Reprint from the International Enforcement Law Reporter (Aug. 2020).

By Mitchell Beebe (Staff Editor) and Bruce Zagaris (Attorney)

 

In the past it has been notoriously difficult for foreign tax authorities to go directly after U.S. persons who are or were involved in fraudulent tax schemes. These lawsuits often fail on jurisdictional grounds as the people involved and the evidence needed to substantiate a claim are sheltered behind offshore intermediaries. In a major ongoing lawsuit, this veil may now be lifted as a federal judge in New York has agreed to issue letters rogatory seeking evidence and testimony from offshore entities allegedly involved in the scheme.

Customs and Tax Administration of Denmark Litigation

Between 2012 and 2015, Denmark’s tax authority (“SKAT”) was the victim of a “Cum-Ex” tax fraud scheme thought to be controlled by British businessman Sanjay Shah.[1] Danish law requires public companies listed on the OMX Copenhagen 20 Index to withhold 27% tax on dividends paid out to shareholders. Under Art. 23 of the U.S. Tax Convention with Denmark, this tax is reimbursable to some non-Danish shareholders to avoid double taxation concerns.[2] Taking advantage of this, the conspirators allegedly purchased fictitious shares from themselves in a series of circular transactions facilitated by offshore intermediaries.[3] These fraudulent transactions generated trading records in Danish stocks which were then used to collect reimbursement on the dividends withholding tax.[4]

SKAT is now suing to recover $2.1 billion from dozens of U.S. pension plans that profited off of the scheme. The original 184 complaints filed across eleven federal districts have been consolidated in the Southern District of New York, where Judge Lewis Kaplan provided a major boost to the SKAT litigation efforts. In a pair of motions filed in April, counsel for SKAT asked the court to issue letters rogatory to courts in the British Virgin Islands and Cayman Islands. The discovery seeks “registers of shareholders; register of directors; customer due diligence records…; beneficial ownership records” and various other records involving the disputed transactions.[5] On June 30, Judge Kaplan granted both motions without altering the scope of discovery requested.[6]

Operation of the Letters Rogatory

Letters rogatory are the standard means by which a court in one country can formally request that a court in another country lend its judicial assistance in obtaining evidence or performing some other judicial act.[7] Both the British Virgin Islands (“BVI”) and the Cayman Islands are parties to the Hague Convention on the Taking of Evidence Abroad in Civil or Commercial Matters, and it is pursuant to this convention that letters rogatory are processed in these jurisdictions.[8] Now that the court in the U.S. has agreed to issue the letters rogatory, the request will next pass through the courts abroad in these territories. Provided they are satisfied the evidence sought adequately relates to the ongoing civil proceedings in the SKAT litigation, they will enforce collection of the information sought.[9]

Although these proceedings can take months to carry out, successful evidence collection pursuant to the letters rogatory will be critical if SKAT is to succeed in its litigation in the U.S. The intermediaries that will be compelled to provide evidence participated in every aspect of the scheme, from conducting the fraudulent stock transactions to acting as conduits distributing the money obtained from SKAT in a way that obfuscated the true beneficiaries of the scheme.[10] The records and witness testimony sought cannot otherwise be compelled by a U.S. court, and this evidence is necessary to expose the extent to which the accused pension companies were involved in the scheme.

Significance

Governments around the world will be closely following the ongoing SKAT litigation. It is one of the few cases where a U.S. court has not only granted jurisdiction to foreign authorities to pursue recovery against U.S. persons for tax matters, but also agreed to issue letters rogatory in furtherance of the litigation.[11] This could lead to a surge in similar lawsuits where the chances of success were deemed low after the rulings in RJR Nabisco, Inc. v. European Cmty. and its progeny dealt a major blow to foreign governments suing under RICO to recover tax revenue or  stolen assets.[12]

The rulings in RJR Nabisco and another recent case, City of Almaty v. Viktor Khrapunov, exemplify the difficulty foreign governments usually experience when trying to recover stolen assets in the U.S. In both cases, recovery under RICO’s private cause of action provision was denied for injuries that occurred outside of the U.S. These outcomes demonstrated that the courts in the United States are still willing to broadly invoke the presumption against extraterritoriality and place a high burden on plaintiffs to demonstrate a direct domestic injury. Although these cases involved RICO actions, it is likely that the same logic denying recovery in these cases could be applied to actions under any federal statute.[13]

Aside from its decision in RJR Nabisco, the Supreme Court has yet to supply an answer to this, and in the meantime foreign governments are often left to rely on the DOJ Kleptocracy Asset Recovery Initiative (“KARI”) or bringing an action elsewhere and trying to enforce a foreign judgment in U.S. courts. Governments may also choose to simultaneously prosecute individuals and seek their extradition from the U.S. Each of these alternatives presents unique challenges, particularly when trying to directly recover assets in the U.S. The KARI unit offers perhaps the best means of doing so, but a shortage of resources hampers the DOJ’s ability to bring many cases.

