Closing the Floodgates

Collecting to pay for development

Commissioned by The Norwegian Ministry of

Foreign Affairs

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Contents

Abbreviations…………………………………………………………………………………………………. 4 Foreword – Closing the Floodgates ……………………………………………….……………. 5 Recommendations…………………………………………………………………………………………. 7 Section 1 – The Flood of Lost Taxation……………………………………………………… 12 Chapter 1 – Taxation and Development………………………………………………. 12 Chapter 2 – The Floodgates are Open..………………………………………………. 15 Chapter 3 – The Scale of the Flooding………………………………………………… 36 Section 2 – How the Floodgates are Opened ……………………………………………. 42 Chapter 4 – How Companies Reduce Their Tax Bills……………………………. 42 Chapter 5 – How Individuals Reduce Their Tax Bills……………………………. 57 Chapter 6 – How Governments Don’t Help Themselves………………………. 64 Chapter 7 – The Role of Tax Intermediaries………………………………………… 72 Chapter 8 – The Role of Tax Havens……………………………………………………. 81 Section 3 – Closing the floodgates………………………………………………………………. 91 Chapter 9 – The Next Steps …………………………………………………………………… 91 Chapter 10 – Tackling Harmful Tax Practices ………………………………………. 115 Chapter 11 – Capital Flight and Through Abnormal Pricing in International – the issue and solutions …… 118 Bibliography …………………………………………………………………………………………………. 123 Appendices …………………………………………………………………………………………………… 124 1. – The Millennium Development Goals ……………………………………………………. 124 2. – rates ………………………………………………………………………………. 127 3. - The world’s tax havens and the firms that operate in them ………………. 128 4. - Mirror, Mirror on the Wall, Who’s the Most Corrupt of All? ………………… 132 5. – passes law allowing ‘sham’ trusts for use by tax evaders ………. 148 About the authors ………………………………………………………………………………………. 151 About the Tax Justice Network …………………………………………………………………… 152

© Tax Justice Network and the authors 2007 David Spencer and Simon Pak respectively wrote chapter 10 and 11. Tax Justice Network International Secretariat Ltd c/o 3 Jonathan Street Chris Steel undertook the research in Appendix 3. London SE11 5NH United Kingdom Alex Cobham provided invaluable editorial input and comment throughout the production of this report, This paper represents the views of the authors and for which thanks are offered. may not reflect the views of the Norwegian Ministry of Foreign Affairs (MFA). The authors have asserted their moral rights to the sections of this report for which they are responsible. This report was edited by Richard Murphy. He was also the author of chapters 4 to 9. Any part of this report may be reproduced without the permission of the authors or publishers if that John Christensen and Richard Murphy wrote the reproduction is not for commercial purposes or is for recommendations. the advancement of education. All such use must be attributed. Permission to reproduce any part of this John Christensen, Sony Kapoor and Richard Murphy report must be sought in all other cases. co-authored chapters 1 to 3.

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Abbreviations

CPI Corruption Perceptions Index CTJ Citizens for Tax Justice ECOSOC United Nations Economic and Social Council EITI Extractive Industries Transparency Initiative EPZ processing zone EU European Union EUSTD European Union Savings Tax Directive FDI Foreign direct investment GANTIP General Anti-Avoidance Principle GDP Gross Domestic Product GST General HMRC Her Majesty’s Revenue & IASB International Accounting Standards Board IBC International business corporation IFI International financial institution (viz World Bank) IFRS International Financial Reporting Standard IMF International Monetary Fund IRS Inland (United States) LLC Limited liability company LLP Limited liability partnership MDG Millennium Development Goals MNC Multinational corporation OECD Organisation for Economic Cooperation and Development PCC Protected cell company PWYP Publish What You Pay coalition ROSCS Reviews of Standards and Codes SIE Small island economy TI Transparency International TJN Tax Justice Network TNC Transnational corporation (also called an MNC) UN United Nations UNCAC United Nations Convention Against Corruption UNCTAD United Nations Conference on Trade and Development VAT Value added tax WTO World Trade Organisation

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Foreword

Closing the Floodgates

For those concerned about persistent achievement of the Millennium poverty in a world of plenty, the Development Goals. More research is Millennium Development Goals were needed to accurately quantify the sums amongst the most important statements lost to individual countries, but a review of hope ever written1. of the various estimates suggests that in aggregate it runs to many hundreds of This report is submitted within the billions of US dollars a year. Whilst not all context of those Goals, and builds on the of the losses will be recoverable, even work of the International Conference on partial recovery could significantly Financing for Development (Monterrey, increase the resources available for Mexico, 2002) which called upon development. We therefore propose that developing countries to mobilize their placing capital flight and on domestic resources for development. The the Leading Group’s agenda would be a authors also recognise the important major step towards creating an enabling contributions made in the Landau Report2 environment for tackling poverty and commissioned by President Jacques financing development. Chirac and the ‘Lula Report’3, ‘Action against Hunger and Poverty.’ As all of In preparing this report we have these reports have made amply clear, purposefully set out to provide (a) the urgent steps need to be taken to prevent most comprehensive review ever the flood of domestic financial resources published of the nature and scale of the out of the poorer countries and to protect problems, and (b) a series of already impoverished states from abusive recommendations for how governments tax practices. These actions are a and international agencies might tackle prerequisite to ensuring that the them. The report is structured in three Millennium Project does not become a sections: wasted opportunity. Section One deals with the issues as they As this report demonstrates, the scale of relate to development, and assesses the capital flight and tax evasion is more damage caused by the flood of capital than sufficient to finance the flight and lost taxation revenues.

1 See appendix 1. Section Two, consisting of five chapters, 2 considers how corporations and http://www.conservationfinance.org/Docume individuals avoid and evade tax; how nts/CF_related_papers/Landau_commission_a governments have facilitated abusive rticle2.pdf accessed 26-1-07 practices, or have not taken sufficiently 3 robust steps to prevent such abuse; the http://www.cttcampaigns.info/documents/br azil/Report-final per cent20version.pdf role of the tax intermediary professions accessed 26-1-07 (lawyers, bankers, accountants, other tax

Closing the Floodgates www.taxjustice.net 5 agents and financial services providers); And there are other significant gains to and the role of the offshore tax havens be had from adopting a tax justice that provide the mechanisms, often in agenda, including: combination, to facilitate capital flight · Reduced opportunities for crime, and loss of taxation revenue. including crime related to corruption

of all sorts; Finally, in Section Three we propose a series of measures for tackling the · Exposure of the ‘secrecy spaces’ problems and closing the floodgates provided by tax havens will through which the financial resources of strengthen economies because developing countries are draining away. enhanced trade and investment transparency will lower risk and We recognise that can be reduce costs; complex, particularly in an international · Action against aggressive tax context. We have therefore sought to do avoidance will reduce incentives for two things in this report: firstly to corruption and increase incentives for demystify the issues, and secondly, to genuine entrepreneurial activity demonstrate that much can be done undertaken to increase human well immediately to diminish capital flight and being rather than create short term tax evasion. Crucially, we show that the increases in post-tax profits. normal assumption that this requires multilateral agreement before effective progress can be made is simply not the We regard it as crucial that corrupt tax case. practices are tackled in a comprehensive manner in order to restore public As our report makes clear, tackling the confidence in the ability of democratic flood of capital flight and abusive tax forms of government to protect the rule practices would probably yield sufficient of law and promote the equity of our to accomplish the Millennium systems. Development Goals. Beyond that the additional tax revenues could also: Taken in combination, our proposals could go a long way towards achievement · Provide the necessary resources for of the Millennium Development Goals; developing countries to free towards tackling the harmful inequalities themselves from aid dependence; within and between countries; and towards restoring the credibility of the · Strengthen the relationship of market system itself. democratic accountability between

citizens and state to enhance standards of governance;

· Provide opportunities for progressive

cuts in tax rates in many countries as John Christensen the tax base is broadened to include Director sums now evaded or avoided; TJN International Secretariat · Provide opportunity for simplification London of in many countries, thereby 1st February 2007 reducing the burden of tax administration for many people.

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Recommendations

The attached report is longer than those comprehensive. This problem needs to be customarily presented to conferences, tackled through a variety of measures, but is in fact itself a summary of an and to suggest there is either a ‘magic enormous body of material that bullet’ that solves it or that one solution documents the problems that are faced in will suit all countries is unrealistic and collecting taxation revenues throughout wrong. This explains why we have split the world. The issues involved are too our recommendations into groups and important to be reduced to a page or have avoided suggesting priorities, since two. We can do no more than ask that these will need to be determined locally you read the report we have written. in many instances. There are several good reasons for There are, however, four exceptions making this request. The first is that it is which we would like to draw particular clear from Chapter 3 that addressing the attention to. The first is that the issue of evaded and avoided taxation International Accounting Standards Board revenues as a means to finance (IASB)4 is currently consulting on a paper development might yield returns that will presented to it by the Publish What You exceed sums raised using any other Pay coalition, which it prepared in approach. When the losses from these association with the Tax Justice Network. activities run to hundreds of billions of US The objectives of that paper are dollars a year even relatively minor explained in section 7 of chapter 9 of this improvements in collection rates would report. We are of the opinion that there provide enormous sums to finance the is no action that could be more useful at Millennium Development Goals. this moment than each country affiliated to the Leading Group making clear to the The second point to note is that this is IASB that they support the principles not an issue for developing countries inherent in that submission, which calls alone. A recurring theme of this report is for transparent accounting by that the problems faced are not multinational companies (MNCs) on a ‘elsewhere’; they are located in every genuine country-by-country basis for state around the world, whether it be a every country in which they operate, developing, transitional or developed without exception. This would benefit a country and, additionally, whether it is a wide range of stakeholder groups, but or not. The reason is most particularly those governments in straightforward. Nothing less than a the developing world who have enormous change in our attitude towards taxation difficulty in holding MNCs to account for and corruption is required if this initiative the tax that they owe them. In addition, is to succeed. That change starts at a it will assist those supporting wider personal level, and can extend to accountability by governments in those embrace the globe. On the way it will same countries for the funds entrusted to require changed accounting, law, them, whether they be derived from regulation and professional conduct, all of which are issues that this report addresses. 4 It is for this reason that the http://www.iasb.org/News/Press+Releases/IA SB+issues+convergence+standard+on+segment recommendations made in this report are +reporting.htm accessed 31-1-07

Closing the Floodgates www.taxjustice.net 7 taxation or other sources. That is our first Finally, and as David Spencer highlights in specific request. chapter 10, there is a need for countries to work together on this issue. To date Our second request is that whilst we the international initiative on harmful tax know the scale of the problem we are practices has been led by the OECD, and facing not everyone is persuaded of its there is no doubt that they have the significance, or that benefit may be greatest expertise on all these matters. obtained from the practical The OECD is not, however, open to recommendations we make for tackling membership by all and as the example this issue. We believe that hearts and from Chile in chapter 8 shows, its minds have to won to this cause, which is members obtain preferential treatment best done through clear reasoned when compared with developing argument backed by facts and research. countries. As such, valuable as its role This report is a contribution to that has been the OECD needs to now lend its process, but much more needs to be expertise to a wider grouping of nations if done. That is why the research agenda the dual objective of tackling harmful tax which makes up the fourth part of our practices and raising money for recommendations is so important, and development is to be achieved. should not be overlooked. It is a scandal that funding for research into tax We draw particular attention to these evasion, offshore activities and abusive issues, but in doing so we do not want to tax practices is almost impossible to downgrade our further recommendations, secure, even in the world’s universities. all of which would progressively assist in Contrast this with the massive funding tackling the roots of the problems. In available to those who promote tax summary these recommendations are: competition and offshore activities for both research and public advocacy. Much greater resource needs to be secured to Recommendations that may be research these issues and to promote the adopted unilaterally at a domestic research findings and recommendations. level Thirdly, as is widely acknowledged, trade 1. Use the language of tax justice: tax is mispricing is one of the most common a ‘good thing’, but that is not always mechanisms used to facilitate capital clear even in the case of many flight, tax evasion and tax avoidance. In government pronouncements; chapter 11 Simon Pak succinctly summarises both his work in quantifying 2. Redefine corruption to include the this problem, and a mechanism for supply of ‘corruption services’ that tackling it. His method is transferable and enable those seeking to evade and most countries in the world will have the avoid tax and to arrange capital flight data to create the system for identifying both onshore and offshore; likely trade pricing abuses at their ports 3. Put transparency onto the domestic and airports as it happens. If ever proof agenda by requiring open disclosure were needed that real action can be of corporate information and the taken on this issue, this is it. In addition, abolition of ‘secrecy spaces’ in this is an area where both data and domestic economies; expertise can be transferred from the 4. Remove tax haven and harmful tax developed to the developing world to practices from the domestic tax and help countries tackle this issue world- regulatory agenda, this being a major wide. challenge for some of the principle

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international financial centres such as comprehensible accounts of their the UK, the USA and the Netherlands; activities. These accounts should be published on a timely and consistent 5. Require disclosure of all innovative basis, and should be subject to audit, tax planning by commercial preferably by a government funded enterprises before such schemes are but independently managed agency; put into operation; 13. Governments should estimate the size 6. Require companies to disclose their of their ‘tax gaps’ on a regular basis tax accounting to taxation authorities and have a published strategy for thus revealing what planning they are reducing them; undertaking; 14. Redefine the residence basis for 7. Support the call to the International individuals so that the remittance Accounting Standards Board for an basis of tax abused by some is no International Financial Reporting longer available. Also redefine the Standard requiring country-by- residence basis for both corporations country reporting of trading activities and trusts so that those linked in any and tax paid by multinational way with a person resident in a corporations; country are assumed resident in that 8. Protect professional tax country unless contrary evidence can intermediaries seeking to promote be supplied by the taxpayer. tax compliance by their clients from 15. Banks should be required to disclose legal challenge because they have the ownership of all foreign entities failed to minimise a client’s tax to which they supply services so that liability by using aggressive tax this information might be exchanged avoidance techniques; with the countries in question. 9. Encourage the creation of codes of 16. Sanctions should be imposed on tax conduct for the management of havens that do not actively cooperate domestic taxation to which the on information exchange including government, tax intermediaries and the denial of tax credits for tax paid taxpayers can subscribe as indication in those territories and the imposition of a commitment to tax compliance; of withholding on payments 10. Introduce a general anti-avoidance made to them; principle (GANTIP) into taxation law 17. Sequester funds that have been to ensure that those seeking to abuse secured by either tax evasion or the spirit of taxation law whilst capital flight transactions as is complying with its letter are denied allowed under money laundering the benefit they seek from such regulations throughout most of the abusive behaviour; world, and require professional 11. Introduce an equitable basis for the intermediaries to report on all interpretation of tax law so that transactions where there is suspicion current injustices resulting from the that tax evasion is a likely outcome; use of a legal basis of taxation law in 18. Increase the resources available to many countries of the world are tax departments to do their work eliminated; since the additional yield derived 12. Ensure that governments demonstrate from this investment is always a commitment to transparency by significant at current levels of producing clear, comprehensive and spending.

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19. Develop a trade pricing matrix for 3. Development of locally appropriate each country and make use of it at all accounting systems to enhance tax ports and airports as goods are declaration. These may be quite presented for checking by tax or different from those used in other authorities, thus limiting the developed countries; prospect of capital flight and tax 4. Designing taxes suited to local evasion through trade pricing abuse. circumstances. This might require abandonment of the current IMF conditionality that has required the Recommendations for action at an abandonment of trade tariffs and the international level promotion of the idea that VAT and 1. Put strong pressure on UN ECOSOC to other indirect taxes are the solution address the issues covered by this to all taxation problems when it is report, and promote the formation of apparent from experience on the a World Tax Authority charged with ground that this is not the case; effectively tackling harmful tax 5. Support for identifying financial practices in association with the need crime; to raise finance for development; 6. Assistance for initiatives such as the 2. Require the IMF to enhance its Extractive Industries Transparency Reviews of Standards and Codes Initiative5, and their expansion to all (ROSCs) to determine which countries sectors of the economy; are willing to over-rule banking secrecy in cases of suspected tax 7. Technical support with developing fraud; which countries and territories taxation measures to mitigate the actually hold the data required to effects of tax avoidance and evasion; answer enquiries from other states; 8. Practical assistance in the supply of and which countries effectively information where trade mispricing is exchange such information in believed to have taken place at cost practice; to the country in question; 3. Use OECD and IMF data to create a 9. The supply of similar information on new list of states unwilling to an automatic basis, i.e. without the cooperate to eliminate harmful tax need for request, where it is believed practices. that capital flight is taking place; 10. Development of a multilateral Provision of direct assistance to automatic information exchange developing countries regime between all countries and tax haven territories (i.e. widening and This might include: deepening the work of the OECD 1. Training of tax officials in developing Fiscal Affairs Department). countries including the payment of salaries sufficient to make corruption or private sector poaching less attractive as options; 2. Provision of appropriate IT systems to developing country tax authorities; 5 See http://www.eitransparency.org/section/abou teiti accessed 28-1-07

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Promoting research In addition research is required to identify effective measures to tackle Research is the key driver of our agenda. abusive tax practices. This might include We highlight the following priorities: work on the following: 1. The volume and origin of funds held 1. Mechanisms for promoting automatic offshore; information exchange for individuals, 2. Capital flight flows; trusts and bodies created by statute law; 3. The origin and target destination of foreign direct investment; 2. Drafting a Code of Conduct for tax professionals; 4. What is happening in the tax havens; 3. Practical mechanisms to prevent 5. The extent to which information trade mis-pricing, such as those sharing is taking place; Simon Pak refers to in chapter 11; 6. The cost that offshore and other tax 4. Alternatives to the outmoded ‘arm’s planning activities impose on length principle’ basis for governments; international corporate taxation; 7. The size of the tax gap – nationally, 5. Methods of accounting for regionally and globally; governments which might 8. The structure of the world’s major communicate key information to corporations and the degree to which taxpayers to induce greater tax their decisions are tax driven; compliance; 9. The real role of the tax 6. Appropriate accounting systems for intermediaries and their professional use in developing and other countries bodies in promoting tax avoidance, which might promote tax compliance; and what can be done about it; 7. Ways in which tax codes might be 10. The impact of the tax losses arising simplified whilst broadening the from offshore and other tax planning taxation base; both on income distribution per head 8. Means of successfully introducing and also on distribution by gender general anti-avoidance principles into and between ethnic and race groups; taxation law; 11. The impact of tax planning on trade 9. The possibility of creating a World and the loss of welfare that might Tax Authority and what powers it result from the distortions that tax might need to regulate this sector; planning and tax driven corporate structures add into the trade 10. Ways in which taxes might be charged mechanisms of the world. on MNCs on a global basis. 12. The economic impact of trade mispricing; 13. The role of in development and the potential costs it imposes on developing countries;

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Section 1 The Flood of Lost Taxation

Chapter 1

Taxation and development

Domestic revenue mobilisation is key to main means by which wealth is sustainable development finance – only redistributed in any society; self-sufficiency will allow the · ‘Reprice’ goods and services to development of fully-functioning states ensure that all social costs of with flourishing systems of political production and consumption are representation and economies reflecting reflected in the market price; societies’ expressed preferences in regard to, for example, inequality.6 · Strengthen and protect channels of political representation;8 This idea summarises the intent of this · Provide a tool for the management of report. an economy, usually in combination

with government borrowing9.

