As the maxim goes, every cloud has a silver lining. There is growing hope that this might turn out to be the case with the fallout from the current global financial crisis. One of the defining characteristics of the crisis is the erosion of confidence in the self-regulating powers of markets. In the wake of the summit of the G20 countries in London last week, some critics believe that the deregulation process has been thrust into reverse gear. There have already been numerous company closures, massive job losses, and market collapse, prompting government bailout initiatives in several countries. These developments appear to herald a new era of greater transparency and international co-operation in combating financial crimes. Experts predict that increasing powers will be given to law enforcement agencies to work across borders to track down unlawful capital flight, especially tax evasion.
The events of the last few weeks suggest that the predictions about greater regulation are not far fetched. On Thursday 12th March 2009, Liechtenstein and Andorra announced that they were loosening their strict bank secrecy laws. The following day, Austria, Luxembourg and Switzerland followed suit. Why are these long-standing offshore financial centres abandoning their tradition of banking confidentiality? Does this mark the demise of tax havens? If so, what will be the implications for developing countries?
The distinct feature of financial offshore centres over the years has been that they offered investment environments for foreign companies to either pay very little tax or no tax at all. In addition, they refused to share information on the identity of such companies or on their financial dealings with other countries. Significantly, they would not co-operate with tax authorities from the countries from which companies doing business offshore originated.
This protection was over the years extended to individual offshore investors. As a result, tax havens were therefore ideal for criminal elements, seeking to evade tax and to launder ill-gotten wealth. Following up and investigating corruption and tax fraud presents insurmountable challenges for law enforcement agencies if a tax haven is involved. At the heart of the problem lies the fact that tax havens insist that the inquiring agency should present full information on the identity of the account holder as well as the account details. Often this information is the subject of the inquiry, and therefore not readily available. In February 2009, the Union Bank of Switzerland (UBS), which is the world’s largest wealth management firm, admitted that it had helped some of its American customers to evade US taxes. It agreed to pay a fine of $780million and disclose the identity and account information of 250 American clients. In 2008, some banks in Liechtenstein made similar admissions in respect of high net worth German clients.
By facilitating tax evasion and capital flight, tax havens impacted negatively on developing countries - which lost both tax revenues and investment capital. Tax evasion erodes the domestic tax base and contributes to balance of payments deficits persistently experienced by developing countries.
It must be emphasized that not every individual or company that banked in these tax havens was involved in tax evasion or money laundering. Offshore investment also involves lawfully earned funds, and could be motivated by the uncertainties of economic management in some countries.
The global financial crisis has put pressure on tax revenues of developed countries. It also revealed that many of the most complex debt instruments were based in offshore financial centers. Some leaders in the developed world, such as British Prime Minister Gordon Brown, insist that the lifting of tax secrecy in tax havens is central to turning the economic meltdown around. It is argued that financial regulators in tax havens should be obliged to spontaneously disclose information on the identity of offshore investors. They should also disclose full account details and transactions.
In response, the tax havens concede their vulnerability to abuse by tax fraudsters. They are however only prepared to enter into bilateral agreements with specific tax authorities. They are firmly opposed to facilitate ‘fishing expeditions’ by tax authorities. In this regard, they are supported by Article 26 of the Model Tax Convention of the Organisation for Economic Co-operation and Development (OECD), which provides for the sharing of tax information on a case-by-case basis.
Article 26 falls short of the demand by Gordon Brown and others for automatic sharing foreigners’ account information. Assuming that he persuades other G20 countries to support him, Brown still has long way to go before the dear of spontaneous disclosure by tax havens becomes reality. For that to happen, much legislation will need to be passed. Secondly, the tax havens will need to renegotiate various double taxation treaties and enter into Tax Information Exchange Agreements with various States. Some of these treaties will be subject to approval in referenda.
What do these developments mean for developing countries? It is increasingly being recognized that steps to assist developing countries to move beyond dependence on aid and debt will require measures to tackle capital flight, tax evasion and the abuse of international trade to launder money. The lifting of the veil of banking secrecy by offshore financial centers presents an opportunity for developing countries to track down companies and individuals involved in tax evasion and laundering of proceeds of tax evasion and corruption in tax havens.
There are numerous hurdles still to be overcome. In addition to those raised above are the significant capacity deficits in developing countries. The investigation of tax evasion in developing countries is usually impeded by the lack of specialized training in financial investigation amongst law enforcement agencies.
In the final analysis, the fate of tax havens as a catalyst for tax evasion and corruption will largely depend on the determination of developed countries to tame offshore financial centres. The quality and depth of the legislation to achieve this will be critical. The devil, as they say, will lie in the detail.
Charles Kamba: Consultant Researcher, Organised Crime and Money Laundering Programme, ISS Cape Town
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