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Tax Evasion Nation: Ending Tax Haven Abuse (what Obama gets wrong)

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The American Interest, May 12, 2016 
By Lucy Komisar

Solving the offshore money-laundering and tax evasion system is easy, but the Obama Administration’s proposal isn’t the way to do it.

Stung by the Panama Papers revelations of worldwide tax evasion by the rich and powerful, President Obama has seized the moment to propose a solution guaranteed to gather headlines—and then fail. But if he wanted to, he could, through the Treasury Department, end the system of offshore tax havens with a stroke of the pen.

First, let’s look at the solution and, then, at what’s wrong with the President’s proposal.

Obama proposal says it targets illicit dollarsThe goal at hand is to prevent criminals, terrorists, kleptocrats, and others looking to hide ill-gotten loot from getting access to the U.S. financial system anonymously.

Tax havens—offshore centers—are used to facilitate all kinds of bad stuff that threatens our national well-being and security. They facilitate illegal international drug and arms trafficking, and they enable corruption by corporations, dictators and run-of-the-mill fraudsters.

The Obama proposal acknowledges the threat offshoring poses to our national security. Treasury estimates that $300 billion in illicit proceeds are generated annually in the United States due to financial crimes. But it then essentially ignores the powerful weapon it can wield against that threat.

The U.S. Treasury Department has the authority to ban access to the U.S. financial system by banks deemed a threat to national security. The Office of Foreign Assets Control (OFAC) lists sanctions against 283 banks—in North Korea, Iran, Syria, Sudan, Burma, Zimbabwe, Lebanon, Somalia, Venezuela, Ukraine, and elsewhere. It’s a harsh punishment: Since so much of world trade is in dollars, which must clear through New York, banks need access to the U.S. system.

Former New York District Attorney Robert Morgenthau, who claimed jurisdiction against foreign miscreants on the grounds that their dollars cleared through New York, once told me that all the United States needs to do to end the offshore system is to block transfers into the U.S. financial system from secrecy jurisdictions. Nobody would launder their money in Panama, the British Virgin Islands, the Cayman Islands, Switzerland, the Isle of Man, or any of the dozens of such places if they could not move the money into and through dollar accounts in the United States.

Is our national security threatened by arms traffickers that use offshoring to provide weapons to terrorists? By gangsters who use offshoring to run the world’s drug and human-trafficking networks? By tax evaders who use offshoring to loot our treasuries and give politicians reasons to refuse to pay for education or health or infrastructure. Is it threatened by the corporations and individuals who use offshoring to hoard purloined cash that they use to buy politicians?

The Obama Administration got a lot of public corporate pushback to its proposal (and most likely private pushback as well). So it wrote a plan so full of loopholes that one can only assume the goal was good public relations, perhaps intentionally timed ahead of the anti-corruption summit this week in London, not to end the abuses it claims to attack.

To begin with, the plan starts too late in the offshoring process, when perpetrators—defined as terrorist organizations, corrupt actors, money launderers, drug kingpins, proliferators of weapons of mass destruction, and other national security threats—are stashing their assets in the United States. It ignores the earlier stage in which offshore companies and accounts are set up and the money is transferred into the United States, which the OFAC rule does not cover.

President Obama’s proposal would set up a centralized federal registry of the true owners behind any newly established corporation, and would mandate that financial institutions collect and maintain information on these owners as bank accounts are set up.

The law assumes that it’s quite okay to allow criminals, terrorists, and kleptocrats to keep the accounts they already have. Retroactive application would be “unduly burdensome,” says the proposal. So shell companies with no owners listed are “grandfathered” in to continue their illicit activities. There’s also no requirement to update the information on new companies; it would be so easy to get a straw man to set up a company and then shift real ownership.

