Shepard v. First Federal Sav. Bank of Puerto Rico

• Decision Date: 27 December 1985
• Docket Number: Civ. No. 85-2070 (JAF).
• Parties: Olga SHEPARD and John Doe, Plaintiffs, v. FIRST FEDERAL SAVINGS BANK OF PUERTO RICO and Juan Agosto Alicea, Secretary of the Treasury of the Commonwealth of Puerto Rico, Defendants.
• Court: U.S. District Court — District of Puerto Rico

625 F. Supp. 1359

Olga SHEPARD and John Doe, Plaintiffs, v. FIRST FEDERAL SAVINGS BANK OF PUERTO RICO and Juan Agosto Alicea, Secretary of the Treasury of the Commonwealth of Puerto Rico, Defendants.

Civ. No. 85-2070 (JAF).

United States District Court, D. Puerto Rico.

December 27, 1985.

Norberto Medina Zurinaga, Hato Rey, P.R., for plaintiffs.

Jorge E. Pérez Díaz, Federal Litigation Div., San Juan, P.R., for defendants, Juan Agosto Alicea.

Antonio R. Escriba, San Juan, P.R., for First Federal Sav. Bank of P.R.

OPINION AND ORDER

FUSTE, District Judge.

This is an action seeking declaratory judgment and injunctive relief of three (3) laws approved by the Legislature of Puerto Rico, to wit: Law No. 1 of August 12, 1985,¹ Law No. 1 of October 8, 1985,² and Law No. 6 of October 16, 1985,³ (hereinafter referred to as "the Laws"). The two latter laws become effective on January 1, 1986. These laws were enacted to curb the use of bearer certificates of deposit as vehicles of tax evasion and money laundering. They also establish an alternative rate for income taxation of interest on savings.

The facts of the present case are not in dispute. These are as follows:

Plaintiff Olga Shepard is the trustee of a trust solely created to avoid the effect of the mentioned laws and to hold and manage as its sole asset two (2) certificates of deposit payable to the bearer in the amounts of $50,000 and $52,300, respectively. Plaintiff John Doe is the true equitable holder of the certificates of deposit. John Doe will not disclose his identity so as to preserve what he understands to be his absolute constitutional privilege against self-incrimination. In order to preserve their rights, the grantor Doe and the trustee Shepard invoke jurisdiction over the present case based on Federal Question. The faltering jurisdictional allegation is that the above-referenced laws are unconstitutional, inasmuch as they violate plaintiffs' rights guaranteed under the Fifth and/or Fourteenth Amendments to the Constitution of the United States. It is further claimed that the area of regulation by said laws is preempted under Article VI of the Constitution of the United States and by The Federal Home Loan Banks Act, 12 U.S.C. §§ 1421-1459.

Co-defendant First Federal Savings Bank of Puerto Rico, hereinafter referred to as "First Federal", has presented a responsive allegation requesting that all actions pertaining to it be stayed. First Federal wants to be let alone. It states that the actual controversy is one between the Department of Treasury of Puerto Rico, ("Department"), and plaintiff. The Department has requested the dismissal of the present case based on the statutory language of the Butler Act, 48 U.S.C. § 872.

The matter was heard by the Court on December 3, 1985. Documentary evidence was received.⁴ The parties submitted the controversy on the basis of their pleadings, allegations, evidence, and argument. The Court is not convinced of the merits of the declaratory and injunctive relief sought by plaintiffs. The amended complaint governing the controversy will be dismissed based on the following findings and conclusions. Fed.R.Civ.P. 52.

Law Number 1, August 12, 1985:

Plaintiffs seek injunctive relief from the provisions of the above-quoted law and regulations promulgated thereunder. Generally, said law provides a mechanism under which the Department of the Treasury requires all banks and savings and loan institutions issuing bearer certificates of deposit to act as a withholding agent, retaining 20% of the total amount deposited. In the event that the taxpayer does not elect to request an administrative release of the retained monies,⁵ he must pay a 20% tax, be it through the mentioned withholding or by direct payment to the Department. In the case of a taxpayer who has not resorted to any of these alternatives by December 31, 1985, the financial institution will automatically withhold 20% of the principal and interest accrued until said date, and remit it to the Department with whatever information it has available on the identity of the owner or bearer of the particular certificate of deposit. See Sections 5(b)(1) and 10(f) of the regulations.

Law No. 1 of October 8, 1985 and Law No. 6 of October 16, 1985

Law Number 1 of October 8, 1985 essentially establishes an alternative tax rate under which to pay taxes on interest income received during a taxable year. In general terms, the law authorizes financial institutions, if the taxpayer consents, to withhold and remit to the Secretary 17% of the interests to be paid out or accrued. The 17% withholding is a flat tax alternative to interest income being taxed as part of ordinary income under the regular tax rates.

