The Law Offices of Gordon C. Rhea

V.I. jury clears Kapok partners of tax evasion

V.I. jury clears Kapok partners of tax evasion

Mar 5, 2009
After nearly three days of deliberations, a V.I. Superior Court jury on St. Croix acquitted four partners of Kapok Management of numerous federal charges of tax evasion, conspiracy and fraud.

During the past seven weeks, jurors heard testimony from dozens of witnesses and saw exhibits that included hundreds of pages of tax, financial and business documents, as prosecutors laid out their case against defendants: Chicago businessman James Auffenberg; Peter Fagan, Kapok president; James Ferguson, Kapok vice president; and David Jackson, Kapok treasurer.

Kapok operated in the territory between 1999 to 2003 and was a beneficiary of territory's Economic Development Commission tax-incentive program.

In May 2003, federal agents raided Kapok's offices in St. Croix's Industrial Park just north of Rohlsen Airport, and about four years later, a grand jury handed up a 21-count indictment in March 2007. The indictment charged the men and related companies with conspiracy to defraud the United States, attempt to evade or defeat taxes, fraud and false statements, fraud by wire, radio or television and concealing or destroying invoices or other documents.

On Wednesday morning, 12 jurors found them not guilty on all charges.

"I'm ecstatic," said attorney Gordon Rhea, who represented Jackson.

Rhea said the defense succeeded in showing that Kapok was a valid company under the EDC program.

Tax exemptions Kapok received were 90 percent of income taxes and 100 percent of gross receipts taxes plus dividend and interest withholding tax exemptions for 15 years. These benefits became effective on Jan. 1, 2002.

During trial, defense attorneys maintained that the government failed to prove that any wrongdoing was a willful attempt to defraud the government. They said the case was not about greed or abuse of power, but rather it was about a tax-benefit program that was too good to be true and operated without any guidance from the U.S. Internal Revenue Service.

"The purpose of the program was to draw investors to the territory and that's what Kapok did," he said.

During trial, the prosecution, assistant U.S. attorneys Michael Quinley, Bruce Reppert, Michelle Petersen and Gregory Tortella, argued that the four men, and other unknown associates, conspired to defraud a legitimate EDC program and evaded taxes by engaging in sham financial transactions to create the illusion of a management consulting business.

The case was heard by visiting District Judge Harvey Bartle.

"I consider the verdict a tremendous vindication for the EDC program and for Kapok," Rhea said. "It's a win-win for the Virgin Islands, and hopefully, it will lead to a re-invigoration of the EDC program."

In 2004, provisions in the American Jobs Creation Act changed federal rules that apply to the EDC program.

The program's purpose is to promote investment in the territory by granting hefty income tax breaks for business owners who relocate to, or start businesses in, the Virgin Islands. Beneficiaries of the program can get exemptions on income taxes, gross receipts taxes, excise taxes, property taxes, and on withholding dividends and interest.

Following many alleged abuses of the EDC program by companies receiving V.I. tax breaks while conducting their business in the states, Treasury was charged with drafting specific regulations setting new strict rules for residency and source of income. Treasury issued final regulations establishing bona fide residency in January 2006, and final regulations on source of income in April 2008.

"This case has impacted many lives as well as deterred investment in the territory and effectively put the USVI on the defensive with potential business partners, Congress, and the IRS," Marjorie Rawls Roberts, a St. Thomas-based tax attorney said Wednesday. "Now that the jury has spoken, the USVI can hopefully revisit its relationship with the federal government on all tax matters and move forward for a fair and timely resolution of outstanding issues. With that done, the territory's private sector can work with local and federal governments to create a brighter economic future for the Virgin Islands."

- Contact Reporter Tim Fields at 774-8772 ext. 364 or e-mail