This is a chapter from the book: "Taxes Crossing Borders (and Tax Professors Too) - Liber Amicorum Prof Dr R.G. Prokisch".
A. Draghici LL.M.1
On matters of compliance, taxation is a special area of the law in that it requires legal subjects to consistently and actively take steps with a view to fulfilling obligations set out in the law In turn, this emphasizes the importance of government supervisory and enforcement capabilities as tools to backstop the inevitable incidence of non-compliance. However, the broad-based exercise of supervision and enforcement is incompatible with the resource-intensive nature of these functions.
Tax administrations are not functionally integrated within the environment of taxpayers, meaning they often need to rely on external sources to obtain information about the affairs of taxpayers and uncover tax avoidance and fraud. In recent years, some of the most flagrant instances of tax avoidance and fraud were revealed through whistleblowing.2
The status of whistleblowers under the law has long invited competing considerations. From the outset, few would disagree with the conventional viewpoint that whistleblowers fulfill a desirable, perhaps sometimes necessary social function. However, this broad statement determines a series of policy-related questions. Should whistleblowing in tax matters be merely protected or incentivized? When the status of whistleblowers is defined under the law, what are the factors prompting this? How and to what extent does information supplied by whistleblowers strengthen the supervisory capabilities of tax administrations? This brief contribution explores these questions at a high level. In doing so, it relies on facts and inferences from the approaches to whistleblowing in tax matters in place in Europe and United States of America (hereafter: US).
Within the European Union (hereafter: ‘EU’), the most recent and inarguably far-reaching step towards ascertaining a protected status for whistleblowers was through the adoption of Directive 2019/1937 on the protection of persons who report breaches of Union law (hereafter: Whistleblower Directive or the Directive).3 Prior to the adoption of this instrument, EU law was silent on the subject of whistleblowing.4 The legislation of some individual Member States set out safeguards for whistleblowers, however many of such measures either established a narrow degree of protection or applied on a merely sectoral basis.5 The European Court of Human Rights (hereafter: ECtHR) and Council of Europe (hereafter: CoE) were comparatively more proactive in matters of whistleblower protection and attempted to mitigate the effects of the otherwise limited scope of protection afforded to whistleblowers.
In Guja v Moldova and later in Heinisch v Germany, the ECtHR found that whistleblowing may qualify as protected speech under the European Convention on Human Rights provided that a number of conditions are met. Firstly, the approach developed in ECtHR jurisprudence inquiries into whether the whistleblower’s disclosure concerns a matter of public interest reported in good faith. Secondly, the ECtHR’s methodology assesses the channels through which the disclosure occurred. In principle, individuals are expected to report an identified wrongdoing internally to the organization concerned before proceeding to reporting to public authorities and, finally, to public disclosure.6
For its part, in 2014, the CoE published a Recommendation advising the adoption of domestic frameworks for whistleblower protection.7 The Recommendation is drafted along broad normative lines, establishing the characteristics that domestic frameworks should display as a matter of best practice. According to the Recommendation, the scope of protected information should be broadly defined based on public interest. Additionally, (potential) whistleblowers should have access to several channels of disclosure (i.e., internal reporting, reporting to regulated public bodies and public reporting in the media) and should be entitled to the protection of their identities and against retaliation, provided the whistleblower acted in good faith and under a reasonable belief that the information disclosed is accurate.8
Notwithstanding these developments at CoE level, the action at EU level was broadly perceived as a welcome next step towards a robust and cohesive framework for improving and safeguarding the integrity of whistleblower protection. The Whistleblower Directive establishes a ‘tiered-channel’ approach for whistleblower disclosures in a manner that resembles the framework established through ECtHR case law. Accordingly, the Directive requires public and private sector undertakings that employ more than 50 employees to establish and maintain internal reporting channels for the reporting of breaches of EU law covered under the scope of the instrument.9 Separate from this requirement, Member States are required to set up independent and autonomous external reporting channels through which disclosures may be made.10 Under the Whistleblower Directive, no stringent order of priority applies between reporting through an internal or external channel. The