The role of taxation In short, the sustainability of any modern Taxes are used to: society and economy requires the state to have a well functioning taxation system · Provide public funds; to both fund the physical and social infrastructure essential to economic · Redistribute income to reduce welfare and development and to provide poverty and inequality. Progressive stability and security. 7 forms of taxation , are one of the

How tax flows out of economies

6 Quoted from Cobham, A. Tax Evasion, Tax Avoidance and Development Finance, Working Paper 129, Queen Elizabeth House, University 8 Analysis based on Cobham, A. 2007 The tax of Oxford, 2005 consensus has failed presented to TJN conference, Nairobi, Kenya, January 2007 7 A tax system where as income rises the amount of tax paid increases in proportion to 9 See income as well as in absolute amount i.e. the http://en.wikipedia.org/wiki/Fiscal_policy percentage increases as the income accessed 29-1-07 for a discussion of fiscal rises. policy.

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It has been suggested that tax flows out route out of poverty. That is our primary of economies in five ways10: objective.

1. Due to the existence of the shadow Securing the revenues might at the same economy which acts as a conduit for time create the political accountability capital flight and enables tax evasion; that is the other essential component in this process. This is our second 2. Due to tax not paid on income objective. received or on assets held offshore;

3. Due to MNCs shifting the location in which profits are recorded (i.e. Common problems through trade mispricing in its various forms); Some of the problems facing tax 4. Due to the pressure of tax authorities are common across the world. competition; In particular tax evasion is always an issue, as is tax avoidance. Both issues are 5. Due to tax due not being paid for a addressed in this report: in particular variety of reasons. approaches to tax management and the mechanisms used by companies and individuals are explored in chapters 3 and Tax and development 4. The problems that many governments create for themselves in tackling these The role of the state in the provision of issues are explored in chapter 6, whilst protection, infrastructure and basic the role of tax intermediaries and tax services is critical to creating an enabling haven states in exploiting these situations environment for sustained development. are explored in chapters 7 and 8. This is especially the case in developing countries, where the higher risk involved Issues addressed in those chapters are not in investment, the lack of a capital-rich repeated in detail here. That does not private sector, and high levels of extreme mean that developing countries do not poverty, create problems unknown in face these challenges. Where these issues industrialised countries. At its most basic have a particular development dimension level the inability of developing countries this will be highlighted. The significance to provide basic health services is seen of the matters referred to in those daily in the loss of lives from preventable chapters is that all states need to address diseases. them. That is one of the key messages of this report. The flood of lost tax money In our opinion the whole range of issues does not happen ‘elsewhere’, whether referred to in the MDGs11 cannot be that be in the tax havens or in developing tackled unless developing countries countries. For every country it starts in secure their own tax revenues. This will their domestic tax system. This is a key free them from aid dependence in the issue all governments and tax supply of these services. Success in this administrations have in common. objective would help countries determine their own futures and chart their own Crucially, however, some of these issues are of greater concern in developing countries, and they have problems all of their own. 10 Cobham, A. (2007) ibid 11 See appendix 1

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Tax problems in developing 4. The particular impact of tax planning; countries 5. The impact of tax competition

The key tax issues faced by developing 6. Administration issues including: countries are: a. Corruption and its impact;

b. Weak tax administrations; 1. The scale and extent of their shadow economy; c. The lack of accountability of governments; 2. Capital flight;

3. The dependence of many such These issues form the basis of the countries on export earnings from following chapter. mineral and commodity conducted by MNCs, and which are prone to trade mispricing;

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Chapter 2

The Floodgates Are Open

Tax problems in developing countries

The scale and extent of the shadow living at or below subsistence levels. economy Nonetheless, recording the income is important if, as a result, this provides Most developing countries have a large opportunity to protect vulnerable informal economy which is not taxed or members of society by providing transfer under taxed. As Alex Cobham12 has noted payments. the average size of the shadow economy of low-income countries in 2002/3 is 32.7 per Dealing with this issue requires a number cent of official GDP; the equivalent for of issues to be addressed, all of which are members of the European Economic and dealt with in detail in the Monetary Union is 18.5 per cent. At its recommendations in chapter 9, including: most basic level this means the level of tax evasion in developing economies is almost · Improved and simplified accounting double that of developing countries. systems for the self-employed: an issue on which UNCTAD alone seems to 13 It is unrealistic to expect that the level of be making progress ; unrecorded activity in developing country · Support for tax administrations; economies will reduced to OECD levels within the foreseeable future. However, · Design of appropriate tax systems; even halving the difference between the · A change in the perception of taxation size of these shadow economies - thus and all that implies for the relationship reducing the size of the average shadow between the individual and the state. economy in the developing world to 25.6 per cent - would bring US$58 billion into recorded GDP.

It is important, however, to avoid making the assumption that this will automatically give rise to significant tax revenues. Many of the people whose incomes might be recorded as a result of this change will be 13 See SMEGA level 3 accounting guidance from UNCTAD at http://www.unctad.org/templates/webflyer.as 12 Analysis based on Cobham A, 2007 The tax p?docid=4926&intItemID=3913&lang=1 accessed consensus has failed presented to TJN 30-1-07, which is the most innovative conference, Nairobi, Kenya, January 2007 programme in this area at the moment

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Capital flight14 Capital flight has certain characteristics Capital flight involves the deliberate and that help distinguish it from normal illicit disguised expatriation of money by monetary and resource flows. These are: those resident or taxable within the country of origin. · Flight capital is domestic wealth permanently put beyond the reach of This process has great significance. As a appropriate domestic authorities. result of capital flight domestic resources Much of it is unrecorded because of available for development and for deliberate misreporting; financing public services are reduced. This · Because no (or little) tax is paid on activity also depresses economic activity wealth that is transferred as capital and has a negative impact on long-term flight, it is associated with a public growth rates15. loss and private gain.

Tax evasion is often the motive for the · Because tax evasion is illegal in many flight of capital and the two are implicitly countries (though not in all tax havens) linked. It is however important to note and subject to criminal sanction in that other reasons do exist e.g. seeking a most countries the management of secure location for cash resources, the flight capital is a form of money avoidance of local currency risk (even if laundering. Offshore secrecy that is illegal in the country in which the arrangements play a crucial part in the taxpayer is resident) or the avoidance of laundering process by enabling the other legal obligations within the state origin and ownership of the capital to from which capital flight takes place. be effectively disguised. These might, for example, relate to It must be stressed that legal, well- compulsory inheritance laws. As such it is documented and reported flows of wealth important to note that capital flight would on which proper taxes have been paid are remain a problem even if there were no a perfectly legitimate part of everyday implicit within it. commercial transactions and do not

constitute capital flight. Legal It is important to note that the tax loss international payments include those from capital flight is likely to be greater where: than that from domestic tax evasion of initially similar value. This is because in · The source of the wealth being domestic tax evasion the money that stays transferred abroad is legal; in the country will generate at least some tax revenue (for example sales tax or VAT · The outflows represent fair payment in when it is spent domestically) whereas a commercial transaction; capital that has fled does not generate any · The transfer of wealth does not violate revenue for the state and nor does it help any laws of the country relating to stimulate local economic activity and foreign exchange or capital control; growth. · The taxes due on the capital being 14 This section is in part drawn on Plugging the transferred have been paid in the (Resource) Leaks by Kapoor, S. Christian Aid country of their origin; UK, (forthcoming) · The flows constitute a part of the 15 Lessard, D.R. & Williamson, J., Capital Flight and Third World Debt. Washington: official statistics of the country Institute for International Economics, 1987

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involved and are properly reported, documented and recorded 2. Transfer mis-pricing This is the manipulation of prices of transactions

between related affiliates of MNCs. While capital flight often occurs through The motives are the same as those similar channels to those used for the noted above for mis-invoicing, and legitimate transfer of funds, it does not mis-pricing can take place using the meet some (or all) of the characteristics same mechanisms. This practice is listed above. discussed in more depth in chapter 4.

The mechanisms most commonly It must be stressed though that implicated in the flight of capital are as itself is a legitimate follows practice so long as it is undertaken

using an ‘arm’s length principle’ - 1. The mis-invoicing of trade that is the price be equivalent to an transactions. This can be done by: open market price17 which would exist a. Under-invoicing the value of between unrelated entities. Expertise exports from the country from in getting these prices right should be which cash is to be expatriated. prevalent because: The goods are then sold on at full value once exported, the excess Around 60 per cent of trade takes being earned at that sale being place between subsidiaries of MNCs. the value of the flight capital; As these transactions occur between b. Over-invoicing the value of different parts of the same company, imports into the country from there is ample scope for mis-pricing which cash is to be expatriated, and, as a result, in shifting of 18 the excess part of which profits . constitutes capital flight and is deposited in the importer’s In practice prices based on the arms offshore bank account. length principle are difficult to establish within the highly complex c. Misreporting the quality or grade international production networks that of imported products to assist exist today and where companies use value over or under-statement trade marks, patents, brands, logos for the reasons noted above; and a variety of company specific d. Misreporting quantities to assist intangible assets. As is noted in value over or under-statement chapter 4, such mis-pricing is also for the reasons noted above; much more likely in the case of developing countries with neither the e. Creating fictitious transactions means to assess the risk that transfer for which payment is made. As pricing is taking place, or the resource has been noted: to investigate it where they believe it One well-worn wheeze is to pay is occurring. for imported goods or services 16 that never materialize 17 OECD. 2001. Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. Paris: OECD 16 The Economist, Quiet Flows the Dosh: A 18 The Economist, Quiet Flows the Dosh: A piece on capital flight out of Russia, 7 piece on capital flight out of Russia, 7 December 2000. December 2000

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drugs and other high value 3. Using mis-priced financial transfers. commodities such as arts, antiques and These transactions involve either ‘thin rare coins also serve as means to take capitalisation’ arrangements or involve wealth out of poor countries. the relocation of intellectual property which is then subject to mis-pricing. These arrangements are described in 6. The payment of bribes and corrupt more detail in chapter 4. The capital monies offshore. In many instances flight that occurs through these involving bribes payable to public channels shows up as a part of officials by commercial organisations legitimate current or capital account there is an element of capital flight transactions and is impossible to involved. The payment of a bribe identify through official balance of always means that the recipient payments statistics. Only a thorough country will not get a fair value on the transaction by transaction analysis of commercial activity undertaken by the legitimate looking financial payments firm paying it and that both tax and transfers would allow authorities evasion and capital flight will deprive to capture the true extent of this the country of scarce resources. phenomenon.

4. Unscrupulous wire transfers. These ‘Round tripping’ involve a bank or a non-banking financial institution transferring money Not all the capital that flees developing out of a country illicitly. Wire transfers countries stays out. Some of it comes back are of course a legitimate way of disguised in the form of what appears to moving money between countries but be foreign direct investment. This is the it is when such transfers violate laws, consequence of the flight money being or are used to avoid taxes or hide ill- disguised offshore during the capital flight gotten wealth that they constitute process prior to reinvestment in the illicit capital flight. country from which it originated. This is called ‘round tripping’. The preferential 5. Other mechanisms. These include the treatment accorded to many foreign of cash and other high value investors provides an incentive to engage mobile assets. Luxury yachts have in this process. For example, in the case been regularly sold and moved across of China foreign investors typically enjoy oceans to shift capital from one lower tax rates, favourable land use rights, country to another. Popular with convenient administrative supports and journalists seeking good stories, such even favourable financial services from transfers are generally less important domestic and foreign financial institutions. than the mis-pricing and wire transfer They also enjoy superior property rights mechanisms discussed above. The protection. illegal export of currencies (especially hard currencies) in the form of As a result of these incentives, it has been smuggling of bank notes is fairly estimated that as much as a quarter of the common. Diamonds19, gold, illegal more than US$100 billion that China loses

19 For example “from 1993 to 1997, Guinea reported 2.6 million carats of official diamond Guinea of 4.8 million carats at an average of exports at an average of US$96 per carat to US$167 each” Greg Campbell, Blood Diamonds: Belgium. However, Belgium, through the Tracing the Deadly Path of the World’s most Diamond High Council reported imports from Precious Stones, 2004

Closing the Floodgates www.taxjustice.net 18 every year to capital flight comes back in · Subsidies; the form of round-tripping FDI20. It is · Relaxation of regulations, including currently believed that the Chinese market those relating to labour, health and accounts for the largest number of new safety and consumer rights as well as companies registered in the British Virgin those relating to financial disclosure; Islands each year and many of these will be associated with capital flight and round · The absence of withholding taxes; tripping21. · Tax inducements for mobile labour

required to service the mobile capital

(such personnel being believed to be in Tax planning short supply and subject to different

forms of incentive from other forms of The techniques associated with tax labour). planning are explored in chapters 4 to 8. There is no doubt that all the issues referred to in these chapters apply to These ideas have been promoted by developing countries, but since none of economists and business advisers who them are peculiar to developing countries subscribe to what is commonly called the we will not elaborate the issue further at Washington Consensus.22 Under pressure this stage. from the major International Financial Institutions23 (IFIs) to adopt development strategies based on attracting foreign Tax Competition direct investment, many governments now routinely engage in tax competition by Capital account liberalisation in the last lowering taxes on capital and profits and quarter of the 20th Century greatly by offering some or all of the incentives increased capital mobility. This process listed above to attract investment. has been further facilitated by technological changes, such as the ability to move funds electronically. Increased The impact of tax competition on tax mobility of capital has been used to apply rates pressure on governments to lower taxes on capital and businesses. The hypothesis put As the data in Appendix 2 to this report on forward is that since capital is so mobile corporate tax rates shows, from 1997 to nations should compete with one another 2004: to attract inward flows of capital by offering: 1. Average corporation tax rates fell from 33.3 per cent to 29.1 per cent; · Lower tax rates on profits; 2. The fall in the rate was higher in the · Tax holidays; OECD at 6.7 per cent than in non-OECD · Accelerated tax allowances for spending on capital assets; 22 For a discussion of ‘The Washington Consensus’ see http://en.wikipedia.org/wiki/Washington_Consensus accessed 25-1-07 20 Xioa, G. People’s Republic of China’s Round-Tripping FDI: Scale, Causes and 23 The IMF, World Bank, African Development Bank, Asian Development Bank, Bank for Implications International Settlements, European Bank for 21 Sharman, J. in The Future of Offshore Reconstruction and Development and Inter- 2007 (forthcoming) American Development Bank

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countries, where it was just 0.9 per cent in the OECD 25. revenues cent; which are progressive in nature and can be used for effective redistribution are 3. The fall was smaller at 4.1 per cent on especially low; 2 to 6 per cent of GDP average in large countries (assessed by compared with 12 to 18 per cent for population size alone) than in small developed countries26. countries, where it was 4.6 per cent;

4. In contrast, the fall was highest where The advantage has not been given to GDP was high, with a 6.3 per cent fall companies alone. In the UK, for example, in rates in high GDP countries, but a the top decile (one fifth) of earners pay a fall of 2.6 per cent in low GDP smaller proportion of their income in tax countries; than the bottom decile,27 whilst the 5. Tax rises did occur throughout the average top marginal rate on personal survey period, but were far income in the OECD has been reduced outnumbered by tax cuts. from 46 per cent in 2000 to 43.2 per cent in 2005. Of the 30 OECD countries for which data is reported, 17 have reduced The position seems clear. Wealthier their top level personal and countries appear to cut have their tax only 5 have increased it between 2000 and rates more than lower income countries. In 200528. The effective tax rate applicable reality, however, high income countries to dividend income has also been reduced are generally better placed to defend their from 24.7 per cent in 2000 to 21.3 per tax base (i.e. the profit on which tax is cent in 200629. charged) than lower income countries (see Cobham, 2007) and as such tax rates are In summary, the tax situation of the not by themselves a good indication of the world’s wealthy elites is improving as a problems arising in this area. result of tax competition. What has therefore to be considered is whether this A clear indication of this problem with the is at the expense of developing countries. tax base is that despite its stable tax rates and the overall underlying increasing trend in corporate profitability, the share that Tax competition: the inter-state corporation taxes play in the total direct gains and losses taxation revenue of the UK fell from 26 per cent in 1998 to just below 20 per cent The correct response by governments to in 200524. It is clear that companies are increased mobility of capital should have paying a smaller contribution to the UK been co-operative and collaborative, not Treasury than they might. competitive. In the same way that

This trend has to be considered in the context of developing country, where tax 25 Cobham A, Tax Evasion, Tax Avoidance and revenues are lower on average than their Development Finance, Working Paper 129, Queen Elizabeth House, University of Oxford, rich country counterparts, with the 2005 average revenue in South Asia for example being 12 per cent of GDP (1999-2002) less 26 ibid than half of the average level of 26 per 27 New Statesman, 7 March 2005 28 OECD tax database available on http://www.oecd.org/document/60/0,2340,en 24 Based on data at _2825_293564_1942460_1_1_1_1,00.html http://www.hmrc.gov.uk/stats/tax_receipts/1 _2_v2_dec05.xls accessed 29-1-07 29 ibid

Closing the Floodgates www.taxjustice.net 20 countries have managed to impose some A reduction of the tax rate is unavoidable order and regulation on global trade flows because of international tax through the WTO, it would have been (and competition31. still should be) possible to create an environment where no matter how mobile But the advantage gained by one country capital is, it can be taxed. This requires an from lowering its taxes is often short term effective and multilateral framework for because it is quickly offset by similar exchange of information and enhanced co- moves in neighbouring countries. This operation in other areas with regard to tax leads to long term revenue losses in all administration and collection, all of which countries that engage in such short-sighted are discussed in chapter 6 of this report. competition.

