Published in the Russia/Central Europe Executive Guide, January 15, 2003, Volume 13, Number 01
Western Anti-Corruption Laws and Their Effects on Doing Business in Ukraine
Laws are Broad, but Key is Enforcement
By Richard Smith
Any Westerner who has done business in the countries of the former Soviet Union can tell you – the realities of local business do not always make it easy to comply with anti-corruption legislation passed “back home”. Companies need to walk a fine line if they are to accommodate the wishes of their counterparts in countries such as Ukraine, Russia, Georgia and the FSU’s half-dozen or so “Stans” without violating their home country’s laws. The good news, however, is that it is often possible to walk this line. You just need to know where the line is drawn.
Anti-corruption Alphabet Soup: the U.S. FCPA and the EU’s OECD
There are two primary rules to consider when it comes to international regulation of corrupt business practices by Western companies. For years, there was only one—the U.S.’s Foreign Corrupt Practices Act (FCPA). But recently, Europe’s Organization for Economic Cooperation and Development has joined in with its own counterpart, the Convention on Combating Bribery of Foreign Public Officials in International Business Transactions of the Organization for Economic Cooperation and Development (OECD Convention).
The FCPA criminalizes the bribery of foreign officials—anywhere in the world—for the purpose of influencing an official decision to obtain a business benefit. It also requires U.S. public corporations to comply with certain standards regarding their accounting practices, books and records and internal controls over payments.
As a result, under the FCPA, a business that either (i) intentionally bribes a foreign official, or (ii) fails to exercise sufficient control over its agents with the (perhaps unintentional) result that a foreign official is bribed, or (iii) fails to maintain its accounting records so as to prevent its funds being used to bribe foreign officials, risks prosecution by the U.S.
The OECD Convention is a multilateral agreement among—primarily—European countries (although the U.S., too, is a party), binding them to pass laws holding their own citizens and resident corporations to standards similar to those imposed by the FCPA on U.S. corporations.
One of the key differences between the OECD Convention and the FCPA is that the former (being in essence a multilateral agreement among nations) contains a mutual legal assistance requirement for its signatories. Article 9 of the Convention requires signatories to assist other signatories when they request help in prosecuting crimes covered by the Convention (i.e., bribery of public officials). At present, however, because Ukraine is not a member of the OECD, the Convention’s “mutual legal assistance” clause does not require OECD countries to assist Ukraine in prosecuting crimes under the Convention.
Capital Flight or Money Laundering?
When people speak about “money laundering” in much of the world, they usually mean funneling funds earned from illegal activities through legal “front” businesses. Such “laundering” allows the funds to appear to have been earned legitimately.1 The key concepts here are that (1) the money in question was obtained from an illegal activity and is therefore “dirty” and (2) it is the inherent “dirtiness” of the money that makes its transfer or “laundering” illegal.
Ukraine’s definition of money laundering, per se, agrees with that of the United States. Ukraine’s November 28, 2002 Law On Preventing and Counteracting the Legalization (Laundering) of Income Obtained by Criminal Means defines laundering of income as committing acts aimed at creating an appearance of legality for the use or distribution of income [from crime], or acts aimed at concealing the source of such income.
Even the export of “clean” money can be illegal in Ukraine—and this sometimes causes confusion in the United States, where free movement of capital is the norm.
For example, assume that a Ukrainian company wires $50,000 from its Ukrainian bank account to a U.S. bank account. Under U.S. law, the transfer needs to be reported to the IRS.2 However, no permit is required to transfer the money and no one will be fined, jailed or otherwise punished for making the transfer.
This, however, is not necessarily the case under Ukrainian law. To combat “capital flight,” i.e., the movement of hard currency out of Ukraine, Ukraine has severely limited the ability of Ukrainian residents to transfer hard currency abroad. In most cases, one needs to obtain a special license from Ukraine’s National Bank every time one wishes to transfer funds out of the country (unless the transferor can prove the payment is for goods or services imported). This is true regardless of whether the money in question is “dirty” or “clean.”
Under Ukrainian law, while it is true that all transfers of “dirty” money are illegal, it is not necessarily true that all illegal transfers involve “dirty” money.
To illustrate the problem, recall the 1999 “money laundering” scandal surrounding the Bank of New York’s alleged involvement in Russian “money laundering.” While some of the funds involved in that scandal were almost certainly “dirty,” it is likely that the vast majority of the funds transferred to the Bank of New York were not derived from illegal activities. Rather, they were legitimately-earned funds that were funneled out of Russia, through the Bank of New York, in violation of Russian currency control laws.
