New York residents David Pasquantino and his brother, Carl, believed they had devised the perfect crime in 1996 when they smuggled the first of 39,000 cases of cheap liquor from the U.S. for sale on the black market in Canada.

Although their activities cost the Canadian government about $5.8 million in lost duties, the Pasquantinos thought they were safe under a 200-year-old common law doctrine in the U.S. known as the “revenue rule.” The rule bars U.S. authorities from prosecuting individuals who broke foreign tax laws.

That changed April 26 when the U.S. Supreme Court decided Pasquantino v. United States.

“Before Pasquantino, many in corporate America considered it an acceptable practice to evade foreign taxes without fear of prosecution in the U.S.,” says Tom Carlucci, the chair of Foley & Lardner's white-collar defense and corporate compliance department. “But the Supreme Court's ruling authorizes the Department of Justice to prosecute foreign tax evasion in the U.S.”

According to Carlucci, a U.S. multinational pursuing an aggressive tax-planning policy in a foreign jurisdiction could now become subject to investigation in the U.S. To make matters worse, Carlucci believes the decision may open the door to suits by foreign governments alleging schemes to defraud them of taxes, as well as civil suits by corporations against competitors that have obtained an advantage by cheating on their foreign taxes.

“These are even bigger concerns for business on a day-to-day basis than the threat of criminal proceedings,” Carlucci says.

Who knew a pair of bootleggers from Niagara Falls could stir up so much trouble?

Expensive Liquor

The Pasquantinos saw dollar signs when they discovered Canada's average tax on liquor, including a “sin tax,” was 83 percent. A bottle of liquor that cost $56 in the U.S., they realized, would fetch at least $102 in Canada. Anyone willing to buy the liquor in the U.S. and get it into Canada without paying duty could easily pick up the difference. The cheapest sources of liquor, the Pasquantinos discovered, were discount stores in Maryland.

During a four-year period, the Pasquantinos ordered liquor from Maryland and hired drivers to take it over the Canadian border. The drivers avoided paying excise taxes by hiding the liquor in their vehicles.

Eventually, the Bureau of Alcohol, Tobacco and Firearms (ATF) became suspicious of the large and frequent booze orders coming into Maryland stores. With the stores' cooperation, ATF agents collected evidence against the suspected smuggling operation.

In April 1999, Arthur “Butch” Hilts, one of the Pasquantinos' drivers, was traveling back to western New York when he discovered that ATF agents had been trailing him from Maryland. After evading capture, he abandoned the truck and the 222 cases of liquor he was transporting.

But the authorities soon caught up to Hilts, who led them to the Pasquantinos. Acting on information from the ATF, Canadian authorities indicted the brothers, but–for some reason–didn't seek to extradite them. Instead, U.S. authorities charged the brothers under the federal wire fraud statute in April 2000. The indictment alleged the defendants used interstate wires in a scheme “to defraud the governments of Canada and the Province of Ontario of excise duties and tax revenues relating to the importation and sale of liquor.”

The Pasquantinos argued the charges were a veiled attempt to enforce Canadian tax laws in the U.S. “The core issue was whether the court was punishing foreign or domestic conduct,” Carlucci explains. “Is the ultimate crime one of defrauding Canada of excise taxes or of committing the offense at which the U.S. mail statute is aimed?”

Unfortunately for the Pasquantinos, U.S. courts took the latter view.

Rule Changes

In February 2001, a Maryland federal court sentenced the brothers to five years in prison. The 4th Circuit Court of Appeals reversed the convictions in 2002. “Although this case doesn't require us to enforce a foreign tax judgment as such,” the majority wrote, “upholding [the] conviction would amount functionally to penal enforcement of Canadian customs and tax laws.”

But the Pasquantinos didn't get off the hook so easily. In early 2003, the 4th Circuit granted an en banc review of the ruling. And in a 9?? 1/2 2 decision in July 2003, the full court reinstated the convictions, reasoning the old revenue rule didn't bar the prosecution because the Pasquantino's case only required U.S. courts to “recognize” Canadian tax laws, not “enforce” them.

The Supreme Court upheld the ruling. The proceedings against the brothers, the majority noted, didn't seek to collect money to satisfy foreign tax claims. Rather, the object of the prosecution was to punish fraudulent conduct, which was “entirely independent of foreign tax enforcement.” The link between the case against the Pasquantinos and the revenue rule was “incidental” to the charges, the High Court reasoned.

Some experts argue that as a result of this decision, U.S. courts may see it as equally irrelevant that a foreign government is the complainant in a civil suit citing foreign tax law–and even more irrelevant when the complainant is a private party.