Instead the idea of tax competition The issue is not just one of concern prevailed. For example, the UK Chancellor between nation states. Its impact can in of the Exchequer stated in his 1997 budget many ways be best demonstrated by its speech that: impact within a federal state where other factors are relatively constant. As Greg I want the United Kingdom to be the LeRoy wrote in a recent issue of Tax obvious first choice for new investment. Justice Focus32: So I have decided to cut the main rate of corporation tax by 2 percent from 33 per Tax competition is an international blight, cent to 31 per cent, the lowest ever rate but it is also a plague within the borders in the UK. This means that we will have of the United States. In fact, competition the lowest corporation tax rate of any of for jobs and tax receipts within the United our major competitors. States has been an ‘economic war among the states’ for more than three decades. And in its 2000 budget, the Canadian government stated that: LeRoy further comments that:

In recent years, many industrialized Economic development – defined as countries have either reduced their spending by states and cities for job corporate tax rates or announced their creation or retention – now finds the intention to lower them. If no action were average state with more than 30 subsidy taken, Canada’s general corporate tax programmes: abatements, rate would not be competitive with those corporate income tax credits, sales and of our trading partners. The Government’s tax exemptions, tax increment objective is to reduce, within five years, financing, low-interest loans and loan the federal corporate income tax rate to guarantees, free land and land write- 21 per cent from 28 per cent. downs, training grants, infrastructure aid – and just plain cash grants. President Jacque Chirac has proposed slashing France's corporation tax rate from 33 per cent to 20 per cent in January 200730. The Finnish finance ministry, while 31 reducing the tax rates on capital gains and http://www.vm.fi/vm/en/03_press_releases_a corporate profits tellingly said that: nd_speeches/01_press_releases/2004/85795/na me.jsp 30 32 http://www.telegraph.co.uk/money/main.jht http://www.taxjustice.net/cms/upload/pdf/TJ ml?xml=/money/2007/01/05/cnfrance05.xml F_2-4_on-screen.pdf

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The bottom of the iceberg – in every sense inter-state competition in Brazil, and of the word – is tax breaks. Those granted found that: by states – income, sales and excise – are the least visible, least accountable, and The fiscal cost for the country of the tax most corrosive ways states fund economic war is very high. A recent dissertation development. Those granted locally – that analyzes three cases of newly especially property tax abatements and installed vehicle factories (Silva, 2001) diversions – are especially harmful to concludes that, in two of the cases, the schools. present value of the stream of subsidies exceeds the value of the private This is a particularly relevant to investment; and the fiscal cost of creating developing countries that have a federal a job is over US$ 350,00034. structure, not least because he concludes: Furthermore, this does not seem to be a States and corporate lobbyists justify cost incurred to attract investment to the economic development tax breaks by country. The plants would probably be claiming job creation and tax base located in Brazil in the absence of the tax enhancements. But they routinely fail to break. deliver on both counts…… In the second half of the 1990s, when the U.S. economy This reveals how tax competition turns was sizzling, federal corporate income tax economic theory on its head, entirely revenues grew an average of six per cent a negating the principle of comparative year. But state corporate income which provides the basis for collections rose at just half that rate. trade and investment theory. In practice, Same companies, same profits, same tax incentivisation reduces production years, half the tax. efficiency in the majority of cases.

This was entirely because of inter-State Despite the obvious flaws in the tax tax competition. Furthermore, as LeRoy competition approach, both developed and reported: developing country governments are now competing with each other by shifting the Analysing by 16 industrial sectors (such as tax burden from capital to less mobile food processing, transportation labour and consumption at the behest of equipment, etc.) University of Iowa the IFIs. When they reach the stage at Professors Peter Fisher and Alan Peters which further increased taxation of labour found that for Texas, in 9 out of 16 becomes politically and economically sectors, companies are getting negative difficult they resort to cutting government income taxes; in Ohio, it’s 13 out of 16; services as well. In a developing country and in Kentucky, 15 out of 16. In three this can only harm wellbeing and states – Iowa, Michigan, and South undermine job creation since the shifting Carolina – they found that in all 16 tax burden lowers the cost of capital sectors, companies are getting negative relative to labour and therefore induces tax rates!

the literature and policy recommendations, Covering similar ground, an academic Brazilian Political Economy, vol. 25 no 3, 2005 study33 from Brazil analysed the effect of 34 Silva M. A. (2001) Guerra Fiscal e Finanças Federativas no Brasil: o Caso do Setor Automotivo. Universidade Estadual de Campinas 33 Ferreira SG, Varsano R and Afonso JR Inter- jurisdictional Fiscal Competition: a review of

Closing the Floodgates www.taxjustice.net 22 increased use of the former relative to the fail the international community is called latter. in to rescue the situation.

This situation has arisen because the In addition, tax competition does not, theory of tax competition conflates the contrary to the argument of those who micro economic theory of the firm with support it38, exert competitive pressure on the political economics of the state. This is governments to be more efficient. a fallacious notion whose main use appears Governments are not profit-maximisers in to be the justification of tax cuts for the economic sense of that term and do powerful companies and the rich.35 The not collude with one another to raise tax fact that governments do not compete levels in the way that businesses do to with one another to provide defence, raise price levels. In a democratic system health, education and other public services governments are accountable to their to their citizens has not inhibited electorate, who are keenly aware of tax prominent economists from supporting the levels. We suggest that any electorate concept. Milton Friedman has said: should be allowed to decide between high tax / high spend and low tax / low spend Competition among national governments governments in a democratic process. in the public services they provide and in Seeking to create an artificial the taxes they impose, is every bit as ‘competition’ between different states productive as competition among undermines the ability of electorates to individuals or enterprises in the goods and choose between these options and is services they offer for sale and the prices fundamentally anti-democratic. which they offer.36 It is clear that the combination of reduced In contrast, Financial Times columnist corporate tax rates, generous tax breaks Martin Wolf has written: and tax holidays has meant that MNC’s have reduced their overall tax liabilities. The notion of the competitiveness of This has happened in both developed and countries, on the model of the developing countries. For example, competitiveness of companies, is research done by Richard Murphy showed nonsense.37 that between 2000 and 2004 alone the effective tax rates of the fifty largest UK The logic inherent in Wolf’s argument is companies fell from 26.6 per cent to 22.1 simple and obvious. When businesses fail per cent at an overall costs to the UK they are replaced by more efficient treasury of at least £4 billion (US$7.6 businesses, whereas when governments billion) annually during that period, with the trend increasing over time.

35 For evidence of the impact of President In developing countries such as Honduras, Bush’s tax cuts see the evidence of Bob most foreign investors have no tax McIntyre of Citizens for Tax Justice in the USA liability. In Senegal, Jamaica and Namibia submitted to the Senate Budget Committee on 24-1-07 available at firms have been granted permanent tax http://budget.senate.gov/democratic/testimo exemptions, and tax holidays provided to ny/2007/McIntyre_TaxGap012307.pdf accessed companies operating from export 25-1-07 processing zones (EPZs) in countries such 36 http://www.freedomandprosperity.org/ accessed 1 February 2006 38 See, for example, 37 Wolf, M., (2005), Why http://www.heritage.org/Research/Taxes/BG1 Works Yale Nota Bene, p258 460.cfm accessed 29-1-07

Closing the Floodgates www.taxjustice.net 23 as Sri Lanka are now being stretched to as infrastructure, well-educated workforce much as 20 years. Elsewhere the situation and a local dynamic market far higher in is even more fragile. In Guatemala, for their list of priorities. All evidence points example, where state expenditure barely to the idea that governments have reaches 10 per cent of GDP, tax revenues conceded too much to MNCs in exchange are so low that the state is in danger of for too little43. disintegrating39. In any case, the development potential of attracting MNCs through tax breaks is The harm from tax competition limited with the total employment in outweighs any possible benefits developing country EPZs estimated to be 44 between 4 - 6 million . This is a tiny More than 95 per cent of changes to fraction of the more than 350 million jobs investment regimes introduced since 1991 in the informal sector, and is wholly have been favourable to MNCs40 and more insignificant when compared with the than 120 countries now have some form of more than 1,200 million people living on investment promotion policy in place, less than a dollar a day. Yet the outcome typically including tax breaks.41 of providing tax incentives to MNCs is that countries in need of tax revenues are This has happened despite the fact that increasingly substituting taxes on wage evidence linking tax breaks to increased earners or consumers for taxes on capitals. long term investment is at best This trend is regressive, harms ambiguous.42 Though there are, no doubt, employment generation and increases individual cases where tax rates have inequality. In the longer term, tax swayed commercial decisions on where to competition increases poverty and social locate production, there is overwhelming inequality, and slows economic growth. evidence that MNCs rank quality of Research has also made it clear that using tax incentives to attract mobile capital 39 Mold, A. 2004. ’A proposal for unitary taxes on the profits of transnational does not provide a sustainable basis for corporations’ CEPAL Review 82, April 2004. creating and retaining jobs. As Sheila 40 UNCTAD. 2003. World Investment Report Killian (University of Limerick, Ireland) 2003: FDI Policies for development: national notes: and International perspectives. New York and Geneva: United Nations. Countries which were successful at the 41 UNCTAD.2004. World Investment Report first round of tax competition are now 2004: The Shift Towards Services, New York finding that tax rates alone will not hold and Geneva: United Nations the multinationals on which they have 42 See McKinsey and Company. 2004. The become so dependent. The economic McKinsey Quarterly 2004 – 1. Research by McKinsey highlights the ineffectiveness of growth associated with their earlier incentives, including tax breaks, in attracting success has brought high operating and foreign investment. Also see, Morisset, J. wage costs. Multinationals who have and Pirina, N. 2002. ‘How Tax Policy and Incentives affect FDI: A Review’ Occasional remained lightly rooted in the soil of Paper 15, World Bank. And Wells, L. and these countries can easily move their Allen, N. 2002. ‘Tax holidays to attract foreign investment: lessons from two experiments’, in 43 Mold, A. 2004. ’A proposal for unitary taxes L. Wells, N. Allen et al. Using Tax Incentives to on the profits of transnational corporations’ Compete for Foreign Investment: Are They CEPAL Review 82, April 2004. Worth the Cost?, Occasional Paper 15, Washington, D.C.: International Finance 44 Dicken, P. 1998. Global Shift- Transforming Corporation / World Bank. the World Economy London: Paul Chapman.

Closing the Floodgates www.taxjustice.net 24 manufacturing to cheaper, emerging business over the start-up47 and the large economies, taking with them their business over the small one48. coveted jobs and exports.45 This can impact particularly badly on developing countries where firms are Tax competition and MNCs usually smaller, newer and more domestically focussed than those in the Historically companies competing to make developed world. Tax breaks for foreign better (or cheaper) products have driven investors, and the ability of MNCs to use innovation and productivity increases. aggressive tax avoidance strategies distort However, competition between MNCs is the playing field between domestic increasingly shifting to tax strategies. As a companies and MNCs, adding to the result of more or less aggressive tax existing economies of scale that MNCs planning strategies competitors are facing generally enjoy and hence stunting the 49 sharply different tax rates. For example in growth of domestic enterprises . the 1990s - Maytag and GE (both makers of kitchen appliances) paid sharply different The logic of this uneven competition rates of tax with Maytag paying 35 per requires either that all businesses must cent of its profits as tax and GE paying move offshore in order to compete on a only 8.1 per cent. Abbot Labs and Pfizer, level basis, or that tax authorities adjust both pharmaceutical companies paid 29 their tax regimes to place a greater burden per cent and 3.1 per cent respectively46. on other factors of production (particularly labour) and onto consumption, as has been The ability of MNCs to structure their the trend in many countries over recent affairs via tax havens provides them with a decades. significant tax advantage over their nationally based competitors. National Increasingly, tax is also determining how competition, no matter whether it is more companies organise themselves. The technically efficient or innovative than its fundamental tenets of capitalism of MNC rival, will be competing on an uneven competing on core products are being playing field in this case. In practice, of undermined as firms devote more effort to course, this differential tax treatment tax planning, which is not core to the favours the international business over the business. Increasingly, tax minimisation is national one, and the long-established determining how businesses organise themselves50.

47 Christensen, J. and Murphy, R. (2004) The 45 Killian, S. 2007. ‘Taxing Thoughts:Tax Social Irresponsibility of Corporate Tax Competition and the True Cost of Intellectual Avoidance: Taking CSR to the Bottom Line, Capital’ Paper given to the Tax Justice Development, Vol.43, No.3 Research Workshop, held in Nairobi, Kenya, January. 48 Nicodeme, Gaetan ‘Do Large Companies Have Lower Effective Corporate Tax Rates? A 46 McIntyre, R. and T. Nguyen (2000): European Survey’, Solvay Business School, 2007 Corporate Income Taxes in the 1990s, Washington, D.C., Institute on Taxation and 49 Christensen J and Kapoor S (2004): Tax Economic Policy, October. Avoidance, Tax Competition and Globalisation, Accountancy, Business and Public Interest Vol.3 No.2, 2004 50 The Economist (2004) ‘A Taxing Battle,’ 31 January

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More than 60 per cent of world trade is think tanks and anti-regulatory now intra firm trade carried out between scholarship. Political contributions have subsidiaries of MNCs with much of it turned theory into reality53. passing through tax havens51. The price used for these internal transactions – the In fact some commentators have been transfer price – is particularly susceptible even more disingenuous in trying to to manipulation in order to move profits to portray non-payment of taxes not just as the lowest tax jurisdictions to minimise acceptable but as something desirable, tax liability. This practice of profits even necessary. For example, an Ernst & laundering is widespread with over 80 per Young tax partner has claimed that: cent MNCs surveyed in a study having reported being investigated52 for is a cost of doing business so, price abuse. Further discussion of this naturally, a good manager will try to issue is to be found in chapter 4. manage this cost and the risks associated with it. This is an essential part of good corporate governance54 The promotion of tax avoidance as a strategy to enhance shareholder As John Christensen of the TJN has said of 55 value this comment :

One of the many strategies employed by This statement needs careful unbundling those who benefit from a reduction of tax to understand its underlying politics. revenues resulting from tax competition is Firstly, a tax on profits is not a business to try and make the practice of not paying cost but a distribution to society. This their fair share of taxes appear much is clear from how tax is reported on acceptable. the profit and loss account alongside distribution to shareholders. According to one commentator: Secondly, the use of the word risk is Corporate managers have spent the last revealing. What risks arise from tax other century developing tools for avoiding than those involving a legal challenge to regulation and taxation. They brag that an avoidance or evasion strategy? acts of tax avoidance are part of corporate productivity. For them, each Thirdly, directors wanting to pursue dollar of tax not paid because of their ethical corporate practices would machinations is the added value they bring generally not regard tax avoidance as to a company. Tax avoidance is a profit acceptable practice, and are therefore centre. Avoidance of regulation and likely to resent pressures from supervision is an equally high priority. competitors who abandon ethics in favour Corporate contributions and the personal of higher short term profits. contributions of senior corporate managers have funded anti-regulatory 53 http://www.alternet.org/columnists/story/173 51 Transfer pricing: Keeping it at arm’s length, 56/ 11 December 2003. The OECD Observer, April 2002 available at http://www.oecdobserver.org/news/fullstory.p 54 P.J. Henehan, senior tax partner of Ernst hp/aid/670/Transfer_p accessed 29-1-07 & Young, in an article published in the Irish Times on 7th May 2004 52 Lorraine Eden (1998) Taxing Multinationals University of Toronto Press p.635 cited by 55 Christensen, J. The Corruption Interface, Giddens (2000:102). TJN, 2006

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Finally, there is no requirement under company law – anywhere in the world – for This risk to good corporate governance has company directors to minimize their tax been noticed by some investment fund payments, especially when this involves managers. Henderson Global Investors, actions that might infringe national laws who have more than US$110 billion under and hiding these actions from the scrutiny management, in a publication entitled of shareholders and national authorities. Responsible Tax60, recommended that large corporations: The truth is that in practice shareholders do not like earnings shocks. For this reason 1. be open with the tax authorities; aggressive tax strategies are detrimental 2. be wary of excess complexity in to shareholder interests56. For example, structures designed to reduce tax; when Vodafone revealed a disputed £2 billion tax liability in November 2005 it 3. have tax arrangements that are contributed to a fall in its share price of 11 consistent with the ‘real world per cent in one day57. This also led some to business’; 58 question whether Vodafone’s tax 4. maintain good relations with the tax department was really fulfilling its stated authorities and not engage in actions aim which is: that risk damaging their corporate reputation; To maximise shareholder value in relation to the taxation consequences of all 5. abide by both the letter and the spirit aspects of the Group’s business activity. 59 of the law; and 6. be socially responsible. Despite this obvious conflict of interest, many MNC managers have their compensation linked to the short term The same theme was taken up by leading share price through stock option CSR agency Sustainability in its 2006 report incentives. These options provide a clear ‘Taxing Issues- Responsible Business and 61 incentive to use aggressive tax strategies Tax’ . It is also appropriate to note that to boost short term earnings, even when two of the Big 4 firms of accountants have such strategies could have a high cost for also addressed this issue in response to the shareholders in the long term. Tax Justice Network’s (TJN) campaigning on this issue.62

56 For a full discussion of this issue see And, there is good reason for shareholders Murphy R, ‘Extracting Transparency’, Global to be wary of companies which use off Witness 2005 available at balance sheet structures, shell companies http://www.publishwhatyoupay.org/ifrs/pdf/e xtracting_transparency.pdf accessed 29-1-07 57 60 Henderson Global Investors, Responsible http://business.timesonline.co.uk/article/0,,9 Tax, 2005 076-1874227,00.html 61 See 58 http://www.sustainability.com/insight/researc http://www.taxresearch.org.uk/Blog/2007/01/ h-article.asp?id=450 accessed 29-1-07. 23/accounting-for-tax/ 62 See KPMG’s ‘Tax in the Boardroom’ 59 available at http://www.vodafone.com/article/0,3029,CAT http://www.kpmg.co.uk/services/t/cts/tcs/tm EGORY_ID per cent253D3040107 per s/strategy.cfm# and PricewaterhouseCooper’s cent2526LANGUAGE_ID per cent253D0 per initial publication on the ‘Total Tax cent2526CONTENT_ID per Contribution’ published 2005 but no longer cent253D266240,00.html accessed 29-1-07 available on any website.