Plus, U.S. states like Delaware and Nevada advertise “shelf companies,” waiting on “the shelf” for any purchaser to turn to illicit use. The drafters of the proposal are not naive about this fact. They say that “a shelf corporation is a legal entity that has been registered with a state but not yet used for any purpose; it has instead been kept on the ‘shelf’ for a buyer who does not want to go through the process of creating a new legal entity.” The prices of shelf companies should skyrocket, making big profits for their shadowy purveyors.

The proposal requires that banks know the identity of anyone who owns at least 25 percent of a legal entity or who “controls” it. You don’t need a tax evasion lawyer to know that you should list yourself, your spouse, your children and other relatives as owners so that everyone falls below the limit. Treasury says criminals might find reducing individual beneficial ownership below the disclosure threshold to be costly and inconvenient. Really, when they are playing with free money? The proposal allows the listed “control” names to be company officers, who could easily be straw men fronting for the true owners.

The “U.S.A.” corporate brand helps illicit actors even if they launder their money in offshore accounts. But, there is no requirement for U.S. states to collect owner information at the time a company is formed, which is when it would be easiest. And it’s a way for the banks to get the information more readily, instead of complaining to Treasury about the “burden.” But states like the money they get from registering companies without listing their true owners, and President Obama apparently didn’t want to challenge them. Nor did members of Congress, who like that easy (non-taxed) cash and must approve this proposal.

Another loophole: The rule doesn’t apply to the beneficiaries of trusts, a very easy way to facilitate illicit money movements. The IRS lawsuit against the Texan Wyly brothers details how they controlled the supposed hands-off trust that allowed them to evade taxes with the help of the Bank of America, which knew that the Wylys were directing the offshore entities’ investments and benefiting from their account income. In fact, the proposal is a boon for accountants and lawyers for illicit clients, in that it would require accountants and lawyers handling trusts to register themselves and not their clients! On May 10, a federal bankruptcy judge ruled that Sam Wyly engaged in “deceptive and fraudulent actions” by evading taxes on more than $1 billion held in offshore trusts. The Internal Revenue Service went to trial to get $1.43 billion in back taxes, penalties and interest from Wyly and $834.2 million from Caroline Wyly, the widow of his late brother Charles.

The Treasury Department acknowledged that criminals could move their accounts to countries without beneficial ownership identification and verification but said it was unlikely because “most” countries require financial institutions to collect and verify beneficial ownership of legal entity account holders. The proposal excludes foreign financial institutions in jurisdictions where regulators maintain beneficial ownership information regarding such institutions. But that’s a truck-sized loophole. Major tax havens routinely refuse to make that information available to outside law enforcement.

Beneficiaries of pooled investments are excluded; just an officer or manager has to be listed. So you get the Dewey, Cheathem & Howe hedge fund or private equity fund pooling investments from the family of the you-name-it drug clan or kleptocracy. Or maybe members of ISIS.

This is really where the barrier to illicit financial flows from offshore comes in. How can you check on every investor in a hedge fund? What a fine place to launder money. Or maybe there should be a financial threshold. Obama’s convoluted proposal, full of compromises and exemptions, can be easily gamed. Good PR aimed at people who read the headlines. Not so good for actually dealing with international criminality, tax evasion, and terrorism.

Sven Giegold, Financial and Economic Policy spokesperson of the Greens/EFA group.

Sven Giegold, Financial and Economic Policy spokesperson of the Greens/EFA group.

The Treasury Department notes that the United States is one of a very small number of the 35 Financial Action Task Force (FATF) members not in compliance with the requirement that financial institutions identify and verify the identity of the beneficial owners of legal entity accounts. FATF was set up in 1989, lots of time to deal with the problem. This, as the department notes, “undermines U.S. leadership on illicit finance issues.”

The Greens/European Free Alliance group in the European Parliament issued a report on May 11 that argues that the United States has fallen behind on tax transparency and should be considered as a tax haven under the new EU blacklist. It says that the new reform proposal is inadequate: “Even the U.S. Treasury final proposals on beneficial ownership collection by financial institutions are not enough to solve all the problems nor to bring the U.S. into line with the OECD’s standard for automatic exchange of information.” The report comes a week before a delegation of the European Parliament’s special committee investigating tax avoidance visits the United States.