These experts maintain that the fallout from Pasquantino could transcend the criminal law to the civil courts.

“Pasquantino's consequences could go in many different directions,” says Ellen Podgor, a professor of law at Georgia State University College of Law. “But watering down the revenue rule in the criminal context certainly raises the prospect that courts will do the same in the civil context.”

Up In Smoke

The Pasquantino majority, however, left the question open. “We express no view on the related question [of] whether a foreign government, based on wire or mail fraud predicate offenses, may bring a civil action under the Racketeer Influenced and Corrupt Organizations Act [RICO] for a scheme to defraud it of taxes,” the court wrote.

The High Court is poised to confront that issue next. Less than a week after deciding Pasquantino, the Court remanded European Community v. RJR Nabisco back to the 2nd Circuit “for further consideration in light of Pasquantino v. U.S.”

In Nabisco the European Union attempted to recover lost tax revenues resulting from alleged schemes by a number of tobacco companies to smuggle cigarettes into the EU. The tobacco companies argued the allegations would require the court to interpret foreign revenue laws.

The 2nd Circuit, applying an earlier decision in which the Canadian government unsuccessfully sued for similar conduct, held that the revenue rule applied and dismissed the action. Podgor says the 2nd Circuit–and inevitably the Supreme Court–could go either way in light of Pasquantino.

The Pasquantino majority, she notes, concluded that a wire fraud prosecution didn't offend the main justification for the revenue rule, which sought to avoid judicial evaluation of the tax policies of foreign countries. Rather the case could go forward because the executive branch–which has exclusive jurisdiction over international relations–obviously concluded that prosecuting the Pasquantinos wouldn't adversely affect relations with Canada.

“In the civil context, however, it is a foreign state or private party rather than the executive branch that makes the decision to proceed, so foreign policy considerations start to weigh heavily again, and that discourages the extension of Pasquantino into the civil area,” Podgor says.

On the other hand, Podgor notes that the Supreme Court hasn't been reluctant to extend doctrines of criminal responsibility into the civil sphere, particularly in the field of antitrust law.

Whatever the outcome, Canada's lawmakers–who are always complaining about the American government's attempts to impose its laws extra-territorially–will likely be surprised at the long reach of their own tax legislation.

New York residents David Pasquantino and his brother, Carl, believed they had devised the perfect crime in 1996 when they smuggled the first of 39,000 cases of cheap liquor from the U.S. for sale on the black market in Canada.

Although their activities cost the Canadian government about $5.8 million in lost duties, the Pasquantinos thought they were safe under a 200-year-old common law doctrine in the U.S. known as the “revenue rule.” The rule bars U.S. authorities from prosecuting individuals who broke foreign tax laws.

That changed April 26 when the U.S. Supreme Court decided Pasquantino v. United States.

“Before Pasquantino, many in corporate America considered it an acceptable practice to evade foreign taxes without fear of prosecution in the U.S.,” says Tom Carlucci, the chair of Foley & Lardner's white-collar defense and corporate compliance department. “But the Supreme Court's ruling authorizes the Department of Justice to prosecute foreign tax evasion in the U.S.”

According to Carlucci, a U.S. multinational pursuing an aggressive tax-planning policy in a foreign jurisdiction could now become subject to investigation in the U.S. To make matters worse, Carlucci believes the decision may open the door to suits by foreign governments alleging schemes to defraud them of taxes, as well as civil suits by corporations against competitors that have obtained an advantage by cheating on their foreign taxes.

“These are even bigger concerns for business on a day-to-day basis than the threat of criminal proceedings,” Carlucci says.

Who knew a pair of bootleggers from Niagara Falls could stir up so much trouble?

Expensive Liquor

The Pasquantinos saw dollar signs when they discovered Canada's average tax on liquor, including a “sin tax,” was 83 percent. A bottle of liquor that cost $56 in the U.S., they realized, would fetch at least $102 in Canada. Anyone willing to buy the liquor in the U.S. and get it into Canada without paying duty could easily pick up the difference. The cheapest sources of liquor, the Pasquantinos discovered, were discount stores in Maryland.

During a four-year period, the Pasquantinos ordered liquor from Maryland and hired drivers to take it over the Canadian border. The drivers avoided paying excise taxes by hiding the liquor in their vehicles.

Eventually, the Bureau of Alcohol, Tobacco and Firearms (ATF) became suspicious of the large and frequent booze orders coming into Maryland stores. With the stores' cooperation, ATF agents collected evidence against the suspected smuggling operation.

