Tax evasion is not a “Panama” problem, it is a global problem. It poses a serious threat to world economies, as governments face an increasing need to bolster tax revenues to remain solvent and to provide adequate welfare and public services. When revenues fall short, there is often an added tax burden placed on honest tax paying citizens. It is time for the world economy to take a closer, more serious look at tax evasion, for the benefit of all. But this will not happen without the cooperation of many hands.
In light of the Panama Papers revelations, it is easy to blame the liberal tax laws of offshore jurisdicitons for the problem. But that would not be entirely correct. Tax evasion and tax avoidance are two different things. Reducing personal or corporate taxes through offshore vehicles—avoidance—is perfectly legal within the ambit of the law. Tax evasion is not. It is a criminal offense that is subject to a prison term or a fine if one is found guilty of it. It involves escaping payment by illegal means and is usually combined with greater criminality, as law breakers seek to hide ill-gotten gains. But here’s the rub: although governments have worked to contain tax evasion for decades, globally, enforcement remains difficult, spotty, or non-existent in some jurisdictions.
So, what is the solution? Currently, we see legislative and policy reforms on the rise, which is a start, but this alone is not enough. It will require the hands of many participants, working in cooperation, globally, including the governments and regulatory bodies of offshore tax havens, the financial institutions and other service providers that provide opportunities to transfer funds, and the respective parliaments and law reform agencies that can harmonize laws internationally. Perhaps more urgently, global enforcement authorities must cooperate across borders to ensure stern action against tax evaders is taken within their own countries, according to the laws in place.
Intensified emphasis on tax evasion in cross-border investigations
In the wake of the Panama Papers leak, prosecutors and officials across the world have initiated investigations to determine whether any of their nationals or financial institutions have used Panama for tax evasion or other economic crimes. In the United States, the Department of Justice has opened criminal investigations for potential prosecutions against the alleged individuals and institutions exposed by the Panama Papers. And as more information emerges, more investigations will be carried out by all countries involved—cases will be opened and trials will be held. Yet, however urgent this intensified emphasis on investigations becomes, the fact remains that cross-border investigations pose complex legal, cultural, and practical issues that differ substantially from country to country.
Without a doubt, cross-border investigation is challenging and complex and may be the tallest summit in the quest to control financial crimes. For example, cultural differences in cross-border investigations can create significant problems if investigators do not understand and respect the culture. There are also practical difficulties in investigating offshore corporations. Unlike individuals, it is not possible to extradite a company or force an overseas company to turn up in a court to face prosecution. Further, most offshore companies have layers of shell corporations that may harbor the true identity of the beneficial owner. In such a scenario, time is of the essence if maximum recovery is to be expected. Unfortunately, civil remedies to locate, freeze and recover assets take much time and personnel to explore.
Therefore, collaborative efforts between local and international law enforcement agencies are critical. Where little infrastructure exists in some of the most abused jurisdictions, an increased effort to deploy a disciplined, organized approach is needed. Legal counsel with expertise in cross border litigation will be essential, as investigations must account for the various laws on reporting, privilege and data privacy, as well as cross-border transmission of evidence. And they must be able to advise on jurisdictional issues and nuances, and become an integral part of the investigative team, along with tax authorities, regulators, and enforcement agencies.
National legislative reforms to harmonize laws
A world of diverse laws and business practices contributes to the pethora of legal loopholes that allow criminals to hide money, evade taxes and commit other illicit financial activities. The most crucial step to overcome this is to reform and harmonize laws internationally to effectively close loopholes that allow offenders to shift monies offshore in order to avoid paying tax in their home countries.
One solution that has been championed by the Obama administration in the U.S. is a proposed national registry. The registry would document the beneficial owners of shell companies and make that ownership information publicly available. Such measure is expected to close the current loophole that allows foreign persons to hide assets in the U.S. through shell companies. With a registry in place, the identity of a beneficial owner, who might be on law enforcement radar, would be revealed and thus discourage such activity in the U.S. Other desirable global legislative reforms on the table are expected to be initiated at the national level in many countries. These include providing for either the apprehension and extradition of suspects to foreign authorities or for their prosecution within the jurisdiction and encouraging early steps to ensure that evidence and facts agreed and admitted are not altered or destroyed before they can be obtained from another country.