The financial and economic policy spokesperson of the Greens/EFA group, Sven Giegold, said that the United States “fails to live up to the standards of global reporting that it requires of others.” He said, “Its exchange of tax information with other countries is more limited and full of loopholes,” adding: “We should introduce a withholding tax on U.S. banks not exchanging information as the U.S. has done with European banks.”

This proposal, so full of loopholes, won’t change that. President Obama should explain why the robust system he deploys against terrorists cannot also fortify and simplify the fight against others who benefit from illicit money-laundering.

The EU Greens/European Free Alliance on the U.S. Proposal’s Major Flaws

The Greens/European Free Alliance report says the Treasury proposal will not bring the U.S. into line with the standard for automatic exchange of information adopted by the OECD.

The report detailed why the U.S. is a major tax haven. Obtaining an anonymous shell company, it said, is easier in the United States than anywhere else in the world. In most cases, companies only have to identify one “responsible party,” who may be a nominee director (that is, a straw man). In 14 states, companies can be created without identifying either shareholders or managers. Wyoming, Delaware, and Nevada were among the worst, in that they were most likely to supply untraceable shell companies to foreign clients.
Since 2006, the Western economic powers’ Financial Action Task Force (FATF) has found that, contrary to FATF Customer Due Diligence requirements, financial institutions in the United States have not been required to identify beneficial owners in all cases, including in relation to corporations and trusts. It said the new rules had the same problems.
It pointed out that the new measures proposed on May 5, 2016 to provide that information would apparently still be about the “responsible party” and not necessarily about the real person owning and controlling the company (the so-called beneficial owner).
The report pointed out that financial institutions’ verification of the identity of beneficial owners would rely mainly on customers’ own certification. And that the definition of beneficial owner lacked the criterion of “control through other means.” Moreover, proposed requirements to identify the beneficial owner applied only to customers opening new accounts and didn’t cover trusts or require beneficial ownership information to be routinely updated in the future in case of changes.
Other shortcomings of the new proposal included that some entities will still not be covered (for example, insurance companies), the definition of “beneficial owner” is incomplete (it does not include the “control through other means” test, meaning that, if you cannot identify at least one person owning 25 percent or more of the shares, financial institutions should try to find someone who controls the company through other means, before identifying only someone with a managerial position, who may be a nominee director). The verification of information would rely mainly on the customer’s own certification, information on beneficial owners would be required for new accounts only (not for existing ones) and it will not need to be updated after the first time of collection, unless the financial institution becomes aware of changes as part of monitoring for risks. In addition, trusts will not be required to provide beneficial ownership information unless they own enough equity in an entity, such as a company, required to provide this information.
The United States Won’t Cooperate
The Greens/EFA report also noted that the United States has refused to join the trend for multilateral automatic exchange of information. Instead, it implements the domestic Foreign Account Tax Compliance Act (FATCA), enacted in 2010, and the related Inter-Governmental Agreements signed with other countries which involve unequal exchanges of information: The United States receives more information than it sends out (for example, about beneficial ownership data). The report noted, “Oddly, though, the OECD did not include the U.S. among jurisdictions that did not commit to its new standard.”
And it added: “Even if the U.S. committed to exchange equal levels of information in the future, the current U.S. legal framework does not allow its financial institutions to collect beneficial ownership information for all relevant cases covered by the OECD’s global automatic exchange of information standard.”
FATCA requires all financial institutions in the world to provide information to the U.S. tax authorities regarding Americans’ financial accounts abroad. The consequence for not complying is a 30 percent withholding tax on all U.S.-sourced payments to incompliant financial institutions.
But it doesn’t work the other way around. All EU countries signed the Multilateral Competent Authority Agreement to implement the CRS and committed to start exchanging information in 2017, except for Austria which chose to start in 2018. In contrast, the U.S. decided not to implement the CRS, but to apply only FATCA. 
This means that EU countries provide, under automatic exchange, the maximum scope of information to the U.S. and to the rest of the jurisdictions implementing the CRS. In contrast, the United States received the maximum scope of information from the European Union and from many other countries, but only sends limited information to most EU countries, and no information whatsoever to Austria, Bulgaria, Switzerland, and many other countries. Compared to EU financial institutions, this is the information that U.S. financial institutions will not need to report under the new proposal:

