Ex­plainer: What are tax havens?

In the wake of the Panama Pa­pers leak, we take a look at how tax havens op­er­ate.

Finweek English Edition - - THE WEEK - Ed­i­to­rial@fin­week.co.za

thePanama Pa­pers leak sheds some light on the in­tri­cate ways in which the wealthy can ex­ploit se­cre­tive off­shore tax regimes. As well as charg­ing min­i­mal or no tax to res­i­dents and non­res­i­dents, the main char­ac­ter­is­tics of tax havens are their lack of trans­parency and ef­fec­tive in­for­ma­tion ex­change.

As the leaked files of Panama-based law firm Mos­sack Fon­seca show, these havens are used by in­di­vid­u­als and com­pa­nies to stash their cash, away from the pry­ing eyes of civil­ians or in­ves­ti­ga­tors. This is not nec­es­sar­ily be­cause their money has been ob­tained il­le­gally. In the case of pub­lic fig­ures such as politi­cians, for ex­am­ple, they may want to keep the size of their wealth a se­cret or hide from their elec­torates that they or their rel­a­tives are legally min­imis­ing their tax con­tri­bu­tions. To do so, they hide their iden­tity us­ing a num­ber of com­plex le­gal mech­a­nisms.

Whether it is a wealthy en­tre­pre­neur or a drug traf­ficker, the tricks used to make their af­fairs hard to trace are pretty sim­i­lar. It all starts by in­cor­po­rat­ing a “shell com­pany” (or a “let­ter­box com­pany”) in an off­shore tax ju­ris­dic­tion, us­ing the ser­vices of a law firm such as Mos­sack Fon­seca. These com­pa­nies have the out­ward ap­pear­ance of be­ing a le­git­i­mate busi­ness but in re­al­ity are just empty shells. They man­age the money they re­ceive and hide who owns it. The man­age­ment is made up of lawyers and ac­coun­tants whose only role is to sign doc­u­ments and al­low their names to ap­pear on the com­pany’s let­ter­head.

The money is re­ceived by this shell com­pany from peo­ple who wish to hide these funds from tax au­thor­i­ties and the wider pub­lic. Very few ques­tions are asked about the source of this money, which can then be used by the shell com­pany to carry out le­gal ac­tiv­i­ties such as in­vest­ing in real estate – or il­le­gal ac­tiv­i­ties such as brib­ing a gov­ern­ment of­fi­cial.

The own­er­ship of these shell com­pa­nies can be eas­ily trans­ferred, through the use of bearer shares and bonds, whose own­er­ship be­longs to the per­son that holds the phys­i­cal stock cer­tifi­cate. These were abol­ished in the UK in 2015 and the US gov­ern­ment stopped sell­ing bearer bonds in 1982 in a bid to in­crease trans­parency. They al­low large sums of money to be moved around eas­ily, with full anonymity.

Lack of trans­parency

ma­jor Ice­landic banks, which col­lapsed in 2008. In 2009, Gunnlaugs­son en­tered par­lia­ment but failed to de­clare his wife’s own­er­ship of Win­tris. The elec­torate was none the wiser due to the lack of in­for­ma­tion ex­change be­tween the Bri­tish Virgin Is­lands and Ice­land, which en­sured that this in­for­ma­tion was not avail­able.

It is not il­le­gal to have deal­ings with a tax haven – and in fact there can be very le­git­i­mate rea­sons to con­duct busi­ness there, such as in­vest­ing in a hedge or mu­tual fund. And tax havens are of­ten used by busi­ness peo­ple in un­sta­ble coun­tries where they are at risk of “raids” by crim­i­nals or their gov­ern­ments.

In spite of this, the lack of trans­parency and lack of in­for­ma­tion ex­change can also be used for il­licit pur­poses, in­clud­ing money laun­der­ing, bribery, cor­rup­tion, tax fraud and other il­le­gal ac­tiv­i­ties. Be­cause the ben­e­fi­cial own­ers of a com­pany are kept se­cret, the pro­ceeds of crime can be hid­den or used for ne­far­i­ous pur­poses with­out any au­thor­i­ties be­ing able to trace it. If law en­force­ment and other com­pe­tent au­thor­i­ties had ac­cess to ben­e­fi­cial own­er­ship in­for­ma­tion, they could “fol­low the money” in fi­nan­cial in­ves­ti­ga­tions in­volv­ing sus­pect ac­counts or as­sets held by cor­po­rate ve­hi­cles.

The lack of ef­fec­tive in­for­ma­tion ex­change is en­sured through se­crecy laws that pre­vent overseas tax au­thor­i­ties from ac­cess­ing in­for­ma­tion on the com­plex struc­tures lo­cated in tax havens. A num­ber of coun­tries have bi­lat­eral Tax In­for­ma­tion Ex­change Agree­ments (TIEA) with tax havens, which en­able their gov­ern­ments to en­force do­mes­tic tax laws by ex­chang­ing, on re­quest, rel­e­vant tax in­for­ma­tion. How­ever, Panama has only signed one TIEA (with the US).

Panama is far from alone in this busi­ness. Ac­cord­ing to the 2015 Fi­nan­cial Se­crecy Index for 2015 com­piled by the Tax Jus­tice Net­work, Switzer­land, Hong Kong, the US, Sin­ga­pore and the Cay­man Is­lands are the top five ju­ris­dic­tions for se­crecy and the scale of their off­shore fi­nan­cial ac­tiv­i­ties.

In 2013, The Econ­o­mist es­ti­mated that around $20tr could be stashed in off­shore ac­counts world­wide. Much of this may be used for le­gal ac­tiv­i­ties – but un­til there is full trans­parency and in­for­ma­tion ex­change be­tween tax havens and overseas tax au­thor­i­ties, it is im­pos­si­ble to de­ter­mine to what ex­tent tax havens fa­cil­i­tate il­le­gal tax eva­sion and other crim­i­nal ac­tiv­i­ties.

It all starts by in­cor­po­rat­ing

a “shell com­pany” (or a “let­ter­box com­pany”) in an

off­shore tax ju­ris­dic­tion.

The build­ing in Shang­hai, China, where Panama-based law firm Mos­sack Fon­seca has an of­fice.

Sig­mundur Davíð

Gunnlaugs­son

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