wording of the Directive suggests that a person may either escalate a report to an external channel after attempting an internal report within the organization concerned or, in the alternative, report directly through an external channel when internal reporting would be ineffective or unfeasible.11 Finally, the Directive extends whistleblowers’ protection for public disclosures in two cases. The first of these concerns an objective set of circumstances, wherein internal and external reporting efforts were exhausted and no action was taken at either level. The second covers a set of subjective circumstances wherein the whistleblower is under the reasonable belief that the breach concerns an imminent matter of public interest, that external reporting would be unlikely to result in the effective resolution of the breach or where the whistleblower perceives a high risk of retaliation.12
The material scope of the Whistleblower Directive is broadly drafted to cover breaches of EU law in a number of areas, including breaches related to corporate tax or arrangements aimed at obtaining a tax advantage that defeats the object or purpose of applicable corporate tax law.13 This wording is notable in that it paves the way for comprehensive whistleblower protection. The safeguards enshrined for whistleblowers under the Directive only apply to the extent that the whistleblower reports on conduct covered under the scope of the Directive. If the scope of applicability of the Directive were restricted stricto sensu to breaches, the reporting of lawful conduct would not trigger whistleblower protection. Ordinarily, the term ‘breach’ refers to conduct that runs contrary to a mandated legal obligation. Within the realm of tax law, the characterization of conduct as lawful or unlawful may be a particularly challenging feat when viewed from the subjective lens of the whistleblower. The absence of clear lines drawn at EU level between ‘acceptable’ tax planning in accordance with the law, aggressive tax planning and genuine tax crimes further compounds this issue.14 In principle, the onus falls on the whistleblower to determine whether a certain conduct is reportable. And since the nature of the conduct impacts the eligibility of the whistleblower for safeguards, this determination is far from inconsequential. However, the Whistleblower Directive does away with such interpretative obstacles in two main ways. Firstly, Article 2(1)(c) specifically refers to arrangements purposed on obtaining a tax advantage that defeats the object or purpose of corporate tax law. This wording readily extends to lawful conduct. Secondly and perhaps more interestingly, the Directive applies a particularly liberal definition of the term ‘breach’. In recital 18 of the preamble, the Directive discusses how breaches and arrangements aimed at securing tax advantages by defeating the object and purpose of applicable law work to negatively impact the integrity of the internal market.15 Through this wording, the Whistleblower Directive seemingly perceives breaches and arrangements equivalently. But perhaps more notably, in recital 42 the Directive sets out an outcome-based viewpoint whereby the ‘effective detection of serious harm to the public interest requires that the notion of breach also includes abusive practices’, including ‘acts or omissions which do not appear to be unlawful in formal terms but defeat the object and purpose of the law’.
Based on the Directive, protected whistleblower status may be vested upon a broad category of persons, including employees of the undertaking (and public servants), self-employed individuals, shareholders and any other person that acquires information on breaches covered by the instrument as part of work-related contexts.16 Additionally, protection extends to so-called ‘facilitators’ who assist the whistleblower in reporting or who are otherwise connected to the whistleblower.17 The rationale for including third parties within the ambit of protection is justified by the risk of retaliation against them.18
The Whistleblower Directive institutes a series of safeguards for whistleblowers and covered facilitators. This covers most notably safeguards against retaliation, defined in the instrument as any direct or indirect act or omission prompted by the disclosure, irrespective whether this occurs through an internal, external or public channel, and which is likely to prejudice the whistleblower or facilitator.19 Member States are required to set up frameworks that enable access to remedies for whistleblowers and facilitators against retaliation, e.g. by access to legal information and counsel.
As will become apparent from the following brief description, the US approach to whistleblowing in tax matters differs from the EU attitude and methodology in two main ways. Firstly, whereas the EU approach is focused on protecting whistleblowers against negative consequences for disclosures, the US approach is designed as a reward system. Secondly, whereas the EU approach amalgamates all whistleblower matters in a comprehensive context, whistleblowing in tax matters in the US is arranged under a dedicated framework.
