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Exclusive: IRS abruptly stopped criminal investigation of Mar-a-Lago member accused of massive tax fraud months after Trump took office

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David Cay Johnston
David Cay Johnston

William Ingraham Koch lives five blocks away from President Donald Trump’s Mar-a-Lago resort, where he is a member. The only one of the four billionaire Koch brothers to support Trump, Bill Koch even hosted a Trump campaign fundraiser at his Cape Cod vacation home in August 2016. Co-chairs were asked to donate or raise $100,000 for the event; simply attending cost $2,700.

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Atop the invitation to Koch’s home? Trump Finance Chairman Steven T. Mnuchin, now Treasury Secretary of the United States, whose duties include overseeing the Internal Revenue Service.

In part one of the Koch Papers, we revealed that Bill Koch has enjoyed hundreds of millions of dollars of untaxed profits from his carbon-based businesses, having shifted profits earned in the United States to a subsidiary in the Bahamas. A 2016 whistleblower complaint prompted an IRS criminal investigation, but the IRS halted all communication with the whistleblower’s attorneys shortly after Trump became president.

In part two, we’ll explore how Koch’s businesses withheld critical documents, stymying IRS auditors. We’ll also publish the contents of the June 2017 email that signaled the IRS had stopped pursuing the complaint against Koch’s businesses, five months after Trump took office.

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These documents are among nearly a thousand pages obtained by [email protected], which we refer to as the Koch Papers.

Critical documents withheld

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Before auditing two years of Koch’s Oxbow Carbon LLC business tax returns in 2014, a team of Internal Revenue Service auditors sent routine requests for information to determine whether additional taxes were due. For simplicity we will refer to the various companies as Oxbow America and Oxbow Bahamas.

The IRS was supplied with innocuous documents. The IRS was also given a study by the Grant Thornton accounting firm that blessed Koch shifting Oxbow money abroad, based on inaccurate information Oxbow provided.

IRS auditors asked in writing for other documents they considered crucial to a proper examination. These documents would explain how Oxbow America shifted profits earned in America by mixing and selling petroleum coke to Oxbow Bahamas, where no income tax would be owed.

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Oxbow America’s operations earned $229 million of profit in 2009, the year before the Bahamas gambit began. By 2015, the parent company reported losing money in the United States.

Oxbow America executives told the IRS auditors that their requests were “overly broad…burdensome and resource intensive,” the Koch Papers reveal.  The papers show that Bill Koch participated in meetings, emails and phone calls in which the IRS was also told that documents could not be located or did not exist.

After initially finding grounds for a criminal investigation more than two years ago, the IRS appears to have abandoned it.

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Another Koch Papers document directs Oxbow America’s executives to “do whatever possible” to conceal profitability data the IRS auditors requested.

The IRS audit team never saw many requested documents. Without having seen these important documents, the IRS closed its audits in 2014, accepting the 2011 and 2012 business tax returns as filed.

Near the end of the audit, Charles Middleton, then the company’s chief tax executive and a specialist in international transactions, grew suspicious about assertions that the requested documents were too hard to find. One day he sat down at an Oxbow computer. He logged into a database that Oxbow America had paid a vendor to create.

With a few keystrokes Middleton located all the documents. Middleton promptly notified Koch and other top executives.

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The reaction was swift.

“When I suggested Oxbow take action to correct the false statements and amend the fraudulent 2010 tax return, I was immediately removed from the audit team and prohibited from having further contact with the IRS,” Middleton wrote, not saying who issued the order. His attorney, William Cohan, said such action would not have occurred unless Bill Koch directed it or agreed to it.

Once the IRS formally closed the two audits, Oxbow America fired Middleton. The company, in a statement, said Middleton was fired for cause without specifying the reason.

The Koch Papers, obtained by [email protected], raise serious questions about the strategy to escape American income taxes.

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The documents include internal discussion about whether the tax strategy is lawful and the prospect of massive penalties if IRS auditors understood how profits earned in America were siphoned out of the country. Some executives and advisers expressed concern that even if the strategy might work legally, it was not being done with the precision required to lawfully slip profits past the IRS.

Middleton calculated that our federal government is now due $350 million in taxes, penalties and interest for the years 2010, 2011 and 2012.