The other relevant law, No. 6 of October 16, 1985, establishes the obligation of investment brokers and other financial institutions to report to the Department all monetary transactions over $10,000. Also, the law typifies the penalties that apply if said obligation is not met.⁶

Legislative Background and Intent

The laws under scrutiny were enacted after the U.S. Department of Justice concluded a phase of operation "Greenback",⁷ an investigation which culminated with the arrest of several employees and ex-employees of diverse banking institutions in Continental United States and Puerto Rico. The basic criminal charge against the majority of those indicted in Puerto Rico was their failure to report to the Internal Revenue Service the details of the transactions relating to cash received in their trade or business over $10,000, in violation of 26 U.S.C. 6050I and 26 U.S.C. § 7203. As a result of operation Greenback, it came to be of public knowledge that bearer certificates of deposit constituted not only a loophole through which taxpayers evaded their income tax payment obligations, but also they were being utilized to launder monies which were the product of malum in se activities, such as narcotic and drug trafficking.⁸

At this point in time, the Government of Puerto Rico had to deal with not only the fiscal problems of generating tax revenue to cope with economical demands, but also had to put an end to the undesirable practices mentioned herein. On July 1, 1985, the government announced that all financial institutions would be required to keep a register of the identity of every purchaser of a bearer certificate of deposit. The government's intention was to implement this policy in a six-month phase-out plan so as to avoid panic among bank depositors. See Report of the Joint Hearing of the Senate and House Finance Committees, August 11, 1985. The inevitable occurred. Confusion, concern, and in extremis attempts to avoid any kind of tax accounted for mass withdrawals of approximately $250 Million in deposits since June 6, 1985 to the time of the approval of Law No. 1 in August, 1985.⁹ Seeking to detain the high fuge of capital from Puerto Rico banks, coupled with a legislative intent of promoting a more equitable tax burden¹⁰ among all citizens, the present laws were enacted.

Remedies under the Law

Law No. 1, of August 12, 1985, Section 3, provides for administrative and judicial review of procedures initiated by the Department action. The taxpayer adversely affected by an administrative decision under the law may request reconsideration within fifteen (15) days from the date the decision was notified. The Secretary of the Treasury must decide said request for reconsideration during a period of thirty (30) days after the request for reconsideration. After the Department enters its decision in reconsideration, the taxpayer adversely affected may request judicial review before the Superior Court of Puerto Rico; venue being determined by the place of residence of the taxpayer. The Superior Court will determine whether to affirm, reverse, or modify the administrative decision.¹¹ In the case a taxpayer has not filed a request for release or has not paid the 20% tax by December 31, 1985, the banking institution will automatically withhold 20% of the lump sum of combined principal and interest. The amount withheld is sent to the Department of Treasury. At this stage of the proceedings, the administrative remedy available to the taxpayer is to request for a refund. See sec. 5 of Law No. 1, August 12, 1985. Such request must be filed before the Department within the period of ninety (90) days after the date of payment to the Department of the tax withheld. In this case, when the taxpayer has proven to the Department that the amount represented by the certificate of deposit has been already taxed or its source of income is tax exempt under the dispositions of the Income Tax Law of 1954, he will receive a release from the imposition of the 20% tax and the monies will be refunded with interests paid at the same rate it was accruing in the bank.

Applicability of the Butler Act

Under the above-described legal scenario, plaintiffs request that we enjoin the collection of the 20% tax imposed under Law No. 1 of August 12, 1985 and declare unconstitutional all three (3) quoted laws as they relate to their two certificates of deposit. Co-defendant, Juan Agosto Alicea, Secretary of Treasury, has requested the dismissal under 48 U.S.C. § 872.

Section 872, in its relevant part, establishes that:

No suit for the purpose of restraining the assessment or collection of any tax imposed by the Laws of Puerto Rico shall be maintained in the United States District Court for the District of Puerto Rico.

The case law interpreting Section 872 has consistently held that the U.S. District Court for the District of Puerto Rico should not interfere with the assessment or collection of local taxes, unless there is an irreparable, threatened injury to the taxpayer. Said exception materializes only when a tax statute does not afford an adequate remedy. Smallwood v. Treasury of Porto Rico Tax Appeals, 275 U.S. 56, 48 S.Ct. 23, 72 L.Ed. 152 (1927); Paul Smith Construction Co. v. Buscaglia, 140...