Jan. 28, 2009 — An IRS undercover operation busted James A. Auffenberg Jr. and three other men charged with evading federal taxes by misusing the V.I. Economic Development Commission program, trial testimony revealed Tuesday and Wednesday.
The U.S. Department of Justice charges that the four men illegally claimed a 90-percent federal tax break on more than $300 million funneled through the St. Croix-based company Kapok Management.
Federal officials say Kapok, which receives Economic Development Authority tax incentives, helped Auffenberg get 90-percent tax breaks on more than $300 million in revenue generated by Auffenberg's mainland companies.
In return, Kapok kept five percent of Auffenberg's money in exchange for bogus management fees, the indictment said.
It alleges that Auffenberg, a prominent car dealer in Swansea, Ill., illegally avoided more than $74 million in taxes from 1999 to 2002 by joining Kapok as a partner and shipping money to Kapok, run by Peter G. Fagan of De Leon, Texas; James W. Ferguson III of Amarillo, Texas; and J. David Jackson of St. Croix.
All four have pleaded innocent. Trial is underway on St. Croix and will likely continue for another month and a half or so.
The four were charged in Illinois on March 23, 2007, but the case was moved to V.I. District Court at the request of Jackson's attorneys in August on the grounds that Jackson lives here and the case is about activities involving a V.I. program and residents.
The EDC confers very substantial tax benefits on select new businesses that open in the Virgin Islands, reducing most taxes to zero. In exchange, individuals and companies must commit $100,000 of capital, employ 10 local residents, buy goods and services from local suppliers and promise to make charitable donations. They must also establish residency, and are advised to buy or lease a house and car, obtain a local driver's license and join local clubs, among other things.
The 21-count indictment also charge that Auffenberg falsely claimed to live in the Virgin Islands and filed false tax returns to claim the EDC tax benefits. The federal government also seeks the forfeiture of about $16.2 million in cash.
Ferguson, Fagan and Jackson allegedly promoted the scheme to wealthy individuals, who would join Kapok Management as limited partners, forming single-member limited-liability companies in the United States and the U.S. Virgin Islands, respectively. The U.S. company would contract with Kapok to "manage" the partner's stateside business, and pay bogus "management fees" to Kapok, Justice officials say.
Under questioning Tuesday from Assistant U.S. Attorney Michael Quinley, U.S. Customs Agent Sarah Walker presented voluminous charts and graphs describing the flow of money into and out of Kapok.
Between 1999 and 2003, ever-increasing sums were spent on "management fees," with the bulk occurring in December or November and December of each year. But, she said, within a very short time, the money was returned to the limited partner as "partnership distributions" paid to the limited partner's V.I. affiliate, minus a fee. According to the indictment and Walker's testimony on Tuesday, no management services were provided by Kapok Management to the mainland businesses, and each limited partner determined their own fee.
"Did the Kapok partners set their own salaries?" Quinley asked Walker Tuesday.
"Yes," she replied.
"Is this a usual practice in the industry?"
"No."
Kapok had a total of 83 partners who contributed "management fees," Walker said. Shortly after making the payments, a "distribution" of varying amounts, between 90 to 97 percent of the management fee would be returned — often in less than a week, she testified.
This week and next the court is hearing from a variety of expert witnesses. Earlier, testimony came from former EDC Chairman Frank Schulterbrandt and other top EDC officials and former corporate officers.
On Wednesday, a witness who participated in an undercover sting operation against Kapok began preliminary testimony and a source close to the case said there will likely be some showing of undercover surveillance video toward the tail end of the trial.
The case is being followed closely by V.I. government officials, companies with current EDC benefits and business advisors stateside because of its potential impact on the EDC program and potential for federal prosecution for companies that stretch the program's rules.
If convicted, the defendants face the following maximum potential sentences: On the conspiracy charge, five years imprisonment followed by up to three years supervised release and a $250,000 fine. On each income-tax-evasion charge, five years imprisonment, followed by up to three years supervised release, a $250,000 fine and costs of prosecution. On each false income-tax-return charge, three years imprisonment, followed by up to three years supervised release, a $250,000 fine and costs of prosecution. And on the wire-fraud charge, five years imprisonment followed by up to three years supervised release and a fine of up to $32 million.
This is the second indictment against Kapok partners. Insurance salesman Gary J. Payne pleaded guilty to tax fraud in 2004 after claiming Economic Development tax credits on money generated in Massachusetts. He also never lived in the islands full time. Widespread media coverage of the Payne debacle prompted Congress to tighten the Economic Development Program, imposing strict rules. V.I. lawmakers — most notably Delegate Donna M. Christensen — still hope to loosen those new rules to dissuade misuse of the program without scaring off investors. (See "Tax-Evasion Case Moved to Territory.")
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