

But the primary concern, I believe, was that there would be an impact on the capital flow to banks, in other words U.S. domestic banks lobbied against that provision because they were concerned that they would not receive the same deposits if they were required to report the interest. I don't think the system is a problem any more, my own view.

REP. NEAL: Okay.

And Professor Avi-Yonah, you seem to be the lone voice against the QI system today. You referred in your testimony that the dark secret before the QI system was implemented -- before the QI system was implemented was that no one had any idea where the payments were going.

And at least, with QI they have some idea, would you support this system with modifications that were outlined by the commissioner today.

MR. AVI-YONAH: Yes. I didn't mean to imply that I think the QI system is worthless.

I think there is a world imaginable in which we would not need a QI system and I think that will be a preferable world in which we in fact withhold all payments that are not, for example, to treaty countries.

That is we repeal the portfolio interest exemption or at least the treasury secretary applies his ability to suspend it to all payments to countries that don't participate in full exchange of information.

But that I appreciate following, Mr. Blessing's testimony just now, we can't really under current circumstances do that unilaterally without triggering a capital outflow from the United States.

I think that can only be done in corporation with the Europeans with other members of the G-20 because they are already on record. Because of the status directive and other initiatives, (OECD ?) initiatives, that they would be interested in extending such a regime to fundamentally deal with the tax haven problem.

But as long as that is not done, I think we need something like a QI program, but I think that the issue with the QI was always about, to some extent, sharing information -- not sharing information from the QI to the foreign -- to the U.S. withholding agent who may be a competitor, and that I accept.

But when we had the previous hearing, where the GAO presented the QI report, the QI representatives all said, "We are fully willing to share information with the IRS."

That is, this is not about not sharing information with us. Well, lo and behold, UBS is not willing to share information with the IRS even when asked -- even when given a John Doe summons and the other QIs also, I don't think they are really willing to share information with the IRS.

I think we could live with the QI program if the QIs have to share all the form W-8BEN with the IRS and if they provide the information about U.S. people that they know about and provide -- and also share the information about foreign people in which case it is available under the shared information. And that, I don't think will kill the QI program.

REP. NEAL: Thank you, Professor.

Mr. Tiberi.

REP. TIBERI: Thank you, Chairman.

Mr. Blessing, you mentioned in your testimony the tax information exchange agreements and if we look at those and other agreements that we have with other foreign entities, whether they be foreign governments or financial institutions, do you -- would you predict any backlash if we pursued a policy of blacklisting specific countries rather than maybe strengthening those agreements and adding focus to those agreements.

MR. BLESSING: I think that a unilateral blacklist is a very different concept than a multilateral --

(Cross talk)

REP. TIBERI: Yeah, that's what I mean.

MR. BLESSING: I think what I just commented on was that the G-20 approach, which was a multilateral approach was very effective. It represents 80 percent of the economies of the world.

REP. TIBERI: Right.

MR. BLESSING: In terms of trade and together countries can do a lot. Together the pressure was enormous on -- and the facts speak for themselves. The number of countries that previously had relied on their bank secrecy dropped their objections under that pressure.

A unilateral blacklist could, well, the first thing is it's not going to raise revenue. It may have some other benefits, for example, the benefit of changing the burden of proof and so forth. But it's not going to raise revenue, because obviously the deposits will go to another country.

And it's very hard to administer. It's one thing to threaten -- it's another thing to actually select the countries in a fair way, have a system that permits them to be added and taken off, and it's a very onerous process and much of a sledgehammer. So I'm -- I would be very cautious about blacklist.

REP. TIBERI: Thank you. And to -- just to extent it a little bit, we heard earlier about the number of countries that don't apply -- that aren't involved in the -- the QI program. I keep saying Q1, a name of a band back home.

The QI program and the number of foreign banks that aren't involved, how do we get them engaged more either through these agreements or other mechanisms because obviously, very easy for someone who wants to break the law to try to go outside one of these participating countries or participating financial institutions. How do we expand the scope?

