Office of the Comptroller and Auditor General - Dirt Investigation - Chapter 25

Chapter 25 : Reclassification of Accounts by AIB Group

Background

There was a recognition within AIB from 1989 onwards that the group needed to address compliance with non-resident procedures.

This recognition culminated in

efforts to stop the branch network accepting any potentially bogus non-resident accounts after 1989

the taking of positive steps in 1991 to reclassify existing bogus non-resident accounts.

The first set of measures were described by the bank's former General Manager - Branches as part of a range of issues being addressed at the time in the context of a new structure for the company. The second phase arose out of an approach by Revenue in February 1991.

Origin of the Non-Resident Problem

The bank has pointed out that the origin of the non-resident compliance problem lay in the historical position, under which pre-1986 provisions allowed exemption from reporting of interest paid to non-residents on the basis of a notice (Form F) under which an account was classified as non-resident in circumstances where the notice declared that the beneficiary of the interest (who was not named) was non-resident.

The bank contended that

The pre - 1986 legislative provision was open to abuse

Non-resident books of banks contained accounts opened before 1983 when banks had no function in checking the bona fides of a person signing a Form F or of the beneficial owner of interest.

There were several exchanges with Revenue on the problem over the years 1963 - 1986.

There was a major competitive issue for banks as other financial institutions (particularly building societies) could offer complete confidentiality from reporting of interest to Revenue which was valued very highly by customers.

There was sensitivity in both official and banking circles that any severe action across the area of non-resident accounts would cause a flight of funds. The economy was in difficulty and liquidity was tight. A flight of funds would have had negative repercussions on interest rates and exchange rates.

With the introduction of DIRT the existing pool of non-resident funds became eligible for exemption from the tax on the basis of the existing Form F notice for a transitional period up to April 1987.

In regard to the situation that pertained on the introduction of DIRT AIB bank contended that

At its introduction, there was considerable sensitivity to the potential for a flight of funds and its consequences for the economy.

On the expiry of transitional provisions in 1987, the Minister for Finance gave assurances that, while Forms 37 were inspectable, no such inspection would in fact take place at any time. The only inspection of Forms 37 ever conducted in AIB was in April 1998, some twelve years after the introduction of DIRT.

Despite efforts by the financial sector to comply with the new DIRT provisions, there was evidence that bogus non-resident accounts were still a problem in 1987 and 1988 and that Revenue and the Department of Finance were aware of this.

Attempts to address the Problem in 1990

Internal AIB documentation indicated that the General Manager - Branches was involved in moves to address this matter in the 18 months leading up to February 1991. A memorandum of a meeting on 31 January 1991 between the Group Taxation Department and the General Manager - Branches records that the General Manager advised that the present policy of the bank which had been in place for the previous 18 months or so since he took up his present position was that only genuine non-resident accounts could be excluded from DIRT. All other Anon-resident@ accounts which were formerly the subject of a Form F had since been made liable to retention tax in situations where they remained with AIB.

In evidence the General Manager - Branches explained that this was being pursued in the context of an attempt to change culture within the bank and in 1990 the thrust of the efforts were towards ensuring that new accounts opened by the bank and categorised as non-resident were genuine.

The efforts did not extend at this time to reviewing existing accounts.

While this pertained within the branch network there is evidence that approximately ,15m was reclassified as DIRT liable in the RDC of AIF in the year ended December 1990.

The 1991 Reclassification Exercise

Revenue Approaches

In early February 1991 Mr McCarthy of the Revenue's Inspection Branch informed the bank that he wished to discuss the administration of non-resident accounts on a bank-wide basis. A meeting subsequently took place on 13 February 1991. The issues discussed and the results of the discussions are outlined in Chapter 26. Subsequently Mr McCarthy wrote to the bank and a series of telephone discussions were recorded by the bank.

There is disagreement between Revenue and the bank on the interpretation of discussions, letters and telephone communications. For purposes of this Chapter, I am recording the AIB understanding of the agreement as set out in its internal papers in order to present a coherent summary of the action undertaken by the group in response to the Revenue approach.