But achieving uniformity of legislation is neither simple nor quick. To make matters worse, pressure from international bodies may not allow for enough time to produce good quality regulations at the national level, where diverse legal and business cultures persist. Although it might be thought that harmonization of national laws is an end in itself, the amount of time and effort to be invested in these measures demands that much care is required. Yet, one can be sure that no matter what reforms are instituted around the world, what matters most is how reforms will be interpreted by national courts. In a domestic context, reform will present new, unique, and unforeseen issues. Suffice to say that any harmonization process will be a complex exercise. The legal cultures between various jurisdictions will inevitably create complex challenges involving time, resources, and cooperation.
The reform of international taxation will require unfettered cooperation between countries to progress in the fight against tax evasion. If this does not happen, the problem of tax loopholes will not be resolved and international business will be beset with the problems of tax evasion and costly compliance. As such, it is essential that international treaties are executed with as many participating countries as possible, in either bilateral or multilateral settings. For example, the G20 and Organization for Economic Cooperation and Development have taken the lead over many years in pursuing a wide range of global tax initiatives, including producing model tax treaties and encouraging countries to sign these treaties to demonstrate compliance on tax matters. The U.S. Foreign Account Taxpayer Compliance Act is another example that provides similar intergovernmental agreements to enable global exchange of information.
An international treaty that allows the automatic exchange of information on tax matters is considered to be a superior approach because it involves a system where a source jurisdiction periodically transmits taxpayer information to the taxpayer’s country of residence. This allows tax administrators to determine whether an individual has accurately reported their foreign source income and to calculate an individual’s net worth with more ease. Further, automatic information exchange can offer timely information on tax evasion, as well as provide a powerful deterrent to potential non-compliers. However, these treaties are consensus based which can be challenging and potentially protracted. Treaties are often criticized for not taking into consideration the interest of developing countries, which can be a separate, highly problematic issue. Another major hurdle is that the guidelines in any international treaty would then have to be reconciled with competing interests in the national legislation. Nonetheless, multilateral treaties can offer great potential for enhanced cooperation among countries with respect to implementation of tax evasion measures, confiscation of criminal assets, promotion of extradition and mutual legal assistance mechanisms, and the application of modern technology in the fight against crime.
Bolstered regulations for financial institutions and service providers
Allied to the harmonization of laws is the need to harmonize aspects of business practices in order to provide a global environment in which economic crime is difficult to perpetrate and yet simple to detect. The U.S. Department of the Treasury Financial Crimes Enforcement Network has issued proposed regulations, known as “customer due diligence,” to require U.S. financial institutions to identify any individual who owns 25 percent or more of an entity owning a U.S. bank account. These rules are intended to ensure the U.S. banking industry has systems in place to track the ultimate beneficial owners of U.S. accounts and avoid the type of secretive financial transactions disclosed in the Panama Papers. Critically, financial institutions and corporate service providers should be held liable for failing to prevent the criminal facilitation of tax evasion by its representatives in relation to taxes. The intensified due diligence regulations will improve financial transparency in the effort to prevent criminals from using companies to hide their identity and launder criminal proceeds.
The Panama Papers leak is a wakeup call for all service providers including banks, investment houses, accountants, law firms, tax advisers and other professional advisers. In order to set things right, international professional bodies can have a role to play in creating uniform ethical practices globally which mitigate fraud. An example of such an international body is the International Accounting Standards Committee which was founded as result of an agreement between accountancy bodies in various countries, and helps to promote uniform accounting practices and procedures within the business community.
Looking ahead, some of the most pressing issues that need to be addressed include the continuing harmonization of laws with a view to strengthen laws and procedures that make economic crimes difficult to commit. Tax treaties are a critical tool for countries to ensure enforcement of tax laws and reciprocity with other jurisdictions. This will be a key component of any successful strategy for combatting international tax evasion. Further, banks and service providers must remain vigilant and consider the importance of enhanced due diligence regimes when dealing with offshore transactions. If there are concerns of possible complicity in financial crimes, they should be reported immediately and investigated promptly by the requisite agencies.
It would also be wise that the outcomes of judicial proceedings against tax evaders be widely and effectively disseminated, internationally, to enhance general deterrent effects on potential offenders, as deterrence remains an important component of fraud control. In particular, public notification of the confiscation of assets represents one of the most effective means of achieving deterrence from economic crime. Yes, ultimately the solution could be quite simple, because it all boils down to a public emphasis on crime prevention measures. A culture of honesty and ethical business practices among members of the public could actually bring about the much needed change.