Similarly, on those occasions when money laundering charges are levied at a U.S. company doing business with Ukraine, the charges often boil down to accusations of assisting in, or benefiting from, capital flight from Ukraine, an activity that is not illegal under U.S. law.
The major point to keep in mind, then, is that even if a transfer of money from Ukraine to the U.S. violates Ukrainian law (which requires a license), it does not necessarily follow that this violates U.S. law (which requires no license).
“Is There Any Way for the IRS to Find Out if…?”
Another concern that often arises in financial dealings with Ukraine is the fear of being charged with tax evasion. Tax evasion charges often result from the use of schemes—i.e., transactions used to remove profits from Ukraine without paying more Ukrainian taxes than necessary.
Tax minimization schemes often fall afoul of Ukrainian laws—especially given that Ukraine’s parliament changes the tax laws almost as often as Ukraine’s tax authorities change their minds on the meaning of those laws. So liability can certainly attach in Ukraine. That is the bad news.
The good news is that liability for alleged violations of Ukrainian tax laws generally ends at the Ukrainian border. The risk of being prosecuted by the U.S. for violating Ukraine’s tax laws, however, is minimal.
U.S. law on the subject is clear and is encapsulated in the so-called “revenue rule.” The revenue rule can be summed up as saying that "courts of one sovereign will not enforce final tax judgments or unadjudicated tax claims of other sovereigns." Attorney General of Canada v. R.J. Reynolds Tobacco Holdings, Inc., 268 F.3d 103 (2d Cir. 2001). The logic of the “revenue rule” was laid out in Her Majesty the Queen in Right of the Province of British Columbia v. Gilbertson, 597 F.2d 14, 23-24 (2d Cir. 1963), where the court reasoned that “[U.S.] courts customarily refuse to enforce the revenue and penal laws of a foreign state, since no country has an obligation to further the governmental interests of a foreign state.”
Although the U.S. and Ukraine signed a “Convention Between the Government of the United States of America and the Government of Ukraine for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital” in 1994 (Tax Convention), this Tax Convention is not relevant to Ukrainian tax evasion prosecutions. As noted in The Republic of Ecuador v. Philip Morris Companies, et al., 2002 WL 337075 (S.D.Fla. 2002), “U.S. tax treaties typically provide for information exchange and limited collection assistance but not extraterritorial enforcement of tax judgments or claims in U.S. courts.” The judge in The Republic of Ecuador went on to say that unless a tax treaty between the U.S. and a foreign country expressly abrogates the revenue rule in relation to that foreign country, a U.S. court must abide by the revenue rule.
The Tax Convention does not expressly abrogate the revenue rule. However, the Tax Convention requires the exchange of information between the U.S. and Ukrainian governments so far “as is necessary for carrying out the provisions of this [Tax] Convention or of the domestic laws of the Contracting States concerning taxes covered by the [Tax] Convention…” But the “provisions of this [Tax] Convention” do not deal with one State enforcing the other State’s tax laws, nor punishing citizens of the first State for violating the tax laws of the second. And again, as Attorney General of Canada makes clear, the “domestic law of the [U.S.]” is the “revenue rule,” which does not envision the U.S. punishing its citizens or its corporations for violating other States’ tax laws.
It is regrettable that Ukraine’s tax laws and its tax authorities’ unpredictable enforcement of those laws often force U.S. and other Western countries to engage in convoluted tax minimization schemes. But when Ukraine objects to such transactions, U.S. companies, at least, can draw some comfort from the fact that their government will not permit Ukraine to enforce Ukrainian tax law within the United States.
118 USC 1986 codifies the U.S. understanding of the term “money laundering” (specifically, “laundering of monetary instruments”). It reads in relevant part: (1) Whoever, knowing that the property involved in a financial transaction represents the proceeds of some form of unlawful activity, conducts or attempts to conduct such a financial transaction which in fact involves the proceeds of specified unlawful activity… (B) knowing that the transaction is designed in whole or in part—(i) to conceal or disguise the nature, the location, the source, the ownership, or the control of the proceeds of specified unlawful activity; or (ii) to avoid a transaction reporting requirement under State or Federal law, shall be sentenced to a fine of not more than $ 500,000 or twice the value of the property involved in the transaction, whichever is greater, or imprisonment for not more than twenty years, or both.
2Transfers of funds in excess of $10,000 are required to be reported to the IRS by law.