Bar News - April 17, 2009
Zappers—High Tech Ways to Steal Tax Revenue
By: Richard T. Ainsworth
No other State is as vulnerable to Zappers as is the State of New Hampshire. Zappers and related software programming, Phantom-ware, facilitate an old tax fraud – skimming cash receipts. In this instance skimming is performed with modern electronic cash registers (ECRs). Zappers are a global revenue problem, but to the best of this author’s knowledge they have not been uncovered in New Hampshire. Seen from a global perspective however, it seems unlikely that they are not here.
New Hampshire’s fiscal vulnerability to Zappers comes from its heavy reliance on precisely the industry segment that has been found to be the “hot bed” of this fraud – the restaurant industry. In the most recent fiscal year the Meals and Room Tax (M&RT) trailed only the Business Profits Tax (BPT) in revenue yield ($206,726 to $317,439 million). Taxes on meals approximate 70% of the M&RT. As a result, when tax fraud arises in this industry segment it is a significant concern.
Zappers and Phantom-ware
Technology has changed the efficiency with which businesses skim cash receipts. The agents of change are software applications – Phantom-ware and Zappers. Phantom-ware is a “hidden,” pre-installed programming option(s) embedded within the operating system of a modern ECR. It can be used to create a virtual second till and may preserve a digital (off-line) record of the skimming (a second set of digital books). The physical diversion of funds into a second drawer is no longer required, and the need for manual record keeping of the skim is eliminated. Because Phantom-ware programming is part of the operating system of an ECR, its use can be detected with the assistance of a computer audit specialist.
Zappers are more advanced technology than Phantom-ware. Zappers are special programming options added to ECRs or point of sale (POS) networks. They are carried on memory sticks, removable CDs, or can be accessed through an internet link. Because Zappers are not integrated into operating systems, their use is more difficult to detect. Zappers liberate owners from the need to personally operate the cash register to skim receipts. Remote skimming of cash transactions is now possible without the knowing participation of the cashier who physically rings up each sale. This attribute of Zappers allows the incidence of skimming fraud to migrate beyond the traditional “mom and pop” stores (where manual skimming was common). Zappers now allow owners to place employees at the cash register, check their performance (monitor employee theft), but then remotely skim sales to cheat the taxman.
It is something of an anomaly that Zappers and phantom-ware appear to be very serious problems in a wide range of developed countries (Canada, the Netherlands, Germany, Brazil, Australia and Sweden) but they do not appear to be a concern in the US, and have never been found in New Hampshire. In fact, there are only two Zapper cases in the US, the $17million skimming fraud at Stew Leonard’s Dairy (a grocery store) in Connecticut and the $20 million skimming operation at the LaShish restaurant chain in Michigan. It is alleged that the cash skimmed at the LaShish was used to finance Hezbollah terrorists in Lebanon. In both cases the size of the fraud attracted the attention of the IRS because gross receipts were substantially understated. Lesser levels of fraud seem to fly under the IRS radar, and never seem to attract State authorities in business or sales taxes.
The New Hampshire experience with Zappers contrasts dramatically with the Zapper enforcement activity of the Quebec Ministry of Revenue (MRQ). Over 230 Zapper cases have been prosecuted over the past ten years just across the border. Is there something New Hampshire can learn from the MRQ?
Three stories from Quebec
The MRQ first discovered that Zappers were in wide use in 1997, and has engaged in an aggressive enforcement action ever since. Some of the highlights of this activity over the past ten years include, for example, the Audio Lab investigation, the Stratos restaurants investigation, and the investigations related to Mr. Luc Primeau.
The Audio Lab investigation first became public on April 8, 2004 after search warrants were executed at the San Antonio Grill, a restaurant in Laval, Quebec. The allegation was that a “sales Zapper” (camoufleur de ventes) was used to delete sales records. The owner pleaded guilty one year later. But more importantly on October 14, 2005, Revenue Quebec announced that it was executing five more search warrants in Montreal and Laval on Audio Lab LP, Inc. as it was under suspicion of having developed and marketed the sales Zapper used in the cash registers at San Antonio’s Grill. Audio Lab LP, it turns out, not only developed the operating software in the cash registers at San Antonio’s Grill (called Softdine), but it developed and sold the Zapper that defeated it.
