In popular Indian imagination, a >tax haven is generally associated with Switzerland and its numbered bank accounts. But tax havens are numerous, have grown in importance, and are the routes through which half of international trade now takes place. Apart from high-net-worth individuals, tax havens are liberally used by multinationals and their army of accountants and lawyers for tax planning and transfer pricing. They are also wonderful places for money launderers.
Tax havens come in all shapes and sizes. Each has its own comparative advantage, whether in terms of cost or time taken to set up structures, discretion used, or links to particular countries. Nevertheless, they have some common characteristics such as ease of setting up companies/trusts/foundations, minimal disclosure requirements, the possibility to hide beneficial ownership, and low or no effective taxation on income or wealth.
Threats posed by tax havens
Panama fits the bill perfectly. In Panama, there are firms that can help set up a company within 48 hours and provide nominee directors/shareholders. Many international banks operate from Panama, and banking confidentiality is guaranteed. Panama follows a strict territorial system of taxation. Consequently, all foreign incomes of non-residents are not taxable. Further, Panama has no official central bank and no exchange control.
The >Panama papers are raising a storm across the world. However, shorn of all the razzmatazz, the terabytes of data released by the International Consortium of Investigative Journalists do not tell us anything new about the modus operandi adopted by the high and mighty to hide their assets.
The one definitive conclusion that one can draw from the Panama papers is that those in charge of designing the rules in the fight against such tax havens also took advantage of the same for diverse motives, whether for tax avoidance/evasion, masking conflict of interest, or for corrupt practices and money laundering.
It is not as if the threats posed by tax havens are not known to regulatory authorities. The >Organisation for Economic Cooperation and Development never tires of proclaiming that due to its revised standard for exchange of information, the days of secrecy are over. Indian politicians and administrators say the same. As the current leaks show, the utility of such agreements in discouraging tax havens from offering their services, or for foreign clients from using their services, is rather limited.
OECD’s initial project on harmful tax practices, including the use of sanctions, came unstuck due to American opposition. While there has been improvement in the monitoring mechanism over time with a peer review process, jurisdictions carry on with business as usual even after declaring their intention to comply with >OECD standards . OECD’s initial list of non-cooperative jurisdictions has been empty since 2009. Of course, following the U.S. Foreign Account Tax Compliance Act, OECD has come up with an automatic exchange of information and apparently only four jurisdictions have not committed to its standards — Bahrain, Nauru, Panama and Vanuatu. But does that mean that there are no worries about other tax havens such as the Channel Islands, the British Virgin Islands and the Cayman Islands? As the Panama papers show, the truth is far removed. ‘Don’t ask, don’t tell’ is the policy followed by many tax havens.
While examining the history of tax havens, Gabriel Zucman in his book The Hidden Wealth of Nations: The Scourge of Tax Havens has shown that action against them works only if there are credible sanctions, which he proposes in the form of trade tariffs. Considering the storm created by the Panama papers throughout the world, his proposals, including that of a global finance register of all financial securities in circulation, are worth considering at the international level.
Inviolability of corporate structure The Panama papers prove the ease with which companies can be formed in jurisdictions which make a mockery of the concept of separate corporate existence. For example, the papers show how banks registered nearly 15,600 shell companies with only one law firm, and how difficult it is for the tax administration to get meaningful information. In the circumstances, one can question the concept of almost total inviolability of the corporate structure as propounded by the >Supreme Court in the Vodafone case : “When it comes to taxation of a Holding Structure, at the threshold, the burden is on the Revenue to allege and establish abuse, in the sense of tax avoidance in the creation and/or use of such structure(s).” The Supreme Court-monitored Special Investigation Team now oversees the investigation of all the Indian cases emanating out of the various leaks. In two years, it does not seem that the SIT has made any significant headway in investigations of all the cases involving tax havens.
There are some apologists who believe that tax havens serve some important functions. Mauritius is often mentioned in this connection as being one of the largest foreign investors for India. Any action against the tiny nation is stonewalled. The Panama papers show that tax havens are used overwhelmingly for secrecy and dissimulation, putting distance between assets and owners thereof. Corporate structures help such dissimulation. Therefore, countries and jurisdictions that help in such efforts of tax planners, avoiders and evaders need to be put on alert. In the Indian scene, much of the alleged foreign investment apparently comes from Mauritius through Global Business Companies-1 that Mauritus allows non-residents to set up. If we are serious about tackling tax evasion and avoidance, there needs to be a rethink about the way these companies are allowed to be operated. There are many Mossack Fonsecas that specialise in offering their services for setting up such structures, including supply of directors and shareholders for routing investments through Mauritus (and others) and for availing of its treaty benefits. Panama is a tax haven, but Mauritius is a tax haven with which we have a comprehensive double tax treaty. That complicates the matter even more by allowing rampant ‘treaty shopping’, double non-taxation, and erosion of India’s tax base. It is therefore time to bury the Azadi Bachao theory of treaty shopping being good for developing countries. Nobody should believe in that theory.
Since 2011, we have a provision in the Income Tax Act in Section 94A to deal with jurisdictions that do not effectively exchange information. So far, only Cyprus has been notified. There are reports that perhaps Panama will also be put on that list. But considering that in almost all collusive international deals at least one tax haven is involved, there needs to be a review of all tax havens and the provision used effectively. Otherwise, the promise of bringing back black money stashed abroad will remain a chimera. We are smug about the relative lack of political names from India being disclosed in the Panama papers. But had the leak occurred elsewhere, things might have been different. We should not wait for another leak to break out, but need to take proactive actions both internationally and domestically.
Dikshit Sengupta, formerly of the IRS, is now with the National Institute of Public Finance and Policy, New Delhi