Miami: Our Best Climate is the One Serving Your Business

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According to recent media reports, Miami has become the “go-to” location for companies seeking a better business, a fact that has been noticed by many major New York observing the trend of migration to Florida. Consider the following statistics comparing the Miami and New York metro areas:

  • Miami’s sales tax is 6.62% vs. New York’s 8.48%
  • Metro Miami’s overall cost of living is 52% lower than the New York Metro area
  • State and local tax burden in Florida is 9.3% vs. New York’s highest-in-the-nation rate of 12.8%
  • Commercial real estate costs per square foot in New York are double Miami’s and residential costs may be five times more in New York

Source: Fox Business News

Miami’s far lower cost of living is allowing relocated businesses to attract and retain employees. But while “lifestyle climate” may be crucial to a happy business move, Miami’s real enticement may be found in Florida’s business climate. The attorneys at Fuerst, Ittleman, David & Joseph can ensure that your company maximizes the many tax advantages and business incentives offered by the state to companies relocating to Florida:

Tax Advantages

Florida’s stable and highly favorable tax climate provides advantages that make a Florida location profitable for every type of business. Progressive legislation also ensures that Florida remains a worldwide hub for new and expanding businesses.

Florida has”¦

NO corporate income tax on limited partnerships

NO corporate income tax on subchapter S-corporations

NO state personal income tax guaranteed by constitutional provision

NO corporate franchise tax on capital stock

NO state-level property tax assessed

NO property tax on business inventories

NO property tax on goods-in-transit for up to 180 days

NO sales and use tax on goods manufactured or produced in Florida for export outside the state

NO sales tax on purchases of raw materials incorporated in a final product for resale, including non-reusable containers or packaging

NO sales/use tax on co-generation of electricity

Florida offers Sales and Use Tax Exemptions on”¦

Machinery and equipment used by a new or expanding Florida business to manufacture, produce or process tangible personal property for sale

Labor, parts and materials used in repair of and incorporated into machinery and equipment

Electricity used in the manufacturing process

Certain boiler fuels (including natural gas) used in the manufacturing process

Semiconductor, defense and space technology-based industry transactions involving manufacturing equipment

Machinery and equipment used predominantly in research and development

Labor component of research and development expenditures

Commercial space activity ”” launch vehicles, payloads and fuel, machinery and equipment for production of items used exclusively at Spaceport Florida

Aircraft parts, modification, maintenance and repair, sale or lease of qualified aircraft

Production companies engaged in Florida in the production of motion pictures, made for television motion pictures, television series, commercial music videos or sound recordings.

Incentives

Florida offers bottom-line advantages for long term profitability for all types of businesses, from corporate headquarters to manufacturing plants to service firms. Florida offers incentives for:

Targeted Industry Incentives:

Qualified Target Industry Tax Refund (QTI)

The Qualified Target Industry Tax Refund incentive is available for companies that create high wage jobs in targeted high value-added industries. This incentive includes refunds on corporate income, sales, ad valorem, intangible personal property, insurance premium, and certain other taxes. Pre-approved applicants who create jobs in Florida receive tax refunds of $3,000 per net new Florida full-time equivalent job created; $6,000 in an Enterprise Zone or Rural Community (county). For businesses paying 150 percent of the average annual wage, add $1,000 per job; for businesses paying 200 percent of the average annual salary, add $2,000 per job; businesses falling within a designated high impact sector or increasing exports of its goods through a seaport or airport in the state by at least 10 percent in value or tonnage in each year of receiving a QTI refund, add $2,000 per job; projects locating in a designated Brownfield area (Brownfield Bonus) can add $2,500 per job. The local community where the company locates contributes 20 percent of the total tax refund. There is a cap of $5 million per single qualified applicant in all years, and no more than 25 percent of the total refund approved may be taken in any single fiscal year. New or expanding businesses in selected targeted industries or corporate headquarters are eligible.

Qualified Defense and Space Contractor Tax Refund (QDSC)Florida is committed to preserving and growing its high technology employment base by giving Florida defense, homeland security, and space business contractors a competitive edge in consolidating contracts or subcontracts, acquiring new contracts, or converting contracts to commercial production. Pre-approved applicants creating or retaining jobs in Florida may receive tax refunds of $3,000 per net new Florida full-time equivalent job created or retained; $6,000 in an Enterprise Zone or rural county. For businesses paying 150 percent of the average annual wage, add $1,000 per job; for businesses paying 200 percent of the average annual salary, add $2,000 per job.

Capital Investment Tax Credit (CITC)

The Capital Investment Tax Credit is used to attract and grow capital-intensive industries in Florida. It is an annual credit, provided for up to twenty years, against the corporate income tax. Eligible projects are those in designated high-impact portions of the following sectors: clean energy, biomedical technology, financial services, information technology, silicon technology, transportation equipment manufacturing, or be a corporate headquarters facility. Projects must also create a minimum of 100 jobs and invest at least $25 million in eligible capital costs. Eligible capital costs include all expenses incurred in the acquisition, construction, installation, and equipping of a project from the beginning of construction to the commencement of operations. The level of investment and the project’s Florida corporate income tax liability for the 20 years following commencement of operations determines the amount of the annual credit.

High Impact Performance Incentive Grant (HIPI)

The High Impact Performance Incentive is a negotiated grant used to attract and grow major high impact facilities in Florida. Grants are provided to pre-approved applicants in certain high-impact sectors designated by the Governor’s Office of Tourism, Trade and Economic Development (OTTED). In order to participate in the program, the project must: operate within designated high-impact portions of the following sectors– clean energy, corporate headquarters, financial services, life sciences, semiconductors, and transportation equipment manufacturing; create at least 50 new full-time equivalent jobs (if a R&D facility, create at least 25 new full-time equivalent jobs) in Florida in a three-year period; and make a cumulative investment in the state of at least $50 million (if a R&D facility, make a cumulative investment of at least $25 million) in a three-year period. Once recommended by Enterprise Florida, Inc. (EFI) and approved by OTTED, the high impact business is awarded 50 percent of the eligible grant upon commencement of operations and the balance of the awarded grant once full employment and capital investment goals are met.

Workforce Training Incentives:

Quick Response Training Program (QRT)

Quick Response Training (QRT) – an employer-driven training program designed to assist new value-added businesses and provide existing Florida businesses the necessary training for expansion. A state educational facility – community college, area technical center, school district or university – is available to assist with application and program development or delivery. The educational facility will also serve as fiscal agent for the project. The company may use in-house training, outside vendor training programs or the local educational entity to provide training. Reimbursable training expenses include: instructors’/trainers’ wages, curriculum development, and textbooks/manuals. This program is customized, flexible, and responsive to individual company needs. To learn more about the QRT program, visit Workforce Florida.

Incumbent Worker Training Program (IWT)

Incumbent Worker Training (IWT) – a program that provides training to currently employed workers to keep Florida’s workforce competitive in a global economy and to retain existing businesses. The program is available to all Florida businesses that have been in operation for at least one year prior to application and require skills upgrade training for existing employees. Priority is given to businesses in targeted industries, Enterprise Zones, HUB Zones, Inner City Distressed areas, Rural Counties and areas, and Brownfield areas. For additional information on the IWT program, visit Workforce Florida.