Closing the Floodgates www.taxjustice.net 27 and other offshore structures to billion worth of US government contracts aggressively ‘manage’ their balance sheet, and yet all these firms were based in tax tax and cash flows. Such structures were havens to minimise their tax liability. used by the likes of Enron, Parmalat and Accenture, for instance, paid just 7 per WorldCom to both avoid taxes and hide cent of its profits in taxes worldwide from losses. 1997 to 200065. Furthermore, a number of companies such as Halliburton that have obtained large contracts for military The cost of tax competition to support and the reconstruction of Iraq are stakeholders amongst those with the largest number of 66 subsidiaries in offshore tax havens . The concept of focusing on maximising shareholder wealth alone was briefly This trend is widespread. As was noted by 67 challenged by the ‘stakeholder’ Martin Sullivan in 2004: management concept in the 1990s as corporate social responsibility gained in The profits of foreign subsidiaries of US popularity.63 A firm’s stakeholders will corporations in 18 tax havens soared from include its customers, staff, suppliers and US$88 billion in 1999 to US$149 billion in the government and society of the 2002. jurisdictions it operates in amongst others. Shareholder value seems to have the upper Multinational corporations derive large hand in this debate at present. benefits from their operations in developing countries. For instance the Clearly, a firm that engages in aggressive World Bank has reported that the average tax minimisation strategies is not being rate of return on Foreign Direct Investment managed in the interests of its (FDI) in developing countries is 18 per cent stakeholders including the government with the return in sub Saharan Africa being 68 which provided its licence to operate64. as high as 36 per cent . MNC’s benefit This policy, amongst other defects, fails to from the availability of cheap unskilled recognise that governments are labour (in countries such as Bangladesh), a themselves large consumers of the goods cheap yet highly educated workforce (in and services produced by firms. Many of countries such as India) and the the largest corporations receive tens of availability of abundant and easy to billions of dollars of government contracts. extract natural resources (in countries This mutuality extends the obligation of such as Zambia and South Africa). Yet firms with such relationships, though this despite the fact that they and their behaviour is not evidenced in practice. 65 Reported in ‘Having their cake and eating In the US, for instance, a US Senate it too – the big corporate tax break’, ICFTU, 2006 Government Accountability Office study found that in 2001 four large companies – 66 Cray, C. and Drutman, L. ‘Sacrifice is for suckers: How Corporations Are Using Offshore Accenture, Tyco, Foster Wheeler and Tax Havens to Avoid Paying Taxes’, A Citizen McDermott International received US$2.7 Works briefing paper, http://www.citizenworks.org/corp/tax/taxbrei f.php 63 For a discussion of the issues see http://en.wikipedia.org/wiki/Stakeholder_conc 67 Sullivan, M. Tax Notes 13 September ept accessed 29-1-07 2004. 64 This issue is discussed in depth at 68 Private Capital Flows to Developing http://www.sustainability.com/insight/researc Countries: the Road to financial integration, h-article.asp?id=450 accessed 29-1-07 World Bank 1997

Closing the Floodgates www.taxjustice.net 28 shareholders derive enormous benefits significant cuts in trade taxes that are from these operations evidence points to central to the liberalisation process. the fact that MNC’s seek to reduce their developing country even more aggressively Import tariffs are amongst the easiest than in rich countries. taxes to administer and hence have contributed significantly to revenue income for many developing countries, The cost of tax competition to sometimes to the tune of 30 – 50 per cent developing countries of total . In the last two decades, under pressure from the IMF A recent study69 reported that during and World Bank, developed countries have negotiations on the privatisation of the pursued an aggressive trade liberalization Zambian copper mining sector, MNCs agenda which involved a sharp reduction negotiated the already low 3 per cent of import tariffs. royalty provision that Zambia had in place down to just 0.6 per cent. The same report While the overall impact on the economies also points out that despite the booming may be somewhat debateable, the fiscal price of copper and record profits the impact of these reductions was actual royalty paid in 2004 (the most largely negative. The IMF has attempted to recent year for which data is available) quantify the fall in government revenues was an just 0.02 per cent with a total of as a result of reducing import tariffs and only 0.7 per cent (including taxes) of the concluded that the fiscal impacts vary production value accruing to the state. remarkably between countries at different stages of development. For example, high The result is clear. The non-payment of income countries, which derive only a taxes in rich counties no doubt has severe small share of tax revenue from trade negative repercussions but the impact is taxes, have been able to recover revenue invariably higher and starts from a lower from other sources, principally base of revenue in developing countries. consumption taxes. Middle income countries have fared less well, recovering between 45 -65 per cent of the fiscal Fiscal impacts of trade liberalization revenues they lost. on developing countries The situation has been dramatically worse,

however, for low income countries. As the Another area in which developing countries IMF itself notes: have fared worse than their developed country counterparts has been the fiscal Troublingly, however, revenue recovery impacts of the trade liberalisation has been extremely weak in low-income programmes promoted by the IFIs and countries (which are those most national development agencies. Whilst dependent on trade tax revenues): they there is little doubt that trade has the have recovered, at best, no more than 30 capacity to have a significant positive cents of each dollar lost. Nor is there impact on development, one aspect of much evidence that the presence of a trade liberalisation that has received little value added tax has in itself made it attention has been the fiscal impact of the

69 A Rich Seam: Who benefits from the commodity price rise? Christian Aid UK, 2007

Closing the Floodgates www.taxjustice.net 29 easier to cope with the revenue effects of as deals which allow companies to pay trade liberalisation.70 much lower taxes than those they pay in richer countries, firms also employ various The fiscal outcome of trade liberalisation tax avoidance tactics to get money out of for many developing countries has been developing countries. New figures that the (regressive) value added tax compiled by Christian Aid show that there regimes substituted for trade taxes, have is significant under-pricing of exports to fallen far short of revenue replacement, avoid tax. Our research found under- overall revenues have fallen, and the tax pricing valued at between 0.1 and 29 per burden has been shifted from imports cent of total exports in 2005. (often of luxury goods) onto the basic goods and services consumed by low These issues are discussed in more depth income households. in chapter 4.

What is clear is that because taxation lies Holding governments to account at the heart of the relationship between a government and its citizens, accounting The last source of tax leakage identified in for tax and other forms of government chapter 1 is that arising from the existence revenue must be transparent. We stress, of poor tax administrations. This might be, this is an issue for developed, transitional and often is, the result of those and developing countries. administrations being under-resourced or under-trained, but the failure by some Such accountability has benefits. For governments to provide political support example, when Uganda started publishing for the collection of tax or the legal the amount of money being sent by the enforcement mechanisms for tax federal government to each of the local collection exacerbates this further. In councils, the leakage of funds was reduced combination, these factors provide drastically from about 50 per cent to less opportunities for abuse of the tax system than 5 per cent as the local population both by domestic and foreign entities and started holding the local politicians and create the opportunity for capital flight. bureaucrats to account.

These situations can also be exploited in developing countries. As Christian Aid has The particular problem with the reported,71 MNCs use a variety of tactics extractive industries to negotiate lucrative tax deals with the governments of developing countries and What is clear though is that whilst to ensure that as little tax as possible is accountability to citizens is important paid to them. They note: when they pay the majority of the taxes a government receives (which is Most developing country exporters receive commonplace) this is harder when a large a tiny fraction of the profits from the part of government revenue is derived minerals extracted from their soil. As well from resource extraction as happens in many developing countries. This weakens 70 Baunsgaard, T. and Keen, M. (2005) Tax the incentive for citizens to hold the Revenue and (or?) Trade Liberalisation, IMF Working Paper, WP/05/112 government to account whilst the governments involved can fall into the trap 71 Ibid, downloaded from of thinking they have a ‘right’ to the http://www.christianaid.org.uk/indepth/0701 mining/Mining per cent20Report per cent20complete.pdf accessed 25-1-07

Closing the Floodgates www.taxjustice.net 30 resource that is independent of their As the EITI has evolved it has become clear accountability to their citizens. that all it does is reconcile the figures that companies say they have paid to These (and other problems) give rise to the governments to the payments government so called ‘resource curse’72 whereby say they have received. The process did countries rich in natural resources have a not seek to determine whether the sum tendency to be badly governed, have lower paid was correct. In other words, the truth growth rates, and a higher probability of and fairness of the process is not conflict. addressed by the EITI reconciliation process. As campaigners came to realize, It is widely believed that transparency in knowing that 95 per cent of the revenues the amount of royalty and taxes generated companies have declared are accounted through the extractive sector can improve for by governments is of little value if the accountability and citizen incentive to declared payments are only half the real engage with the government and hold it to sum due76. account. This perception arose as a result of the Global Witness report ‘A crude Since then, the TJN has worked with PYWP awakening’73 which promoted awareness to tackle this issue. The first result was a of this issue. That report concluded with a proposal for an international accounting public call on the oil companies operating standard for the extractive industries77. in Angola to "publish what you pay”. The This was subsequently expanded to be a wider Publish What You Pay74 campaign proposed standard that tackled the issue was launched in June 2002 and called for for all companies subject to the the publication of all payments made to international financial reporting standards governments by oil, gas and mining whatever sector they worked in78. The companies in a easy to understand and importance of this issue is addressed again accessible manner. in chapter 9 of this report but it is important to stress that it is believed that Following the lead taken by PWYP this mechanism could provide valuable initiative, the same year British Prime information to assist identification of: Minister Blair launched the Extractive Industry Transparency Initiative75 which is · Where MNCs operate; supported by the UK Department for · What they are called in those International Development and also works locations; closely with the IMF and the World Bank. · What the scale of their activity is in each country in which they operate;

72 For further explanation see http://en.wikipedia.org/wiki/Resource_curse 76 See Murphy, R ‘Making it Add Up’, Global accessed 29-1-07 Witness, 2005 73 Available from http://www.globalwitness.org/media_library_d http://www.globalwitness.org/media_library_d etail.php/130/en/making_it_add_up accessed etail.php/93/en/a_crude_awakening accessed 29-1-07 29-1-07 77 74 http://www.publishwhatyoupay.org/ www.publishwhatyoupay.org/english/objective accessed 29-1-07 s/ias.shtml 75 78 http://www.eitransparency.org/section/about www.taxresearch.org.uk/documents/ias14final. eiti accessed 29-1-07 pdf

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· How much tax they pay in each in any strategy intended to raise additional country in which they operate; taxation for development, and to hold governments and MNCs accountable for · Those MNCs operating complex their resulting actions. structures;

· Which MNCs engage in offshore arrangements (which it must be Corruption added, might be legal); · Those MNCs that need to be The accountability of both governments questioned on their activities by a and the private sector is important wide variety of stakeholder groups. because corruption is a fact of life.

The authors of this report consider this an The TJN does, however, have a very effective way of making MNCs more particular view of corruption, summarised accountable for their actions, which could in John Christensen’s paper ‘Mirror, Mirror yield two results. Firstly, the tax paid by on the Wall, Who’s the most Corrupt of an MNC to a government will be more all?’ (attached as appendix 4 to this readily identified because the payment report.) will be on public record. This is vital. Secondly, and as importantly, governments In that paper he argues that the current - as stakeholders of those MNCs with the pre-occupation of developed countries and final responsibility for assessing the tax institutions such as the World Bank with due by them - will have an overview of the corruption is based on too narrow a structure of that MNC across all the definition of the issue, which chooses to countries in which it operates. This will ignore the central role played by help them: developed country institutions, the offshore financial infrastructure, MNCs and 1. Assess the likely supply chains within professionals in the supply of what might the MNC, and so determine whether be called ‘corruption services’. there is a risk that trade mis-pricing needs to be investigated; It is indisputable that corruption is an 2. Calculate whether it is likely that a impediment to development. When fair part of the value added by the government funds are not used as those MNC is being recorded in their who provided them intended, ordinary territory i.e. an overall assessment of people suffer. Paul Wolfowitz has during the application of the ‘arms length’ his tenure at the World Bank made this a rule might be possible so that risk can focus of his strategy79. However, he has be determined; broadly accepted the definition of 3. Comparative performance between corruption promoted by Transparency MNCs can be checked. International, which is80:

Because this would be done globally, corporations could not object to being subject to unfair disclosure requirements, 79 See for example and the pressure on any government, http://www.nytimes.com/2006/09/14/business whatever its relative strength is /14wolf.html?ex=1315886400&en=cb130a950d3 eliminated. When added to the benefits 37b28&ei=5088&partner=rssnyt&emc=rss for other stakeholders outlined in the 80 submissions made in support of this idea, http://www.transparency.org/news_room/faq/ corruption_faq the TJN believes it an important element

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Corruption is operationally defined as the much as 50 per cent;83 and that the misuse of entrusted power for private activities of the offshore system should gain be more carefully scrutinised to ascertain the harmful impacts of tax havens on the We do not dispute that this approach to functioning of global markets and on the corruption has served a purpose. It has integrity of the rule of law. succeeded in highlighting an issue that needs to be addressed in developing Regrettably, Transparency International, countries in particular. But there are despite its commendable role in putting substantial problems with this definition: corruption onto the political agenda, has undermined the efforts of reformers 1. It focuses on the symptoms and not through its publication of the Corruption the cause of this problem; Perception Index (CPI) which reinforces stereotypical perceptions about the 2. It emphasises corruption within geography of corruption. Africa, in government, or corruption as crime; particular, is consistently identified by 3. It ignores illicit corporate activity; the CPI as a nexus of corruption, 4. It specifically ignores the issue of tax accounting for almost half of the bottom evasion as corruption. quintile of countries in the 2005 index. Only one African country, Botswana, features amongst the least corrupt 81 As John Christensen has noted : quintile. But closer examination reveals that about 40 per cent of the countries In terms of orders of magnitude, the identified by the CPI as least corrupt are proceeds from bribery, drugs money offshore tax havens, including major laundering, trafficking in humans, centres such as (ranked 5th counterfeit goods and currency, overall), Switzerland (7th), United smuggling, racketeering, and illegal arms Kingdom (11th), (13th), Hong trading account in aggregate for 35 per Kong (15th), Germany (16th), USA (17th), cent of cross-border dirty money flows and Belgium and Ireland (jointly 19th). originating from developing and For good measure Barbados and Malta, transitional economies. In contrast, the both offshore tax havens, rank 24th and proceeds from illicit commercial activity, 25th respectively. What do these rankings incorporating mispricing, abusive transfer tell us about the current politics of pricing and fake and fraudulent corruption? I find it hard to disagree with transactions account for 65 per cent of the prominent Nigerian who, during 82 such flows. The very least one might protracted negotiations to secure the expect in such circumstances, is that repatriation of assets stolen by former equal emphasis be given to corruption in Nigerian President Sani Abacha, both private and public spheres; that commented that: greater prominence be given to how corruption can reduce tax revenues by as “It is rather ironical that the European based Transparency International does not think it proper to list Switzerland as the 81 Quoted from http://www.taxjustice.net/cms/upload/pdf/Fo first or second most corrupt nation in the llow_the_Money_-_RGS-IBG__final_31-AUG- world for harbouring, encouraging and 2006.pdf 82 Baker, R. (2005) Capitalism’s Achilles 83 The Other Side of the Coin: The UK and Heel, John Wiley & Sons, Hoboken, New Jersey, Corruption in Africa, report by the Africa All p369 Party Parliamentary Group, March 2006, p12

Closing the Floodgates www.taxjustice.net 33 enticing all robbers of public treasuries argues that the supply side should be around the world to bring their loot for tackled every bit as vigorously as the safe-keeping in their dirty vaults.84” demand side. Only by adopting this dual approach will this problem be effectively TJN proposes that a change in how we tackled. In the absence of a dual track perceive corruption is required. approach, developing countries are being Perceptions of corruption need to be unreasonably penalised for the broadened to include those illicit involvement of some in their governments commercial activities most closely in corruption whilst those who facilitate associated with trade mispricing (in all of these activities are going unpunished. In its various guises) and tax evasion. addition, until corruption is categorised in this way the loss of taxation revenues In addition, the focus must shift from the from developed countries because of tax ‘demand side’ for corruption, which is the corruption facilitated by places such as sole focus of attention within the TI Luxembourg, Switzerland and the British definition as used by the World Bank. The tax havens will be more readily tolerated ‘supply side’ is important and since that is by society. This cannot be ignored any the case corruption has to be considered longer. to include:

1. The activities of those governments Summary who supply the secret spaces in which corruption can take place, which Developing countries face particular issues include (but by no means exclusively) when it comes to taxation but the the recognised tax havens; problems they face are not theirs alone, 2. Those who supply the services that and are by no means entirely of their own allows such corruption to happen making. As the TJN’s argues in this report, including the bankers, lawyers, most of the underlying causes of these accountants and trust companies who problems are located in the developed set up and operate such world even though it is developing arrangements; countries who suffer most from them.

3. Those who undertake illicit It is unacceptable to say that action is not transactions related to capital flight possible on these issues because and tax abuse; developing country corruption prevents it. 4. Those who ignore such transactions in the course of their duties. It is not possible to say that weak tax administration cause this problem when developed countries and the accounting These activities provide what we term a bodies located in them take no action to ‘corruption interface’, linking the illicit ensure that those administrations have the economy of dirty money flows to the information they need to tackle these mainstream global economy. Without this issues at an international level. financial interface it would be far harder to hide corrupt practices from It is impossible to ignore the role of tax investigation and to protect the proceeds intermediaries and the MNCs of the world of crime from seizure. For this reason TJN in creating the structures in which trade mis-pricing abuse of all forms takes place. 84 Former Education Minister Professor Aliya Babs Fafunwa quoted in This Day, 6th June 2005

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It is the responsibility of the IFIs to say that tax competition has caused harm, as some (but too few) economists now realise.85

It is impossible to continue turning a blind eye to the fact that: respected accounting firms, banks, investment advisors and lawyers have become high-powered engines behind the design and sale of abusive tax shelters. The evidence showed that these professionals were collecting hundreds of millions of dollars in fees while robbing the U.S. Treasury of billions of dollars in revenues each year86.

The cumulative impact of these issues on the tax compliance87 of billions of ordinary people has to be taken into account when considering the tax lost for development.

It is for precisely this reason that much of this report, whilst focussed firmly on the issue of using taxation to raise the funds needed for the fulfilment of the MDGs and more, addresses this issue in the context of action that can be taken in any and every country, developed, transitional or developing.

