February 2018 JD Supra
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If IRS wants to obtain records held in another country, Don’t ignore its request! – JD Supra.

At a certain point during an income tax examination, if the IRS determines that it needs documents or items located outside the U.S., it may issue a Formal Document Request (FDR) under the Internal Revenue Code Section 982 (IRC 982).  

IRC 982 was passed by Congress to assist the IRS during a dispute with a Taxpayer whose documents are domiciled in a foreign country. Documents located outside of the U.S. may be relevant or material to the tax treatment by a U.S. Court of a disputed item that is examined by IRS.  IRC 982 also includes documents held by a foreign entity whether or not it is controlled by the Taxpayer. 

Under IRC 982, if a Taxpayer fails to submit foreign based documentation requested in an FDR within the 90 day window prescribed by IRC 982, the Taxpayer forfeits the opportunity to use that documentation during a U.S court proceeding.  Code Section 982 prevents a Taxpayer that receives an FDR and fails to timely respond to it from presenting previously “not submitted documentation” to defend its tax position in a Court.  

When a Taxpayer ignores an FDR, an IRS Revenue Agent conducting the Taxpayer’s tax examination may conclude the examination with the information at hand, and issue an unfavorable Examination Report or a Notice of Deficiency detrimental to the Taxpayer.   If after the examination, a Taxpayer contests or challenges a decision made in Tax Court (or any other appropriate court), the IRS would file a Motion under IRC 982 to disallow  Taxpayer use at trial of foreign based documentation that was not delivered to the IRS Revenue Agent during the 90 day window provided for in the FDR. 

The IRC 982 prohibition barring Taxpayers from introducing foreign-based documentation into civil proceedings if the Taxpayer “fails to substantially comply” with an FDR, is a facts and circumstances test.  IRS Guidelines state that the following are not reasonable causes for a Taxpayer not to respond to an FDR:

  • Minority status in a foreign entity may or may not be reasonable cause for not producing records.
  • Foreign nondisclosure law is not reasonable cause under IRC section 982. Therefore, Taxpayers cannot use secrecy laws as a defense. The presence of secrecy laws does not render an FDR unreasonable.
  • If a foreign country makes it impossible to remove original documents requested, not because of secrecy laws but because of foreign tax laws or laws as to the rights of creditors, true copies may be sufficient.

Taxpayers have procedures available for resisting an FDR.  Taxpayers have the right to file a Motion to Quash an FDR in an appropriate District Court.  If a Taxpayer files a Motion to Quash an FDR, the IRS has the burden to prove to the District Court that:

  • the documentation requested in the FDR is material and relevant to the audit,
  • the audit is being conducted for a legitimate purpose,
  • the documentation sought in the FDR is not already in the IRS’s possession,
  • the IRS followed all obligatory administrative steps before issuing the FDR and
  • If the Taxpayer begins a proceeding to quash, the civil and criminal statutes of limitations are suspended during the period the proceeding to quash and related appeals are pending.

Before IRS issues an FDR, it must:

(i)                   First, issue an Information Document Request (IDR) to the Taxpayer requesting specific information.  The Taxpayer must fail to substantially answer an IDR before an FDR is issued. An FDR is not a routine information-gathering tool.

(ii)                  Send the FDR by registered or certified mail to the taxpayer’s last known address.  State the time and place for the Taxpayer to produce the documentation, an explanation of why any documentation previously supplied by the Taxpayer is not sufficient and a description of the documentation that the IRS is seeking.  It also must warn the Taxpayer of the consequences of failing to comply with the FDR (meaning not being able to present the documentation as evidence at a Court trial).

IRS is focused on international tax compliance.    Obtaining documents held in a foreign country is part of the IRS strategy.  Of importance to the IRS is its ability to obtain information that relates to offshore funds; determining if foreign source income is reported, what happens to funds when offshore accounts are closed and if information returns have been properly filed. 

Don’t be a victim of your own making.  Taxpayers that make a decision to not respond to an FDR should to understand the consequences of litigating against the IRS without documentation that could be instrumental to a positive and beneficial outcome.  Consult your tax specialist.