Infrastructure Incentive:

Economic Development Transportation Fund

The Economic Development Transportation Fund, commonly referred to as the “Road Fund,” is an incentive tool designed to alleviate transportation problems that adversely impact a specific company’s location or expansion decision. The award amount is based on the number of new and retained jobs and the eligible transportation project costs, up to $3 million. The award is made to the local government on behalf of a specific business for public transportation improvements.

Special Opportunity Incentives:

Rural Incentives: Florida encourages growth throughout the state by offering increased incentive awards and lower wage qualification thresholds in its rural counties. Additionally, a Rural Community Development Revolving Loan Fund and Rural Infrastructure Fund exist to meet the special needs that businesses encounter in rural counties.

Urban Incentives: Florida offers increased incentive awards and lower wage qualification thresholds for businesses locating in many urban core/inner city areas that are experiencing conditions affecting the economic viability of the community and hampering the self-sufficiency of the residents.

Enterprise Zone Incentives: Florida offers an assortment of tax incentives to businesses that choose to create employment within an enterprise zone, which is a specific geographic area targeted for economic revitalization. These include a sales and use tax credit, tax refund for business machinery and equipment used in an enterprise zone, sales tax refund for building materials used in an Enterprise Zone, and a sales tax exemption for electrical energy used in an enterprise zone.

Brownfield Incentives: Florida offers incentives to businesses that locate in brownfield sites, which are underutilized industrial or commercial sites due to actual or perceived environmental contamination. The Brownfield Redevelopment Bonus Refund is available to encourage Brownfield redevelopment and job creation. Approved applicants receive tax refunds of up to $2,500 for each job created.

Local Government Distressed Area Matching Grant Program (LDMG)

The Local Government Distressed Area Matching Grant Program stimulates investment in Florida’s economy by assisting Local Governments in attracting and retaining targeted businesses. Applications are accepted from local governments/municipalities that plan on offering financial assistance to a specific business in the area. These targeted businesses are required to create at least 15 full-time jobs and the project must either be new to Florida; expanding operations in Florida; or leaving Florida unless it receives local and state government assistance. The amount awarded by the State of Florida will equal $50,000 or 50% of the local government’s assistance amount, whichever is less, and be provided following the commitment and payment of that assistance.

Source: Enterprise Florida.

How to Ensure That Your Company’s Data Doesn’t Get Lost in the Clouds PART III

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Cloud Service Termination, Transfer and Other Issues

Cloud computing has become an increasingly popular option for businesses to cheaply and efficiently manage their data systems.  Businesses interested in utilizing these services should be cautious, however, when entering into agreements to use these services.  Just like with any corporate transaction, the contracts and agreements for cloud services must be drafted effectively so as to mitigate business risks to the greatest extent possible.

In Part I of our cloud-computing blog series we addressed privacy and security concerns for business engaged in cloud computing.  Part II of the series examined jurisdictional issues and subscriber data ownership issues that may arise in cloud-computing agreements.

Now n our third and final installment of this blog series we will address how subscribers should structure the termination of a cloud computing agreement to ensure “ to the greatest extent possible “ that their data are safely returned and/or disposed by the cloud service provider.  We will also address some miscellaneous issues that may arise with respect to the transfer or termination of ownership by the cloud provider.

1. Termination

At the end of a transaction or upon the termination or expiry of an agreement, in traditional corporate contract settings, there are usually standard provisions calling for the return of data by the party that was using the data, or the destruction of that data and a certification to that effect.  In a cloud computing arrangement, however, the parties to the corporate contract are not is possession of that data “ the cloud service provider is.

Many would argue that the contract party cannot be held responsible, therefore, for the return or destruction of the data.  Nothing could be further from the truth.

Upon the conclusion of a cloud computing agreement, a procedure should be in place for the cloud-computing service provider to return all data to their subscriber, or to destroy the data and certify as to its destruction. Most businesses seeking a cloud service provider likely already have internal policies and procedures in place for retaining, backing up, and disposing of data.  It is crucial that subscribers inquire into their prospective cloud-service provider’s data retention and destruction policies to ensure that the policies of the subscriber can be adhered to in their cloud provider’s environment.

For example, the cloud service agreement can call for the service provider to return all data to the subscriber or, upon the request of the subscriber, destroy all data and certify as to its destruction.  Then, in the corporate contract, appropriate language can be added to allow for the cloud service provider to return or destroy the data.  A sample agreement provision might read:

Upon the expiration or termination of this Agreement, the Receiving Company immediately shall delete or order the deletion of all proprietary data and information from any on-demand computer network access storage location (i.e., cloud computing service) and provide the Providing Company with (a) written notice, certified by an appropriate officer of the Receiving Company, of such actions, and (b) written certification(s) from such on-demand computer network access storage location service provider(s) that the deletion has taken place.

Contract provisions of this type will help ensure that your data is not left floating in the Cloud at the end of an agreement or transaction.

2. Transfer

Along the lines of termination, use of a cloud service provider raises additional questions. What happens if the cloud service provider changes?  Situations such as the sale of the cloud service, sale of the cloud company, merger, or government seizure can all have tremendous effects on the subscriber’s serviced data Comingling of personal information, jurisdictional issues, and sharing of a subscriber’s business data could all prospectively result from these situations.

Awareness and prior planning are key features to mitigating these business risks. Subscribers need discuss these issues with their prospective cloud service provider prior to entering into an agreement. In many situations, specific clauses can be drafted into the cloud service agreement to allow for the safe return or destruction of a subscriber’s data before any change in the dominion or control over that data can take place.

At a minimum, to protect their data from ending up in the hands of unforeseen third parties, subscribers should require their cloud service provider inform them of any situation in which their data may be accessed by, or transferred to, an unrelated third party.  While similarly worded “assignment” clauses are ubiquitous in business contracts, our recent review of several cloud service agreements found these clauses to be altogether lacking. To protect your valuable data, subscribers must reserve the right to terminate the cloud service agreement for cause “ and demand return or destruction of the data “ in events such as these.

3. Additional Issues

There are many other ways in which operating in the cloud computing environment must be considering by all businesses. While far from exhaustive, some of the most critical areas to consider are:

  • Segregation of Subscriber Data. In your local, server-based systems, confidential data, proprietary data, and sensitive financial data (to name a few), can be segregated from other business data and protected appropriately. Very often businesses certify to customers and business partners that their data will receive this special treatment. Is your cloud service provider also guaranteeing this segregation and an appropriate level of safeguarding?
  • Authentication of Data. Does your cloud service provider have the technical processes and control procedures in place to guarantee that your data will not be (inadvertently or otherwise) changed over time? Think of the ramification to your business if credit approvals, account receivable limits, or termination dates on contracts were changed while in the cloud.
  • Responding to Litigation. In the world of e-discovery in litigation, being able to preserve subscriber data and provide copies of that data in a timely and complete fashion are critical. Can your cloud service provider respond to your needs in the event of litigation. Moreover, what if the service provider itself is the target of litigation. Is your data safe from unwarranted disclosure or disclosure without prior notice to the subscriber?

Concluding Thoughts

It goes without saying that the contractual nuances arising in the cloud computing environment could easily fill several volumes.  Our goal in this blog series is to educate business as to how operating in the Cloud requires you to rethink even the most fundamental aspects of the business agreements you currently use.

Cloud computing can provide significant business advantages in efficiency and cost savings. In the age of transparency it will be key for businesses to maintain sensitive intellectual property, customer, and confidential data in such as way as to ensure that they preserve their competitive advantage and avoid any issues regarding unauthorized use of data.  As such, businesses must carefully negotiate and draft not only their cloud service agreements, but all of their commercial contracts and agreements to insulate themselves from liability and protect their invaluable data.

