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From the Spring Issue "The Unknown"
By Andres Knobel
BUENOS AIRES, Argentina—Traces of explosives, sharp metal objects, and seemingly innocent liquid containers are checked daily for every passenger trying to board a plane in the United States. A CIA document obtained by Wikileaks describes even more subtle screenings performed by undercover agents in foreign airports looking for signs of nervousness. Customs officers are trained to detect lies, inconsistencies, or unusual behavior. Still, it took years before UBS banker Bradly Birkenfeld’s secret for shiny teeth was discovered. He was smuggling diamonds in toothpaste tubes on behalf of American tax evaders.
But those days are over. The United States already knows of Credit Suisse bankers deceiving American immigration officers about the real purpose of their visits. Espionage-like code names to conceal clients’ identities and encrypted computers are also as old as time, or at least the online universe. With all these tricks now in the open, some have been led to believe that the magic of invisible money is over. They could not be more wrong.
Efforts and plots to escape a country’s laws and taxes have been going on for as long as there have been taxes and their collectors. One option is to live sailing all year round in a luxury apartment of a cruise ship, effectively becoming a resident of the sea rather than any single nation. Recently, a man in Florida revived the idea of such a large vessel, officially called “Freedom Ship,” while others christened it a floating tax haven. Yet more ambitious are “seasteads”—floating cities designed to experiment with innovative political systems. But none of these fantastic schemes pose any real threat to sneaky, land-based tax havens. After all, there are easier and cheaper ways to achieve the same results, without needing to leave the mainland.
In order to be successful it is important to remain under the radar. One option is to approach this literally by hiding your identity. Apart from bitcoins and other virtual currencies, today the Internet offers all but limitless options to create a new profile, where imagination has an equal weight with reality, including fake photos, names, Facebook accounts, and LinkedIn work experience. Once this appears in a Google search, an identity is as real as it gets. For amateurs, it’s as easy as creating a false e-mail or bogus address when registering at a webpage. For the sophisticated, changing an IP address, simulating GPS location, even using TOR (“the onion router”) anonymity software could be equally effective. But black money is not like deep secrets no one should ever unearth. While it is similarly important to keep its location (and origin) hidden, black money is supposed to be used eventually. And the more liberty to spend it, the better.
A superior alternative is thus to be less secretive about who you are, but smarter about where you choose to be so as to look legitimate—ideally holding a bank account or creating a company or a trust in a well-respected place. Indeed, many Western first-world countries are being strategically chosen by tax dodgers and money launderers precisely because of their law-abiding history, foreigner-friendly rules, and first-rate financial services that no one would ever (manage to) question. These are the great unknowns of the future in the hidden worlds of subterranean finance—the first real major challengers to the remote offshore islands in the Caribbean and South Pacific that have for so long been the principal stereotypes of tax havens.
LEGALLY ILL-GOTTEN GAINS
However contradictory it may sound, ill-gotten money has a lot to do with legality. Just as the Nazis first embarked on their economic actions against Jews within the scope of their racial laws, so trillions of dollars are held offshore under the auspices of tax havens’ rules and regulations. Provisions like “no foreign country’s inheritance laws may ever be invoked to invalidate a Trust created here” may appear perfectly legal, not because any honest person would ever agree with them, but because they were formally enacted and remain unchallenged. This legal framework that enables the discrete generational transfer, deposit, and enjoyment of illicit financial flows has not happened by chance, but is the result of deliberate and careful policies undertaken by major financial centers.
Nevertheless, it’s not only written statutes but also tacit social norms that keep the system running. Chatham House researcher Nick Shaxson describes the global community of offshore banking as “a peculiar mixture of characters [who] populate this world: castle-owning members of old continental European aristocracies, fanatical supporters of the American libertarian writer Ayn Rand, members of the world’s intelligence services, global criminal networks, assorted lords and ladies, and bankers galore.”