Shifting Oxbow America profits out of the United States continued at least through late 2015, the Koch Papers show. There is no reason to believe the tax practices stopped.

Assuming the strategy is still in place, my analysis of the Koch Papers and other documents indicates that our federal government is owed hundreds of millions of taxes, penalties and interest.

Should the IRS recover any additional money, Middleton might be eligible to receive up to 30 percent as a whistleblower award. The IRS has long been parsimonious with such awards, which in 2018 totaled $312 million, which is less than one dollar for every $10,000 of total tax federal collected that year. Middleton’s attorney Cohan said the terms of Middleton’s departure, however, would preclude him from receiving any reward money.

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Oxbow America, in a statement, said that the company “and William I. Koch were the subject of Internal Revenue Service audits related to tax years ending December 31, 2011 and December 31, 2012. The Company and Mr. Koch cooperated fully with the IRS throughout the audit process.”

The statement said the audits were closed in 2014 and 2015 with “no adverse finding.”

Tax Crimes Alleged

Middleton’s whistleblower claims detailed what he says were “tax crimes” both in the offshore tax strategy and hiding documents from IRS auditors. His first claim was filed in 2016, his most recent in May 2018.

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“Substantial false, fraudulent and misleading information was provided to the IRS” about shifting of American profits to the Bahamas, Middleton told the IRS Whistleblower Office in 2016.

The Koch papers estimate that the shift would eliminate $21 million annually in federal income taxes. Other documents cite $40 million to $50 million annually of taxes that would not be paid if the strategy worked. Any fraud penalties would add 75 percent to those sums.

“Oxbow fraudulently withheld material documents properly requested by the IRS” during the audit of its 2011 and 2012 tax returns and, Middleton wrote,  “Oxbow knowingly made false statements to IRS personnel.”

“I was the Senior Vice-President of tax for Oxbow at the time of the audits,” he added. “When the false statements were initially made, I was unaware they were false. I subsequently discovered documents that established with 100% certainty that Oxbow willfully made false and misleading statements.”

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“Oxbow’s response to many of these” document requests “was to deny the existence of responsive documents despite the fact that many responsive documents existed and Oxbow’s senior leadership … were aware of these documents,” Middleton wrote, naming Bill Koch and four other senior executives.

Middleton listed 15 documents. He called them “a small percentage of the documents fraudulently withheld from the IRS. The total of documents withheld numbers in the hundreds or thousands. I have enclosed some of these documents with this submission; there are many more in my possession and on Oxbow’s computers.”

Few, if any, of the documents are protected by attorney-client privilege, he wrote, referring to broad claims of privilege the company made during the audit to withhold documents from the IRS. One key document, Middleton wrote, was written by a nonlawyer and was widely distributed within the company, which would invalidate any claim of attorney-client privilege.

One of the many pregnant observations in Middleton’s report is that “Oxbow chose to ignore the advice” of one of its outside lawyers, who was also terminated. A consultant report stated that the “Rotterdam tax people are very aware of DUTCH law and fear that when a contract transfer is made Oxbow may be exposed to significant tax exposure in Holland.”

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Communications between lawyers and their clients are usually privileged. However, there is a crime-fraud exception to that privilege, which Middleton cited repeatedly in his whistleblower complaints.

Middleton also stated in writing that he signed the 2010 Koch company tax return, only later to conclude that it was fraudulent. Middleton told the IRS that as a newly hired executive he trusted what others at Koch’s company told him, but later concluded that they had lied to him.

A Swiss-Bahamas-U.S. Tax Triangle

The whole claim to tax-free profits rests on the assumption that the Bahamas was the main center of business activity and that Oxbow Bahamas is a Swiss company doing business in Nassau.

The Swiss government issued a formal ruling that Oxbow Bahamas isn’t subject to Swiss tax because it doesn’t do business or make any money in Switzerland. Middleton says that means it cannot benefit from the United States-Swiss tax treaty, an issue that the IRS has never tested in court even though many companies rely on that treaty to reduce or eliminate taxes on their profits.

Oxbow America’s operations earned $229 million of profit in 2009, the year before the Bahamas gambit began. By 2015, the parent company reported losing money in the United States.