Does your company need assistance in ensuring the security and integrity of its cloud-based business and information?  Fuerst Ittleman David & Joseph has experience in designing cloud-based business solutions, including negotiating, drafting and executing a wide variety of transactional agreements to ensure that while your business may be in the clouds, your feet are firmly rooted on solid legal ground.  Contact us today for a free consultation.

How to Ensure That Your Company’s Data Doesn’t Get Lost in the Clouds: Part II

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Jurisdiction & Cloud-Service Providers Rights in Data

Cloud computing has become an increasingly popular option for businesses to cheaply and efficiently manage their data systems.  Businesses interested in utilizing these services should be cautious, however, when entering into agreements to use these services.  Just like with any corporate transaction, the contracts and agreements for cloud services must be drafted effectively so as to mitigate business risks to the greatest extent possible.

In Part I of our cloud-computing blog series we addressed some of the privacy and security concerns of which businesses should be aware and offered some guidance as to what steps they should take to mitigate risks to their businesses and stored data.

In Part II of this series we now take a close look at some of the jurisdictional issues that may arise in cloud-computing agreements as well as what rights and responsibilities the cloud-service provider has “ or may have “  in a subscribers data.

1. Jurisdictional Issues in Cloud Computing

As recently as a few years ago, if one company shared computer files with another company under a data sharing agreement, it was reasonably certain that those data files would be physically stored somewhere. The files would be sent by CD, thumb-drive, or some file transfer protocol (FTP) from computers physically residing in one location to computers physically residing in another location. It was easy back in the “old days” to say that a Data Sharing Agreement was governed under Florida law, for example, because the files were actually located in Florida. As a result, jurisdiction of Florida courts over those files was never an issue.

We recently concluded a major merger and acquisition transaction in which a companys data located in the Cloud was sent via file transfer software (also resident in the Cloud) to a recipient Company which was also storing the data in the Cloud. On a conference call we discussed jurisdiction over the data between the Florida corporation and the Delaware LLC. The Chief Information Officer (CIO) of the Delaware company remarked, “State jurisdiction what a quaint concept.”

To be sure, the advent of cloud computing raises a bevy of data location and cross-border issues of which companies need to be aware when entering into cloud-computing agreements. The nature of subscriber data and the physical location of its processing may expose subscribers to litigation and will dictate what legal obligations (and possible remedies) prospective subscribers may have.

For example, one of the most important questions that subscribers can ask their cloud service providers is whether they employ servers in foreign countries for cloud services. Cross-border data flow issues are not new; however, in a cloud-computing context they are magnified because of the free flow nature of the technology. Under the European Union (“EU”) Data Protection Directive, the movement of personal information of EU residents to countries outside of the EU can constitute a violation of EU law. Canada also has similar data transfer provisions. Under the United States dual-use export control regime, the Export Administration Regulation (“EAR”), companies may unintentionally subject themselves to liability for export violations by transmitting sensitive technical data on foreign servers.

Furthermore, processing data in an unexpected country may expose subscribers to legal risks and subject them to different laws and regulations that could otherwise have been avoided on a jurisdictional basis. Many foreign companies are aware of this and purposely maintain their data outside of the United States to avoid the U.S. Governments compelled disclosure provisions of the PATRIOT Act.

The previous examples illustrate how important it is for subscribers to be aware of the possible consequences that can stem from trans-border data flow. Below we have provided a few steps that subscribers can take to help insulate themselves from possible jurisdictional troubles:

  • The subscriber should require their respective cloud-service provider to reveal the physical location of all servers that will be processing the subscribers cloud data and provide reasonable notice of any changes.
  • Some cloud service providers may not be able to provide server location information because they lack the infrastructure or resources to track this content. We strongly suggest that subscribers avoid working with a cloud data provider which cant provide this information, especially if the information to be stored is sensitive customer information.
  • Finally, the subscriber should also require the service provider to collaborate with the subscriber to assure compliance with local laws and restrictions stemming from the transfer of data from one jurisdiction to another. Compliance provisions covering all possible jurisdictions and covenants not to allow data to stray outside of the disclosed jurisdictions should be the norm in cloud-based service agreements.

2. Cloud-Vendor Rights in Data and Service Level Agreements

The Service Level Agreement (“SLA”) is an ancillary component of most cloud-based service agreements. SLAs typically function as an outline for all of the cloud-service providers access and availability commitments. A good SLA will formally define the level of service by providing quantifiable target performance levels, operational requirements, and cloud-vendor responsibilities. SLAs also define technical terms and very often delineate the cloud-service providers rights in the subscribers data.

This is a critical component of the SLA. Without realizing, a company can allow a service provider to access (and potentially use) subscriber data. Due to this risk, it is advantageous for subscribers to tailor the SLA as narrow as possible to limit cloud vendor rights to utilize data outside of the subscribers business requirements.

Subscribers should also limit the cloud-providers use of third-party platforms whenever possible. While the subscriber and service provider may have well crafted non-disclosure, confidentiality, and data security provisions in their agreement, very often cloud agreements do not restrain the service providers right to use third-parties for data storage, back-up, and other technical services. In fact, in the cloud environment, the use of third-party services is ubiquitous. Google, for example, describes itself as a “data processor” and uses “agents” to perform other functions.

Whenever third parties are involved, the subscriber and data provider need to address the applicability of the service agreement to those third parties as well as any prospective liability and service failure issues that may arise. By carefully negotiating and drafting this portion of the agreement, subscribers can significantly mitigate risks associated with the potential unauthorized use of their data.

A cloud-service provider may also create and incorporate additional code in attempts to provide customized solutions for its subscribers. It is prudent for subscribers to specify clearly the ownership interests in and to any intellectual property created in the course of the agreement. Following the cloud-service agreement negotiations, both parties should be aware of whether or not any resulting intellectual property is maintained and owned by the cloud-service provider or the subscriber as work for hire.

In the third and final installment of the cloud-computing blog series, we will discuss cloud-based data retention and termination issue. We will also address how business customers should protect themselves from possible issues that can arise when a prospective cloud-service provider transfers ownership of a customers data through a merger or sale of the cloud-service providers business.

Look for Part III in our series coming soon.

How to Ensure That Your Company’s Data Doesn’t Get Lost in the Clouds

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Within the past few years cloud computing has become popular with respect to everyday personal and business productivity. Between email, file sharing, word processing, web chatting and social media, the cloud concept has become integral in creating collaborative and efficient means of accessing and sharing data across multiple platforms. The popularity of cloud computing has transcended these everyday uses and has become a functional and cost effective storage option for businesses lacking the resources to store massive amounts of data.

Cloud computing generally involves some form of subscription-based service where a third party satisfies the computing and storage needs of its subscriber through a virtually unlimited hardware and communication source that can be accessed remotely thorough an internet connection. Typically the most attractive feature of cloud computing for consumers is that it allows subscribers to access their data remotely from multiple electronic platforms. Content is made available via the clouds web based utility so limited storage and hardware capacity becomes irrelevant to the respective device’s functionality. The increase in popularity of netbooks, tablets, and mobile computing can attest to this fact.