85 Lynch, R., (2004) Rethinking Growth Strategies: How State and Local Taxes and Services Affect Economic Development, Economic Policy Institute, Washington D.C. 86 From the web site of Senator Carl Levin http://levin.senate.gov/senate/investigations/ index.html accessed 30-1-07 87 For definition see Chapter 4

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Chapter 3

The scale of the flooding

The Sources offered here are based on his work unless otherwise indicated. Estimating the scale of the tax lost as a result of the leaks in the tax system As Cobham notes, international data identified in chapters 1 and 2 is sources are available to attribute values immensely difficult. The sources of the to leakages 1-3; comparable values for leaks are as follows: leakages 4 and 5 are not currently available and some estimates will have to 1. Tax due on the shadow economy do. (economic activity which is not captured in official statistics and constitutes tax evasion). The Price of Offshore 2. Tax due on income earned from 89 assets which are held offshore: that Research by TJN (2005) estimated the is, by individuals using tax havens. offshore assets of high net worth 3. Tax due on income earned by individuals at US$11.5 trillion. This multinationals and then moved translates, having taken conservative offshore without paying appropriately assumptions on estimated rates of return (through e.g. transfer pricing). and possible tax paid whether by source 4. Tax that would have been received or voluntary declaration into account, had not rates been diminished by tax into an annual tax loss due to individuals’ competition between jurisdictions use of tax havens at US$255 billion. seeking to attract foreign investment 5. Tax due but not paid; a potentially It is important to note that this figure large leakage where enforcement does not include the offshore holdings of mechanisms and administration are corporations. However as noted by US tax 90 under-funded, and/or penalties for columnist Martin Sullivan in 2004: non-payment are small and therefore tax avoidance in all its forms is rife. The profits of foreign subsidiaries of US corporations in 18 tax havens The value of the sums in question have soared from US$88 billion in 1999 to been most recently reviewed by Alex US$149 billion in 2002. Cobham of Oxford University in a paper for the TJN conference in Nairobi, Kenya Despite substantial evidence on the shift in January 200788 and the estimates taking place, Sullivan was unwilling to

89 The price of offshore available at 88 Cobham, A, The tax consensus has failed! http://www.taxjustice.net/cms/upload/pdf/ Oxford Journal on Good Governance, January Price_of_Offshore.pdf 2007 available at http://www.oxfordgovernance.org/fileadmin/ 90 Sullivan, M. Tax Notes 13 September Publications/ER008.pdf accessed 29-1-07 2004.

Closing the Floodgates www.taxjustice.net 36 estimate the cost to the US Treasury that both individual and corporate resulted. What was clear to him though components contributing US$50 billion was that: each.

It would be foolish to assume anything other that the Treasury has The Price of the Shadow Economy many billions of dollars on the line. Cobham’s estimate of the tax losses Using a different approach, Richard inflicted on developing countries by the Murphy for the TJN estimated that the existence of shadow economies uses is tax lost as a result of the 50 largest based on an average shadow economy corporations in the UK not paying the tax size of about one third of GDP in low at the headline rates expected of them income economies. Using this Cobham resulted in: arrives at a figure of annual tax loss of US$285 billion of which US$110 billion is Over 5 years, these companies have recoverable in his estimate by thus paid £20 billion less tax on their appropriate action to close the profits than expected rates would floodgates. suggest appropriate91

Extrapolated over the UK economy as a The Total Tax Losses – Excluding Tax whole he estimated the loss to be £9.2 Competition billion (US$17,5 billion) a year. It is not clear how much of this was due to which Using these cautious estimates as a leakage noted above. What is clear from starting point for our analysis, if these combined findings is that the tax multilateral action were taken to curb lost from the corporate sector is the widespread abuse of the offshore significant and additional to that noted system and if developing countries were from individual activity. given appropriate help to reduce the size of their domestic shadow economies, 92 Cobham (2005) builds on the TJN then developing countries could increase estimate of US$255 billion and using an their annual domestic resource 93 earlier estimate (2000) of the mobilization by over US$200 billion ($50 annual losses to developing countries billion dollars from revenues secured from corporate profit laundering reports from individuals using offshore; US$50 annual losses of US$100 billion of tax billion from corporate abuse as referred revenue for developing countries with to in the Oxfam report; and just over US$100 billion from recovery from the 91 Murphy R, Mind the Tax Gap, 2006, page shadow economy). This alone comes to 2 available from twice the amount of overseas http://www.taxjustice.net/cms/upload/pdf/ that is currently being Mind_the_Tax_Gap_-_final_-_15_Jan_2006.pdf accessed 29-1-07 disbursed.

92 Cobham A, Tax Evasion, Tax Avoidance and Development Finance, Working Paper 129, Queen Elizabeth House, University of Oxford, 2005 93 Oxfam, Releasing the Hidden Billions for Poverty Eradication, 2000 http://www.oxfam.org.uk/what_we_do/issue s/debt_aid/tax_havens.htm

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billion annually from developing Capital Flight countries) in Baker (2005).

Raymond Baker (2005)94 has estimated that global cross-border flows of dirty The Tax Gap money range between US$1.06 trillion and US$1.6 trillion annually of which While all these estimates may appear to between US$539 billion and US$829 be very large, country level estimates of billion comes from developing and the tax gap in the US and UK help put transitional economies. He breaks these them in perspective which suggests that down further and estimates that two these figures may be conservative. The thirds of this flow is driven by commercial US Inland Revenue Service for instance motives (including reducing or eliminating estimates that the annual tax gap in the the payment of taxes) and only about a US is about US$345 billion96. However, in third is related to drugs and trafficking an ongoing hearing session at the US etc related crimes. The extent to which senate, this figure has been described as this sum is recoverable depends upon a significant underestimate being: adoption of many of the measures suggested in this report. based on old and limited research … and leaving out some of the most important Simon Pak’s work in Chapter 11 of this things … [such as] offshore tax-sheltering report suggests that value shifting into schemes97. the USA alone might exceed US$250 billion per annum, and this calculation is Even with this limited number, the based on a massive empirical dataset. cumulative tax gap estimate since 2001 has been estimated to exceed US$2 Epstein et al (2005)95 have calculated and trillion already98. compiled estimates of capital flight for a number of developing countries. Their The likelihood of this figure being an estimates show that for example South underestimate is amplified when one Africa has been losing an average of 9.2 looks at the comparable tax gap per cent of GDP (losing US$13 billion in calculation for the UK, an economy one 2000), China 10.2 per cent of GDP (losing tenth the size of the US economy. The UK US$109 billion in 1999), Chile 6.1 per cent annual tax gap has been estimated by Tax of GDP (losing US$4.7 billion in 1998) and Gap LLP (2006) to exceed £75 billion or Indonesia 6.7 per cent of GDP (losing about US$150 billion at current exchange US$14 billion in 1997). rates99. In fact there have been other

This indicates a very large aggregate 96 number for total annual capital flight http://www.treasury.gov/tigta/congress/con gress_07262006.pdf from developing countries which again seems to fall in the ball park estimates of 97 http://budget.senate.gov/democratic/testim dirty money flows ($539 billion to US$828 ony/2007/McIntyre_TaxGap012307.pdf 98 94 Baker, R. (2005) Capitalism’s Achilles http://finance.senate.gov/press/Bpress/2005 Heel, John Wiley & Sons, Hoboken, New press/prb072606d.pdf Jersey 99 95 Gerald Epstein et al, 2005: Capital Flight http://www.taxresearch.org.uk/Blog/2006/12 and Capital Controls in Developing Countries, /08/ho-w-much-does-tax-evasion-cost-the-uk- Northampton, MA. start-at- per centc2 per centa375-billion/

Closing the Floodgates www.taxjustice.net 38 higher estimates one of which states that Adam and Bevan (2004: 60)103 comment the annual tax loss due to avoidance is on the failure of the tax consensus for likely to be £100 billion100 and another developing countries to produce the which is attributed to leaked UK Treasury desired revenue outcomes: papers of between £97bn and £150bn to tax theft every year101. Remarkably enough, however, very similar tax structures and tax rates seem These massive losses of tax revenue have to generate very different revenues in a very negative impact on the economy different countries. The reason and society of the countries experiencing presumably lies in different levels of them. For example, in his testimony to taxpayer compliance and of the the US Senate, the chairman of the US efficiency of tax administration, and this Inland Revenue Service said102: is where a government’s discretion to increase revenue lies. The tax gap can have corrosive effects upon our entire tax administration Cobham argues104 that governments’ system and the fiscal health of the discretion to address non-compliance in nation. The tax gap’s consequences are the whole economy is powerfully all too real and we feel them in our undermined by international tax evasion: everyday lives. The main findings [from the First, at the most basic level, the tax gap experimental economics literature] are is an injustice. It means that honest these: that compliance depends taxpayers are bearing the financial positively on (i) the perceived or burden of those who do not pay what expected level of redistribution, and (ii) they owe. The taxpayers who play by the individuals’ expectation of others’ rules – regardless of income bracket – pay compliance levels (Bosco & Mittone, more in taxes to make up for those who 1997105; Mittone, 2006106). The game the system and cheat. In a very implication is that paying tax is a social tangible way, honest taxpayers are act (Frey & Torgler, 2006107) - reflecting subsidizing those who evade their taxes.

Second, it deprives our government of 103 Adam, C., and Bevan, D., 2004, ‘Fiscal revenue to which it is entitled. policy design in low-income countries’, in T. Addison & A. Roe (eds.), for Development, Palgrave Macmillan/UNU- Third, and perhaps most troubling, the WIDER: Basingstoke tax gap undermines confidence in the fairness of our tax administration system 104 Cobham, A., 2007, ‘The tax consensus has failed!’, Oxford Council on Good and contributes to non-compliance. Governance Economy Recommendation 08. pages 5-9 105 Bosco, L., and Mittone, L., 1997, ‘Tax 100 evasion and moral constraints: Some http://politics.guardian.co.uk/comment/stor experimental evidence ‘, Kyklos, pp.297-324. y/0,9115,1562889,00.html 106 Mittone, L., 2006, ‘Dynamic behaviour in 101 tax evasion: An experimental approach’, http://society.guardian.co.uk/publicfinances/ Journal of Socio-Economics. comment/0,,1986352,00.html 107 Frey, B., and Torgler, B., 2006, ‘Tax 102 http://www.senate.gov/~finance/hearings/te morale and conditional cooperation’, CREMA stimony/2005test/072606rw.pdf Working Paper 2006-11.

Closing the Floodgates www.taxjustice.net 39 a desire to participate in a group, rather While a lot of the discussion above has than economic maximisation. related to the opportunity cost – the tax that should have been paid but was not As a result, it can come as no surprise paid, sometimes the loss can also include that the consensus has also failed in a substantial amount of actual cash loss addressing the problem of non- from a country’s finances. This is compliance. Non-compliance is self- exemplified by the so called ‘Carousel reinforcing in the presence of obvious Tax Fraud’ in the UK. This VAT fraud is evasion by rich individuals and large estimated to have costs the UK alone companies, and a lack of redistribution sums in the range from £1.1 billion to exacerbates these effects. £1.9 billion for 2004/05. These sums increased to figures in the range £5 Torgler & Schneider (2007a108, b109) show billion to £10 billion ($4.5 billion to US$18 110 that the size of the shadow economy billion) in 2005/06 with another 111 depends directly on the level of ‘tax estimate reported to be £8.4 billion . morale’ - that is, the ‘belief in Corruption is not limited to developing contributing to society by paying taxes’ country economies, as is also noted in (2007b, p.8). The estimated US$385bn of this report. One feature in common tax revenues lost annually by developing though is that almost all this lost cash is countries are seen to be primarily driven believed to have been channelled through by the international tax evasion of one offshore bank – the First Curaçao corporates and rich individuals that also International Bank in the Netherlands 112 undermines this tax morale, enlarging Antilles . the shadow economy.

To address the issue of lost annual Summary revenues in excess of the aid budget, developing a culture of compliance is It is not possible to estimate the precise key. From this it follows that the high- cost of the flood of tax revenues that are profile evasion by multinationals and not being used for their rightful purpose individuals through tax havens must be in the world. tackled first, and as an immediate priority.’ It is clear, however, that in combination the sums involved could more than cover The agenda for action is clear. the cost of the Millennium Development Goals, probably several times over. Of course, it is also not clear how much of Theft this loss is recoverable, but Alex

110 http://www.moneyweek.com/file/17602/how -carousel-fraud-is-putting-the-vat-system-in-a- spin.html and 108 Torgler, B., and Schneider, F., 2007a, http://business.guardian.co.uk/story/0,,1943 ‘The impact of tax morale and institutional 994,00.html quality on the shadow economy’, CREMA Working Paper 2007-01 111 http://news.bbc.co.uk/1/hi/programmes/pan 109 Torgler, B., and Schneider, F., 2007b, orama/5366914.stm ‘Shadow economy, tax morale, governance 112 See and institutional quality: A panel analysis’, http://www.guardian.co.uk/crime/article/0,, CREMA Working Paper 2007-02 1877288,00.html accessed 29-1-07

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Cobham’s estimates suggest that the potential sums which could be recovered are sufficiently large to make this a more than worthwhile project. Indeed, nothing else could raise as much cash both for the development agenda and to ensure that developing countries can mobilise their own resources for this purpose. In terms of orders of magnitude, tackling capital flight and tax evasion is probably the biggest issue on the finance for development agenda.

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Section 2 How the floodgates are opened

Chapter 4 How companies reduce their tax bills

Companies can manage their tax bills in b. Makes full disclosure of all three ways, each of which has its own relevant information on all its tax description. For the sake of clarity these claims; are worth noting: c. Seeks to pay the right amount of tax required by law (but no more) 1. Tax evasion is an illegal activity at the right time and in the right undertaken to reduce a company’s tax place. bill. It might be for example that the This activity attracts remarkably company: little attention, but some companies do practice it. a. Fails to declare all or part of its income; 3. Tax avoidance. Tax avoidance is the b. Makes a claim to offset an grey area between tax compliance expense against its taxable and tax evasion. When tax avoiding a income which it did not incur or company seeks to ensure that on of which is of a type not considered these happens: suitable for tax relief in the a. less tax is paid than might be country in which the claim is required by a reasonable made; interpretation of the law of a c. Makes a tax claim which looks country, or legal but only because a relevant b. tax is paid on profits declared in fact with regard to that claim has a country which does not appear not been disclosed to the tax to be that in which they were authorities, and if it were the tax earned, or claim would be denied. c. tax is paid somewhat later than the profits to which it relates 2. Tax compliance is the other end of were earned. the spectrum from tax evasion. When a company seeks to be tax compliant The difference between tax avoidance it does the following: and tax compliance is that tax compliance seeks to ensure that tax is paid in a. Seeks to comply with tax law in accordance with a straightforward all the countries in which it interpretation of the letter of the law operates; whilst tax avoidance seeks to reduce tax

Closing the Floodgates www.taxjustice.net 42 paid by working between the letters of MNCs113 and maybe less than 1 per cent the law. Both can claim to be legal, but are the parent companies of multinational only tax compliance can justify that claim groups but it is estimated that their intra- with certainty. Tax avoidance relies on group sales (i.e. transactions across the existence of doubt for its validity. international borders but between The practices referred to in this report companies with common ownership) fall largely in the area of tax avoidance, account for more than 60 per cent of and suggest ways in which companies seek world trade114. to minimise their tax bills whilst working around the law of one or more countries. To understand this it is important to note that whilst MNCs like to appear to be one entity, and indeed will publish accounts Tax planning that suggest this is the case, MNCs are typically consist of large numbers of Any company, anywhere in the world has separate companies. A parent company the opportunity to undertake tax planning usually owns all or most of the others, and within the law of the territory in which it controls all the others because ownership operates. Sometimes this planning is a of a company’s shares provides that right simple matter of making choices between in company law. The companies that the various options quite deliberately made parent owns are called its subsidiaries. available within taxation law about how a There can be just a few of these. There transaction may be treated. This is an may be thousands. For example, a recent issue of tax compliance. On other count at BP suggested it had more had occasions the planning may seek to find more than 3,000 subsidiary companies loopholes within the domestic law of the around the world115. country in question, at which point it moves into the area of tax avoidance. The This means that whilst the corporation range of domestic options for planning may like to present a single front to the available to companies is so wide, and yet world, and one published glossy set of are so locally specific that the purpose of accounts, the reality is that when it this paper is to consider those options comes to taxation there is no such thing that are instead available to international as an MNC. Each company that makes it companies, because these tend to be up is taxed separately. It will usually be easier to categorise and are of greater taxed in one of two places. The first is the significance for those involved with country in which it is incorporated. For international justice, development and example, a company established under the interaction of taxation and the relief English law is always taxable on its of poverty. worldwide income in the UK. Secondly it may be taxed where it . So, for International tax planning can take place example, a company incorporated in whenever a company trades across an England but which has a branch in France international boundary, but it is much more likely to take place when a company 113 This is based on the fact that only 0.5 per actually undertakes its activities in more cent of all companies in the UK are plcs. Even than one country. When this happens it if each has 20 subsidiaries on average in the UK that means 90 per cent of the register is UK becomes a multinational corporation based. Proof of this is not possible. (MNC). It is likely that less than 10 per 114 OECD Observer April 2002 cent of the world’s companies are part of 115 BP Annual Return appendices dated 5 May 2005, lodged at Companies House in the UK

Closing the Floodgates www.taxjustice.net 43 will be taxed in France in the first This is a long list. Each needs to be instance on the income of the French explored to show how a group of branch and then, for a second time in the companies might plan its taxation affairs. UK, but with credit given for the French tax already paid under the terms of the 1. Where to locate a head office. double between the UK and France which has as its intention the This requires deciding in which country a elimination of . It is head office will be located. Sometimes precisely because of the complications the decision relates to what are called that this arrangement causes that most ‘intermediate holding companies’ instead. MNCs have separate companies for each activity they undertake in each country in The importance of the decision is which they operate. As a by product the determined by the fact that a company resulting complex structure is guaranteed usually has to pay tax in the country in to provide enormous opportunity for an which it incorporated. So, choosing to MNC to plan its taxation liabilities. The locate a company in a high tax territory ways in which it might do so include such as the USA (which has amongst the decisions on the following: highest corporate tax rates in the world) can be expensive116. However, quoted 1. Where it will incorporate its head companies usually need to be office: incorporated in a major such as London, New York or Frankfurt. 2. Where it will incorporate its The result is that tax cannot be minimised subsidiary companies: in those locations. 3. Whether it will use tax havens or not; Instead companies set up what are called 4. What companies it will, or will not ‘intermediate holding companies’. These include in its group structure (which are owned by the parent company and in means which ones are added into the turn own the operating subsidiary glossy accounts, and which ones are companies. Little or nothing happens in not); the intermediate locations, except that they collect dividend income from the 5. On what terms it will trade between subsidiary companies they own and then group companies. usually loan, but not pay as dividends, the 6. Where it will record its sales; resulting cash that they hold to the parent company in London, New York, or 7. Where it will incur its costs; wherever. The intermediate location is 8. Where it will locate its assets; chosen for having low tax rates on dividend income received, a lot of double 9. Where it will employ its staff; tax treaties with other countries to ensure 10. Where it will borrow money; that it is not treated as a tax haven (even though it is) and a favourable regime for 11. Where it will locate its intellectual taxing interest income, of which it may property; have a great deal. The most popular 12. How it will structure its operations; locations are Ireland, the Netherlands, Luxembourg and Switzerland, all of which 13. Whether it will seek special tax offer these arrangements. privileges.