The tax avoidance work appears to have been very sloppy.

Oxbow Bahamas did not pay for its offices, about 1,200 square feet in a Nassau shopping center where three to five people worked, some part-time. The office and staff are much too small to handle just the invoicing and record keeping for hundreds of millions of dollars of petroleum coke deals, never mind all the other work that keeps more than 300 people employed by Oxbow America.

Not even a pound of petcoke was produced in the Bahamas. Most of the millions of tons of petcoke, one of the dirtiest carbon fuels, came from American oil refineries, was processed and mixed in the U.S. and sold by American sales agents.

Middleton told the IRS that much of the executive time recorded on the books of Oxbow Bahamas books was really golfing trips and that one key executive spent at most 15 days a year working there, while another worked from New York. A Koch Papers document shows one key person employed by Oxbow Bahamas spending about a third of his time in Florida, which could give Oxbow Bahamas an American presence that could wipe out any tax savings.

Middleton’s complaints to the IRS assert that time sheets recording where at least three Oxbow Bahamas executives work are fraudulent and that travel and spending records will establish fraud.

Oxbow America also picked up many costs of Oxbow Bahamas, creating tax-deductible expenses in the United States. A junior executive assigned to run the Bahamas operation in 2009, after some other executives said he lacked the gravitas even for that position, was paid not from the Bahamas, but from the United States until 2013, the Koch Papers show.

A Loss Here, Tax Savings There

Taking tax-free profits in the Bahamas and creating tax losses in the United States created additional tax benefits. It “permitted its U.S. owners to use phantom U.S. losses to offset other U.S. taxable income,” Middleton told the IRS.

The tax losses of Oxbow America would enable Bill Koch to offset profits from selling, for example, personal assets such as stocks, real estate, objets d’art and other assets. That could wipe out taxes on any gains up to the amount of the Oxbow America tax losses. He could even use them to reduce or eliminate taxes on the record $22 million auction of a portion of his vast wine collection, conducted by Sotheby’s in 2016.

DCReport does not know if Bill Koch took advantage of these opportunities, since personal tax returns are not included in the Koch Papers. But if his tax returns were prepared in accord with annual verification statements, known as 1065s and K-1s, the use of the losses to offset gains would be virtually automatic on his personal tax returns.

Congressional investigators have the power to see these returns. With a written request, they are entitled under Section 6103 of the tax code to obtain the tax returns and related tax information of Bill Koch, his company and other related parties.

This is the same law that Trump has ordered his administration to violate by withholding his last six years of tax returns from Congress, the first time that law has not been obeyed since its adoption 95 years ago. Trump, like all presidents, also has the same power to see anyone’s tax returns.

The Oxbow companies were so focused on taxes that they even found a way to create an American tax loss on a huge coal barn they control at California’s Port of Long Beach. That barn gives Oxbow America exclusive access to Southern California petcoke sales to Asia, where it is burned as fuel. The Long Beach operations produce outsize profits because there is no competition to push prices down, the Koch Papers show.

The coal barn was reported as a $15 million tax loss. As the 75 percent owner of Oxbow, Bill Koch would be entitled to more than $11 million of that tax loss.

The Grant Thornton Study

A key requirement when shifting American business operations offshore is to take into account the value of existing contracts whose profits would be taxable by the United States. Oxbow America commissioned the Grant Thornton accounting firm to study the value of the petcoke contracts being shifted from Oxbow America to Oxbow Bahamas.

That study, Middleton wrote, “was expressly conditioned on Oxbow’s representation that no ‘in the money’ contracts were transferred from the U.S. to [the] Bahamas. This representation was fraudulent.”

In fact, many contracts involving millions of tons of petcoke were “deep in the money,” meaning they had huge built-in profits. Some California contracts had a built-in profit of more than $90 per ton, the Koch Papers show.

Middleton also wrote that IRS auditors “asked for a list of suppliers and customers and their sales before and after the formation of Oxbow Bahamas. This information was readily available to Oxbow. It was part of Oxbow’s regular management reports—yet Oxbow’s audit defense team was instructed to withhold the information.”

The company, in its statement, said that it and Bill Koch “cooperated fully with the IRS throughout the audit process.”