On June 26, 2007 Audio Lab LP, Inc. pleaded guilty to charges of having, “… designed and marketed a computer program designed to alter, amend, delete, cancel or otherwise alter accounting data in sales records kept by means of a software that [Audio Lab LP] had designed and marketed.”
The Stratos restaurants investigation highlights two other characteristics of large scale technology-assisted skimming frauds: the way skimmed cash is used to corrupt other businesses, businesses selling to the “zapping” enterprise, and the ease with which this fraud can sweep through a chain of related businesses. To dispose of the excess cash from skimmed sales the Stratos restaurants (1) put a double billing system in place with suppliers (to conceal purchases made without invoices in cash), and (2) wages were paid to employees in cash (and were not reported as income). All together twenty-eight Stratos restaurants eventually were involved in the fraud. Guilty pleas came in waves – nineteen companies pleaded guilty on September 26, 2002; another six on October 11, 2002, and the four remaining on March 21, 2003.
Press releases provide details of only the final ten companies. In aggregate the taxes and penalties for these companies came to $1,816,070.90, but the real thrust of the news releases was that “… the Department has conducted searches in order to establish proof that the designer of the IT function associated with the cash register software Terminal Resto had participated in the scheme set up by restaurants in the Stratos chain.” On April 25, 2003, Mr. Michel Roy and his two sons Danny and Miguel admitted that they were guilty of facilitating the Stratos tax evasion. The father (Michel) was the creator of the Zapper that worked with Resto Terminal. He promoted it and made the sales. His sons (Miguel and Danny) were also implicated in creating the zapper. Aggregate fraud penalties assessed against the Roys were $1,064,459.
The third example involves Mr. Luc Primeau, a software designer who became the focus of an investigation that began with the announcement on March 17, 2003 that seven Patio Vidal restaurant franchises and a bar, La Tasca, from Gatineau, Quebec as well as another bar named O’Max in Masson-Angers, Quebec were convicted of adding Zappers to their Microflash cash register software (later upgraded to a new version called Caracara). Mr. Primeau not only designed Microflash and Caracara, but was the developer of the associated Zapper program that these businesses used.
On October 17, 2005 Mr. Primeau admitted that his software assisted these companies to evade $435,000 in GST and QST. All together these companies skimmed $2.7 million in cash sales. Mr. Primeau was fined for his involvement. More importantly for this analysis we need to see Mr. Primeau as the classic example of the software designer who is a real threat to the tax system. By morphing into a business consultant Mr. Primeau actively spread Zappers throughout the restaurant sector. He brought this fraud to a series of bars and restaurants that might not otherwise have been involved if the risk of detection were not minimized by his software.
Similar stories can be culled from litigation in the Netherlands, Germany, Brazil, Sweden and Australia. There are government studies that measure the significance of this problem, a multi-nation task force in the European Union looking at it, and a national study by Her Majesty’s Revenue and Customs in the United Kingdom just coming to conclusion.
In these times of fiscal constraint, New Hampshire might benefit from a consideration of the enforcement options being developed around the globe. Waiting for the IRS to develop enforcement tools in this area might not be the optimal choice, because unlike the rest of the world, the US has no national consumption tax.
The bottom line for the State should be that it is preferable to collect a tax that is already due, and has already been paid by the customer (admittedly to an agent of the State who has placed this revenue in his own pocket) than it is to raise taxes on everyone else.
Richard Thompson Ainsworth, is a NH and MA attorney with over 20 years academic, government, and private sector tax experience. He is currently Director of International Tax (Government Affairs) with ADP and an Adjunct Professor at the Boston University School of Law where he teaches courses in VAT, Comparative Income Tax, and Comparative International Transfer Pricing.
 New Hampshire Department of Administrative Services, Comprehensive Annual Financial Report for the Fiscal Year Ended June 30, 2008, at 107 (indicating that for the ten year period from 1999 through 2008 the M&RT was second to BPT in each year, except 2000, and 2002 – 04 where the ranking was reverses and M&RT receipts exceeded BPT revenues), available at http://admin.state.nh.us/accounting/FY%2008/1083-accounting%20cafr%20combined.pdf (last visited March 21, 2009).
 In 2005 meals were the 74.5% of the M&RT; in 2006 meals were 72.6% of the M&RT; in 2007 meals were 71.7% of the M&RT; in 2008 meals were 70.2% of the M&RT. This downward trend in relative meals revenue coincides with the M&RT dropping behind the BTP after exceeding it for the prior three years.