As such, the cloud concept is becoming more popular within the business community. Cloud computing allows employees to access sensitive tech information, customer information, insurance records, accounting and business data, etc. from anywhere at anytime. From a productivity and accessibility standpoint cloud computing is invaluable to the traveling business person. In addition to the flexibility of use, businesses find Cloud computing particularly appealing because it can minimize expenses and increase efficiency by lessening or even eliminating on-site disk storage and maintenance requirements.

Under the standard pay-per-use model offered by most Cloud vendors, businesses are able to quickly scale computing power up or down without fear of significant capital losses. From an economic standpoint, this overall increase in productivity and decrease in IT costs can be extremely valuable for companies competing in their respective markets.

Unfortunately there is a potential downside for businesses seeking to utilize a cloud vendor’s services. With sensitive business data now in the control of a third party, several potential business and legal risks come into play. Over the course of this three-part blog series we will address some of the major emerging business and legal issues that can arise with respect to cloud computing and provide recommendations on how to mitigate risks for companies who intend on entering into a cloud service agreement.

Part I of this three part cloud-computing blog series will address some of the potential security and privacy issues of which businesses should be aware when entering into a cloud agreement. This will be followed by Part II which will overview the jurisdictional and cloud-service provider rights in subscriber data. The third and final installment of the blog series “ Part III “ will look to the conclusion of the cloud-computing agreement, most specifically what should be done at the outset of the agreement to ensure that the ultimate termination of the agreement is as smooth and problem-free as possible. It is our hope that upon reading this series, businesses will have a basic but strong idea of how to negotiate and properly draft a cloud-service agreement to protect themselves and their customers from the legal and business risks associated with entering into a cloud contract.

Part I:

Security & Privacy Issues and Solutions

Privacy protection and security of cloud data is one of the biggest concerns with utilizing cloud features. Maintaining significant safeguards on sensitive data is one of the foremost priorities of any popular cloud vender. However, it is difficult to completely guarantee the safety of a customer’s data. Information stored by the vendor may have weaker privacy protections than what the creator of the information provides.

For example, in a 2009 Federal Trade Commission complaint by the Electronic Privacy Information Center (“EPIC”) regarding Google, Inc.’s (“Google”) cloud-based services, EPIC claimed that Google failed to adequately safeguard its users confidential information. While claiming to users that their data would be secure and private, Google’s terms of service policy explicitly disavowed any warranty or any liability for harm that could result from its negligence to protect the privacy and security of user data.

In a 2011 settlement to this FTC investigation, Google was forced to establish a comprehensive privacy program to address these allegations and strengthen its protection for its users. With respect to many of the consumer cloud-based services, the reality is that service arrangement’s terms of use policies are often limited to standardized shrink wrap agreements where the consumer is afforded little to no negotiation power.

Fortunately for businesses, an increasing amount of cloud-based service providers are providing customized data management services that require negotiation with respect to the terms of their cloud agreements. Businesses that are potential cloud computing subscribers (“Subscribers”) are encouraged to carefully negotiate their prospective cloud service transaction so as to ensure high-level privacy and security. In the following paragraphs we will discuss some considerations when negotiating the transaction.

1. Structure the Cloud Computing Agreement to Mitigate Risks

a. Limitation of Liability and Professional Liability Insurance

Subscribers should attempt to structure the agreement to make the cloud service provider primarily responsible for data security risks. To whatever extent responsibility is not transferred to the vendor, the Subscriber should then transfer personal risk to a professional liability carrier. Subscribers are advised to structure limitations of liability sections carefully, and indemnity and insurance provisions properly. By doing so both vendor and customer can effectively balance possible data and security risk.

b. Require Vendor to Provide Documentation of its Security Policy

Subscribers should also, as part of its cloud agreement, require the vendor to provide significant documentation of its security procedures in a Statement on Auditing Standards No. 70 Audit (“SAS70 Audit”) or updated Statement on Standards for Attestation Engagements (“SSAE16 Audit”) (collectively “Security Audits”). The American Institute of Certified Public Accounts developed the SSAE16 Audit and its predecessor the SAS70 Audit to ensure that service providers demonstrate that they have adequate control and safeguards in place when they host or process data belonging to their customers. These audits provide an authoritative and uniform format for vendors to report this information, and should be negotiated into a prospective cloud agreement between the Subscriber and Cloud service provider.

c. Incident Response System in the Event of Breach

In the event that a cloud provider suffers a security breach, an effective response plan should be in place. The terms of the agreement should require the cloud-service provider to promptly notify all parties that may be affected by the breach. Terms should be written into the agreement that further require the cloud-service provider to coordinate and assist customers with the investigation mitigation and containment of the breach. It may be beneficial for Subscribers to also reserve the right to conduct their own forensic assessment and investigation of the breach. Issues regarding terminating and limiting data access will be discussed in further detail in the upcoming entry, but with respect to data security, data preservation, and substantive defense issues it is crucial that both Subscriber and cloud-service provider are both in agreement as to what responsive action will be taken in response to a security breach.

In the next installment of the cloud-computing blog series, we will discuss some of the Jurisdictional issues that may occur with respect to the trans-border flow of data in a cloud environment. We will also discuss what rights the Cloud-Service provider has in the customer data it manages.

Does your company need assistance in ensuring the security and integrity of its cloud-based business and information? Fuerst Ittleman David & Joseph has experience in designing cloud-based business solutions, including negotiating, drafting and executing a wide variety of transactional agreements to ensure that while your business may be in the clouds, your feet are firmly rooted on solid legal ground. Contact us today for a free consultation.

Look for the second installment in our blog series on Cloud-Based Business coming soon.

Switzerland’s Oldest Bank, Wegelin & Co., Pleads Guilty to Tax Violations, Agrees to Pay $74 Million to the United States

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On January 3, 2013, the United States Attorneys Office for the Southern District of New York announced that Switzerlands oldest bank, Wegelin & Co. (“Wegelin”), has pled guilty “to conspiring with U.S. taxpayers and others to hide more than $1.2 billion in secret Swiss bank accounts and the income generated in these accounts from the Internal Revenue Service (the ‘IRS’).”  The plea agreement is available here, and the indictment charging Wegelin with violating 18 U.S.C. 371 (commonly referred to as a “Klein conspiracy”) is available here

As the press release, indictment, and plea agreement reveal, Wegelin pled guilty to conspiring with U.S. taxpayers and others to hide more than $1.2 billion in secret Swiss bank accounts and the income generated in these accounts from the Internal Revenue Service (the “IRS”). One of the managing partners of Wegelin, Otto Bruderer, appeared on behalf of the bank to enter the guilty plea before U.S. District Judge Jed S. Rakoff. This case represents the first time that a foreign bank has been indicted for facilitating tax evasion by U.S. taxpayers and the first guilty plea by a foreign bank to tax charges.

As part of its guilty plea, Wegelin agreed to pay approximately $20 million in restitution to the IRS and a $22.05 million fine. In addition, Wegelin agreed to the civil forfeiture of an additional $15.8 million, representing the gross fees earned by the bank on the undeclared accounts of U.S. taxpayers. Together with the April 2012 forfeiture of over $16.2 million from Wegelins correspondent bank account, this amounts to a total recovery to the United States of approximately $74 million.