But as Shaxson explains, silence is guaranteed by accomplices and dissenters alike. For active contributors (such as bankers, lawyers, accountants, and other service providers), it’s either a complete indifference to the consequences that corruption and tax evasion may have in places like Africa and Latin America, or directly believing that they are doing the right thing by helping foreigners protect their money from political risk or unstable currencies. In some cases, it’s blatantly justified as “poor people in Africa are poor because they don’t work hard enough.” Sadly, many of the system’s foes have also learned neither to criticize nor to ask questions, otherwise they will pay the price of ostracism—losing any chance to get promoted, being socially isolated, attacked by the media, legal persecution (instead of protection for denouncing a wrong-doing), becoming a traitor, or designated as the enemy. As whistleblowers Rudolf Elmer and Antoine Deltour painfully discovered, these are not attributes specific to sparsely populated islands, but are also available in prominent countries in the heart of Europe—Switzerland and Luxembourg in particular.
After the financial crisis of 2008 and recent tax scandals by major companies (and countries), a clampdown against tax havens is underway, leaving a trail of bewilderment over which will prevail or what new ones might replace them. With global household wealth calculated at $263 trillion by Credit Suisse and 11 percent of that, or $30 trillion estimated to be held offshore, stakes are high for candidates to attract these funds. Growing inequality will create even more millionaires, certainly billionaires, trying to avoid scrutiny, evade taxes, or both. It’s unlikely that one country alone will be able to serve the whole offshore world. After all, most investors—legal and illegal alike—believe in the importance of diversifying. Just as in the international division of labor, tax havens have also learned to cater to specific industries or nationalities. Still, there are clues to the next illicit hotspot.
Tax havens can be classified into two large groups. First are those that always come to mind—palm-filled islands scattered across the Pacific Ocean and the Caribbean, and pariah states, which neither sign treaties nor attend international conferences. Nauru in the South Pacific, for example, will still appeal to some erratic criminals, smugglers, and tax evaders. However, no big fish would dare to be (openly) related to it. In other words, it is unlikely that Nauru will be joining the major leagues of tax havens chosen by Fortune 500 companies or Forbes’ list of billionaires.
The second group comprises the big pretenders. A rule of thumb applied by tax havens suggests that the best way to disguise inaction is by pretending to do something. Otherwise, unwarranted attention will be drawn. Simulating cooperation may be achieved by joining multilateral conventions against corruption, transnational organized crime, or financing of terrorism, but then making subtle reservations to either limit its applications or ring-fence specific territories and colonies. A more popular strategy is to sign a treaty about exchange of bank account information while knowing ratification will never happen or not until a distant future, blaming domestic political rifts for the delay. An equivalent tactic is to run national consultations about new transparency platforms so as to democratically decide that nothing will change.
An even more sophisticated ruse is not only to be part of the herd, but to become the shepherd. By ensuring that international rules will be designed and imposed by organizations that include only rich countries as their members (such as the G20 or the OECD), tax havens guarantee that ‘global standards’ will be consistent with their own interests. An example of this is the OECD Model Treaty to avoid double taxation, which favors capital-exporting countries (instead of developing ones) when it comes to levying taxes. This model agreement also allows big companies to avoid paying any tax at all in the countries where they operate as long as they structure their businesses carefully. This is exacerbated by the OECD Guidelines on Transfer Pricing, which are easily exploited by multinational companies that, through intra-group transactions, shift profits to low-tax jurisdictions and thus avoid paying taxes again. Some of these issues are currently being addressed by a process called BEPS, which stands for Base Erosion and Profit Shifting, but big surprise, it is also run by the OECD.
It is already well known that major Internet companies and other well-known retailers make use of the so-called double Irish-Dutch sandwich strategy to avoid paying taxes “legally.” It combines U.S. check-the-box rules (to choose how to classify foreign subsidiaries), setting up two companies in Ireland (one to invoice services performed somewhere else, like the United Kingdom, and the other one to “exploit” Irish tax-residency rules), a Dutch company to avoid withholding taxes when transferring profits among the two Irish companies, and finally a company in a zero-tax jurisdiction like Bermuda where profits will finally be transferred. Less understood, however, is what was (not) done to appease the outrage against big companies not paying their fair share of taxes. In an attempt to calm any sense of outrage, the end of the double-Irish was proclaimed, although surprisingly, Ireland was portrayed as the naïve innocent, while big companies and small islands were to take all the blame. The small print, however, reveals a different story.
The significant change is that the end of the double Irish will only affect new companies, which had failed to take advantage of the popular scheme. Clever ones, in contrast, will have a transition period through 2020. As if this were not enough, Ireland’s prime minister announced the development of a “patent box” regime, which is nothing but the option to “strategically” register patents or trademarks in a place with low taxes, even if no research and development actually took place there. This allows companies to transfer royalties wherever they want to make sure that little to no tax will be paid. No wonder big companies have little to fear from Dublin.
