You are tax director of a multinational corporate group sitting in your office in New York. It is late Friday and, after a difficult week (like every other week), you are looking forward to some time off at the beach. Based on information that Country X, with a new administration and a view to maintaining its manufacturing base, has recently adopted a lax transfer pricing enforcement policy, you have just signed-off on a new transfer pricing strategy for the sale of goods by your company’s Country X manufacturing unit to your sales unit in Country Y, a well-known low tax jurisdiction. Based on Columbia Rope Co. and PPG Industries, you are comfortable that your foreign tax planning services has a valid business purpose for U.S. tax purposes, and that your U.S. parent does not have constructive dividend exposure. You also are comfortable that your source of information on Country X’s new policy is reliable and that Country X will not be challenging you. Time to head to the beach? Not just yet. You now need to consider whether you have just exposed yourself and your company to criminal tax liability in the U.S. Perhaps you also need to consider the possibility of a civil RICO claim by that contentious competitor always on the look-out for any possible advantage.
In Pasquantino v. United States, decided April 26 of this year, a bare majority of the Supreme Court held that persons smuggling liquor into Canada in violation of Canadian excise tax laws (but not U.S. law) violated the federal wire fraud statute. Pasquantino spells bad news not only for smugglers. Under the rationale of that decision, any lawyer, accountant, corporate tax officer or other person developing or implementing strategies to reduce someone’s foreign taxes might similarly be criminally prosecuted. The only elements needed for conviction are that the planning or implementation activity occurred on U.S. soil and relied on the use of a telephone, e-mail or mail, and that the tax savings strategy evades the laws of a foreign country, all as determined by a U.S. court.
The Court in Pasquantino faced two principal issues: first, whether the smuggling scheme before it violated the wire fraud statute in the first instance and, second, if so, whether the common law “revenue rule” excepted frauds directed at foreign tax avoidance from the reach of the wire fraud statute.
As to the first issue, the defendants argued that their conduct failed to constitute a “scheme or artifice to defraud” and that, even if it did, the object of their fraud was not money or property, as required by the statute. Justice Thomas, writing for the majority, wasted little time finding both that the right to be paid taxes is a property right worth of protection by the wire fraud statute and that the defendants. conduct, involving concealment and a failure to declare the liquor in their trunk to customs officers, plainly constituted a “scheme or artifice to defraud.”
Justice Thomas took a more studied approach to the defendants’ revenue rule contentions. The Court appeared amenable to the proposition that the revenue rule, of ancient common law origin, would bar a foreign sovereign from suing in a U.S. court to collect taxes owing to it under its own laws. Pasquantino, however, involved an action, not by a foreign sovereign to collect a tax owed to it, but by the United States to enforce a penal statute in its own courts, and on this distinction the majority Justices and the defendants parted ways. The defendants marshaled an abundance of authority to the effect that the revenue rule enjoyed a far broader reach and foreclosed any use of the courts of this country where the underlying conduct at issue was the violation of a foreign country’s tax laws. Granting that that case against the defendants effectively enforced Canadian tax law, at least “in an attenuated sense,” Justice Thomas concluded that revenue rule jurisprudence, as it existed in 1952 in any event (when the wire fraud statute was enacted), did not clearly proscribe all access to U.S. courts just because foreign tax evasion was an element of the underlying conduct. Moreover, Thomas found nothing in revenue rule law suggesting that it should be so construed. While acknowledging that the principal evil that the revenue rule was designed to guard was “judicial evaluation of the policy-laden enactments of other sovereigns,” Thomas concluded that the executive branch’s very involvement in the case may be taken as an indication that it has assessed “the prosecution’s impact on the Nation’s relationship with Canada and concluded that it poses little danger of causing international friction.” As to the defendants’ final assertion that U.S. courts lack the competency to evaluate the validity of foreign tax laws and/or schemes to avoid them, Thomas simply found that “[f]oreign law, of course, posed no unmanageable complexity in this case. The District Court had before it uncontroverted testimony of a Government witness that petitioners’ scheme aimed at violating Canadian tax law.”
At bottom, however, the Court’s action sanctions use of the wire fraud statute as a means to enforce foreign tax law. Clearly, the defendants’ conduct fell within the scope of the wire fraud statute only because such conduct violated Canadian tax law. But for the violation of Canadian law, no aspect of the defendants’ conduct was criminal in the U.S.
Certainly, one might legitimately wonder why or to what extent the federal government would be motivated to prosecute its own citizens for violating the laws of a foreign country, particularly when the conduct involved is not a universally recognized crime such as smuggling, or when the foreign laws involved and/or the alleged violation of them are not clear. Pasquantino consequently may see little real life application. But a wire fraud violation conceivably may serve as a predicate offense triggering claims under the Racketeer Influenced and Corrupt Organizations Act (RICO), and a wide range of private interests can have standing to bring civil RICO actions, including not only a foreign government whose tax laws have been skirted but also a competitor seeking to wrest any advantage it may over a tax-aggressive rival.
In fact, in the week following Pasquantino, the Court vacated and remanded a decision of the Second Circuit barring the European Community from pursuing on behalf of itself and member states a RICO claim in the U.S. courts against the major tobacco companies based on their alleged participation in cigarette smuggling schemes in violation of the tax laws of various European countries. In that case, European Community v. RJR Nabisco, the alleged predicate offenses included a variety of crimes, including violations of the wire fraud and mail fraud statutes. The plaintiffs sought an injunction and damages based on lost tax revenue and costs of prosecution. The Second Circuit upheld the District Court.s rejection of the case, holding that the substance of the action was for the collection of foreign taxes and that the revenue rule therefore barred the same.
To the extent that the revenue rule, after Pasquantino, does not bar a case such as RJR Nabisco, the volume of foreign tax issues heard in U.S. courts could increase dramatically. If a foreign sovereign can sue in U.S. courts to collect tax owed to it, the classic evil targeted by the revenue rule, then any person with standing to bring a RICO claim could also sue in a U.S. court on account of alleged foreign tax evasion, using a violation of the mail or wire fraud statutes as the predicate offense.
It is by no means clear that the Pasquantino Court’s reading of the revenue rule will compel the Second Circuit to find that RJR Nabisco can go forward. As discussed in Pasquantino, part of the rationale informing the revenue rule is avoidance of the international friction that conceivably may follow from the courts of one country interpreting the tax laws of another (“policy-laden enactments” in the words of Justice Thomas). Under our Constitution, international relations are the exclusive province of the executive and legislative branches, and U.S. courts therefore arguably should avoid the interpretation of foreign tax laws altogether. In response to the defendants’ contentions along these lines in Pasquantino, Justice Thomas wrote that it is “[t]rue a prosecution like this one requires a court to recognize foreign law to determine whether the defendant violated U.S. law. But we may assume that by electing to bring this prosecution, the Executive has assessed this prosecution’s impact on this Nation’s relationship with Canada and concluded that it poses little danger of causing international friction.” The same conclusion may not follow where the claimant is a foreign sovereign. It particularly may not follow where the claimant is a private citizen with little or no stake in the world of foreign relations.
Accordingly, the scope of Pasquantino’s full impact will need to await another day. At a minimum, however, the case is remarkable for allowing the conviction of a U.S. criminal statute to stand on nothing more than the evasion of foreign taxes and it stands as yet an additional beacon counseling a new level of prudence in the conduct of international business affairs in the United States in the early twenty-first century.