Publicly available documents detail the manner by which Wegelin violated U.S. law:

  • Opening and servicing undeclared accounts for U.S. taxpayer-clients in the names of sham corporations and foundations formed under the laws of Liechtenstein, Panama, Hong Kong, and other jurisdictions for the purpose of concealing some clients identities from the IRS;
  • Accepting documents that falsely declared that the sham entities were the beneficial owners of certain accounts, when in fact the accounts were beneficially owned by U.S. taxpayers, and making them part of Wegelins client files;
  • Permitting certain U.S. taxpayer-clients to open and maintain undeclared accounts at Wegelin using code names and numbers to minimize references to the actual names of the U.S. taxpayers on Swiss bank documents;
  • Ensuring that account statements and other mail for U.S. taxpayer-clients were not mailed to them in the United States;
  • Communicating with some U.S. taxpayer-clients using their personal email accounts to reduce the risk of detection by law enforcement; and
  • Issuing checks drawn on, and executing wire transfers through, its U.S. correspondent bank account for the benefit of U.S. taxpayers with undeclared accounts at Wegelin and at least two other Swiss banks. In so doing, Wegelin sometimes separated the transactions into batches of checks or multiple wire transfers in amounts that were less than $10,000 to reduce the risk that the IRS would detect the undeclared accounts.

As a result of its guilty plea and fines, Wegelin has  announced that it will “cease to operate as a bank.”
This case demonstrates that the U.S. Department of Justice is serious about punishing foreign banks that facilitate tax evasion by enabling U.S. taxpayer to avoid their income tax obligations.

The attorneys at Fuerst Ittleman David & Joseph anticipate that the Wegelin case will be just the first in a string of prosecutions of foreign banks.  Further, we anticipate that the U.S. Department of Justice will continue to be active in prosecuting those individuals that hide money in foreign banks, fail to report their foreign holdings as required by the Bank Secrecy Act, and fail to properly report and pay the correct amount of tax due and owing to the IRS.
The attorneys at Fuerst Ittleman David & Joseph have extensive experience litigation criminal and civil tax cases before the U.S. District Courts, the U.S. Tax Court, the U.S. Court of Federal Claims, and the U.S. Courts of Appeal.  You can contact us by email at contact@fidjlaw.com or by calling us at 305.350.5690.

Update: Third Party Payment Processor Sentenced to Jail Time for Processing Internet Poker Company Funds

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On October 3, 2012, Judge Lewis A Kaplan of the United States District Court for the Southern District of New York sentenced Chad Elie to five months in prison for his role in facilitating the processing of payments for three online poker companies. A copy of the Department of Justices press release announcing the sentencing can be read here.

As we previously reported, the poker companies, Fill Tile Poker, Absolute Poker, and PokerStars, were shut down by the FBI on April 15, 2011 as part of an investigation and eventual indictment of 11 people for various gambling related charges including violations of the Unlawful Internet Gambling Enforcement Act (“UIGEA”) 31 U.S.C. §§ 5361-5366, bank fraud  18 U.S.C. § 1344, wire fraud 18 U.S.C. § 1343, and money laundering 18 U.S.C. § 1956. A copy of the indictment can be read here.

As a result of the indictment, PokerStars and Fill Tilt reached a $731 million settlement with the federal government. Additionally, several top executives have pleaded guilty for their roles in the alleged UIGEA, bank fraud, and money laundering conspiracy. More information on these guilty pleas and the PokerStars settlement can be read in our prior reports here, here, and here.

According to authorities, the companies used third party payment processors to disguise financial transactions between the companies and U.S. players so that the transactions would appear to be unrelated to online gambling. The third party payment processors would then lie to U.S. financial institutions about the source of the funds processed, often times facilitated by the creation of nonexistence online companies and phony websites.

Authorities alleged that between 2008 and 2011, Elie served as a payment processor for each online poker company. Authorities further allegedly that in order to conceal the sources of the funds he was processing, Elie falsely represented to U.S. banks that he was processing “payday loans” and payments for online club memberships. As a result of these allegations, Elie pleaded guilty to participating in a conspiracy to commit bank fraud and to operating illegal gambling businesses.

In sentencing Elie to five months in prison, rather than the federal Probation Departments recommended sentence of probation, six months home confinement, and community service, Judge Kaplan found that the evidence against Elie indicated that he continued to process payments for the poker companies despite his knowledge of the federal investigation and arrests of other payment processors and company executives. In addition to prison, Elie was ordered to two years of home confinement and was ordered to forfeit $500,000 to the United States. Elies sentencing highlights the potential consequences and criminal penalties payment processors can face when processing ill-gotten assets on behalf of others.

If you have questions pertaining to UIGEA, the BSA, anti-money laundering compliance, and how to ensure that your business maintains regulatory compliance at both the state and federal levels, or for information about FIDJs experience litigating white collar criminal cases, please contact us at contact@fidjlaw.com

Update: Online Poker Executives Guilty Plea Highlights the Additional Penalties Payment Processors When Processing Illicit Gambling Proceeds

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On September 19, 2012, Nelson Burtnick, former director of the payment processing department of Full Tilt Poker and PokerStars, pled guilty to charges of conspiracy to commit violations of the Unlawful Internet Gambling Enforcement Act (“UIGEA”), Bank Fraud, and Money Laundering, stemming from the April 15, 2011 indictment of eleven people in connection with their involvement in PokerStars, Full Tilt Poker, and Absolute Poker.

The Department of Justice had charged Burtnick with multiple charges including violations of the Unlawful Internet Gambling Enforcement Act (“UIGEA”), conspiracy to commit bank fraud and wire fraud, operating an illegal gambling business, and money laundering. In his plea deal, Burtnick pled guilty to one count of conspiracy to accept funds in connection with unlawful internet gambling, bank fraud, and money laundering, and two counts of accepting funds in connection with unlawful internet gambling. As a result of his guilty plea, Burtnick faces a maximum of 15 years in prison. A copy of the U.S. Department of Justices press release announcing the guilty plea can be read here.

As we have previously reported here, here and here, ongoing federal prosecutions have targeted internet poker operators and their payment processors for violations of federal law under UIGEA 31 U.S.C. §§ 5361-5366 and the Illegal Gambling Business Act (“IGBA”) found at 18 U.S.C. § 1955. However, as exemplified by Mr. Burtnicks indictment and guilty plea, payment processors face various other violations of federal law when accused of processing illicit gambling proceeds. These violations include bank fraud, found at 18 U.S.C. § 1344, which makes it a crime for “whoever knowingly executes, or attempts to execute, a scheme” to either: 1) defraud a financial institution; or 2) obtain any of the moneys under the custody or control of a financial institution by means of a false or fraudulent representation. Here, prosecutors alleged that Burtnick violated 18 U.S.C. § 1344 by deceiving U.S. financial institutions into processing payments for Poker companies from U.S. gamblers through disguising such payments as payments to non-existent online merchants and non-gambling businesses.

Another federal law of which payment processors must be aware is the prohibition against money laundering found at 18 U.S.C. § 1956. Generally speaking, “money laundering” is the act of concealing or disguising the nature, location, source, or ownership of money begotten through illicit means in order to make such funds appear as if earned through legitimate and lawful activity. More specifically, 18 U.S.C. § 1956(a)(2)(A) prohibits the transportation, transmission, or transfer of a monetary instrument or funds from a place in the U.S. to or through a place outside of the U.S. (or vice versa) “with the intent to promote the carrying on of a specified unlawful activity.” In its Indictment, the Government alleged that Burtnick violated 18 U.S.C. § 1956(a)(2)(A) by disguising payments by U.S. gamblers to Full Tilt and Poker Stars, both offshore entities, as payments to phony internet merchants. Bank accounts in the fake merchants names were opened in U.S. banks through which the poker companies could receive payments from the U.S. based gamblers.