Facts are undeniable—like American companies undertaking inversion deals to relocate to Britain as a way to avoid U.S. taxes; London’s high-priced real estate sector overheated by foreigner money launderers; British Virgin Islands’ surprise ranking as the world’s fourth largest recipient of foreign direct investment (receiving more funds than India and Brazil combined, despite its tourist economy and 20,000 inhabitants); Cayman Islands’ Ugland House, which alone serves as the residence of 18,000 companies; or Jersey’s financial brochure aimed at Russian oligarchs trying to avoid both taxes and Russian inheritance laws.
With all this on his plate, Prime Minister David Cameron is passionate about targeting aggressive tax avoidance. He even sent a letter—yes, a paper letter—to British Overseas Territories and Crown Dependencies regarding beneficial ownership registration (politely requesting that they identified the real individuals who own companies regardless of nominees or corporate layers). As a consequence, these tax havens collectively did not hesitate to consult on this new push to establish a truly transparent system. And in an unexpected challenge to the Empire, the Overseas Territories decided to reject the request. Striking back, Cameron decided to impose the central registries of beneficial ownership in the U.K., for whatever marginal use that will likely be in the future, though a tiny—actually giant—loophole was left. Only some trusts would have to register, but even in such a case, their information would not be accessible to the public, leaving a most opportune choice for tax dodgers and money launderers trying to avoid scrutiny.
Even without any awareness of Luxleaks, the disclosure of secret tax arrangements between Luxembourg’s authorities and some of the world’s most important companies, allowing them to reduce their global effective tax rate to about 1 percent, the OECD’s Global Forum on Exchange of Information had already highlighted the Grand Duchy in red as “non-compliant with international transparency standards.” Furthermore, in an attempt to compete with Singapore, last September Luxembourg proudly inaugurated “Le Freeport,” a state-of-the-art free port next to the airport. Interestingly, free ports and special economic zones are supposed to be territories with special rules—no VAT or custom duties, few controls, if any at all—because they are not considered regular parts of a country’s territory, but rather logistical hubs where goods in transit are waiting to be delivered to their final destinations.
Somehow inconsistent with these transit purposes, Luxembourg’s free port offers no-time-limit storage of valuable goods “such as works of art, fine wines, precious metals, jewels and diamonds, vintage cars, etc.” Coincidentally, Le Freeport will come in handy to all those trying to escape reporting to the tax authorities that (some) banks will need to start doing about their account holders. The safest option against these new disclosure requirements will be to keep wealth in the form of gold, art, or jewels. No place will be better suited for this than such a locale as Le Freeport. To avoid any doubt as to the real reason behind this venue, Pierre Gramegna, Minister of Finance of Luxembourg, stressed during its inauguration, “I am convinced that this project will add a new branch of excellence to our financial sector and enhance its wealth management capabilities.” Expectations seem little related to the handling of goods in transit.
Unbeaten at the top of Tax Justice Network’s Financial Secrecy Index—a ranking of tax havens according to their secretive legal framework and their market share of financial services for foreigners—Switzerland is by far the most successful case of whitewashing. Swiss statutory banking secrecy originated with a tax evasion scandal involving Swiss banks and members of French high-society. However, it is usually—and wrongly—associated with helping German Jews during World War II. Contrary to this ‘Good-Samaritan’ myth, the very same Swiss Bergier Commission acknowledged that Switzerland was involved in suggesting Germany identify Jewish German passport holders with a “J,” which in many cases prevented them from entering Switzerland and other countries, when trying to escape from the Nazis.
In addition, Swiss banks showed concern about “Aryanization” of Jewish assets only when Jews were debtors, and the banks’ credits were at stake. The Bergier Commission describes consistent attitudes even after the war. Some Swiss banks deliberately decided not to report unclaimed assets of Holocaust survivors and not to contact heirs, waiting 10 years to destroy all evidence of client relationship. Estelle Sapir’s case offers a good example of this. Being a Holocaust survivor, she was easily able to recover her family’s bank deposits all over Europe, except in Geneva, where the bank requested her father’s death certificate and records of his deposits. The fact that he had been killed in Majdanek Concentration Camp and that she had barely managed to escape made very little difference to the bank. Rules are rules after all.