MR. BLESSING: It is a bit of Catch-22 because of -- on the one hand we're trying to tighten -- we as a country are trying to tighten the reporting, rightfully so, and the audit procedures and so forth, which imposes additional expense -- will impose additional expense.

And I do fear that at least for smaller QIs, at least what I have heard is that they may not be able or willing to continue to participate. For the larger QIs, I think, it's still beneficial. Certainly, Steve Shay has just testified to that effect as well.

And I think it's hard -- what we can do to encourage more it's, I think, the process that's taking place in the OECD, generally, may lead in that direction. I referred to this OECD report by the informal consultative group.

Now, that's a number of years away from any real action, but it is very, very, telling and interesting that they have selected the type of Q -- program that we have as our QI program, as the model going forward that countries would optimally implement.

Right now, it's just a discussion draft but it was put together by members of a number of OECD countries and most importantly the financial community as well.

REP. TIBERI: Can you comment on that sir.

MR. SHAY: It is -- as we -- I never ever said in testimony, the QI is an opt in system. Let me take a slightly different approach to your question. I think it's fair to say that until recently, efforts to make coordinated international attack on cross-border evasion have been frustrated by a lack of interest by countries, politics, and basically a general lack of urgency.

Today, after what has been happening in the last several months if a bank, even if it's not a QI is found to have a U.S. tax evader I think there is a sense of obloquy that is attached to that, that may not have been as true not long ago.

And I think that's a very positive development. So I think part of -- and this goes to Commissioner Shulman's multi-strategy approach. You know, part of this is simple shaming. That did not pass that -- what happened in a major bank did not pass what we in the practitioner community call the Wall Street Journal test. It shows up on the front page of the Wall Street Journal and it was extreme --

REP. NEAL: You should know I failed that test many times.

(Laughter)

MR. BLESSING: Well, we can also call at the Boston Globe test.

(Laughter)

Thank you, sir.

REP. TIBERI: Thank you.

Thank you, Mr. Chairman.

I yield back.

REP. NEAL: Thank you, Mr. Tiberi.

The gentleman from Nevada, Mr. Heller.

REP. HELLER: Thank you very much, Mr. Chairman.

And I want to thank you gentlemen for being here this morning.

Questions were asked specifically. And you can tell that four out of five questions that have been asked, at least on this side, have dealt with specifically the blacklisting.

You heard the commissioner's response to Mr. Davis's question as to whether tax information exchange agreements with several companies are included in the Levin-Doggett blacklist. I think I can confirm that there are. Also I think I can confirm for the record that there are actually full-fledged tax treaties with at least three countries that are on the Levin-Doggett -- Doggett blacklist.

So I guess my point is, and Mr. Blessing, you did answer that question, but I share the concern that the blacklisting approach could invite retaliation from listed countries that could be significant harm to our struggling economy's capital markets given that the U.S. itself sometimes is described as a tax haven with respect to its treatments of nonresidents, especially considering the fact that the U.S. does not impose tax on U.S. Treasury bourn interest paid to foreign investors.

Do you think that there could be potential backlash from other countries that could disrupt our capital markets at this delicate time for our economy? And I would like the professor and Mr. Shay to answer this question.

Mr. Blessing, thank you for answering the question earlier.

MR. AVI-YONAH: Well, I mean let me say a couple of things about blacklists in general. First of all, we're not the inventor of blacklists, not even of unilateral blacklists. Lists in general are employed by most other countries in the world, for example, in the context of their so called CFC regime, some of them.

Most countries, unlike us, designate countries that are eligible to be exempted from their, under the federal regimes and other countries that are specifically included, that is that income from those countries will be subject to the anti-deferral measures because of their judgment that these countries are quote "tax havens" unquote. So we haven't invented this at all.

In addition, of course, the history of this goes back to the OECD list from 1998-1999, and that list was remarkably effective. It started with, I think, 42 countries and ended up with four countries. And that is because the other countries all agreed to participate in the OECD standards about sharing information.