The US has a longstanding history of formalizing whistleblowing in tax matters. Already in 1867, the federal Congress instituted the competence for the present-day Internal Revenue Service (the ‘IRS’) to provide monetary rewards to individuals that supply information which leads to the detection and enforcement of tax law violations on a discretionary basis.20 This practice was only slightly amended in 2006 with the introduction of Section 7623 of the Internal Revenue Code, whereby the amount of rewards to whistleblowers are no longer discretionary but instead granted as a percentage of the proceeds recovered by the IRS from the taxpayer on the basis of information supplied by the whistleblower, provided the proceeds in question exceed USD 2,000,000.21 In all other cases, the IRS retains the possibility to grant rewards on a discretionary basis.22 Whistleblowers may enforce their right to a reward in court.23 In practice, disputes over discretionary rewards are prompted by the criteria applied by the IRS in determining the eligibility of a whistleblower for such payment. Based on IRS regulations, discretionary rewards are only granted when information supplied by the whistleblower substantially contributes to the undertaking of enforcement action resulting in collected proceeds, a threshold requirement interpreted as being dubious and incompatible with applicable legislation in existing literature.24
Interestingly, Section 7623 of the Internal Revenue Code originally did not incorporate an anti-retaliation provision.25 In 2019, the law was amended through the Taxpayer First Act to include a paragraph setting out such safeguards.26 Notably, however, the anti-retaliation rule only explicitly mentions employees, omitting whistleblowers that obtain and report information outside a formal employment relationship or any parties associated directly with the whistleblower. This limitation is arguably odd, since whistleblower reports may be submitted to the IRS, and could potentially be rewarded, by individuals who are not employees of the undertaking in question. An employee that experiences retaliation may seek relief initially by filing a complaint with the Secretary of Labor in good faith. If this complaint is not addressed, the employee is left to resort to other available remedies under applicable labor laws.
In principle, Section 7623 of the Internal Revenue Code is silent as to the scope of disclosure, formally imbuing the suggestion that only disclosures of actual tax fraud may create eligibility for rewards and trigger protection against retaliation for the whistleblower. However, federal court judgments do confirm that Section 7623 of the Internal Revenue Code also protects disclosures related to conduct which does not amount to tax fraud, provided that the whistleblower had objectively reasonable grounds to believe the acts or omissions of the undertaking should have been reported. The question whether conduct that falls below the threshold of tax fraud but would qualify as tax avoidance falls within the scope of Section 7623 of the Internal Revenue Code was not explicitly addressed in jurisprudence at the time of writing.27
The treatment of whistleblowers is markedly different under the EU and US approaches. The EU Whistleblower Directive is predicated on instituting and safeguarding protection against retaliation. This ultimate objective is reflected within the most important provisions of the instrument; i.e., the plurality of channels through which information may be reported, the broad material and personal scope of application of the Directive). Conversely, under Section 7623 of the US Internal Revenue Code, a person supplying information on actual or potential infringements of tax law is considered an informant more so than a whistleblower. As such, the question emerges as to whether the respective histories of the EU and US approach to the treatment of whistleblowing in tax matters reveal other notable details explaining the differences between the two approaches.
As regards the Whistleblower Directive, most commentators agree that its adoption was a necessary step for filling the gaps in the protection afforded to whistleblowers under pre-existing instruments.28 Before the adoption of the Directive, whistleblower protection in Europe was an unfocused collection of (sectoral) domestic laws and ECtHR and CoE-led frameworks.29 According to recitals 1 and 2 of the Whistleblower Directive, the instrument is predicated on the viewpoint that disclosures by whistleblowers are a key component in securing the effective enforcement of EU law.30 Protecting whistleblowers (and facilitators) against factors that may discourage disclosures, preventing retaliation against whistleblowers and enabling access to relief when retaliation occurs are therefore a means to an end in preserving the enforcement and enforceability of EU law. In this respect, it appears initially striking that the US approach to whistleblowing in tax matters was originally predicated on similar notions. In the 19th century, when the US federal Congress vested the IRS with authority to reward whistleblowers for supplying information that leads to the enforcement of tax law, the overarching objective of this development was to create an additional channel on which the IRS could rely to exercise supervisory and enforcement functions.31 However, the whistleblower program was premised on the idea of incentivizing disclosures, with a considerably lesser emphasis being placed on protecting the whistleblower himself.