Another problem of trying to enforce a tax judgment in the U.S. is that, absent a tax treaty with tax enforcement and recovery provisions, the U.S. will not assist in enforcing foreign revenue judgments. The U.S. only has a handful of tax treaties with enforcement provisions. The U.S. is a member of the 1988 OECD/Council of Europe Convention on Mutual Administrative Assistance in Tax Matters.  Section II (Articles 11 through 16) provides for assistance in recovery, but the U.S. reserved on these provisions.[14] The U.S. has since signed the 2010 Protocol and Amended Convention. The Senate Foreign Relations Committee had a hearing, but the U.S. has not ratified it and Treasury has not said whether it intends to reserve again on the recovery provisions. Privately, Treasury officials have said that the reason the U.S. has reserved is it believes far more countries will request assistance under the recovery provisions than will the U.S. request to other countries.

The ongoing SKAT litigation signals that the present state of affairs may not be as dismal as previously thought. It demonstrates that outside of the RICO context, some lower courts have not taken a severe interpretation of RJR Nabisco and are leaving the door ajar for foreign entities looking to recover stolen assets. Here, the reason for this may be that the conduct of entities within the U.S. was in direct furtherance of the fraudulent scheme perpetrated against Denmark, and not a detached downstream consequence of the fraud as was the case in many previous litigation efforts. Although a judgment in this case is still many months away, Judge Kaplan’s opinion will try to answer many of these questions.

One other point of significance that might result from the case is what, if any, liability the intermediaries involved in the tax scheme have. The BVI and Cayman Islands are not the only offshore jurisdictions for sophisticated structuring. Depending on their level of due diligence in arranging these transactions, exposing the actions of these intermediaries could lead to liability and may deter those in other foreign jurisdictions from similar conduct. It is difficult to say at this stage, but this is another area of the case where the decision to issue letters rogatory will have an impact.

[1] Cum-Ex was the name given to a huge number of fraudulent transactions that exploited loopholes on dividend payments allowing multiple parties to claim tax refunds on shares they didn’t actually own. It is thought that at least ten European countries were affected, resulting in the loss of billions of euros from those nations’ treasuries.

[2] Tax Convention with Denmark, U.S.-Den., Aug. 19, 1999, TIAS No. 13056.

[3] Pl.’s Mem. of Law in Supp. of Mot. Req. Issuance of Letters Rogatory. ECF 328.

[4] Id.

[5] Id.

[6] Mems. Endorse. of Case 1:18-cv-04047 Granting Mots. for Disc. Re: Letters Rogatory. ECF 382-83.

[7] See Intel Corp. v. Advanced Micro Devices, Inc., 542 U.S. 241, 246 (2004).

[8] Status Table: Convention of 18 March 1970 on Taking of Evidence Abroad in Civil or Commercial Matters, https://www.hcch.net/en/instruments/conventions/status-table/?cid=82 (last visited July 20, 2020).

[9] See Evidence (Proceedings in Foreign Jurisdictions) Ordinance, Cap. 24 (Oct. 1, 1988) (Virgin Is.), Hague Convention on the Taking of Evidence Abroad in Civil or Commercial Matters, March 18, 1970, 23 U.S.T. 2555.

[10] Pl.’s Mem., supra, note 2.

[11] See e.g. U.S. v. Sealed 1, 2000 U.S. App. LEXIS 27216 (9th Cir. Nov. 1, 2000) (affirming defendant’s motion for dismissal of the Russian Federation’s request for letters rogatory in furtherance of a tax fraud lawsuit).

[12] See RJR Nabisco, Inc. v. Eur. Cmty., 136 S. Ct. 2090 (2016), City of Almaty v. Viktor Khrapunov, 956 F.3d 1129 (9th Cir. 2020), Republic of Kaz. v. Stati, 380 F. Supp. 3d 55 (D.D.C. 2019).

[13] Franklin A. Gevurtz, Building a Wall Against Private Actions for Overseas Injuries: The Impact of RJR Nabisco v. European Community, 23 U.C. Davis J. Int’l. L. & Pol’y. 1, 15-16 (2016) (discussing the broader impacts of the RJR Nabisco decision).

[14] For the text of the 1988 Convention, see https://www.oecd.org/ctp/exchange-of-tax-information/theconventiononmutualadministrativeassistanceintaxmatters-twentiethanniversaryedition.htm.  For a list of the countries participating in both the 1988 Convention and the 2010 Protocol/Amended Convention, see https://www.oecd.org/tax/exchange-of-tax-information/Status_of_convention.pdf.