AIB Summary of Meeting of 13 February 1991

The internal papers of AIB record the bank's understanding of the Revenue demands in the following terms.

That an examination of all non-resident accounts be carried out and each Branch Manager certify to his Regional Manager that, as at 30 June 1991, all non-resident accounts exempted from Retention Tax were genuine.

That AIB, in turn, provide the Revenue with a similar certification.

That it become part of the Internal Audit brief to check exempt non-resident accounts to

ensure that the appropriate declaration was held.

look behind such declarations in order to check their authenticity.

That, when accepting a Form 37 on or after 30 June 1991, the person accepting such declaration should sign it.

The bank was also required to note that

when carrying out the certification, any interest paid gross on bogus non-resident accounts between the 6 April 1990 and the date of the exercise would be the subject of a Retention Tax payment to be negotiated with the Revenue without penalty and publication.

where the Revenue discovered any irregularities after 30 June 1991, both the bank and the official involved would be subject to prosecution.

Implementing the Revenue Demands

An ad hoc committee was established to examine how the above matters might be approached. The committee included a number of Regional Managers, the Group Taxation Manager, representatives from Financial Control and the Retail Deposit Centre and a representative of the Head of Branches. The paper discovered in this connection set out a list of issues to be examined by the committee.

The issues to be addressed included

how to handle bogus non-resident accounts closed since April 1990

the weeding out of extant bogus non-resident accounts and the treatment of interest paid gross in October 1990

how to handle cases of documentary non-compliance on the part of accounts adjudged to be those of genuine non-residents

how the associated exchange control issues might be handled in circumstances where the accounts were to retain their non-resident (external) status for Central Bank reporting purposes but were being classified as DIRT liable for tax purposes.

The result of the committee's work was a set of instructions issued to branches and the RDC. A briefing pack, including a slide presentation was compiled and Regional Managers used this to brief Branch Managers.

Instructions Issued

I was informed in evidence that the process of account reclassification was undertaken by a committee chaired by a Regional Manager. The approach adopted was to brief managers at a series of meetings throughout the country and issue them with instructions.

Branches and the RDC were instructed to proceed as follows

Branch Managers were to carry out an examination of all non-resident accounts held at their branches and take the following action

accounts without declaration forms to be made DIRT liable

in a situation of doubt about the non-residential status of the customer the account should be made liable to DIRT.

in the case of the RDC which administered term deposits on a central basis, the branch introducing the deposit was to identify accounts to be recategorised and advise the RDC. In the case of missing declaration forms the recategorisation was to be done by the RDC itself.

leave the non-resident flag intact for Central Bank reporting purposes but under no circumstances should such funds be transferred outside the State as they were not eligible for credit to an external account.

to make no adjustment for interest paid gross in the past.

Branches were requested to have the exercise completed by 27 March 1991.

Monitoring of the Exercise

The bank has informed me that the ad hoc committee met on a number of occasions to consider progress and discuss problems arising mainly in relation to complaints from branches regarding the threat of loss to competitors of customers' funds because such funds were being made liable to DIRT.

Timing of Reclassifications

From evidence given to me in the course of oral hearings it appears that the bulk of reclassifications in the branch network were effected before the interest crediting in April 1991.

It appears from an examination of the relevant account balances that in the case of the RDC the major portion of reclassifications occurred in the period after April 1991.

In the case of term deposits held in the RDC, interest is credited on maturity. This makes the extent to which a post-April 1991 reclassification impacted on the DIRT yield difficult to estimate.

Retrospective DIRT

The exercise did not extend to a recalculation of DIRT in respect of accounts wrongly categorised as DIRT exempt in the past. This was a departure from the original Revenue directions as recorded by AIB and the correctness of this approach depends on which version of the February 1991 arrangement is taken.

Revenue would maintain the retrospection applies back to the commencement of the bogus non-resident status and applies for all periods of non-compliance

If the contemporaneous AIB version were accepted it would infer that DIRT would be liable on all deficient accounts from April 1990. However, AIB claims that the situation further evolved as a result of subsequent communications.

Chapter 26 deals with these issues.

