The Internal Revenue Service, in probing how $100 billion of credit card payments escape sales and income taxes each year, is looking at clients of processors including First Data Corp.
At a time when the Obama administration is preparing for a battle with multinationals over closing tax loopholes, small retailers and service providers are minimizing their U.S. tax bills by sending credit card receipts to Panama, Nevis, Aruba and the Cayman Islands.
The IRS is investigating whether the practice is illegal, according to court documents. The merchants "may be underreporting income, evading taxes and breaking the law," said Daniel Reeves, the IRS special agent leading the probe, in an affidavit filed last April in Denver federal court.
Businesses that incorporate overseas must notify the IRS of this arrangement and eventually pay corporate income tax on money they bring back into the U.S. in order to operate within the law, said Milan Patel, a tax specialist at Withers LLP in Geneva and former co-manager of the IRS regional offshore credit card project.
IRS investigators suspect a lot of the offshore credit card activity actually goes unreported and that repatriated funds frequently escape taxation, according to the affidavit.
"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," said Todd Fuller, a senior vice president at Jetpay Merchant Services LLC, a domestic U.S. card processor that competes against companies that arrange for offshore deposits.
As part of its probe, the IRS issued a subpoena last April to First Data, demanding the names of all U.S. merchants that have retained the Atlanta unit of Kohlberg Kravis Roberts & Co. to help deposit credit card receipts in foreign banks.
The IRS has not accused First Data of wrongdoing; the company said it complied with the subpoena and does not aid 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.
The company's international services are intended only for corporate customers based outside the U.S., said spokeswoman Elizabeth Grice. None of First Data's customers has been accused of impropriety in dealings with the processor, she said.
In past years a First Data unit, CardService International, promoted a service called "split-jurisdictional settlement." This term referred to the practice of depositing a portion of credit card receipts in U.S. bank accounts and another part in non-U.S. accounts.
In a 2001 press release, First Data 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 and Visa, settled to international jurisdictions." More recent First Data promotions do not address helping American businesses process payments abroad.
"The people involved with those specific promotions are no longer with the company," said First Data's in-house managing attorney, Ralph Shalom.
Filings in two court cases claimed that First Data 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 2003 suit in U.S. District Court in San Francisco involved a contract dispute between two American companies: Payment Resources International and Paycom. The latter 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. Chip Swearngan, a First Data spokesman, said the company acted lawfully and ethically. "We can assert from looking at these cases that First Data did not settle accounts for U.S. merchants offshore," he said.