More importantly, each of these crimes is separate and distinct from the illegal gambling activities themselves. Thus, regardless of whether a payment processor is charged under IGBA or UIGEA, acts of payment processors in disguising or misrepresenting the source of funds they process can subject the processor to criminal liability.

If you have questions pertaining to UIGEA, the BSA, anti-money laundering compliance, and how to ensure that your business maintains regulatory compliance at both the state and federal levels, or for information about FIDJs experience litigating white collar criminal cases, please contact us at contact@fidjlaw.com

Eleventh Circuit Affirms Tax Court in Recharacterizing Loan as a Sale for Tax Purposes

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On August 23, 2012, the U.S. Court of Appeals for the Eleventh Circuit affirmed the decision of the Tax Court and ruled in favor of the IRS in Calloway v. Commissioner of the IRS, case no. 11-10395, available here.

The facts of the case are as follows:
Albert Calloway worked for IBM for a number of years and acquired IBM stock by exercising his employee stock options. During 2001, Bert Falls, Mr. Calloway’s financial adviser, introduced Mr. Calloway to a program operated by Derivium Capital, LLC (“Derivium”). Under that program, Derivium would “lend” a client ninety percent of the value of securities that the client pledged to Derivium as collateral. During the term of the non-recourse loan, Derivium had no restrictions on its use of the collateral. At the end of the loan’s term, the client had three options: (1) He could reclaim the collateral by paying the principal and accrued interest; (2) He could surrender the collateral to Derivium; or (3) He could refinance. Mr. Calloway testified that the loan program was attractive to him because, had he sold his stock, he would have had to pay twenty percent in capital gains tax; under the Derivium program, however, he received ninety percent of the stock’s fair market value.

The details of Mr. Calloway’s arrangement with Derivium are set forth in three documents: “Master Agreement to Provide Financing and Custodial Services” (“Master Agreement”), “Schedule D Disclosure Acknowledgment and Broker/Bank Indemnification” (“Schedule D”) and “Schedule A-1 Proper Description and Loan Terms” (“Schedule A-1”). Schedule A-1 details the terms of the loan. Specifically, the loan amount was ninety percent of the fair market value at the time of closing; the estimated value of the collateral at that time was $105,444.90. The interest rate to be charged was ten-and-one-half percent, compounded annually; the interest accrued until, and was due at, maturity. Any dividends on the pledged collateral were to “be received as cash payments against interest due.” The loan could not be prepaid, and the lender could not seek recourse against the borrower, only the collateral. The closing date was “[u]pon receipt of securities and establishment of [Derivium’s] hedging transactions.” Mr. Calloway executed the Master Agreement and attached schedules on August 8, 2001, and authorized the transfer of 990 shares of his IBM stock to Derivium’s account with Morgan Keegan & Company, Inc., on the following day. Cathcart, as president of Derivium, signed the Master Agreement and schedules on August 10, 2001.

On August 17, 2001, Derivium’s operations office sent Mr. Calloway two documents. The first was a valuation confirmation indicating that Derivium had received the stock, valued at $104,692.50, into its account. The second document, titled “Activity Confirmation,” indicated that, as of August 17, 2001, Derivium had hedged the IBM stock for slightly less, $103,984.70, yielding an “Actual Loan Amount” of $93,586.23. On August 21, 2001, Derivium sent Mr. Calloway a letter informing him that the proceeds of the loan were sent to him according to the wire transfer instructions he had provided a few days earlier. On the same date, $93,586.23 was credited to Mr. Calloway’s credit union account. Previously, on August 17, Derivium had exercised its right to sell the stock without giving notice to Mr. Calloway.

During the period of time covered by the loan, Mr. Calloway received quarterly and year-end account statements. Each quarterly statement set forth the loan balance at the beginning of the quarter, indicated the interest accrued during the quarter and credited the account for the dividends paid during the quarter to yield the end-of-quarter loan balance. The statement also provided the end-of-quarter collateral value. Mr. Calloway did not receive any tax statements reflecting dividend income (Form 1099-DIV), nor did he report on his tax returns any dividend income earned from the 990 shares of IBM stock. In a letter dated July 8, 2004, Derivium informed Mr. Calloway that the loan would mature on August 21, 2004. Consistent with the Master Agreement and accompanying schedules, the letter stated that Mr. Calloway could either (1) pay the maturity amount of $124,429.09 and recover his collateral, (2) renew or refinance the transaction for an additional term, or (3) surrender the collateral. On July 27, 2004, Mr. Calloway returned the response form to Derivium indicating that he was “surrender[ing his] collateral in satisfaction of [his] entire debt obligation.”

The IRS issued a notice of deficiency to the Calloways for failing to include the income from the sale of the IBM stock on their 2001 income tax return. It also assessed two penalties for failure to timely file a return and for significant understatement of income.

The case before the Tax Court produced a majority opinion authored by Judge RUWE, and joined by Judges COLVIN, COHEN, WELLS, GALE, THORNTON, MARVEL, GOEKE, KROUPA, GUSTAFSON, and PARIS. Judge HALPERN, issued an opinion concurring in the result only, which was joined by Judge WHERRY. Judge HOLMES, also issued an opinion concurring in the result only.

The Eleventth Circuit adopted the reasoning of both Anschutz Co. v. Comm’r, 664 F.3d 313, 324 (10th Cir. 2011), available here, and the Ninth Circuit’s opinion Sollberger v. Comm’r, case no. 11-71883 (Aug. 16, 2012), available here, and distilled the analysis regarding whether the transaction was a sale down to the following factors:

(1) Whether legal title passes; (2) the manner in which the parties treat the transaction; (3) whether the purchaser acquired any equity in the property; (4) whether the purchaser has any control over the property and, if so, the extent of such control; (5) whether the purchaser bears the risk of loss or damage to the property; and (6) whether the purchaser will receive any benefit from the operation or disposition of the property. The Eleventh Circuit noted, however, that no one factor is controlling, nor is the list exhaustive.

The 11th Circuit then held as follows: “[W]e believe that the most relevant of those factors point firmly to the conclusion that the 2001 transaction was a sale of stock for the purposes of Federal income tax.” Slip op. at 28. But the 11th Circuit then rejected the alternative analytical framework advanced by either Judge HALPERN or Judge HOLMES (“Moreover, we do not believe that the tests applied by the concurring judges provide viable alternatives to the benefits and burdens test.”). Slip op. at 35-36.

The Calloway case demonstrates that federal courts of appeal tend to take a more holistic and flexible approach to viewing transactions for income tax purposes. However, given the obvious disagreement as to the appropriate analytic framework among the Tax Court judges, it appears that tax court litigants need to be cognizant of the fact that methods of proof may vary not only among judges, but among circuits as well.

The attorneys at Fuerst Ittleman David & Joseph, have extensive experience litigating before the U.S. Tax Court and the various U.S. Circuit Courts of Appeal. You can contact us by calling 305.350.5690, or by emailing us at contact@fidjlaw.com.

