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BW: A Caribbean Tax Holiday for U.S. Businesses

The IRS is investigating how $100 billion a year in credit-card receipts are escaping U.S. sales and income taxes in locales like Aruba and St. Kitts

By Jessica Silver-Greenberg
February 11, 2010, 5:00PM EST

(This story has been updated to correct the location of payment-processing company, First Data.)

Greg Hennessy designs software in New York, where his $2 million-a-year company, SWAT, is based. His customer credit-card payments go to a bank in Panama, where his business is incorporated. As a result, he pays taxes at Panama's bargain-basement rates, far lower than what he'd owe in the U.S. "So far," he says, "it's been excellent."

Red Ball, a company in Phoenix, runs Web sites selling collectibles, software, and assorted other goods. It routes its nearly $15 million in card revenue to the tropical island of Nevis, where Red Ball is incorporated. Gregg Larry, who heads the company, says: "Sure, we get to pay less income tax, but it's not about tax evasion."

These two tiny companies illustrate a growing trend. At a time when the Obama Administration is preparing for a bitter battle with big multinationals over closing arcane tax loopholes, legions of mostly small retailers and service providers are minimizing their U.S. tax bills by sending credit-card receipts to Panama, Nevis, Aruba, the Cayman Islands, and other business-friendly havens. The IRS estimates that $100 billion a year in revenue is escaping U.S. sales and income taxes in this manner.

For several years the tax agency has been formally investigating whether the spreading credit-card practice amounts to illegal behavior. Daniel Reeves, the IRS special agent leading the probe, said in April in an affidavit filed in federal court in Denver that "a number of U.S. taxpayers may be under-reporting income, evading taxes, and breaking the law" by sending card receipts offshore. Reeves declined to talk to Bloomberg BusinessWeek, and the IRS won't provide specifics about the continuing probe.

Companies that route card revenue offshore say what they do is entirely lawful and appropriate. They typically note that they do not have to charge their customers any American sales tax because they have incorporated overseas. The companies say that they notify the IRS of this arrangement. They also maintain that eventually they pay income tax on any money they bring back to the U.S. Tax experts say that if businesses take all of these steps, they are indeed operating within the law.

The IRS suspects that a lot of the offshore credit-card activity isn't, in fact, reported and that repatriated funds frequently escape income taxation. Some executives in the business of processing card payments in the U.S. agree. "You can report a foreign bank account all day long, and that doesn't mean that you are accurately reporting the amount of money stashed there," says Todd Fuller, senior vice-president of Jetpay Merchant Services, a domestic U.S. card processor that competes against companies that arrange for offshore deposits.

Many Caribbean locales levy little or no sales tax, compared with state tax rates of up to 10% in the U.S. Similarly, many Caribbean jurisdictions impose corporate income tax rates far below the standard U.S. rate of 35%.

Hennessy, the software designer, says that while he benefits from this discrepancy, he nevertheless follows the rules. "I comply with all tax laws," he says. "I prefer to have my bank account in Panama, where it's safer than in the U.S., at least from frivolous lawsuits." Red Ball's Larry said he got fed up with paying high processing fees at home: "I just got sick of it." It's cheaper to send receipts to Nevis, he adds.

The credit-card investigation is unfolding as the Obama Administration cracks down on a variety of corporate and individual tax-minimization strategies. In the best known case, the U.S. government has pressured the Swiss banking giant UBS (UBS) to turn over the names of 4,450 American clients who the IRS suspects are using offshore bank accounts to shield personal wealth from income tax. UBS avoided criminal prosecution in the U.S. by agreeing to pay a settlement of $780 million and admitting it helped foster tax evasion.

In the offshore credit-card probe, the IRS is looking into international payment processors that help U.S.-based businesses export their card receipts, according to people familiar with the investigation. The largest such processor is First Data, which operates from offices in Sandy Springs, Ga. The private equity firm Kohlberg Kravis Roberts (KFN) purchased First Data for $26.4 billion in 2007 and installed as CEO Michael Capellas, the former chief executive of the computer company Compaq. Capellas declined to be interviewed.

Last April the IRS issued a subpoena to First Data, demanding the names of all U.S. merchants that have retained the company to help them deposit credit-card receipts in foreign banks. The IRS has not accused First Data of any wrongdoing.

