UBS tax cases expose Hong Kong connection and second Swiss bank

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Two U.S. tax cheats who were aided by UBS (UBS) pleaded guilty last week, one in California and one in Florida. The investigations into their cases opened some new avenues for the IRS to pursue other tax cheats. Both used Hong Kong corporations to help hide their funds. One of them moved his accounts to another small Swiss bank, so far unidentified, in hopes of avoiding detection.

In today's Wall Street Journal, details of a court filing in California show how John McCarthy, a UBS client who pleaded guilty to one count of failing to file an annual report to the Treasury Department, channeled funds to a Swiss UBS account held in the name of a corporation he formed in Hong Kong. Hoping to gain some leniency and avoid the maximum penalty of five years in jail and fines totaling $250,000, McCarthy agreed to the filing, which details his tax scheme. He also must settle with the IRS to pay penalties, taxes and interest on the money he hid from the government.

Documents filed by the Justice Department with the U.S. District Court for the Central District of California in Los Angeles detail how Swiss advisers helped McCarthy sidestep U.S. financial regulators. As part of the deception, he opened his account with UBS under the name of a Hong Kong entity, COGS Enterprises. His Swiss advisers helped him move funds from a Los Angeles business into an unidentified U.S. bank account and then into the COGS account at UBS.

McCarthy worked with UBS representatives and a Swiss lawyer between 2003 and 2008. He told the court that UBS representatives told him that "a lot of United States clients don't report their income and just take it off the top," according to the Wall Street Journal. A Swiss attorney even recommended that he set up a Liechtenstein foundation to further conceal his funds. McCarthy is due to appear in court on September 14.

In another case, Jeffrey Chernick, a Standfordville, New York-based toy company representative, pleaded guilty in federal court in Fort Lauderdale last week to filing a false tax return that failed to disclose $8 million in offshore Swiss accounts at UBS and an unnamed second Swiss bank.

Prior to this case the IRS has focused on UBS accounts. But Chernick was urged by a Swiss bank executive to move some of his money from UBS to a smaller Zurich-based bank in 2003, according to court papers. The Swiss banker thought the smaller bank was off the radar screen of U.S. authorities because it had no U.S. presence and had not signed an agreement that would allow IRS scrutiny. UBS did sign such an agreement. Because of this agreement UBS settled a case in February agreeing to pay a fine of $780 million and to release 250 names to avoid criminal prosecution for helping U.S. taxpayers hide money offshore.

Jeffrey Chernick also used a Hong Kong entity, Simba International, to hide sales commissions he was paid by Hong Kong and Chinese toy makers. Based on the court papers filed in Fort Lauderdale, the IRS used records obtained from UBS to learn that Chernick controlled bank accounts in the name of the Hong Kong corporation. Court records indicate Chernick went as far as hand-carrying checks drawn on the Swiss UBS account from Hong Kong to the U.S. and setting up a sham $700,000 loan between his Hong Kong company and a second Hong Kong entity to repatriate funds in the U.S. so he could purchase property next to his home in New York.

Chernick also paid $45,000 to an attorney who indicated he could find out from a high-ranking Swiss government official whether or not his name was going to be turned over to the IRS. Chernick faces up to three years in prison and a fine of $250,000. Jeffrey Sloman, the acting U.S. attorney for Miami, indicated that the government's investigation is continuing in this case.

Hong Kong, which can be used as a legitimate tax-planning jurisdiction and gateway to mainland China, does make it easy to form a corporation. Some lawyers indicate that the IRS might find challenges as it tries to investigate Hong Kong corporations. In the past Hong Kong has come under fire for not sharing tax information with other jurisdictions. But the tide may be changing. A new law that would align Hong Kong with international standards on exchange of tax information was submitted to lawmakers last month. If this law passes, Hong Kong may no longer be a tax haven for tax cheats.

So far the cases being pursued by the IRS stem from the 250 names that were released last February. But soon more names may come to light. According to new reports, in a deal struck last week UBS is expected to turn over 4,500 to 5,000 names of secret Swiss accounts. Reports indicate that the deal is based on the existing U.S.-Swiss double taxation agreement of 1996 and will not require a change in Swiss secrecy laws, so the Swiss cabinet can implement the deal without having to go through parliament.

If you have been hiding funds in foreign banks and want to avoid criminal prosecution, an IRS amnesty is in effect until September 23. But you can only get amnesty if the IRS hasn't yet gotten your name first.

Lita Epstein has written more than 25 books including Reading Financial Reports for Dummies.

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