Outcome of the Exercise

The net effect of the reclassification exercise is difficult to calculate in precise terms because it was organised on the basis of reflagging accounts without establishing any control totals over the volume of funds being recategorised as a result of the exercise.

Three indicative sets of figures are available to gauge the scale of reclassifications

An analysis of account volumes and numbers

A contemporaneous report produced around July 1991

The results of a lookback exercise completed in 1999.

Analysis of Movement in Volume and Numbers

AIB Branch Network

March 1990

?'000

March 1991

?'000

Movement In Year

?'000

Resident

DIRT Liable

DIRT Exempt

1,765,892

55,439

1,881,467

20,347

115,575

(35,092)

Nn-Resident

DIRT Liable

DIRT Exempt

74,227

359,702

234,307

151,513

160,080

(208,189)

The above figures indicate a net reduction of ,208m in non-resident funds classified as DIRT exempt in the year to March 1991. Any estimation of the total funds reclassified would need to take account of the net external flows of deposit funds. The reduction in the number of non-resident DIRT exempt accounts was around 20,000.

Allied Irish Finance

December 1990

?'000

March 1991

?'000

June 1991

?'000

Movement December 1990 to June 1991

?'000

Resident

DIRT Liable

DIRT Exempt

634,381

66,836

692,324

61,797

757,049

65,352

122,668

(1,484)

Non-Resident

DIRT Liable

DIRT Exempt

18,665

400,302

48,848

373,389

165,590

249,244

146,925

(151,058)

The above figures indicate that a net ,151m moved from non-resident DIRT exempt to DIRT liable funds in the half year to June 1991. The bulk of this reduction occurred after March 1991 (,124m). The gross movement as a result of reclassifications is difficult to estimate as it depends on the extent of net new funds.

The net reduction in numbers of non-resident DIRT exempt accounts was around 4,000.

Contemporaneous Reports

An analysis attached to a report on 29 July 1991 prepared by the Tax Compliance Manager indicates that in the two month period between 5 March 1991 and 7 May 1991 the movement in non-resident deposit levels were

Branch

Deposits

?'000

RDC

Deposits

?'000

Total

?'000

Balance at 5 March 1991

364,591

393,155

757,746

Balance at 7 May 1991

175,701

209,018

384,719

Movement in period

188,890

184,137

373,027

Analysis of Movement

Recategorised DIRT liable

167,473

167,240

334,713

Transfer to RDC - DIRT Liablea

17,512

-

17,512

Transfer to Branches DIRT Liablea

-

7,124

7,124

Transfer to other products

3,137

6,092

9,229

Lost to competitors

2,385

7,713

10,098

Other Movements

(1,617)

(4,032)

(5,649)

Movement in Period

188,890

184,137

373,027

a It is unclear how the net internal movement of ,10m impacted on the figures.

The total amount of funds reclassified as DIRT liable deposits was calculated at ,359m.

Lookback Exercise 1999

Branch Network

In respect of the branch network the lookback exercise completed in 1999 identified those accounts whose status had altered to DIRT liable in the twelve months to March 1991.

The total movement in funds was as follows

?m

Reclassified to DIRT Liable - Non-Resident 161.5

Reclassified to DIRT Liable - Resident 18.2

Total Branch Reclassifications to DIRT Liable 179.7

Retail Deposit Centre

In the case of the RDC the lookback exercise identified ,155m of an increase in the volume of DIRT liable accounts between April 1990 and September 1991.

A paper prepared in November 1998 by the RDC for the Group Taxation Department indicated that recategorisation of former DIRT Exempt non-resident funds had been effected as follows

Period

Transfers to Resident DIRT Liable

Transfers to Non- Resident DIRT Liable

Total

?m

?m

?m

January - December 1990

3.64

11.60

15.24

January - December 1991

18.30

176.74

195.04

January - March 1992

1.10

1.25

2.35

Total

23.04

189.59

212.63

This appears to indicate that ,212m was reclassified in the 27 months to March 1992. ,105m was reclassified during the six months to 30 September 1991.

