	Additional Time Needed to Complete Offshore Tax Evasion Examinations

Examinations involving offshore tax evasion take much more time to  develop and complete than examinations of other types of returns, but  when offshore examinations are completed, the resulting median  assessment is almost three times larger than for all other types of  examinations. However, because of the 3-year statute, the additional time  needed to complete an offshore examination means that IRS sometimes  has to prematurely end offshore examinations and sometimes chooses not  to open an examination at all, despite evidence of likely noncompliance. Some offshore examinations exhibit enforcement problems, such as  technical complexity, which are similar to those where Congress has  granted a statute change or exception in the past. IRS Does Not Pursue Some Apparent Offshore Tax Evasion Because of the 3- Year Statute of Limitations

Revenue agents and managers told us that because IRS has only 3 years  from the time the taxpayer files a tax return, and offshore cases take  longer than nonoffshore cases to identify and develop, some case files are  not opened for examination because insufficient time remains under the  statute to make the examination worthwhile. However, a low percentage of U.S  source income flows through QIs. The qualified intermediary data were reported by  withholding agents and edited by IRS, and do not include an unknown  amount of activity that was unreported. Under the QI program, foreign  financial institutions sign a contract with IRS to withhold and report U.S.  source income paid offshore. The QI Program Provides Some Additional Assurance That Tax Is Properly Withheld and Reported

Compared to U.S withholding agents, IRS has additional assurance that  QIs are properly withholding the correct amount of tax on U.S. source  income sent offshore. Second, QIs accept enhanced responsibilities for providing assurance that  customers are in fact eligible for treaty benefits and exemptions. Third, and importantly, QIs agree to contract with independent third  parties to review the information contained in a sample of accounts,  determine whether the appropriate amount of tax was withheld, and  submit a report of the information to IRS. Source Income and Individuals May Inappropriately Receive Treaty Benefits as Owners of Corporations

Although the QI program provides IRS some assurance that treaty benefits  are being properly applied, a low percentage of U.S. source income flows  through QIs and U.S. taxpayers may inappropriately receive treaty benefits  and exemptions as owners of foreign corporations. Source Income Flows Outside the QI System

As shown in table 1, for tax year 2003, 87.5 percent of U.S. source income  reported to IRS was reported by U.S. withholding agents, not QIs. Thus,  the overwhelming portion of this income flowed through channels that  provide somewhat less assurance of proper withholding and reporting  than exists under the QI program. However, within their limited scope, QIs’  auditors are not responsible for following up on possible indications of  fraud or illegal acts that could have an impact on the matters being tested  as they would under U.S. Government Auditing Standards. In addition,  IRS obtains considerable data from withholding agents but does not make  effective use of the data to ensure that withholding agents perform their  duties properly. The remaining 2 were asked to leave the QI program.
Why GAO Did This Study

Offshore tax evasion is difficult for the Internal Revenue Service (IRS) to address. IRS examines tax returns to deal with offshore evasion that has occurred. IRS's Qualified Intermediary (QI) program seeks to foster improved tax withholding and reporting. GAO was asked to testify on two topics. First, GAO was asked to provide information on (1) the length of, and assessments from, IRS's examination of tax returns with offshore activity and (2) the impact of the 3-year statute of limitations on offshore cases. Second, for the QI program, GAO was asked to address (1) program features intended to improve withholding and reporting, and (2) whether weaknesses exist in the U.S. withholding system for U.S. source income and QI external reviews and IRS's use of program data. GAO relied on prior work for the first topic. For the QI program, GAO used the latest data that were available and corroborated by IRS.

What GAO Found

Examinations involving offshore tax evasion take much more time to develop and complete than other examinations--a median of 500 more days for cases from fiscal years 2002 to 2005, but their resulting median assessment is almost three times larger than for all other examinations. Nevertheless, because they take more staff time, offshore examinations yielded tax assessments per hour of staff time that were about one-half of that for all other examinations. Because of the 3-year statute of limitations, the time needed to complete an offshore examination means that IRS sometimes prematurely ends offshore examinations or decides not to open an examination, despite evidence of likely noncompliance. Congress has granted a statute change or exception when enforcement challenges similar to those found in offshore cases have arisen in the past. QIs are foreign financial institutions that contract with IRS to withhold and report U.S. source income paid offshore to foreign customers. The QI program provides IRS some assurance that QIs are properly withholding and reporting tax on U.S. source income paid offshore. QIs (1) are more likely to have a direct working relationship with customers who claim reduced tax rates under tax treaties, (2) accept responsibilities for ensuring customers are in fact eligible for treaty benefits, and (3) agree to have independent parties review a sample of accounts and report to IRS. However, a low percentage of U.S. source income flows through QIs. For tax year 2003, about 12.5 percent of U.S. source income flowed through QIs. About 87.5 percent flowed through U.S. withholding agents, which provide somewhat less assurance of proper withholding and reporting than do QIs. In addition, U.S. persons may be able to evade taxes by masquerading as foreign corporations. The contractually required independent reviews of QIs' accounts do not require auditors to follow up on indications of illegal acts, as would reviews under U.S. Government Auditing Standards. While IRS obtains considerable data from withholding agents, it does not make effective use of the data to ensure proper withholding and reporting has been done.