In April 1999, Arthur “Butch” Hilts, one of the Pasquantinos' drivers, was traveling back to western New York when he discovered that ATF agents had been trailing him from Maryland. After evading capture, he abandoned the truck and the 222 cases of liquor he was transporting.

But the authorities soon caught up to Hilts, who led them to the Pasquantinos. Acting on information from the ATF, Canadian authorities indicted the brothers, but–for some reason–didn't seek to extradite them. Instead, U.S. authorities charged the brothers under the federal wire fraud statute in April 2000. The indictment alleged the defendants used interstate wires in a scheme “to defraud the governments of Canada and the Province of Ontario of excise duties and tax revenues relating to the importation and sale of liquor.”

The Pasquantinos argued the charges were a veiled attempt to enforce Canadian tax laws in the U.S. “The core issue was whether the court was punishing foreign or domestic conduct,” Carlucci explains. “Is the ultimate crime one of defrauding Canada of excise taxes or of committing the offense at which the U.S. mail statute is aimed?”

Unfortunately for the Pasquantinos, U.S. courts took the latter view.

Rule Changes

In February 2001, a Maryland federal court sentenced the brothers to five years in prison. The 4th Circuit Court of Appeals reversed the convictions in 2002. “Although this case doesn't require us to enforce a foreign tax judgment as such,” the majority wrote, “upholding [the] conviction would amount functionally to penal enforcement of Canadian customs and tax laws.”

But the Pasquantinos didn't get off the hook so easily. In early 2003, the 4th Circuit granted an en banc review of the ruling. And in a 9?? 1/2 2 decision in July 2003, the full court reinstated the convictions, reasoning the old revenue rule didn't bar the prosecution because the Pasquantino's case only required U.S. courts to “recognize” Canadian tax laws, not “enforce” them.

The Supreme Court upheld the ruling. The proceedings against the brothers, the majority noted, didn't seek to collect money to satisfy foreign tax claims. Rather, the object of the prosecution was to punish fraudulent conduct, which was “entirely independent of foreign tax enforcement.” The link between the case against the Pasquantinos and the revenue rule was “incidental” to the charges, the High Court reasoned.

Some experts argue that as a result of this decision, U.S. courts may see it as equally irrelevant that a foreign government is the complainant in a civil suit citing foreign tax law–and even more irrelevant when the complainant is a private party.

These experts maintain that the fallout from Pasquantino could transcend the criminal law to the civil courts.

“Pasquantino's consequences could go in many different directions,” says Ellen Podgor, a professor of law at Georgia State University College of Law. “But watering down the revenue rule in the criminal context certainly raises the prospect that courts will do the same in the civil context.”

Up In Smoke

The Pasquantino majority, however, left the question open. “We express no view on the related question [of] whether a foreign government, based on wire or mail fraud predicate offenses, may bring a civil action under the Racketeer Influenced and Corrupt Organizations Act [RICO] for a scheme to defraud it of taxes,” the court wrote.

The High Court is poised to confront that issue next. Less than a week after deciding Pasquantino, the Court remanded European Community v. RJR Nabisco back to the 2nd Circuit “for further consideration in light of Pasquantino v. U.S.”

In Nabisco the European Union attempted to recover lost tax revenues resulting from alleged schemes by a number of tobacco companies to smuggle cigarettes into the EU. The tobacco companies argued the allegations would require the court to interpret foreign revenue laws.

The 2nd Circuit, applying an earlier decision in which the Canadian government unsuccessfully sued for similar conduct, held that the revenue rule applied and dismissed the action. Podgor says the 2nd Circuit–and inevitably the Supreme Court–could go either way in light of Pasquantino.

The Pasquantino majority, she notes, concluded that a wire fraud prosecution didn't offend the main justification for the revenue rule, which sought to avoid judicial evaluation of the tax policies of foreign countries. Rather the case could go forward because the executive branch–which has exclusive jurisdiction over international relations–obviously concluded that prosecuting the Pasquantinos wouldn't adversely affect relations with Canada.

“In the civil context, however, it is a foreign state or private party rather than the executive branch that makes the decision to proceed, so foreign policy considerations start to weigh heavily again, and that discourages the extension of Pasquantino into the civil area,” Podgor says.

On the other hand, Podgor notes that the Supreme Court hasn't been reluctant to extend doctrines of criminal responsibility into the civil sphere, particularly in the field of antitrust law.

Whatever the outcome, Canada's lawmakers–who are always complaining about the American government's attempts to impose its laws extra-territorially–will likely be surprised at the long reach of their own tax legislation.