116 See Appendix 2 on corporate tax rates for comparative company data.

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a ‘duty’ is actually used as an excuse to 2. Where a company will incorporate justify chosen corporate behaviour. its subsidiaries.

A combination of tax law and other 3. Whether a company will use tax regulation makes it almost certain that an havens or not MNC will have subsidiary companies in each territory in which it operates. But This question is related to that of where then it has to decide if it needs others in subsidiaries may be located, but not locations that are purely tax driven. entirely. There may of course be a valid reason for locating a subsidiary in what is Non-tax haven countries tend to have called a tax haven if a real trade is higher tax rates than the tax havens. A undertaken there. For example, a retail few geographically smaller developed company running a store in Guernsey may countries, such as Ireland and the wish to have a Guernsey based company Netherlands also offer low tax rates on for that purpose, and no suggestion of tax profits of some or all sorts. In this they avoidance would result. However, when join with the tax havens in seeking to planning a group structure a company increase their tax revenues by attracting does have to decide if it not only wants profits to their shores which were not the tax advantages some countries, such earned there but which are relocated to as the Netherlands, supply but the lack of that country using some of the transparency that is also usually mechanisms described elsewhere in this associated with tax havens where report. accounts and even proper ownership details do not have to be filed on public Any group of companies has a simple record. decision to make. It has to decide if it wants to relocate its profits from the Some companies undertake transactions place in which they were really earned to which they would prefer not to disclose to places in which they may be declared, the public, their shareholders, with reasonable chance of getting away competitors, or regulatory agencies with the relocation, with lower taxes including tax authorities. The anonymity being paid in consequence. provided by tax havens allows them to obscure the reporting of the trades they Many MNCs claim they have a to their undertake in order to secure profit for shareholders to minimise the tax that the their groups of company. company pays117. There is in fact no such requirement in the law of many countries, including that of the UK where a much wider degree of discretion is provided to directors. See section 172, Companies Act 2006 the directors of companies as to how they available at http://www.opsi.gov.uk/ACTS/acts2006/ukpg might manage the affairs of the entity a_20060046_en.pdf accessed 25-1-07 118 they manage . In that case, this claim of It would be interesting to speculate what change in behaviour might result from explicit changes in legislation in this area. Clauses 118 This issue was the subject of much requiring companies to comply with the spirit debate during the passage of the UK’s of taxation law in all the territories in which Companies Act 2006 through Parliament and it they operated were introduced to the House of is clear as a result that whilst profit is Lords during the debate on the UK Companies important a much broader range of obligations Act (partly at the suggestion of the TJN) but need also to be considered by UK company were rejected by the government.

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It is now almost universally agreed that company outside the group so that its transparency reduces risk, enhances the transactions may be treated as if quality of corporate governance, reduces undertaken by an independent third corrupt practices (including fraud) and party. This technique is often used for must therefore be of benefit to society. financing debt e.g. from credit card But not all companies behave as if the customers, the customers of utility interests of society coincide with those of companies or mortgages, but the their shareholders. If that is their opinion technique can also be used for other tax havens may well be attractive to them purposes, as Enron proved all too because the risk of their trade being clearly119. subject to serious scrutiny is reduced. On the other hand, they face questions as to The use of what are clearly artificial the reasons for their choice of location structures created by professional people from both taxation authorities and others, e.g. lawyers and accountants who claim but might believe this a price worth independence from their clients whilst paying for secrecy. clearly working under their direction and control, raises questions about the ethical Such decisions are rarely made for standards of these professions. taxation reasons alone. 5. What terms of trade will be used 4. Which companies will, or will not be between group companies included in the group structure When companies engage with their It seems logical to assume that all customers or suppliers (‘third parties’) it companies over which an MNC has control is assumed that each party is out to get should be included in its group accounts the best deal possible for themselves and and so be subject to scrutiny as part of its that the resulting prices set for the trade operations. Many companies, however, will reflect that fact. These are called choose to hide transactions “off balance ‘arms length prices’. However, when two sheet”. This may be because the companies that are under common companies in question include liabilities ownership trade with each other they do that they would rather not recognise since not necessarily want the best price for they would make the MNCs’ finances look each individual company but may be worse; or those companies are being used motivated to set a price that gives the to undertake transactions that change the best overall result for the MNC of which view of the MNCs financial results e.g. by they are a part. This will be influenced by inflating profit (as was the case in the the amount of tax that is, or is not, paid notorious situation of Enron). as a result of the consequent allocation of profit between the two subsidiary MNCs can take advantage of situations companies. For example, a company in where they can create ‘orphan’ Cyprus (tax rate 10 per cent) selling to a companies. These are usually companies French company (tax rate 33.33 per which are heavily dependent on the MNC for the trade that they undertake but which are theoretically not owned by it. This is usually achieved by placing 119 For a broader discussion of this issue see pages 12 – 17 of a report written by the author ownership of the orphan company in a of this paper for a Scrutiny Committee of the charitable trust located in a tax haven. States of Jersey available at This structure is then claimed to move http://www.taxresearch.org.uk/Documents/4 both ownership and control of the orphan 180-12935-2962005.pdf accessed 25-1-07

Closing the Floodgates www.taxjustice.net 46 cent)120 has a strong incentive when both the major developed economies where are owned by a UK parent company to these matters are now subject to routine overstate the selling price in Cyprus if the enquiry by tax authorities. This is not the third party selling price in France is fixed case in developing countries. In December because this will mean more profit is 2004 the Big 4 accountants Deloittes taxed in Cyprus at a lower rate than is reported in South Africa that they had charged in France than would otherwise never seen a successful transfer pricing be the case. This process of selling challenge out of Africa121, and most between related companies in an MNC is countries in Africa do not at present have called ‘transfer pricing’ and is completely the legislation, the expertise or the legal. Abuse of transfer prices may be commercial confidence to raise such illegal however, depending upon the challenges against the MNCs that operate countries involved. there.

MNCs have to set transfer prices. There can be no trade within the group if they 6. Where a company will record its do not. When doing so, however, they are sales in a position to make choices. Since before the Second the It is inevitable that an MNC will trade principle has been established in internally. When doing this it can international law that prices between relocate transactions to give rise to related companies in an MNC should be favourable outcomes for taxation and set on an ‘arms length basis’. This is other purposes. One transaction that can believed to result in the allocation of the be relocated is where a sale is recorded. profit earned to the country in which it was generated and this is considered a Some products can be recorded as being just and equitable outcome. sold from almost anywhere, and it is hard to prove that the claim is wrong. This is Companies can decide whether they want particularly the case with software and to achieve this outcome. They can use other such products sold on-line over the their best endeavours to do so. It must be internet. stressed however that this is not straightforward. There may be no way of Where real, physical products are involved determining the ‘third party’ price for it can be harder to relocate where a sale some products transferred across is recorded, but by no means impossible. international borders e.g. the price of a For example, in the case of a mining part finished component that will never company ore is extracted from the be sold in that state to a customer has by ground. That ore is, in the vast majority definition no ‘arms length price’ and so of cases destined for export. Decisions can estimates have to be made. Such process be made as to where the sale of that ore of estimating can be undertaken in good is to be recorded. In the first instance, faith, or with the intent of disguising the there must be a sale from the country in reallocation of profit. Likewise, which it was extracted. That is obvious. companies can decide to only operate But the condition in which it is sold is ‘arms length prices’ in locations where a clearly a decision, and that can be tax challenge to their policy is likely e.g. in

120 121 Reported in tax us if you can TJN 2005 http://www.kpmg.com/Services/Tax/IntCorp/ available from CTR/ accessed 7-11-06 http://www.taxjustice.net/cms/upload/pdf/t uiyc_-_eng_-_web_file.pdf accessed 25-1-07

Closing the Floodgates www.taxjustice.net 47 driven. If the tax rate in the country of in the extractive industries, for example, extraction is high, the ore may be shipped which can have the benefit of both in unprocessed state even if that reducing tax and reducing the proportion increases transport costs. The added of production due to the host government value resulting from processing then takes under some mining and oil concessions, so place elsewhere. Alternatively, the ore giving a double benefit to the company can be processed first. That changes its engaging in such practices. value. The decision as to where to undertake this process changes the Cost loading can be as hard, or harder, to location in which the sale of the identify than sales mis-pricing since in processed ore is located. many cases it will be even harder to establish a market price for the items in Even if the ore is not processed, question. The principle of the ‘arms alternative arrangements can be made for length rule’ of pricing still applies in these its sale. For example, it might be sold cases, but companies have considerable straight to a third party for processing. discretion over how they can interpret Alternatively, it may be sold within the that obligation. MNC to a central marketing organisation (a common arrangement) which then adds a profit margin for the work it 8. Where a company will locate its undertakes. As a result part of the sale assets price has been relocated from the country of origin of the ore to the country in A company has to buy certain physical which the marketing operation is located, property to undertake a lot of the work which may well be a tax based decision. that it does. In the extractive industries, for example, this might include all the Some of these decisions may be mining or drilling equipment it uses. determined by genuine external factors Logically these would be owned in the e.g. the capacity of the country of origin country in which they are used by the to process the ore. Often they are not. entities which have the benefit of using them in their operations. In tax planning 7. Where a company will incur its costs little is that simple.

Just as there is an incentive to shift sales The reason is that many countries offer to low tax areas, there is an opposite special incentives to companies that incentive to shift costs to high tax areas invest in capital assets and give them tax where they will benefit from the greatest reliefs and allowances which are much value of tax relief. This can be of more generous than the accounting importance for developing countries with charges made for their use in the owning relatively high tax rates. For example, company’s published reports. The result is many South American countries engaged that the effective tax rates of the in the extractive industries have nominal companies are reduced and the dates for tax rates in 2006 of around 25 per cent. payment of tax are deferred.

Companies may decide to load costs into These reliefs can be exploited when territories with relatively high tax rates. combined with asset leasing This trend may be exacerbated if this arrangements. Some countries provide tax ‘cost loading’ gives rise to other benefits relief on the cost of assets that are leased as well. Such a benefit might arise by to the legal owner i.e. the lessor. Others inflating the apparent cost of production provide it to the lessee who hires the

Closing the Floodgates www.taxjustice.net 48 asset. If the lessor company gets the tax 9. Where a company will employ its relief on ownership then it is also liable to staff tax on the income arising on the asset. Conversely, in countries where the lessee It seems logical that a company would gets relief on the expenditure incurred on employ its staff where they work. And so creating the asset they rent the lessor it can be for those who are on average who has legal ownership of that asset is earnings for the location in question. The usually exempt from tax on most of the company is likely to rely on these people income it gets from renting it. to be the backbone of their operation, and those people are also unlikely to be Companies can decide to exploit these either significantly mobile as to the rules for their benefit. They do this by a location in which they wish to work or to process called ‘tax arbitrage’ where they be willing to engage in any serious tax chose to locate transactions so that they planning on their employer’s part. get maximum tax benefit from them by trading off the rules of one country But this might not be true for the more against the rules of the country that is senior management of an MNC, many of taxing the other side of the arrangement. whom will have joined it precisely because it offers the opportunity to work So, for example, they might lease an asset in a number of locations. They will most from a country which gives generous probably be internationally mobile and reliefs both for expenditure on capital will be willing to participate in tax assets and also on the incomes received planning for their own and their by the lessor company. The outcome of employer’s benefit. these favourable treatments is that the lessor company generates considerable up The result is that these senior managers front tax losses on the deal, which are might be employed in locations which suit only cancelled out over a considerable tax planning even if their duties are period, and that company then leases the undertaken elsewhere. In fact, the split asset to a territory where the lessee between the employment location and the company gets the relief on the capital place in which duties are undertaken may cost of the expenditure, but no tax relief be deliberate. The reasons are: on the rentals paid. This means that company also gets considerable up-front a. Managers might obtain a favourable tax relief compared to cash expense tax treatment for their earnings if incurred. The result is something called they are employed in a location which ‘double dipping’ in tax terms, where two is not their long term home. This is lots of tax relief have been generated on because part of their income might one expense in effect, with in this case not be taxed anywhere. the transaction taking many years (maybe b. The employer may choose to place 25 years) to reverse, about which no one the employment in a location where cares much since they will no longer be in the tax or national insurance charges their jobs by the time any reversal of the on employing the manager are low, as effect takes place. is typically the case offshore. c. Having a manager employed offshore As a result assets are frequently legally allows the employer to create a new owned in locations far removed from business based in the offshore those where they are actually used. location which supplies ‘management services’, the value of which for transfer pricing purposes is hard to

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prove so that profit can be extracted by an external source e.g. a bank or in this way from the company that venture capitalist group, or from an receives the charge for these services. internal finance company within a group of companies. Internal finance companies A company might decide to organise their are often set up offshore in locations such employment structures in this way for as the Netherlands and Ireland which have three reasons: deliberately created tax structures to attract such ‘businesses’. 1. It allows them to manipulate their tax arrangements by adding another Interest is much more favourably treated international service into the group for tax than dividends. Interest is which can be used for the purposes of deducted from the paying company’s profit reallocation to low or zero tax profits for tax purposes and so reduces its jurisdictions; tax bill. This does not apply to a dividend. Dividends can be subject to tax 2. It can reduce the cost of employing withholding from the country in which staff; they arise i.e. part of their value has to 3. It can increase the net reward to be paid to the host country government. staff, so encouraging them to stay at This is by no means always true of no extra cost to the employer. interest. A company can often arrange to receive interest in a low tax area and But in each case the local market for create a permanent tax saving. This is labour is upset. Overseas staff are harder to achieve for dividends, especially favoured over local people. Allegiance to if there has been before the company is greater as a result than they are paid. allegiance to place. The duty of the staff to any particular country is undermined. The outcome of this different treatment is And mobile staff who are dependent on predictable. Companies have a bias to their employers to create artificial loan capital. So great is this incentive that structures which inflate their earnings by choice they will use almost no share tend to be more compliant, less inclined capital and will have substantial loan to whistle blow and more tolerant of capital in a foreign subsidiary. This is other abuses if they happen within or called ‘thin capitalisation’. This reduces without the company because that culture the profits in high tax areas because will pervade their own employment interest is paid from them, and also environment. reduces the overall tax bill within the group because it allows for the interest to 10. Where a company will borrow be received in a low tax area. The money company might also, unless there is regulation in place to stop it, seek to All business activities require finance to charge whatever rate of interest it likes establish a physical presence in a location to maximise the profit it can extract from and to fund the day to day activities of subsidiary company in a high tax area to the business. This money can be provided then transfer it to a low tax location. in two ways: share capital or loan capital. Share capital earns dividends payable Companies undertake this activity to from profits. Loan capital is paid interest maximise their financial return from the regardless of whether or not profits are activities in which they invest by creating generated. Loan capital can be supplied what can, quite often, be arbitrary financial structures motivated not by the

Closing the Floodgates www.taxjustice.net 50 needs of group financing but by a desire paid). There are other variations on this to abuse tax rules for the sake of theme but these two categories are increasing the after tax profit. sufficient to cover most issues.

The abuse is often complex. For example, Intellectual property may have been third party funds are borrowed in acquired by an MNC from a third party or, territories with relatively high tax rates more likely, has been created by it. For and efficient capital markets where there example, Audi claim they filed 9,621 is no restriction on the use of those funds patent applications when creating their when it comes to giving tax relief. The UK new A6 car. Any company might decide is an example of such a location. where it wishes to locate ownership of its patents or copyrights and this need not be The funds are then lent with very low the country of their creation, with little margins earned to a financial centre e.g. or no tax penalty arising on relocating Dublin. From there they are loaned on to them to a low tax country before they foreign subsidiaries and the charge is have been used and have therefore been inflated, especially if that subsidiary is in proved to have commercial worth. The a high risk area such as a developing same is true of copyright material, such as country, with the justification being that logos. The Virgin corporation, for example the funds to be used there if borrowed licences the use of its Virgin logo to all directly would have been subject to a Virgin operations from the British Virgin higher rate of interest even though the Islands. Microsoft holds the copyright of group itself is not. most of its products for sale outside the USA in Ireland – a low tax state. The result In effect this is another form of transfer is that it appears to be largest company in pricing abuse, but this time on financial Ireland, though the vast majority of its products created specifically for this income in that country has little or purpose. nothing to do with its activities in that country. This practice is normally well regulated in developed countries, but this is not It is notoriously difficult to prove the generally the case in developing value of intellectual property. This means countries. it is an especially popular mechanism for shifting the location of profits from both developed and developing countries into 11. Where the company will locate its low tax locations. intellectual property Almost any company can ‘create’ licensed This decision perpetuates a recurring intellectual property. Even its own name theme throughout this discussion, which is can fall into this category. In many cases one of how an MNC might structure its the legal registration of this property is affairs in order to maximise the number of quite unnecessary. The charging of a fee transactions crossing international for its use is quite often even less borders. Doing this maximises the justified. opportunities for relocating profit to low tax areas. An MNC has to decide if it wants to undertake this activity which is largely Intellectual property comprises patents designed to facilitate the shifting of (on which royalties are paid) and profits to low tax areas. copyrights (on which licence fees are

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12. How a company will structure its operations Other possibilities occur and are exploited by some companies. This theme brings together a number of previous threads. It involves decisions on: The decision the company makes on this issue is essentially political. It is one of 1. Where to incorporate; deciding whether the corporation exists within national spaces called countries, 2. Where to borrow; and is therefore subject to the rules and 3. Where to place subsidiaries and regulations of those spaces, or whether it intermediate holding companies. wishes to float above and between those spaces and exploit the gaps between them Each of these, and indeed the other issues by finding loopholes in the double addressed above, can be seen as discrete taxation treaties that regulate the decisions. But they are also viewed environment. collectively by most MNCs. What they are seeking to do is to create a structure for The current structure of accounting their MNC which minimises tax. In doing encourages MNCs to see themselves as so they are likely to: independent of any nation state. The accounts that they publish are 1. Make full use of taxation treaties ‘consolidated’. They do not actually between countries to ensure that the represent the results of any individual least possible tax is deducted at company within the group. Instead they source from any dividends, royalties, represent the net outcome of the interest or licence fees paid, thus transactions between all the MNCs and ensuring they arrive in the parent third parties. But transactions within the company with as little paid in tax as MNC are entirely eliminated from that possible; reporting. 2. Secure favourable tax treatment by accumulating reserves in low tax As a result the local base for each and jurisdictions such as the Netherlands, every company within the MNC is ignored Ireland and Switzerland with an in the published accounts, which extensive range of double tax consequently float above the national treaties; spaces as if independent of the locations 3. Seek to use ‘conduit’ companies to in which the company works. turn income from relatively unacceptable sources e.g. those This perception is one that many subject to a (e.g. in a companies now replicate in their tax developing country) into an planning. They can create complex group acceptable source to which a double structures knowing that they do not have tax treaty exemption from further to report on them. They can also exploit taxation can be applied. Cyprus is the gaps between the countries in which frequently used for this purpose. they either work, or in which they choose 4. Seek to exploit loopholes between to locate operations for the benefit (as double tax treaties to minimise tax they see it) of their investors (even obligations e.g. by double dipping as though they are, inevitably rooted in noted above. This practice has those self same national spaces) because recently been attacked by a number whatever they do is similarly of tax authorities. unaccountable.