First Data, which employs 25,000 people worldwide, says it has complied with the IRS subpoena. The company rejects any suggestion that it facilitates tax evasion. "First Data does not support or approve any practice that violates United States tax law, including the transfer of credit card proceeds by United States businesses to offshore accounts for the purpose of unlawful tax avoidance," it said in a written statement circulated last year in response to the IRS subpoena. Spokeswoman Elizabeth Grice said in an e-mail response to questions from Bloomberg BusinessWeek that the company's international services are intended only for corporate customers based outside the U.S. None of First Data's customers has been accused of impropriety in their dealings with the processor.

In contrast to First Data's current statements, some past online advertisements circulated by company subsidiaries and affiliates seemed to invite U.S.-based retailers to transmit card payments offshore. A wholly owned First Data unit, CardService International, has promoted a service called "split-jurisdictional settlement." That term refers to the practice of depositing a portion of credit-card receipts in U.S. bank accounts and another portion in non-U.S. accounts. In a 2001 press release, First Data itself said it helped "U.S. merchants to settle domestic credit card transactions in the United States, but have payments with universally accepted cards, such as MasterCard (MA) and Visa (V), settled to international jurisdictions."

More recent First Data promotions don't address helping American businesses process payments abroad. "The people involved with those specific [earlier] promotions are no longer with the company," says First Data's in-house managing attorney, Ralph Shalom.

Filings in two court cases suggest that First Data has helped route receipts from U.S.-based businesses to overseas tax havens. A 2006 lawsuit filed in U.S. District Court in Miami concerned a contract dispute between Republic Bank Ltd., a Trinidadian institution, and Optimal Payments, a Canadian card processor. Optimal stated in court papers that First Data helped transfer credit-card receipts for some of Optimal's business clients to the bank in Trinidad. A separate 2003 suit in U.S. District Court in San Francisco involved a contract dispute between two American companies: Payment Resources International and Paycom. In that case, Paycom said First Data deposited credit-card receipts from U.S. businesses associated with Paycom into Banco Uno, a Panamanian bank. Both suits have been dismissed.

Asked about these court filings, First Data's senior vice-president for communications, Chip Swearngan, says the company conducted itself lawfully and ethically. "We can assert from looking at these cases that First Data did not settle accounts for U.S. merchants offshore," he adds.

The IRS offshore card investigation evolved from narrower probes of the tax-haven activities of online pornography and gambling businesses, according to people familiar with the situation. One of the initial targets, Internet gaming company Bet on Sports, shut down in 2006 after the IRS alleged it illegally solicited bets from American citizens and routed payments to offshore bank accounts.

FriendFinder Networks, based in Boca Raton, Fla., runs dating Web sites, including some that appear to promote casual sex. Assembled from components of the adult entertainment company Penthouse Media Group, FriendFinder reported $224 million in revenue for the first nine months of 2009. The company processes the bulk of its credit-card revenue through a subsidiary in tropical St. Kitts, a low-tax jurisdiction, according to filings with the Securities & Exchange Commission. FriendFinder CEO Marc H. Bell declined to comment.

Now, more mainstream businesses are exploring sending card receipts abroad, according to card-processing experts. Charles Carillo says he spends 70% of his workday as a manager at the processor Offshore Merchants arranging IRS-compliant foreign accounts for U.S.-based businesses. These range from travel agents to loan modification companies to online vitamin marketers. He won't name his clients. "On average, we set up about 20 accounts a day for U.S. businesses," Carillo says.

Some American businesses say that because domestic banks view them as too risky, their only feasible option is to process card receipts abroad. "A lot of businesses—like ticket sales, or gym membership providers—can't get a U.S. merchant account," says Peter McFarlane, who writes a financial newsletter called The Q Wealth Report. "Regardless of their individual financials, they are deemed way too prone to charge-backs," meaning customers who cancel orders. Banks generally don't like doing business with smaller companies that have high rates of cancellation.

Others familiar with card processing say taxes almost always figure into the decision to go offshore. Robert Bauman, a former Republican member of the U.S. House of Representatives from Maryland, works with Sovereign Society, an asset protection company in Delray Beach, Fla. Apart from avoiding the attention of the IRS, he says, "There is simply no reason that a U.S. business needs to have card proceeds deposited in a low-tax locale."

The Daily Telegraph offered a different perspective on offshore tax havens in a Feb. 10 dispatch. The British paper suggested that retirees "may like to look further afield from the usual countries to get the best tax breaks and income tax rates." Monaco and Andorra, for example, offer a sense of romance, and neither country has taxes on income, inheritance, or wealth, the newspaper noted.

To read the full article from the Telegraph, go to http://bx.businessweek.com/tax-reduction/reference/


Silver-Greenberg is a reporter for BusinessWeek.com.

http://www.businessweek.com/magazine/content/10_08/b4167046022885.htm