Comparison between 1991 Report and 1999 Lookback

Branch Network

RDC

Total

Reclassifications per Internal Report of July 1991 between 5 March and 7 May 1991

184,985

174,364

359,349

Lookback Exercise

1 April 1990 - 31 March 1991

179,700

-

374,740

1 January 1991 - 31 December 1991

-

195,040A

Although both exercises offer broadly similar results as to the extent of reclassification care is necessary in interpreting these figures since they were compiled on a different basis and span different periods.

Classification Movements

The designation of non-resident Irish Pound funds in the branch network and the RDC following reclassification compares with the current book as follows.

Branch Network

Retail Deposit Centre

DIRT

Exempt

DIRT

Liable

DIRT

Exempt

DIRT

Liable

Following Reclassification

151,513

39%

234,307

61%

255,346

62%

153,846

38%

Currently

163,987

70%

69,310

30%

584,607

88%

76,835

12%

Following reclassification only 39% of non-resident accounts were treated as DIRT exempt in the branch network. The corresponding proportion in the RDC was 62%. These percentages have risen over the intervening period to 70% in the case of the branch network and 88% in the case of the RDC.

The bank has informed me that accounts which were classified as non-resident but liable to DIRT could have arisen from the following situations

A Form 37 was not received by the bank from the relevant account holder.

The bank had reason to be dissatisfied as to the accuracy of a declaration of non-residence supplied to it.

A non-resident account holder may have consciously decided that he or she would not sign a declaration of non-residence on Form 37 for reasons of confidentiality (typically, a fear of the exchange of information under the provisions of a tax treaty between Ireland and another country) and was prepared to suffer the consequent deduction of DIRT.

AIB Review of the Reclassification Process

In July 1991 the Tax Compliance Manger set out details of the background to and outcome of the reclassification exercise. The full text of that document and others referred to therein is set out in Appendix H.

Branch Certifications

According to the AIB version of the meeting with Revenue two certifications were demanded by the Revenue.

a certification by managers that non-resident accounts designated as DIRT exempt were genuine whether held in the branch or the RDC and that such accounts were supported by the appropriate non-resident declarations

a certification by AIB to Revenue on the result of this process.

1999 Lookback - DIRT at Issue

In the course of the lookback exercise completed in 1999, and without any admission of liability AIB sought to establish the potential DIRT at issue arising out of the reclassifications effected. The bank has stressed that this estimation was done on a very conservative basis and its purpose was to rebut media reports of a potential liability of ,100m.

Chapter 26 refers to the interaction between Revenue and AIB and the contentions of both sides in regard to whether AIB had any retrospective liability for DIRT arising out of the reclassifications effected.

Two separate bases were used to estimate the DIRT at issue - scenario testing and sampling combined with systems interrogation. Scenario tests indicated that a figure in the range of ,25m - ,32m represents the outer limit of the DIRT at issue. The sampling and systems interrogation exercise indicated an outer limit of the order of ,35m.

The report produced following the exercise noted that these estimates were prepared on a conservative basis due to the fact that, in the absence of specific information, the bank worked on the basis that in the case of accounts in existence at April 1990, which were recategorised from DIRT exempt to DIRT liable at any time between 6 April 1986 and 30 September 1991, all were "bogus" for the entire period prior to recategorisation. However, included within this category would be genuine recategorisations, such as in the case of returning emigrants, details of which AIB were not in a position to determine. Also included would have been accounts of genuine non-residents where the appropriate declarations were not in place.

Pricewaterhouse Coopers independently examined the methodologies used and the report assumptions and tested certain samples to determine whether they were supported by underlying records. They reported their opinion that

the scenario tests and their outcomes, as described in the report have been performed using the methodologies described and provide a reasonable basis for the estimation of the DIRT at issue for the period 6 April 1986 to 30 September 1991.

the DIRT at issue, estimated by way of sampling deposit accounts in AIB and systems interrogation in AIF and set out in the report does not materially misstate the DIRT at issue for the period 6 April 1986 to 30 September 1991.

The lookback exercise did not extend to the non-resident book of AIBCM. An examination of the records (less than 50 non-resident accounts mainly deposits by multinational companies and institutions) strongly indicated that bogus non-resident accounts were not an issue.