As is routine, IRS auditors asked for data on how profitable company operations were. Middleton, in his whistleblower claim, said some profitability data was given to the IRS audit team in 2014.

Koch and others in senior management soon learned what the IRS had been told. One of Oxbow America’s highest-ranking executives then sent an email “chastising [the] audit team for releasing profit by supplier information to the IRS,” the Koch Papers show.

Oxbow Bahamas did not pay Oxbow America for the built-in profits transferred offshore. Doing so would have required paying American income taxes. Instead, the Grant Thornton study, which Koch shared with the IRS, showed no value because the accounting firm was not given the actual pricing information.

When asked about the study, Jon Rucket, Grant Thornton’s director of external communications, told [email protected] “as a matter of policy, we do not comment on client matters.”

Middleton told the IRS that “false and fraudulent answers were given to the IRS in the audit, and the IRS dropped the issue. Had Oxbow answered the [document requests] honestly, the IRS would have been able to determine that intellectual property with a value of approximately $1 billion was transferred offshore” without payment.

Had the IRS been allowed to see internal documents about ExxonMobil, a major supplier of petcoke to Oxbow America, it would have known the Grant Thornton study was not to be believed since it was not based on accurate information from Oxbow America. Petcoke from ExxonMobil’s refinery in Torrance, Calif., is a key source of profits for Koch’s companies.

“Oxbow Bahamas had no contracts, no resources, no senior personnel and no capital, yet it was assigned a contract that assured it $45M in profits,” one Koch Papers document states.

“The counterparty (Exxon) would not allow the assignment” of its contract to Oxbow Bahamas unless Oxbow America “guaranteed Oxbow Bahamas’ obligations. From the counterparty’s standpoint, nothing changed. From an economic standpoint, nothing changed. The only thing that changed was the income was assigned to (and thus nominally earned by) a tax haven company.”

There is no suggestion in the papers that ExxonMobil did anything improper, and did nothing other than seek to protect its own financial interests in its Southern California petcoke deals.

IRS Finds Indications of Criminality

The IRS Whistleblower Office concluded that the Koch Papers established substantial indicators of criminality because it referred the matter in 2016 not to the civil audit side, but to the IRS Criminal Investigation Division. IRS rules do not allow pursing taxpayers both civilly and criminally, so the service must choose one approach or the other.

Michael Galdys, an IRS criminal investigator in West Palm Beach, Fla., found the Koch Papers so tantalizing that in February 2017 he set out with another IRS special agent to arrange a meeting with William Cohan, Middleton’s lawyer in Rancho Santa Fe, Calif.

That meeting never happened.

On June 13, 2017, Special Agent Galdys emailed Cohan. “We are in receipt of the documents your client has filed with the Whistle Blower office. At this time our office has determined that a face to face meeting is not needed. If anything changes in the future, I will let you know,” Galdys wrote.

Cohan and a lawyer working with him, Seattle tax litigator John Colvin, say that since then the IRS has ignored their calls, emails and letters.

Both lawyers also say that they and Middleton cannot imagine any legitimate reason to drop the criminal investigation. However, they do point to one logical, but speculative, explanation.

It draws on the fact that Bill Koch is Trump’s neighbor in Palm Beach, Fla., hosted a fancy fundraiser for Trump at his Cape Cod vacation home and is the only Koch brother to support Trump’s campaign. The two men have also tangled in the distant past in litigation over competing casino investments.

“All Trump would have to do is call [Treasury Secretary Steve] Mnuchin and say his friend Bill Koch was having a problem so look into it,” Cohan said for the IRS brass to get the message to back off.

Cohan added that “the underlying question is qui bono—who benefits? Certainly not American taxpayers, except Trump’s friend Bill Koch.”

A White House spokesperson, asked if Trump had said anything to his staff about Koch and taxes, gave a non-responsive answer that he declared was “off the record.” (Journalists, not sources, determine whether comments are off the record.)

The IRS has the authority to re-open audits when “there is evidence of fraud, malfeasance, collusion, concealment, or misrepresentation of a material fact.”

Middleton wrote that the documents he provided the IRS “demonstrate with no room for doubt that there was both fraud and misrepresentation of material facts in the 2011 / 2012 audits.”

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