At some point, however, it seemed as if international pressure had started to crack Switzerland’s banking secrecy. After the United States uncovered UBS and Credit Suisse schemes to assist Americans in evading taxes, it made Switzerland sign a FATCA (Foreign Account Tax Compliant Act) agreement to get information about account holders with Swiss bank accounts. Information would thus start to flow to the IRS. But the Swiss caveat would affect only those account holders who consented to have their information sent. Likewise, Switzerland decided to exchange information automatically with European countries, very concerned not to lose market access. This became especially pressing when French fiscal agents began parking their cars conspicuously in front of leading Swiss private banks, like the Rothschild-owned Banque Privée, and photographing all customers who entered and left in an effort to identify leading French clients seeking to stash the wealth beyond the reach of France’s tax laws.
As to other countries, especially developing countries whose residents hide their undeclared funds in Swiss banks, Switzerland decided to impose some extra conditions. First, unlike the FATCA agreement where information only goes to the United States, the Swiss demanded reciprocity from other countries. Second, countries would be chosen only if they were politically and economically close to Switzerland and if they were promising markets for the Swiss financial industry. Third, countries needed to abide by Swiss safeguards for protection of personal data. Lastly, tax dodgers would be allowed to regularize their situation. In spite of this cherry picking, Switzerland will likely claim with pride that it exchanges information with other countries. It wouldn’t be strange if it ends up saying that all this was done to help African and Latin American countries discover unreported assets. If you tell a big enough lie and keep repeating it, people will eventually come to believe it.
UNITED STATES OF HYPOCRISY
While Switzerland hides behind myths and shenanigans, the United States is crystal clear—and this is where the future unknown may be paramount in tax and banking concealment. Despite protests to the contrary, the United States is eager to become the top tax haven in the world. What about all that monitoring and pointing fingers about money laundering, finance of terrorism, and tax evasion? They are still valid—as long as they apply only to everyone else.
People who accuse the United States usually think the problem concerns a single state. As The Guardian portrayed it, “A wedge-shaped chunk of land 96 miles long sitting halfway between Washington and New York, the state of Delaware is home to 870,000 people, 0.3 percent of the U.S. population. But more than half of the nation’s publicly traded companies are incorporated here, including 60 percent of the Fortune 500 firms. One anonymous office block serves as the registered address of more than 200,000 corporations.” Remember Ugland House in the Cayman Islands? This is more than 16 times the number of Cayman registered entities.
While American companies are condemned at home for their aggressive tax planning schemes—their operations abroad in Ireland and the like—the United States seems to be defending those very same companies against the OECD’s BEPS process, which tries to curb tax avoidance and evasion by multinational companies. Although this seems contradictory, there is some logic to it. The United States only cares about American companies paying taxes to the American treasury. It has little interest in helping other countries achieve the same result.
Regarding banking secrecy, the United States is even more straightforward with its double standard. Washington enacted FATCA rules to oblige foreign banks to send the IRS information about Americans holding bank accounts abroad. It also imposed a 30 percent withholding tax against any financial institution in the world which failed to participate or remained non-compliant with FATCA’s reporting obligations. It had little concern for all the businesses’ costs and domestic legal changes every other country had to undertake to allow its banks to provide this information to the United States. But when other countries, such as Germany, showed interest in receiving information about their own residents with accounts in American banks, the United States offered instead only basic and partial reciprocity. The United States would report information about fewer types of accounts, cover fewer types of income, and most importantly, there would be no look-through provisions to identify (German) individuals trying to avoid reporting by hiding behind some company or trust. In some agreements, the United States did commit to achieving equal levels of reciprocity, but cleverly forgot to set a timeframe for such conformity. Some smaller countries, in fact, were only offered the Hobson’s choice of providing all requested information to the United States or being subject to the confiscatory withholding tax.
FATCA then inspired the OECD’s own standard on automatic exchanges of financial account information, called the Common Reporting Standard or CRS, which was basically an adapted copy of FATCA, though carrying no sanctions. Given their similarities, many were led to believe that the United States would also commit to the CRS so that eventually all countries applied only one standard. To make the offer even more tempting, the CRS allowed special provisions in favor of American banks—and this despite Swiss bank opposition.