The exercise did not appear to examine ,35m of deposits reclassified from DIRT exempt resident accounts. The focus of the lookback was on bogus non-resident accounts only.

In addition to the reclassification of non-resident Irish Pound funds, which was the subject of the lookback exercise, approximately ,10m in foreign currency funds were the subject of reclassification after June 1991. This review was prompted by the extension of DIRT liability to certain foreign currency accounts for the first time in June 1991.

Reporting of Reclassification Exercise to Central Bank

AIB has been unable to locate details of any matters raised by the Central Bank in this connection. However, the AIB was aware from evidence given by the Governor of the Central Bank to the Public Accounts Committee on 15 October 1998 that the then Group Financial Director of AIB discussed the matter with the Central Bank.

At the meeting, which was requested by the Group Financial Director, the Central Bank official records that the following was outlined to the Central Bank

the problem facing AIB relating to non-resident deposit accounts

that AIB had received correspondence from the Investigation Branch of the Revenue Commissioners indicating that it was aware of irregularities relating to the classification of deposit accounts as non-resident which were in fact opened by Irish residents

that Revenue had requested AIB to carry out an investigation into all non-resident deposits and to examine the accuracy of the payment by AIB of DIRT for the current half yearly DIRT tax period

that Revenue was not investigating prior years and that his understanding was that an amnesty was being granted by Revenue in respect of non-resident account irregularities existing prior to the current period

that it was the understanding of AIB that the Revenue Commissioners were conducting a similar investigation into all Irish credit institutions. The Group Financial Director enquired as to whether the Central Bank had received any correspondence from the Irish Revenue authorities. The Central Bank official informed AIB that he was not aware of any correspondence of this nature having been received

that AIB had conducted an initial investigation into all non-resident accounts in branches in the Republic and that it was understood that up to ,600m of non-resident deposit accounts may be mis-classified i.e they were deposits from Irish residents. It was emphasised that these were preliminary estimates which would require detailed investigation

that if these estimates were correct, that AIB would be required to pay additional DIRT of up to ,5m in respect of the latest DIRT half yearly payment

that the full investigation of all non-resident accounts would not be completed until June 1991

that the above development gave rise to the following concerns for AIB

returns submitted to the Central Bank reflected significant mis-classifications of its resident/non-resident deposit accounts i.e. up to ,500m classified as non-resident should be classified as resident

that a significant withdrawal of Anon-resident@ deposits could be suffered if these became liable to DIRT. However, as all credit institutions were subject to similar action the outflow of funds may not materialise.

Central Bank record of telephone conversation between the Group Financial Director and the Central Bank on 25 April 1991

The Group Financial Director outlined the problem of the misreporting of accounts for DIRT purposes. He reported that AIB was to get its "house in order" by June and work to this effect was proceeding. So far no large outflows of deposits had been reported.

He went on to refer to the attitude of the Group's internal auditor which was that on a strict reading of the communications from the Revenue Commissioners, that AIB had a contingent liability amounting to some hundreds of millions of pounds virtually going back to the introduction of DIRT.

The Group Financial Director was not in agreement with this view because, inter alia, the Revenue Commissioners were prepared to extend an unofficial moratorium and did not propose to question DIRT returns earlier than the previous October.

Central Bank record of meeting between AIB and the Central Bank held on 8 May 1991

The Group Financial Director said that the task of regularising accounts was in progress and would be completed by end-June. He said that as far as he was aware all financial institutions had been approached by the Revenue Commissioners regarding the classification of accounts for DIRT.

Central Bank record of telephone conversation between Mr Kevin Kelly, AIB and the Central Bank on 3 April 1992

Mr Kelly stated that the Irish Revenue authorities had agreed that no retrospection of DIRT would be applied in respect of bogus non-resident accounts provided that AIB undertook a review of all non-resident accounts. Mr Kelly stated that this review had been completed and that he was satisfied that the situation was now in order and that no fines had been imposed by the Revenue authorities on AIB.

The contents of this page were last updated on 26/09/03