In reality, however, these differences are perhaps better explained by the changing societal viewpoints towards whistleblowing. In the 19th century, tax fraud tactics were comparatively unsophisticated. Tax administrations – including the IRS – disposed of considerably fewer means of extracting information. Against this backdrop, rewarding individuals for providing support to the IRS in the discharge of its functions is a self-explanatory approach. At the present time, however, whistleblowing in tax matters is indissociably linked with notions of social activism. This implies that the whistleblower is acting in the public interest and not seeking to derive a personal benefit.32
Changing attitudes towards whistleblowing and its underlying function may explain the addition of the anti-retaliation provision in Section 7623 of the Internal Revenue Code. Although the scope of protection is considerably more restricted compared to the EU’s Whistleblower Directive, the addition of the anti-retaliation rule is an implicit acknowledgement of the fact that disclosure requires protection. However, the substance of Section 7623 of the Internal Revenue Code is broadly unaltered. The IRS whistleblower program remains primarily a reward-driven mechanism. The personal and material scope of the anti-retaliation rule is narrow and does not fully account for the retribution which may be experienced by whistleblowers. It amounts to an addition to the reward framework, not to a change of paradigm. In light of the prevailing contemporary attitudes to whistleblowing described here, there is room to rightly argue that rewarding disclosures confuses the meaning of whistleblowing in tax matters. Rewards are prone to create perverse incentives and dent the notion that whistleblowing is primarily an act in the public interest.
Despite its history, the US lacks a robust and cohesive framework for whistleblowing in tax matters. Differently from the Whistleblower Directive, Section 7623 of the Internal Revenue Code frames whistleblowing as a bilateral relation between an informant and the IRS. The US approach to whistleblowing focuses on and foresees a single channel for reporting, namely official disclosure to the IRS. Internal reporting within the organization or public disclosure are not accounted for under Section 7623 of the Internal Revenue Code.
In the US, the whistleblower program entrenched in Section 7623 of the Internal Revenue Code emerged at a time when the IRS’ supervisory resources were considerably more rudimentary than at the present time. Similarly, the EU’s Whistleblower Directive comes into effect at a time when Member States have a variety of channels at their disposal to obtain information on matters of corporate taxation. In light of these realities, there is room to consider where disclosures by whistleblowers fit within the broader approach to administrative supervision and enforcement of present-day tax administration.
In the view of some authors, the Whistleblower Directive complements the body of EU legislation in the area of exchange of information by widening the personal scope of reporting.33 Concurrently, however, whistleblower disclosures are said to create possibilities for considerable overlap with other information subject to reporting by intermediaries.34 In this respect, the added value of whistleblower disclosures as a tool to support administrative supervision and enforcement could be negligible and whistleblower-supplied information may well overlap with information derived from other sources. Similar considerations may be raised in relation to the IRS whistleblowing arrangement.
In my view, any effort of defining the scope of protected whistleblower disclosures to information not otherwise subject to reporting would be superfluous at best and irrational at worst. Overlaps in information reported by whistleblowers and distinct intermediaries are an inherent consequence of ongoing developments in the area of third party information reporting legislation. Further, I dare submit that the incentives afforded to whistleblowers cannot have a meaningful impact on the quality of information disclosed and the contribution of such information to supporting the effective enforcement of corporate tax law. On the one hand, it may be asked whether mere protection against retaliation is a sufficiently strong impetus for whistleblower disclosure. Anti-retaliation legislation, coupled with the provision of resources enabling whistleblowers to access relief against retaliation experienced may be subjectively perceived as formal and overly legalistic safeguards. On the other hand, as previously surmised, an emphasis on rewarding whistleblowers may harness nefarious motives for disclosure.
Despite convergence in ultimate objectives, the EU and US approaches to whistleblowing in tax matters are grounded on different philosophies. Still, both approaches are indicative of the emerging cognizance that whistleblower disclosure should be accompanied by safeguards. In the US, the longstanding absence of an anti-retaliation rule could be attributed to the manner in which the relation between the whistleblower and IRS is impliedly framed under Section 7623 of the Internal Revenue Code, wherein the whistleblower is a mere informant. This practice, however, disregards the inherently precarious position of a person assuming the task of supplying information to a tax administration outside the framework of a legal duty to do so. In the absence of anti-retaliation provisions, the position of the whistleblower is weakened. The emerging emphasis on anti-retaliation provisions is explicable by reference to emerging notions related to the role of whistleblowing in the enforcement toolbox of tax administrations.
Whilst the relation between whistleblowing and tax enforcement is largely self-evident, the status of whistleblowers under the law raises considerations that exceed the realm of taxation. In light of this, the development of a broad-based framework for whistleblower protection in the EU though the Whistleblower Directive, extending beyond the area of taxation, is inarguably a laudable development.