Federal Circuit Invalidates Section 263A Regulation Under the Chevron Test

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On May 31, 2012, the U.S. Court of Appeals for the Federal Circuit concluded that the associated property rule in Treas. Reg. § 1.263A-11(e)(1)(ii)(B) as applied to property temporarily withdrawn from service was not a reasonable interpretation of 26 U.S.C. Section 263A (“Section 263A”).  The Federal Circuit also found that the Treasury Department failed to provide a reasoned explanation when it promulgated that regulation.  Dominion Resources, Inc. v. United States, 97 Fed. Cl. 239 (Fed. Cir. 2012) is available here.  The Treasury Regulation at issue is available here while Section 263A is available here.

The factual background is incorporated in the opinion.  Dominion Resources is in the business of providing electric power and natural gas to individuals and businesses.  In 1996, it replaced coal burners in two of its plants.  While making those improvements, it temporarily removed the units from service “ one unit for two months and the other for three months.  During this period, Dominion incurred interest on debt unrelated to these improvements.  Dominion deducted some of this interest from its taxable income.  The IRS disagreed with the deduction computation under Treas. Reg. § 1.263A-11(e)(1)(ii)(B) and applied the regulation to capitalize $3.3 million of that interest instead of deducting it.  This distinction is notable because a deduction occurs immediately in the tax year, while capitalization occurs over later years.  In a settlement between the IRS and Dominion, the IRS allowed Dominion to deduct 50% and capitalize 50% of the disputed amount.  Dominion nonetheless disputed the amounts and sought to invalidate Treas. Reg. § 1.263A-11(e)(1)(ii)(B) in court.

Section 263A is comprised of five subsections, which the court described as “circular” because each rule referred to another rule in a progression such that the reader ends at the beginning.  Nevertheless, as a general rule, Section 263A requires capitalization of certain costs incurred in improving real property, instead of deduction.   Subsection (f) provides the general rule that interest is a cost requiring capitalization when the cost is allocable to the property.  Furthermore, the section states that “[s]ubsection (a) shall only apply to interest costs which are (A) paid or incurred during the production period, and (B) allocable to property which is described in subsection (b)(1)”  For determining what interests costs are allocable, subsections (f)(1) and (f)(2) provide that interest is allocable “to the extent that the taxpayers interest costs could have been reduced if production expenditures had not incurred.”  In determining the amount of interest required to be capitalized under Section 263A(f)(2), interest on any other indebtedness is assigned to such property that the taxpayers interest costs could have been reduced if production expenditures had not been incurred.  This subsection is generally considered the “avoided-cost principle.”

The regulation at issue defined what constituted production expenditures and determined the amount of interest capitalized. Under Treas. Reg. § 1.263A-11(e)(1), production expenditures subject to capitalization include not only the amount of allocable portion of the cost of land but also the adjusted basis of the entire unit being improved that is temporarily withdrawn from service, known as associated property.  Thus, by including the adjusted basis amount, the regulation increased the amount of interest to be capitalized.

The issue on appeal from the decision of the U.S. Court of Federal Claims, available here here, was whether the inclusion of the adjusted basis of the unit violates various statutory provisions.  Because Treas. Reg. § 1.263A-11(e)(1)(ii)(B) required a larger base amount, it resulted in a larger amount of interest to be capitalized.  The challenge to the regulation was only as applied to property that was temporarily withdrawn from service and not as applied to property that was not placed in service. 

The court analyzed the validity of Treas. Reg. § 1.263A-11(e)(1)(ii)(B) under what is commonly referred to as the “two-step test” set forth in Chevron, USA v. NRDC, 467 U.S. 837 (1984), available here.  Step one is whether Congress has directly spoken to the precise question at issue.  If the statute is silent or ambiguous, the second step resolves the question of whether the agencys answer is based on a permissible construction of that statute. 

In the present case, the regulation did not contradict the text of the statute but only because the statute is opaque, or as previously explained, circular.  Therefore, the Federal Circuit determined that the statute was ambiguous and was forced to turn to the second step of the Chevron test.

Under step two, the Court concluded that the regulation directly contradicted the “avoided-cost rule” which implemented Congresss concern with the avoided cost principle.  This rule recognizes that if the improvement had not been made, those funds could have been used to pay down the debt and therefore reduce interest that accrued on the debt.  In the instant case, the improvement was made and that amount was not used to pay down the debt and interest consequently accrued on that amount. 

Moreover, the adjusted basis did not represent an avoided amount because a property owner does not expend funds in an amount equal to the adjusted basis when making the improvement.  Instead, a property owner expends funds in an amount equal to the cost of the improvement itself.  Additionally, the statute uses the term “expenditures,” the plain meaning of which is an amount actually expended or spent on the improvement.  The Court explained that a property owner would not expend or incur an amount equal to the adjusted basis when making the improvement, and as a result, the regulation unreasonably linked the interest capitalized when making an improvement to the adjusted basis. It reasoned that the only way an amount equal to the adjusted basis could potentially satisfy the avoided-cost rule was by assuming that the property owner did not expend funds in an amount equal to the adjusted basis when making the improvement.  Even so, the Court stated that there was no reasonable explanation that assumed that a property owner would have sold the same unit that it removed from service for the sole purpose of improving.  Accordingly, the federal regulation unreasonably linked the interest capitalized when making an improvement to the adjusted basis.  Therefore, the associated property rule in Treas. Reg. § 1.263A-11(e)(1)(ii)(B) as applied to property temporarily withdrawn from service was not a reasonable interpretation of Section 263A(f)(2)(A)(ii) and was deemed to be invalid.

The Court further held that the associated property rule in Treas. Reg. § 1.263A-11(e)(1)(ii)(B) violated the State Farm requirement that the Treasury provide reasoned explanations for adopting regulations.  State Farm requires the Treasury to articulate a satisfactory explanation for its action, including a rational connection between the facts found and the choice made.  See Motor Vehicles Mfrs. Assn of the U.S., Inc. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983).  The Court stated that the IRS failed to provide guidance that mentioned adjusted basis as part of the interest-capitalization method.  There was no rationale other than the general statement that the regulations were intended to implement the avoided-cost method. 

In conclusion, the IRS failed to provide any explanation for the way that the use of an adjusted basis implemented the avoided-cost rule and it did not satisfy the rule.  The Treasury did alert the interested public how the basis of the property being improved would be treated, but the explanation was not sufficient to satisfy the State Farm requirement that the regulation articulate a satisfactory or cogent explanation.

The attorneys at Fuerst Ittleman, PL have extensive civil and criminal tax litigation experience before the U.S. District Courts, the U.S. Tax Court, the U.S. Court of Federal Claims, and the U.S. Circuit Courts of Appeal.  You can contact us by calling 305.350.5690, or by emailing us at contact@fidjlaw.com.

IRS Win in Appellate Case Portends Bigger FBAR crackdown

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On July 20, 2012, the U.S. Court of Appeals for the Fourth Circuit concluded that the district court clearly erred in finding that the Government failed to prove that J. Bryan Williams willfully violated 31 U.S.C. § 5314 by failing to report his interest in two foreign bank accounts for the tax year 2000 and reversed the district courts opinion.  United States v. J. Bryan Williams, case no. 10-2230 (4th Cir. 2012), an unpublished opinion, is available here.

The matter was before the Fourth Circuit following the Governments appeal of the decision of the U.S. District Court for the Eastern District of Virginia, available here, which had ruled that the IRS lacked evidence to prove Williams willful violation of the FBAR filing requirement.

