The Panama 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 non-residents, 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 minimizing their tax. 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 U.K. in 2015 and the U.S. 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
The Panama Papers investigation by the International Consortium of Investigative Journalists (ICIJ) have already resulted in the resignation of Iceland’s Prime Minister Sigmundur David Gunnlaugsson. ICIJ has documents that show how his wife owned a British Virgin Islands shell company called Wintris Inc. that held millions of dollars in bonds in the three 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 United States).
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 United States, 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 $20 trillion 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 what is the extent of the illegal tax evasion and other criminal activities these tax havens facilitate.
Tommaso Faccio is a lecturer in accounting at the University of Nottingham in the U.K. This article was originally published on The Conversation.