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The structures of international tax have fiscal policy on the part of the country also until recently encouraged this that offers them. because they have been poor at exchanging information between nation The acceptability of these practices states or at enforcing international varies. Some subsidies and grants are taxation liabilities. The consequence has almost above suspicion. Special tax been that an ethos of abuse has allowances are usually beyond developed, with the interests of the international reproach if offered to both company being seen as superior to those local as well as incoming businesses. This of the state. is sometimes acceptable to a government because there is almost no local trade of The company has to do decide whether to similar type. Tax holidays and negotiated accept this philosophy, or not. tax rates are widely frowned upon and income subject to such regimes is usually denied the benefit of the favourable 13. Whether a company will seek special treatment often afforded by double tax tax privileges treaties. However conduit tax havens such as Cyprus can often be used to convert There is a final option available to income of this unacceptable sort into companies. They might simply ask the income that is acceptable under double state for special tax concessions. tax treaties.

Sometimes these are given by way of In all cases there is a direct conflict in grants or subsidies. On occasion they are these arrangements between the state given by special tax allowances e.g. by and the MNC, with the balance being granting accelerated tax allowance for decided between the amount of estimated capital expenditure in certain industries economic benefit the state secures when which have the effect of ensuring that traded against the tax it loses. If, MNCs in that sector do not pay tax for an however, the incentives offered are linked extended period even though they are to unacceptable commercial practices the profitable. They can simply involve balance of the equation quickly moves taxation holidays granted to particular into areas where fraud and other companies whilst they are establishing malpractice is either suspected or occurs themselves in a territory e.g. a ten year in practice. When that is the case the period is common in this respect. state is unlikely to benefit from the Alternatively, they can involve specially negotiated arrangements even if the MNC negotiated tax rates as is frequently does. possible in tax havens. In deciding whether to avail itself of these The final option is to negotiate what is options the company has to assess the risk called a ‘fiscal stability clause’ which to its reputation from doing so. A guarantees the company that the state’s company might also consider whether it is tax laws will not be changed to its allowing tax to cloud its commercial prejudice for the foreseeable period. This judgement: there are studies showing that period can be 25 years or more. These tax incentives often result in business provide certainty to the company activities being undertaken in areas which undertaking inward investment but are not favourable and that the outcomes seriously limit the scope for future do not meet the expectations of either economic management through use of the business or the government.

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There is limited risk in taking opportunity life of the project. 10 years is of available tax reliefs or grants. There is commonplace. increasing risk as a company moves into b. Negotiate special tax allowances for negotiating special allowances, tax investment e.g. 100 per cent write off holidays, special rates and fiscal stability of capital costs to create early year clauses. Some companies choose not to do trading losses which mean tax is not this. Others use the opportunities paid for some considerable time; provided by the rules of corporate reporting, which allow intra-group c. Secure grants, allowances or subsidies transactions to be largely ignored to for the operation which have the suppress details of such trading. This is same effect as tax allowances, or done in the hope that the negative might even be additional to them; aspects of such deals can be kept out of d. Negotiate exemptions from domestic scrutiny whilst the positive advantages to tax laws e.g. on tax withholdings from cash flow are enjoyed. dividend payments so that profits may be extracted tax free. This is Along with many of the decisions to be particularly attractive if no other tax taken by a company with regard to the is being paid during a tax holiday on issues listed in the paper, this is an profits; ethical choice and the MNC has a position to take on this issue which it cannot e. Negotiate special tax rules so that avoid, and about which it should be open limited questions are asked on the and accountable. expenses charged against profits within the local operation of the MNC, Example: What companies in the thereby reducing its taxable profits; Extractive Industries do to reduce their f. Seek a fiscal stability clause for its tax bills own long term benefit, but not that of the host state; One of the most problematic industries in developing countries, and certainly the g. Seek special transfer pricing one to which more attention has been arrangements e.g. so that ore or oil is given than most, is the extractive exported at prices below market rates industries. As an example of what can e.g. on the basis of production costs actually happen, companies in the plus a fixed mark-up, whatever the extractive industries have a range of movements in price in the market choices they can make to shift profits place. with little or no tax paid from the host h. Seek allowance for the vast majority countries in which they operate. These of capital to be invested in the local might be summarised as follows: operation to be in the form of loans so that ‘thin capitalisation’ can take 1. Negotiate favourable local tax place and profits can be extracted arrangements from the host country by way of interest payments. Prior negotiation The MNC will seek to secure a favourable may take place to ensure that there position for itself by negotiating special are no limits on the rate of interest tax arrangements under the terms of its that may be charged. mining or oil extraction concession. i. Ensure that no limitations are placed

on royalty and licence fees paid by a. Negotiate tax holiday so that tax is not paid during the first years of the

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the company located in the host has the dual advantage of reducing the country. of the host country operation and inflating its cost of

production of ore or oil, which will 2. Establish tax effective holding probably reduce the royalties due to the company arrangement for the host host country as well. country operating company

a. Capital equipment will be sold or The company seeks to ensure that profits leased to the host country operation that have not been taxed or which have from another company within the MNC been subject to low rates of tax in the which is either in a low tax area or host country retain that benefit when which allows a double tax deduction moved out of that territory. to be made on leased equipment costs

by claiming the expense in two Any special tax incentives offered by a locations – a process known as ‘double host country will probably negate the dipping’. benefit of double tax treaties with major b. Management services and seconded financial centres where the MNC will have staff will be supplied from offshore its headquarters e.g. the UK, the USA, locations to reduce the tax paid etc. As a result a structure will be created locally on employment costs, thus that ensures that the profits flow from reducing the benefit to the host the host country to a low tax state with country of the operation being reasonably good double tax treaties (e.g. undertaken within their state, and to Cyprus, which is a full member of the EU) enable such costs to be sold to the and from then on they will flow through host country operation at inflated what are called ‘participation prices, with the resulting benefit agreements’ in jurisdictions like the being transferred to a low tax state; Netherlands. This ensures that the c. Charges will be made for the use of benefits of low or no tax paid are MNC owned patents, copyrights and preserved as the profits flow either into ‘management know-how’, the the parent company, or more likely into a ownership of which will be located in group financing operation in the country offshore tax havens. The value of this running the participation agreement such knowledge will be hard to prove and as the Netherlands or Switzerland. These as such is particularly difficult to group financing operations are effectively challenge under transfer pricing rules. intra-group banks which ensure that low d. Cash needed to fund the operation taxed profits never have to reach will be provided by group finance countries with higher tax rates but are companies in locations such as the instead loaned to them. Netherlands, Ireland or Switzerland

where low rates of tax are charged on 3. Source all equipment to establish the receipt of such income. This is the host country operation from especially likely if a tax holiday has within the group not been negotiated.

Supplying services and capital equipment 4. Arrange for sales to be made from within the group means that prices through group marketing charged can be arranged to ensure that arrangements. profits flow to low taxed countries through the manipulation of transfer International sales are meant to take prices on sales into the host state. This place at what are called ‘arms length

Closing the Floodgates www.taxjustice.net 55 prices’ under international tax marketed from outside the host conventions. The intention is to ensure country. That makes transfer prices that each country obtains the correct much harder to negotiate. market price for the commodity sold from f. Require that the ore or oil be sold its territory and so taxable profits are with the benefit of group marketing correctly allocated between states. arrangements for which a licence or royalty will be payable, usually to a Arms length prices have to be negotiated tax haven. in MNCs since by definition they do not operate at arms length when selling on an Summary for the Extractive Industries intra-group basis and MNCs can exploit this in a number of ways to ensure that Given the range of options available to profit is extracted from its host country them, MNCs have considerable operation and moved to another territory opportunity to plan their taxes. The range where it might be more favourably of opportunities available for tax planning treated. are so large that most MNCs are able to engage in tax avoidance, which a. The MNC might seek to negotiate that necessarily means the assumption of risk ‘arms length prices’ do not apply to of getting such arrangements wrong. If its sales from the host country. This is they are undertaken without full not uncommon. disclosure of the nature of the b. If arms length pricing is required the transactions being made to all the parties group might supply only limited, or no involved they face the risk of being information to prove that this is considered tax evasion, at which point actually the case. these activities can be considered illegal. c. If arms length pricing is to take place It is often the case that the divide the MNC will seek to ensure that there between tax avoidance and evasion is one is no market comparison for its of judgement. product e.g. it will be argued that the ore or oil extracted is significantly To minimise this risk for their different from that available shareholders and to ensure that the MNC elsewhere and as such negotiated settles its obligations as a corporate prices have to be used. citizen in the states in which it really d. Sales will be made from the host undertakes its activities it is country to a group marketing recommended that any MNC undertake as company, typically located in a tax few of the noted practices as possible. haven. The group marketing operation will claim a margin for the ‘services’ Note: The research included in this it supplies, thus reducing the price chapter was sponsored by Christian Aid to available in the host country. whom thanks are extended for the e. Ensure that processing of the ore or opportunity to reproduce it here. oil takes place outside the host country. This means that value is added elsewhere, thus suppressing the price paid to the host country. It also allows valuable side products (e.g. silver contained in copper ore) to be

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Chapter 5

How individuals reduce their tax bills

Numerous opportunities present contracts and products, many of themselves for individuals to reduce their which will be luxuries; tax bills. As with corporations, individuals 7. Gift taxes; can choose to manage their affairs in one of three ways: 8. Environmental taxes; 9. Taxes from countries other than their 1. Tax evasion; own. 2. Tax compliance, and 3. Tax avoidance. Given this wide range of taxes, and because the actions an individual takes to

avoid one tax often have impact on the Each term has the same meaning for amount of another tax they pay, this area individuals as it does for corporations. Tax is especially complex and the variety of compliance is the process that tax mechanisms used are enormous and vary authorities promote and which represents from country to country. The following the behaviour of a responsible citizen. generalisations are possible, however: Tax evasion is illegal neglect of the responsibilities imposed by tax law. Tax 1. Poor people don’t plan their tax avoidance lies between the two, so whilst bills. There are three good reasons: likely to be legal it involves abuse of normal understanding of taxation law. · They don’t have tax bills;

Tax planning · They cannot afford to pay the costs associated with tax planning; Tax planning happens when a person seeks · Tax planning usually requires the to manage their tax liabilities. The ways person undertaking it to have income in which an individual might do this can in excess of their current needs: by cover a wide range of taxes e.g.: definition this excludes most people

from the activity. 1. Income taxes;

2. Social security contributions; 2. The wealthiest in society have 3. Value added tax (VAT) or Goods and greatest opportunity to plan their tax services taxes (GST); liabilities. This is because:

4. Capital gains taxes; · Tax planners charge highly for their 5. Wealth or inheritance taxes; services, which means that only the 6. Duties and other charges e.g. on wealthiest can afford their fees. The imports, trading or particular result is that, inevitably, the

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opportunity to ‘minimise’ tax in self employment and this provides liabilities in this way is restricted to many more opportunities for limited groups in society. This almost determining what is to be considered certainly explains why in the UK, for income, and what expenses might be example, the effective overall tax allowed. This means they can usually rate of the top decile of income plan taxation liabilities due on the earners in 2001-02 was 33.6 per cent, whole of their income, whether which was the lowest rate bar that for resulting from their own efforts or the third decile (32.7 per cent) and from investment sources. As such, at substantially below that for the least some of the opportunities for bottom decile (53.3 per cent).122 planning already noted for corporations may also be available to · Tax planning almost always requires the self employed. Since many such the person undertaking it to have cash opportunities have an international or other resources which they do not dimension and most self employed need to use immediately. By people work only in the country in definition this means that the person which they both reside and work, this has wealth in excess of current needs, limits the possibilities for legitimate which is not the case for the vast use of those arrangements. majority of the world’s population;

· The wealthiest members of society 4. Those with international links are the most mobile. Tax planning often have greatest opportunity to plan sometimes requires this; their tax affairs. The reasons are: · If a person is resident in more than · Capital is transient in its location, and one country it provides them with easy to relocate. People find it much some opportunity to choose under harder to move. Capital is owned by which countries rules they will be the wealthiest members of society. taxed;

· If a person has family in more than 3. The self employed have more one country it might provide opportunities for tax planning than opportunity to divert income to lower those who are employed. The reasons tax territories; are: · In a majority of countries in the world · As soon as more than one country is the income of employed people is involved in any tax situation it subject to tax at source i.e. before becomes harder to obtain information the tax payer receives payment. This to determine whether abuse is taking means that the scope for tax planning place, or not; is considerably reduced and any · Those who have employments in more planning is undertaken with regard to than one country can split their investment income or in the claiming income to ensure that part at least is of expenses, of which there tend to subject to lower rates of tax. This is be fewer allowed for employed people commonplace amongst internationally than the self employed; mobile people such as many business · In contrast, self employed people executives; usually pay their tax after calculating the profits arising from their activities · The opportunity to flee is the ultimate way to avoid tax, especially 122 Hills, J Inequality and the State as countries rarely cooperate Oxford, 2004, page 168.

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effectively in collecting tax debts due cent of anticipated tax revenues in the to each other. USA126.

Data on this loss in developing countries is

not available. It is believed that the Ways to save tax proportionate losses are likely to be

higher. For example, The Swazi Observer Against this background, the ways in reported on 16 January 2007 that the which individuals can save tax include estimated tax gap (i.e. the difference (but are by no means limited to) the between anticipated and actual tax following examples, which are generic and revenues) in that country was 41 per ignore the numerous opportunities each cent127. Much of this was, however, tax system offers for specific tax alleged to be because of fraudulent planning: practice by tax officials.

1. Failing to declare income. Whatever the cause, it is likely that tax

evasion is the biggest single cause of This action is tax evasion and is, of revenue loss to tax authorities, and course, illegal, but the practice is almost certainly exceeds the impact of widespread. Recent studies in Sweden, tax avoidance by some way. Measures to which is one of the countries considered tackle tax evasion are, therefore a matter most tax compliant, suggest that on of very high priority for any tax regime average self employed people in that wishing to improve its efficiency of tax country under-declare their income by 30 collection. per cent123. A study in the UK has suggested a higher rate of non- 2. Moving income out of tax. declaration, with the true income for blue collar self-employed people being more The practice will usually be akin to tax than 100 percent greater than reported evasion, but may also on occasion be tax income, whereas true income for white- avoidance. The following practices are collar self-employed people exceeds common: reported income by 64 percent. This was based on 1992 data124. In the USA the 'tax · Moving mobile capital offshore. The gap' is suggested to be at least US$300 result of this practice is that income billion a year125, although the split of this arising from capital is not declared by between evasion and avoidance is not the taxpayer to the tax authority to known. This sum amounts to about 15 per whom they have to report their income. In addition, the offshore 123 Engström, P and Holmlund, B (2006); Tax Evasion and Self-Employment in a High-Tax territory is chosen to ensure that it Country: Evidence from Sweden; Upsalla has no duty to provide information University Department of Economics Working with regard to income earned to the Paper 2006:12 downloaded from tax authority in the country in which http://www.nek.uu.se/Pdf/wp2006_12.pdf 22-1-07 the taxpayer is based.