The background and facts are incorporated in the opinion.  Pursuant to § 5314, taxpayers are required to report annually to the Internal Revenue Service (IRS) any financial interests the taxpayer has in any bank, securities, or other financial accounts in a foreign country.  The report is made by filing and completing form TD F 90-22.1, otherwise known as “FBAR.”  Section 5314 is available here. The FBAR must be filed on or before June 30th of each calendar year and the Secretary of Treasury may impose civil money penalties on any person who fails to timely file the report.  Under 31 U.S.C. § 5321, the Secretary may impose a maximum penalty of up to $100,000 or 50% of the balance in the account at the time of such violation if the taxpayer “willfully” fails to file the FBAR, which was the issue in the Williams case. 

The controversy began in 1993 when Williams opened two Swiss bank accounts in the name of ALQI Holdings, Ltd.  From 1993 through 2000, Williams deposited more than $7,000,000 into the ALQI accounts, earning more than $800,000 in income on the deposits.  Williams, in violation of § 5314, did not report to the IRS the income from the ALQI accounts or his interest in the accounts.  By late 2000, the Swiss and U.S. authorities became aware of the assets in the ALQI accounts, and froze the accounts after meeting Williams and his attorneys.

In January 2001, Williams completed a tax organizer, which had been provided to him by his accountant in connection with the preparation of his 2000 tax return.  The tax organizer included a question regarding whether Williams had “an interest in or a signature or other authority over a bank account, or other financial account in a foreign country.”  Williams answered “No.”  Williams 2000 Form 1040, line 7(a), asked the identical question and included instructions for exceptions and filing requirements for the FBAR.  Williams once again checked “No” and did not file an FBAR by the June 30, 2001 deadline. 

In January 2002, upon the advice of his attorneys and accountants, Williams fully disclosed the ALQI accounts to an IRS agent.  In October 2002, he filed his 2001 tax return that acknowledged his interest in the ALQI accounts. In 2003, Williams amended his 1999 and 2000 tax returns, which disclosed details about his ALQI accounts.

In June 2003, Williams pled guilty to conspiracy to defraud the IRS, in violation of 18 U.S.C. § 371, and criminal tax evasion, in violation of 26 U.S.C. § 7201, available here, for his connection with the ALQI accounts from 1993 to 2000.  Williams submitted an allocution, however, and received a three-level reduction under the Sentencing Guidelines for the acceptance of responsibility. In his allocution, Williams admitted to: (1) choosing not to report the income from the ALQI accounts until he filed his 2001 tax return; (2) knowing that he had an obligation to report to the IRS and/or the Department of Treasury the existence of the Swiss accounts but chose to hide his true income and evade taxes; and (3) knowing that what he was doing was wrong and unlawful and therefore admitting guilt of evading the payment of taxes for the tax years 1993 through 2000. 

In January 2007, Williams finally filed FBARs for each tax year from 1993 through 2000.  The IRS assessed two $100,000 civil penalties against him pursuant to § 5321(5), available here, for his failure to file an FBAR for the tax year 2000.  The IRS only assessed penalties for the tax year 2000 because the statute of limitations for assessing penalties for the other tax years had expired.  Williams subsequently failed to pay these penalties and the Government brought this enforcement action to collect them. 

All parties agree that Williams violated § 5314 by failing to timely file an FBAR for tax year 2000.  Thus, the only question is whether the violation was willful.  In holding that Williams violation was not willful, the district court explained that (1) Williams lacked any motivation to willfully conceal the accounts because the authorities were already aware of such accounts and (2) his failure to disclose the accounts “was not an act undertaken intentionally or in deliberate disregard for the law, but instead constituted an understandable omission given the context in which it occurred.”

In analyzing whether Williams conduct was willful, the opinion explains that willfulness “may be proven through inference from conduct meant to conceal or mislead sources of income or other financial information,” and it “can be inferred from a conscious effort to avoid learning about reporting requirements.”  United States v. Sturman, 951 F.2d 1466, 1476 (6th Cir. 1991).  Likewise, “willful blindness” may be inferred where “a defendant was subjectively aware of high probability of the existence of a tax liability, and purposefully avoided learning the fats point to such liability.”  United States v. Poole, 640 F.3d 114, 122 (4th Cir. 2011).  Importantly, in cases “where willfulness is a statutory condition of civil liability, [courts] have generally taken it to cover not only knowing violations of a standard but reckless ones as well.”  Safeco Ins. Co. of America v. Burr, 551 U.S. 47, 57 (2007).  Whether a person failed to comply with a tax reporting requirement is a question of fact.  Rycoff v. U.S., 40 F.3d 305, 307 (9th Cir. 1994); accord U.S. v. Gormley, 201 f.3d 290, 294 (4th Cir. 2000). 

The Courts review of the district courts decision is narrow under the clearly erroneous standard set forth in Federal Rule of Civil Procedure 52(a).  If the district courts account of the evidence is plausible, the court of appeals may not reverse even though convinced that had it been sitting as the trier of fact, it would have weighed the evidence differently.  However, the district courts findings are not conclusive if they are plainly wrong and the appellate court is allowed to engage in meaningful appellate review.  The dissenting opinion points out that there was evidence to support the district courts ruling, and therefore the circuit court should not reverse. 

Nonetheless, the majority opinion did in fact believe, with a definite and firm conviction, that the district court clearly erred in finding that Williams did not willfully violate § 5314.  In support thereof, the Court explained that Williams signed his 2000 tax return, thereby declaring under penalty of perjury that he had examined this return and accompanying schedules and statements and that, to the best of his knowledge, the return was true, accurate, and complete.  His signature was prima facie evidence that he knew the contents of his return and at minimum, line 7(a)s directions for the FBAR requirements put Williams on inquiry notice of the FBAR requirement. 

As the Fourth Circuit wrote, nothing in the record indicated that Williams ever consulted the FBAR or its instructions. Williams testified that he did not read line 7(a) or paid attention to any of the written words on his tax return.  According to Sturman, Williams made a conscious effort to avoid learning about reporting requirements.  Thus, according to the Fourth Circuit, Williamss false answers on both the tax organizer and his tax return further indicated conduct that was meant to conceal or mislead sources of income or other financial information.  Struman, 951 F.2d at 1476.  This conduct also constituted willful blindness to the FBAR requirement.  Poole, 640 F.3d at 122.

Moreover, the Fourth Circuit held that Williamss guilty plea allocation confirmed that his violation of § 5314 was willful.  Williams acknowledged that he willfully failed to report the existence of the ALQI accounts to the IRS or Department of the Treasury as part of his larger scheme of tax evasion.  Thus, the Court held that that acknowledgement was itself an admission of violation § 5314, because a taxpayer complies with § 5314 by filing an FBAR with the Department of Treasury.  Accordingly, Williams could not claim that he was unaware of, inadvertently ignored, or otherwise lacked motivation to disregard the FBAR reporting requirement.

In conclusion, the Fourth Circuits majority was convinced that, at a minimum, Williamss actions established reckless conduct, which satisfied the proof requirement under § 5314.  Safeco Ins., 551 U.S. at 57.  Thus, the Court ruled that the district court clearly erred in finding that willfulness had not been established. 

The attorneys at Fuerst Ittleman, PL have extensive civil and criminal tax litigation experience before the U.S. District Courts, the U.S. Tax Court, and the U.S. Circuit Courts of Appeal.  You can contact us by calling 305.350.5690, or by emailing us at contact@fidjlaw.com.