But Washington saw an opportunity it couldn’t afford to pass up. It decided instead simply and exclusively to apply FATCA. This way, while all countries would have to exchange information with each other pursuant to the CRS, and send information to the United States under FATCA, the United States need not fully reciprocate to anyone. This way it could offer foreigners the option to open accounts in American banks as a way to limit the disclosure of information to their own authorities. It was a classic tax haven service, but only available in the United States. Though not widely recognized, with an enormous dose of irony, it would appear that by stealth, the United States is quietly en route to becoming the next big unknown—or barely known—among international tax havens.
And there’s a cherry on top. As if Delaware’s anonymous corporate registration process and U.S. banking secrecy weren’t enough, such American flag territories as Puerto Rico or the U.S. Virgin Islands offer an entirely tax free environment. Why go anywhere else?
THE NEXT UNKNOWN
The most toxic tax havens and financial centers hardly involve far away islands, but some of the most important countries of the world. And because they are hiding in plain sight, they are likely to remain the next big unknowns on the darker sides of global finance. These, either through special provisions or using their related territories, manage to ring-fence foreign individuals and companies to “secure” them from other countries’ taxes, laws, and regulations. While the mere presence in a tax haven or opening of a bank account there does not indicate any wrongdoing or illegal activity per se, it is in fact intriguing why people who live and work in one place find themselves holding bank accounts in countries located thousands of miles away. The same applies to multinational companies that create shell companies in countries with no access to the sea, while owning no office space nor having any employees, but still hold intellectual property developed somewhere else or are involved in the international maritime trade of commodities between markets located oceans apart.
Contrary to fair market competition that boosts creativity and innovation, tax havens fight fiercely with each other in beggar-they-neighbor strategies. These consist of tax and regulatory wars to see who offers the ‘best’ conditions—a vicious cycle of lowering taxes, demanding less information disclosure, and loosening supervision—all designed to attract trillions of dollars, regardless of their corrupt, illegitimate, or illegal origins. But if all countries acted the same way (trying to attract money from each other), this would become a zero-sum game where every country would end up levying zero taxes (and state treasuries would be empty worldwide). The solution is to be the only one—or one of the very few—doing this. This is why, tactfully and under the veil of legality and international cooperation, rich countries design rules exclusively for others to follow. But when they can’t impose their own ways, like the United States, there’s always a final ace up their sleeve—either Britain’s trusts’ loophole, Irish tax residency rules, Swiss banking secrecy, or Luxembourg’s secret tax agreements.
In other words, while Panama, Lebanon, Nauru, and Vanuatu may rightly be labeled as harmful tax havens, more dreadful consequences may be attributed to ever more innovative and malign practices by the world’s most important countries. That’s the real unknown, and why there’s yet no need to live on the open sea or in outer space. The top tax havens of the future are much closer to home than expected and oh so eager to be discovered.
WHAT CAN BE DONE?
Increasing and improving international transparency (either by means of unrestrictive online access to data or through exchange of confidential information among authorities) is the only way to counteract the secrecy and anonymity of tax haven facilities, which enable tax evasion, corruption, and money laundering to thrive. Global monitoring and collective sanctions in case of non-compliance are essential, especially if they target some of the world’s richest countries and their financial centers. International organizations, including the G20, the OECD and its BEPS Process against tax avoidance, the Global Forum on Exchange of Information, or the Financial Action Task Force against Money Laundering, are trying to address these issues. However, they tend to be controlled by rich countries, so their proposals are usually filled with loopholes or under political pressure that impedes any real change in the short-term, let alone against the biggest state offenders.
That is why it is important to hear and involve those that are often the most affected (developing countries), by allowing the United Nations to play a more central role. Oxfam International’s World Tax Summit and Addis Adaba’s UN conference on Financing for Development in July 2015 may be some first steps in the right direction. Moreover, non-governmental organizations and investigative journalists have proven to be real game changers. Exposés of banks, companies, and countries shed light on the hidden tricks and crimes involving tax havens, and thus help mobilize society to push for real changes. The more information that is open to the public, the more real, tangible transparency, the sooner the problem will be solved. Illicit money, tax evasion, and corruption that thrive in the dark, shrivel and die in the light of day.
Andres Knobel is a lawyer based in Argentina and a consultant with the Tax Justice Network.
[Photo courtesy of Paul Falardeau]