Global Financial Integrity

Samuel Zeller Unsplash

Financial Secrecy

Neon Brand Unsplash

The phrase ‘tax haven’ often conjures up images of a balmy palm tree-studded island nation with an ‘anything goes’ attitude to accepting financial deposits and a distinct distaste for foreign authorities—“sunny places for shady people,” as author Nicholas Shaxson calls them. But these classical tax havens now have a lot of company—despite recent progress, there are still plenty of places all over the world where one can stash their money without scrutiny.

In other words, tax havens aren’t tax havens just because they have low taxes—rather, what makes a tax haven is its opacity of financial information. This is why tax havens are often more accurately referred to as ‘secrecy jurisdictions,’ and why they facilitate many more problems than just tax evasion.

While the legal regimes that tax havens set up to enable this secrecy are complex, their basic outline is simple—banks, companies, trusts, or other financial actors in the country are allowed to accept money from basically anywhere without reporting it to the authorities in the country where it originates or from which it is controlled. In some cases, it is actually illegal to disclose that information, but in many places, it is simply because the banks or other entities aren’t required to disclose it and there is no mechanism to force them to do so.

Money LaunderingLaundering criminal proceeds through a tax haven is therefore merely a matter of finding a bank in that country to accept your deposit without asking questions, shuffling the money around a bit, and then sending it to wherever you’d like to spend it or to wherever you’d like to receive it. Evading taxes through a tax haven works similarly—disguise income or assets as passing through that country and fail to report it to your home country’s tax authority. For the less criminally inclined, tax havens often also offer a great legal ways to avoid paying taxes, simply by characterizing income as passing through that country and using loose tax treaties or loopholes in one’s home country tax law to claim that the income is untaxable there.

Law enforcement and tax authorities will always be one step behind criminals and tax evaders, following cryptic transaction records and grasping at shadows rather than seeing where money is actually hidden.

What is automatic exchange of financial information?

Over the years, many developed countries have taken steps to break through tax haven secrecy by including provisions in tax treaties or other agreements to exchange financial information with other governments, including tax haven governments upon request. This system has two major flaws, though: First, it requires the requesting government to know what specific information they’re looking for, which can be difficult to pin down when attempting to trace money passing through anonymous shell companies or many other money laundering strategies. Second, the tax haven government may not be able to collect or have access to the information being regulated; so pursuing the process can be an extremely slow process with potentially little reward.

The alternative is automatic exchange of financial information (AEOI or ‘automatic exchange’ for short), and it is exactly what it sounds like—countries automatically exchange information on bank accounts, transactions, and financial flows with each other on a periodic basis, enabling law enforcement and tax authorities to follow up on any leads they may have. GFI has advocated for many years that countries should establish and participate in systems whereby they exchange as much information with each other as is feasible.

While automatic exchange may have been considered unfeasible in the past, technological advances have made the collection, transfer, and processing of the large amounts of data involved relatively easy, and automatic exchange has come to be seen as a common-sense solution to the problems created by tax haven secrecy. The G20 nations declared in 2013 that automatic exchange is “the new global standard,” and pledged to begin exchanging financial information automatically by the end of 2015.  In 2014, every OECD member-state and a group of several other countries endorsed a standard system for multilateral automatic exchange of financial information. GFI strongly supports automatic exchange of financial information on a multilateral basis and believes the opportunity to join this system should be extended to all willing countries, specifically developing countries.

What about developing countries?

Developing countries would benefit tremendously from a well-designed and well-implemented system of automatic exchange of financial information. Developing countries’ law enforcement and tax authorities often have less expertise or technical capacity for tracking transactions and income passing through tax havens, yet these countries are harmed the most by the illicit financial flows enabled by the opacity of tax havens and the shadow financial system.

GFI believes that any multilateral system of automatic exchange should also serve the interests of the world’s smaller economies, but must also take into account the capacity of these countries to effectively utilize the data they would receive from this system. Technical assistance and capacity-building programs will be crucial to this effort, but developed countries should also consider exchanging information to developing countries without obligating them to return the favor, at least initially.

What is the Foreign Account Tax Compliance Act (FATCA)?

The Foreign Account Tax Compliance Act (FATCA) is a U.S. law enacted in March of 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act. FATCA requires financial institutions outside the United States to determine whether it has any customers who are U.S. citizens and report information on all of those customers’ accounts to the Internal Revenue Service (IRS). Any bank refusing to comply will be assessed an automatic withholding tax on its U.S.-source income. Even though it has not even fully gone into effect yet (the first information exchange will take place in 2015), the law is widely viewed as a ‘game-changer’ in global information exchange and helped pave the way for other countries’ commitments to a multilateral information exchange system. For more information on FATCA, please see the U.S. Treasury website.

What about multinational companies?

Multinational companies (or ‘MNCs’) use tax haven secrecy in slightly different ways then criminal tax evaders and money launderers. In general MNCs use complicated corporate structures involving layers of tax haven entities and accounts to disguise or alter the character of their income in ways that (often legally) reduce their corporate tax bill, a process known as ‘tax avoidance’ (in contrast to ‘tax evasion,’ which is illegal). These strategies can be wildly successful for MNCs, bringing their tax bills down to zero or even triggering a tax refund from the government, while they enjoy massive profits.

Cracking down on tax avoidance often requires closing the seemingly endless number loopholes in tax treaties and tax laws one at a time. However, one way to greatly expedite this process, as well as bring public pressure to bear on rampant tax avoiders, is to require them to own up to their tax schemes. Global Financial Integrity recommends that all multinational companies be required to publicly disclose basic financial information, such as their sales, profit, taxes paid, and number of employees, in each individual country in which they operate. This policy, called “country-by-country reporting,” will not only help both rich and poor countries better enforce and amend their tax laws, but it will also make free markets more transparent for investors and the public at large.