The problem is that they have -- they said they would and then they didn't. And this is why the G-20 now proposes to put a lot of these countries back on the list. And I think that those efforts are all to the good and this is a -- the only tool that would really make countries cooperate is listing them. I mean, not the only tool, but this is a pretty effective tool as has been shown historically.

Now, frankly, I don't think that that's where the issue with the capital market comes from at all. The capital -- the investors cannot leave their money in tax havens, that's the basic point. The money has to go to the rich countries, the big countries because that's where the investment opportunities are.

If you leave your money in the tax havens because you are a money launderer or a DragonForce (ph) or drug lord, it earns a negative interest rate, that is, you have to pay the bank interest in order to keep the money there and not have it disclosed.

If the money goes into one of the rich countries, the rich countries, the G-20, you know, 85 percent of the world economy are all in agreement about this, and I don't see that making further progress on this even unilaterally would have any negative impact on the United States at all.

REP. HELLER: So professor, can I interpret from your answer that you support blacklisting?

MR. AVI-YONAH: I support the Levin-Doggett bill and I think it should be enacted tomorrow and signed by the president.

REP. HELLER: Mr. Shay?

MR. SHAY: I would note as a matter of history that Tax Information Exchange Agreements first were authorized in the Caribbean Basin Initiative in the early 1980s. And they were -- a carrot approach was used. Countries that entered into a Tax Information Exchange Agreement were given a more favorable treatment of deductions by Americans who attended conventions in those countries.

There was a second carrot which has since gone away which was -- (inaudible) -- to the Foreign Sales Corporation legislation. And that did encourage a number of Caribbean countries enter into Tax Information Exchange Agreements.

More recently, the efforts of the OECD in the harmful tax competition exercise in the late '90s also encouraged countries both to become parties to Tax Information Exchange Agreements and to provide information on to them. So I think -- I think both those have brought about a lot of progress.

I also would just note that real progress in this area will call for international cooperation and not just at the level of exchange agreements, at the level of collecting information, including by the United States, I endorse the proposals I think of both my colleagues here, I think they are correct, to expand the collection of information on nonresident bank accounts so that it can be exchanged with treaty partners, so that we can get them to give us information

But all of that will only work effectively if we create a system that will allow us to do it electronically and to bring it into the IRS electronic matching systems. This is difficult start. It's going to take real work. It's not going to happen in the short term.

But directionally, I can see a lot of -- particularly in Peter's testimony, things that are -- that he is highlighting that are very favorable and I encourage this committee to support it.

REP. HELLER: Thank you, Mr. Chairman.

REP. NEAL: I thank the gentleman.

Mr. Doggett is recognized to comment.

REP. DOGGETT: Mr. Chairman, thank you.

And thank you. I think the testimony that each of you offered is important as we craft this legislation since the most ringing endorsement for my proposal with Senator Levin, joining Secretary Geithner, and Senator Obama endorsing that proposal was from you Professor Avi-Yonah. I want to direct most of my questions to you.

One thing we haven't really explored fully yet in the hearing that I think is important, the immense dimensions of the problem we're dealing with. And you addressed this in your written testimony, but do I understand that the best estimates are that about $1.5 trillion is kept offshore by U.S. residents?

MR. AVI-YONAH: That is an estimate that was done by the Boston Consulting Group in Merrill Lynch some six years ago. So it's not up- to-date.

REP. DOGGETT: So it's a very conservative estimate. Six years ago Merrill Lynch estimates $1.5 trillion offshore by U.S. residents. Is that individuals only or corporations as well?

MR. AVI-YONAH: This is high net worth individuals.

REP. DOGGETT: All right.

MR. AVI-YONAH: So it's not corporation.

REP. DOGGETT: And your conservative analysis using that data and other studies is that what we're talking about for individuals only, not corporations, is $50 billion of tax evasion every year?

MR. AVI-YONAH: No, I mean this is conservative because what I did was simply take that ($)1.5 trillion, assume 10 percent, you know, income on that which seems reasonable. So that's ($)150 billion. Then apply the U.S. tax rates, that was about -- that's about ($)50 billion. But that assumes that the ($)1.5 trillion are all after tax income.