 For more detailed discussion of Zappers and Phantom-ware see: Richard T. Ainsworth, Zappers: Tax Fraud, Technology and Terrorist Funding http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1095266; Zappers & Phantom-Ware: A Global Demand for Tax Fraud Technology http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1139826; Zappers and Phantom-Ware at the FTA: Are They Listening Now? http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1147023
 U.S. v. Stewart J. Leonard Sr. & Frank H. Guthman, 37 F.3d 32 (1994), aff’d. 67 F.3d 460 (2nd Cir. 1995) (although the tax case was settled, the details of the fraud are preserved in these federal sentencing appeals).
 Press Release, U.S. Dept of Justice, Eastern District of Michigan, LaShish Financial Manager Sentenced for 18 months for Tax Evasion (May 15, 2007) available at: http://www.cybersafe.gov/tax/U.S.aopress/2007/txdv072007_5_15_ElAouar.pdf (last visited Feb. 3, 2008).
 Press Release, U.S. Dept of Justice, Eastern District of Michigan, Superseding Indictment returned Against LaShish Owner (May 30, 2007) available at: http://www.justice.gov/tax/usaopress/2007/txdv072007_5_30_chahine.pdf (last visited Feb. 3, 2008).
 Personal e-mail communication, Gilles Bernard, Adjunct Director General for Fiscal Research, Revenue Quebec November 24, 2008 (on file with author).
 Revenue Quebec, News Release, Tax Evasion: The Ministry of Revenue Suspects the Restaurant Grill San Antonio de Laval of having used a Zapper (Apr. 8, 2004) available at: http://www.revenu.gouv.qc.ca/eng/ministere/centre_information/communiques/ev-fisc/2004/08avril.asp (in French only, last visited Feb. 8, 2008).
 The director, Mr. Apostolos Mandaltsis, was personally fined $65,681.00 and $10,300 respectively for PST (Provincial Sales Tax) and GST (federal Goods and Services Tax). Taxes and interest were due in addition.
 Revenue Quebec, News Release, Revenue Quebec Investigation of a Software Designer Outlet Suspected of having Developed and Distributed Zappers (Oct. 14, 2005) available at: http://www.revenu.gouv.qc.ca/eng/ministere/centre_information/communiques/ev-fisc/2005/14oct(2).asp (in French only, last visited Feb. 8, 2008).
 Revenue Quebec, News Release, The Company Audio LP, Inc. Convicted of Tax Evasion (Sept. 21, 2007) (on the conviction fines were imposed of $12,475) available at: http://www.revenu.gouv.qc.ca/eng/ministere/centre_information/communiques/ev-fisc/2007/21sep.asp (in French only, last visited Feb. 8, 2008).
 The breakdown is: $429,179.07 (GST) + $492,023.11 (PST) + $214,589.55 (federal penalties) + $625,028.89 (provincial penalties) + $55,250.28 (judicial fees). Revenue Quebec, News Release, All Stratos Restaurants Convicted of Fraud in Connection with the use of a Zapper (Mar. 18, 2003) available at: http://www.revenu.gouv.qc.ca/eng/ministere/centre_information/communiques/ev-fisc/2003/18mars.asp (in French only, last visited Feb. 8, 2008).
 Revenue Quebec, News Release, Fines of more than One million dollars – A Father and his Two Sons convicted for Tax Evasion in connection with the Zapper (May 2, 2003) available at: http://www.revenu.gouv.qc.ca/eng/ministere/centre_information/communiques/ev-fisc/2003/02mai.asp (in French only, last visited Feb. 8, 2008).
 Revenue Quebec, News Release, Mr. Marcel St. Louis de l’Outaouais Convicted of Tax Evasion related to the use of a Zapper (Mar. 17, 2003) available at: http://www.revenu.gouv.qc.ca/eng/ministere/centre_information/communiques/ev-fisc/2003/17mars.asp (in French only, last visited Feb. 8, 2008).
 Revenue Quebec, News Release, The Zapper Designer of Boucherville Pleads Guilty to Various Charges brought by Inland Revenue Quebec (Oct. 26, 2005) (additional penalties of $22,513.19 under the GST and QST, as well as income tax of $17,297.08 and related penalties of $26,621.35) available at: http://www.revenu.gouv.qc.ca/eng/ministere/centre_information/communiques/ev-fisc/2005/26oct.asp (in French only, last visited Feb. 8, 2008).