  • Depositary Accounts held by EU-resident entities (for example, companies, trusts);
  • Depositary Accounts held by EU-resident individuals if they earn less than $10 in interest (that is why U.S. financial institutions wanted to offer no-interest accounts—to allow individuals to be below the threshold and avoid reporting);
  • Account Balance of Custodial accounts (that is, holding shares) held by EU residents;
  • Foreign-sourced dividends (EU financial institutions will need to report all dividends paid or credited to the account, while U.S. financial institutions will report only U.S-sourced dividends paid);
  • Other income and proceeds from sale or redemption of property, except if they are sourced in the United States and are already subject to reporting pursuant to the U.S. tax code, Chapters 3 and 6143.

There Will Be No Exchange of Beneficial Ownership Information

An individual trying to circumvent automatic exchange of information could try to hold a bank account via an entity (a company or trust) instead of holding it directly under his or her own name. For this reason, both FATCA and the CRS require that for accounts held by entities which have mostly passive income (income from interest, dividends, and the like), financial institutions have to “look-through” such entities (called “Passive Non-Financial Entities”) to identify and report its beneficial owners (called “controlling persons” for FATCA and CRS purposes). This would prevent the possibility of putting a screen (in the form of a company or trust) between you and your bank account. However, FATCA only demands this from the other country’s financial institutions while U.S. financial institutions do not need to identify or report any beneficial ownership information.

Even if U.S. financial institutions were required in the future to report information on beneficial owners to the EU, they would not be able to do so under current U.S. laws or under the new proposal.EU Institutions May Have to Pay a 30 Percent Withholding Tax, But Not the United States
FATCA’s sanction of a 30 percent withholding tax on all U.S.-sourced payments toward incompliant financial institutions is only applicable against EU financial institutions, not U.S. ones. If EU financial institutions remain incompliant for more than 18 months, the United States may impose the 30 percent withholding tax, regardless of any EU domestic penalty imposed. This does not apply to U.S. financial institutions.
Ironically, Panama signed on to the U.S. system, refusing to implement the European CRS. After the Panama Papers scandal exploded, Panama told the OECD it would automatically exchange tax information beginning in 2018.
Putting the U.S. on a Blacklist
The Greens/European Free Alliance report said the EU should promote the principle that all countries should establish central public registries of beneficial ownership information for all types of legal persons (such as companies) and legal arrangements (such as trusts) created under their laws or operating in their territories. These registries should be publicly accessible, online, free, and in an open data format, to allow information to be cross-checked and analyzed both by authorities and the public, and should ideally be internationally connected. It said the United States should be screened according to the criteria that the European Commission said in January it will develop for a common European blacklist of non-cooperative third-country jurisdictions.
The report said, “Given that the U.S. allows companies to be created without providing beneficial ownership information, and that the exchange of information between EU and U.S. tax authorities is not fully reciprocal (nor has the U.S. committed to implement the OECD Common Reporting Standard for automatic exchange of tax information), the European Commission and Member States should seriously consider including the United States on their upcoming blacklist of tax havens” unless it effectively ensures registration of beneficial ownership information for companies and commits to equal levels of automatic exchange of information with European Union countries.
The European Union could consider imposing a sanction (such as a 30 percent withholding tax on all EU-sourced payments) against any financial institution that refuses to automatically exchange information about EU residents holding accounts abroad. In a second stage, sanctions could also be used to ensure that financial institutions from financial centers also provide information to developing countries with which the European Union is already exchanging information.

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