REP. DOGGETT: Right.

MR. AVI-YONAH: That this was subject to tax already. If it was sum earned overseas, transferred, you know, to Switzerland or the Caribbean and never disclosed, then part of the ($)1.5 trillion principle is also --

REP. DOGGETT: Exactly. And I think that is why Senator Levin -- Senator Carl Levin has estimated that when you add in the corporations to these individuals and recognize that data is -- that we're using is six years old, that the amount may be $100 (billion) to $150 billion every year that is lost in tax evasion.

MR. AVI-YONAH: The truth is that nobody knows. I mean, there is whole range of --

REP. DOGGETT: It's hard to get a precise number.

MR. AVI-YONAH: Right.

REP. DOGGETT: But what we do know is that it's big, it's very big. And my reaction, and I think the reaction of that firefighter or that police officer or that small business on Main Street in Bastrop, Texas is that if there is that much tax evasion, we don't just need a sledgehammer, we need something bigger than that because it's very unfair, it does strike the fundamental fairness as the commissioner of the Internal Revenue Service said.

Now, let me ask you as well while your testimony has focused on individuals, we know that with the click of a mouse an individual can become a corporation. And that's one of the ways as several of you mentioned through hiding behind corporations that individuals can dodge their tax liability.

It is also particularly galling, I think, that some of the biggest recipients of taxpayer money in the bailout that has occurred over the last few months, Morgan Stanley 158 of these subsidiaries; Citigroup 90 of these offshore tax dodging entities; Bank of America, 59. Now, that doesn't compete with the over 300 that Enron had before it failed. But it's a very significant amount of use of these international tax subsidiaries to dodge taxes.

Let me ask you if you agree that there is a serious problem, not just for individuals, but for corporations using foreign subsidiaries to dodge their tax responsibilities which my business on Main Street in Bastrop or Lockhart or Smithville cannot do.

MR. AVI-YONAH: Well, there is a difference that I don't want to draw between things that are clearly illegal tax evasion and things that are tax avoidance using legal loop holes. I think what most corporations, certainly the ones that you mentioned, do is not illegally hide their taxes. I mean, as was mentioned before, there are rules on the -- in the codes that say that any foreign corporation that owned by an American over certain thresholds subjects that American to taxes in one way or another.

REP. DOGGETT: Well, I couldn't agree with you more. It's not only what's illegal, but what's legal that should not be legal --

MR. AVI-YONAH: Well, that --

REP. DOGGETT: -- because it's inequitable to businesses here in the United States. While, most of the questions that you have received this morning had been about the blacklist portion as it is termed of the stop tax haven bill, I want to ask you about another very important part of it that relates to corporations.

One of the provisions of the bill is to treat a corporation that is incorporated abroad as a domestic United States corporation if substantially all the executive officers and senior management are located primarily here in the United States.

I think this is an important provision to restore tax fairness by recognizing that if you have a shell corporation abroad and it's really a United States company, they are just having a paper certificate and a sunny tax haven, is not enough to make you foreign.

Do you agree that this type of provision is needed to restore tax equity by not letting corporations play these type of illegitimate games to avoid taxes?

MR. AVI-YONAH: Yeah, I personally think that this is a very good improvement on the existing law. I first made the suggestion back in 2001 in response to the so-called inversion transaction when American corporations set up shell corporations -- shell parent corporations in Bermuda without changing anything in terms of the actual place of manage and control of the corporation.

And this was done endorsed by the Joint Committee on Taxation as one of their options of reforming the law. Most countries in the world have some kind of management control standard and I think under the limitations that are in the bill, this is a very sensible provision that will add greatly to the enforcement of our tax laws.

REP. DOGGETT: Thank you, Mr. Chairman.

REP. NEAL: I thank the gentleman. I want to also thank our witnesses today for their commentary. It was very thoughtful. There may be some written questions. We would hope that you be able to answer properly if requested.

And if there are no other comments, hearing none, then the hearing stands adjourned. Thank you.

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