124 Lyssiotou, P, P Pashardes and T Stengos (2004), Estimates of the Black Economy Based on Consumer Demand Approaches, Economic 126 http://www.irs.gov/pub/irs- Journal 114, 622-640. utl/tax_gap_facts-figures.pdf accessed 22-1-07 125 127 http://www.irs.gov/newsroom/article/0,,id=1 http://www.observer.org.sz/main.asp?id=3149 37247,00.html accessed 22-1-07 9&Section=main accessed 22-1-07

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This practice is likely to be illegal for individuals to evade their tax most taxpayers who undertake it. obligations by creating sham Nonetheless it is the basis of much of arrangements which have the the offshore banking industry. appearance of being trusts. Such Individuals who operate in this way arrangements give the appearance frequently gain access to their money that the individual has foregone an by using of an offshore debit or credit interest in the arrangement, though in card. That card is used by the reality effective control is retained of taxpayer in the country in which they the assets in question. For example, live but is settled from a bank account the British Channel Island of Jersey located in the offshore territory in passed new trust laws in 2006 which the taxpayer is holding their designed to facilitate the provision of funds to evade tax. The debit or such arrangements by local financial credit card need not be held in the services providers. These are name of the person actually using it. discussed in more depth in an Barclays Bank plc was subject to an appendix 5 to this report. The use of order to disclose details of many of these arrangements, whilst entirely the offshore credit cards that it ran legal in Jersey (and other territories for UK resident people in 2006. This where they are commonplace) is likely was in part because a sample survey to constitute tax evasion in the showed that only 19 per cent of country of residence of the taxpayer Barclay’s customers with UK addresses making use of them. and cards linked to international accounts made tax returns in the · The income due to a person is UK128. The UK’s HM Revenue & attributed to someone else. For Customs expected to recover at least example, income of a parent is £1.5 billion (US$2.85 billion) as a attributed to a child who might enjoy result of this single enquiry129. their own tax free allowance, or the income of one spouse may be · Disguising the source of income. The attributed to a non-earning spouse so process of moving income offshore that they might use tax rates and may be assisted by moving the income allowances that might otherwise go of the individual into either an unused. These arrangements are offshore trust or company. Very often commonly used for investment an is used, but that income, where they can be hard to is in turn owned by an offshore trust. challenge on occasion, and as To be even vaguely legal such an commonly by the self employed where arrangement usually requires the significant anti-avoidance measures person creating the trust to entirely are needed to tackle artificial forego any interest in the income arrangements of this nature. arising from it. In practice the offshore finance industry deliberately · Income subject to one tax is re- ignores this requirement and assists categorised as having a different form which is subject to a different 128 tax, or to no tax at all. For example, http://money.scotsman.com/scotsman/article income that should be subject to s/articledisplay.jsp?article_id=3014506§io income tax is re-categorised so that it n=Tax&prependForce=SM_XML_ accessed 22-1- 07 is subject to capital gains taxes, which are usually charged at lower 129 ibid rates. Many offshore financial

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services companies provide products options so that their value can be to facilitate this objective130. maximised133. It is estimated that 160134 major US companies are being Alternatively, income that is derived investigated for abusing the use of from labour is re-categorised through stock options and that one in ten US the use of privately owned limited company executives may have been companies as investment income by involved in the practice135. Even when way of payment of dividends to used legally these schemes have too owners instead of the payment of often been subject to generous wages to the same people for taxation treatment for both the providing their labour. As a result company making payment of them social security charges are either and the recipient, including on avoided or evaded131. occasion the avoidance of social security obligations on what is · The provision of benefits in kind. otherwise quite clearly labour This arrangement provides rewards income. other than cash to employees who are charged to tax at less than the value · Payment through esoteric mediums. of the benefit provided as a result. Some quite incredible payment Commonly provided benefits include arrangements have been used to avoid company cars and insurance of various tax and social security contributions, kinds, as well as pensions. It is highly particularly on the earnings of highly likely that this practice falls firmly in paid executives. This practice has the area of tax avoidance. required massive anti-avoidance taxation provisions136. · Payment by way of share options. Use of share options to reward 3. Claiming expenses and allowances management and staff (with a for which tax relief is not available. particular emphasis in practice on management) has been commonplace Even if all income is declared it remains during the period when maximising possible that a person may seek to reduce ‘shareholder value’ has been their tax liability by claiming tax emphasised as the objective of deductions to which they are not entitled. management132. It is, unfortunately Examples might include: clear that the availability of such schemes in taxation law has not · Claiming that expenses have been prevented abuse, which has most incurred for business purposes when often happened by backdating share- 133 For an explanation see http://www.macworld.com/news/2007/01/17 130 See, for example, an explanation at /backdating/index.php?lsrc=mwtoprss http://www.moneyextra.com/dictionary/rollu accessed 22-1-07 p-funds-moneyextra-003659.html accessed 22- 1-07 134 http://news.independent.co.uk/business/new 131 For an explanation see, for example, s/article2112605.ece accessed 22-1-07 http://www.hmrc.gov.uk/ir35/ accessed 22-1- 07. 135 http://business.timesonline.co.uk/article/0,,1 132 For a brief explanation of shareholder 3129-2209355,00.html accessed 22-1-07 value see http://en.wikipedia.org/wiki/Shareholder_val 136 See, for example, ue#Shareholder_Value_Maximization accessed http://observer.guardian.co.uk/business/story 22-1-07 /0,,1984272,00.html accessed 22-1-07

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in reality they were not. This form of contractual construction of financial tax evasion is rife and forms the basis arrangements. This is common, for of more tax enquiries by tax example, in countries that use British administrators around the world than law as the basis for their taxation probably any other issue, even though arrangements. the absence of reported income probably gives rise to significantly The challenge posed by such more taxation loss. The normal arrangements is relatively practice is for private expenditure to straightforward to explain. A be disguised as having been incurred transaction is designed that complies for business purposes. with the form of the legislation i.e. the strict letter of the law is complied · Making claims for allowances that with. The spirit of the law is, are not due. however, abused. In other words the substance of the transaction does not The variety of these abuses depends comply with its form. Such upon the tax system of the country in arrangements are, for example, which the taxpayer resides. In commonplace with regard to gift, general, the more tax reliefs that are inheritance or wealth taxes where it available and the more complex tax is claimed that a person has gifted an returns are, the more likely is abuse asset to another person but has, in of this sort. The only effective practice, retained the benefit of the counterbalance to such abuse is the asset gifted for their own use. Other threat of rigorous tax audit by mechanisms frequently involve the authorities who have a range of use of trusts to engineer transactions penalties, including the threat of which are favourable for tax though in adverse publicity. Claims might reality little or no economic loss is however include: suffered by the person making the claim for a tax deduction. · Allowances for children that do not exist; These schemes tend to be esoteric. · Claims to be married when that is They are often ‘packaged’ as though not true; they are products. It was this practice · Claims for gifts to charities that that KPMG was found to be pursuing in have not taken place; the USA by the Senate Investigations · Claims for pension contributions committee. In a report to the US 137 that have not been made; Senate in 2005 it was said that: · Deductions for costs such as those incurred for travelling or for The abusive tax shelters investigated education when such costs have by the Subcommittee were complex not been incurred. transactions used by corporations or individuals to obtain substantial tax 4. The use of artificial arrangements benefits in a manner never intended by the Federal tax code. While some This practice is common in some jurisdictions, especially if tax is 137 Report 109-54 to the 109th Congress charged in accordance with the strict (2005) ‘The Role Of Professional Firms In The U.S. Industry’ available at interpretation of the letter of the law http://levin.senate.gov/newsroom/supporting and in accordance with the /2005/psi.taxshelterreport.GPOversion.041305 .pdf accessed 22-1-07

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of these transactions may have complied with the literal language of specific tax provisions, they produced results that were unwarranted, unintended, or inconsistent with the overall structure or underlying policy of the Internal Revenue Code.

These transactions had no economic substance or business purpose other than to reduce taxes. Abusive tax shelters can be custom-designed for a single user or prepared as a generic tax product sold to multiple clients. The Subcommittee investigation focused on generic abusive tax shelters sold to multiple clients as opposed to a custom-tailored tax strategy sold to a single client.

It was also noted that138:

numerous respected members of the American business community were heavily involved in the development, marketing, and implementation of generic tax products whose principal objective was to reduce or eliminate a client’s U.S. tax liability.

In an earlier report to the US Senate it was noted that just four artificial schemes marketed by international accountants KPMG might have cost the US Treasury at least US$7.2 billion139. It is clear that the cost of such arrangements is high.

138 ibid, page 5 139 Report 108-34 to the 108th Congress (2003) ‘U.S. Tax Shelter Industry: The Role of Accountants, Lawyers, and Financial Professionals, page 3 available at http://www.senate.gov/~govt- aff/_files/sprt10834tax_shelters.pdf accessed 22-1-07

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Chapter 6

How governments don’t help themselves

Many corporations and individuals make it money...make it work harder for you. their objective to save tax, either legally With no income tax to pay on the or illegally. It would seem obvious to investments shown below, you get to presume that the governments of the keep all your returns. world would make it their objective to ensure that they could not do this. In This approach makes no sense when practice this often seems far from true. governments wish to promote the notion Both individually and collectively the that paying tax is a societal duty. In governments of the world could do much addition, it provides opportunity to those to enhance their chances of collecting the promoting offshore and other tax due to them. This section deals with opportunities to say they are only the problems that governments create to providing an alternative to government dealing with this problem. A late section promoted tax free savings schemes, suggests how they might be tackled. whether that is true or not.

The issues 2. The language of tax abuse needs to change. The following issues need to be addressed by most governments: Tax evasion is a crime, and yet it is rarely depicted as such. There are at least three 1. A consistent approach to taxation reasons for this. Firstly, it is not seen as needs to be adopted, and the idea being akin to money laundering, that paying tax is a ‘good thing’ embezzlement or fraud when financial needs to be promoted. crime is being considered. It is as if abusing the property rights of a Far too often governments are as guilty as government is not seen as having the their citizens in promoting the idea that same status as abusing the property rights tax is a ‘bad thing’. For example, the UK of individuals. This is not true. It is just as government’s National Savings & significant. Investment board (NS&I) promotes tax free saving on its website140 using the Secondly, corruption is currently defined following language: by most governments using the definition promoted by Transparency International, You can invest up to £93,000 tax-free which is141: with NS&I. You have worked hard for your

140 141 http://www.nsandi.com/savingneeds/taxfreei http://www.transparency.org/news_room/faq nvestments.jsp accessed 23-1-07 /corruption_faq#faqcorr1 accessed 23-1-07

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The misuse of entrusted power for example, the UK’s Department of Work private gain. and pensions website says142:

The problems with this definition are: There are NO IFS, NO BUTS when it comes to benefit fraud. Deliberately · It focuses upon abuse by public withholding information that affects your employees and politicians, since that claim is stealing. That’s why we are is presumed inherent in the term targeting benefit thieves! ‘entrusted power’; · It ignores the fiduciary duty of This is undoubtedly true, but the same company officials to their language is not used in taxation, where a shareholders and stakeholders when much greater degree of tolerance is they engage in tax abuse; shown. This does not help governments · It ignores individual abuse of the law tackle tax evasion or aggressive tax for private gain by way of tax avoidance because it permits those who avoidance; undertake such acts to believe that they · It focuses upon those who perpetrate are not treated seriously. the abuse, but ignores the actions of those who facilitate that process by 3. Transparency is not a clear part of providing the mechanisms that make the domestic agenda of many it possible e.g. by supplying offshore governments. companies which are often used in such activities. Tax evasion is a crime that takes place under a veil of secrecy. That veil of As a result insufficient attention to the secrecy can be provided by offshore issues of tax evasion as corruption and a structures, but need not be. Many disproportionate amount of attention is countries do not require the filing on given to issues of corruption within public record of the accounts of limited government. The latter is important, but companies. Most allow the use of nominee has to be seen in a broader context if directors, company secretaries or attention is to be given to dealing with shareholders who disguise the real the problem. ownership and management of companies. Not all require key management Thirdly, the language used with regard to documents such as the constitution of the abuse of the tax system is frequently very company to be filed. And almost none different to that used with regard to the require this information of trusts, though abuse of social security and other benefit these are customarily used to provide de systems. So, for example, the term ‘tax facto banking secrecy arrangements and evasion’ is little understood, and most lay to disguise the ownership of assets to people cannot differentiate it from ‘tax make the payment of tax less likely. avoidance’ and are unaware as to which is legal or illegal, or indeed if either is For example, in November 2006 the illegal. In contrast, the language used United States Government Accountability 143 with regard to the abuse of state benefits Office reported that: is unambiguous although the amounts abused are usually much lower. For

142 http://www.dwp.gov.uk/campaigns/benefit- thieves/ accessed 23-1-07

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· Ireland offers artificially low tax rates Most states do not require ownership to encourage the relocation of profits information at the time a company is to be taxed there; formed, and while most states require · Many developing countries offer tax corporations and limited liability holidays to companies undertaking companies (LLC) to file annual or biennial direct foreign investment in their reports, few states require ownership territory, which arrangements are information on these reports. With little different to the forward tax respect to the formation of LLCs, four agreements offered by many tax states require some information on havens; members, who are owners of the LLC. Some states require companies to list the · New Zealand offers trust and other names and addresses of directors, officers capital tax regimes to non-residents or managers on filings, but these persons that emulate many tax haven may not own the company. Nearly all schemes; states screen company filings for · Many countries offer banking secrecy, statutorily required information, but either by law, or by provision in the none verify the identities of company constitution, as is the case in Chile. officials.

By providing these opportunities There is little prospect of tackling tax domestically it becomes much harder to abuse effectively either domestically or ask for transparency from offshore internationally when this duality of territories. approach is adopted by many governments. Unsurprisingly many citizens 4. Many governments provide tax of the countries in question, and of other legislation that does, at least in part, countries, doubt the commitment of mimic tax haven behaviour. governments offering such schemes to tackling tax abuse. For example: 5. Failing to make the tax base broad · The UK’s domicile rules provide a enough. ‘ring fence’ for people not usually resident in the country meaning they Tax is collected as a percentage part of may avoid much domestic taxation an agreed transaction value. Two factors and taxation on all their income therefore determine the likely yield of arising elsewhere in the world; any tax. The first is the tax rate, the second the likely tax base – which is the · The Netherlands, Belgium and technical term for the range of Switzerland provide ‘conduit’ transactions it covers. If the tax base is arrangements that abuse double tax too narrow e.g. because income of certain treaties and allow dividends, royalties forms is excluded (or is subject to and other capital flows to move exemptions and holidays) or allowances through those states with little of not are too great then even if tax rates seem tax being charged, often when on reasonable the tax yield might be their way to a tax haven; negligible or non-existent. This does, for example seem to be a problem in Ghana 143 where the Extractive Industry http://www.gao.gov/new.items/d06376.pdf, page 1, accessed 23-1-07

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Transparency Initiative Aggregators reported144 in September 2006 that: Tax is complex. Complex tax legislation is inevitable as a result. However, all rules Corporate tax is currently fixed at 25 per provide opportunity for abuse and the cent of Net Profit. All the mining greater the number of rules the more companies under consideration are on self abuse there might be. Governments need assessment. to be aware of this and should be wary in using taxation law to: The revenue accruing to the Government from the payment of corporate taxes by · Micro-manage the economy e.g. by mining companies is very little. This offering detailed exemptions or situation arises as a consequence of i) allowances for relatively small scale accelerated depreciation and ii) the carry projects that then encourage abuse of forward of losses concessions granted to the law; mining companies operating in the · Create legislation without clarifying country. its intent so that Courts can be

specific in their interpretation of its Put simply, the definition of the taxation use; base for this tax means that almost no tax is paid. This is a technical issue which · Create conflicting claims or rules e.g. requires attention in Ghana, and many by providing that one transaction be other countries. taxed in different ways for different taxes, such as income tax and national Tax competition, as discussed in the insurance; earlier chapters of this report has had a · Provide incentive to adopt artificial significant impact in this area and has structures e.g. by granting seriously reduced the effectiveness of the corporations or trusts tax rates that taxation systems of many developing are substantially different form those countries. It has also resulted in paid by individuals on the same source degradation of the tax base of developed of income; countries in particular areas e.g. the UK’s shipping taxation laws based purely on · Unreasonably burden one form of tonnage operated bear little relationship income, such as that from to any charge on profit and are subject to employment, thus giving incentive to significant criticism for that reason145. those seeking to re-categorise income as something subject to lower tax 6. Governments create too much rates, such as investment income; complexity in tax legislation. · Provide gaps in the range of income subject to tax. For example, whilst 144 Ministry of Finance And Economic the yield from capital gains taxes are Planning (Ghana Extractive Industries often low one of their major benefits Transparency Initiative -Geiti) Inception is in ensuring that income is not re- Report On The Aggregation Of Payments And Receipts Of Mining Benefits In Ghana. categorised as a gain and so falls out September 2006. Prepared By: Boas & of tax altogether; Associates · Design inappropriate tax schemes e.g. 145 For a consideration by the UK a system of indirect taxes when many government of this obvious exercise in tax of the business in the economy in competition see http://www.hmrc.gov.uk/consult_new/pir_tt. question do not and could not keep pdf accessed 26-1-07 the required records for the

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administration of that tax, as has for If the person sought to be taxed comes example been found to be the case within the letter of the law he must be after the introduction of VAT in India, taxed, however great the hardship may of which it has been reported that: appear to the judicial mind to be. On the other hand, if the Crown, seeking to

recover the tax, cannot bring the subject VAT, to be successful, relies on within the letter of the law, the subject voluntary tax compliance. Since VAT is free, however apparently within the believes in self assessments, dealers spirit of the law the case might otherwise are required to maintain proper appear to be. In other words, if there be records, issue tax invoices, file admissible, in any statute what is called correct tax returns etc. The opposite an equitable construction, certainly such seems to be happening in India. a construction is not admissible in a Businesses are still run on traditional taxing statute. lines. Cash transactions are order of

the day. The unorganised sector It is difficult to see what justification dominates the market. The hope of there can still be for this legal higher tax compliance and lesser construction when it so obviously creates evasion is still a far cry in [the state injustice for all parties. Alternatives are of] Andhra Pradesh. This is reflected available. For example, an Australian law in the high percentage rate of return of 1901148 on legal interpretation said: defaulters (14 per cent), a high

percentage of credit returns (35 per In the interpretation of a provision of an cent) and a high percentage of nil Act, a construction that would promote returns (20 per cent). That is, roughly the purpose or object underlying the Act 70 per cent of VAT dealers are (whether that purpose or object is presently not paying any tax.146 expressly stated in the Act or not) shall

be preferred to a construction that would

not promote that purpose or object. 7. Governments fail to provide

instruction to Courts on how to It may be argued that to ensure that tax interpret tax legislation to prevent legislation is ‘fit for purpose’ there would tax abuse. be considerable benefit in adopting this

approach to the interpretation of taxation In many countries a literal or ‘legal’ law. If that were to be the case then interpretation of the law is used when many of the constraints on government deciding how taxation legislation is to be which are used by taxpayers to their interpreted by Courts. The alternative advantage might be removed. In common ‘equitable’ basis of interpretation is law this includes reliance on what is ignored, or is considered illegal. This called the Duke of Westminster principle, appears to have its origins in a decision of which might be summarised as: the English courts in 1869 in which it was said147: Every man is entitled if he can to order

his affairs so as that the tax attaching 146 under the appropriate Acts is less than it http://en.wikipedia.org/wiki/Value_added_ta x accessed 23-1-07 148 Section 15 AA of the Acts Interpretation 147 Partington v. Attorney-General (1869), Act, 1901 downloaded 4 December 2006 from L.R. 4 E. & I. App. 100, per Lord Cairns at p. http://www.austlii.edu.au/au/legis/cth/conso 122. l_act/aia1901230/s15aa.html 23-1-07

Closing the Floodgates www.taxjustice.net 68 otherwise would be. If he succeeds in · Failing to train staff. Tax staff need ordering them so as to secure this result, training in: then, however unappreciative the § Tax law; Commissioners of Inland Revenue or his § Accountancy; fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an § Commercial law and practice; increased tax.149 § Administration procedures;

This philosophy underpins the tax planning § IT; industry, and is the biggest single issue § Debt recovery; that must be tackled if the problem of raising the revenues needed for § International law. development are to be solved. Such training is expensive and runs that risk that trained officials will be poached 8. Governments are failing to by professional firms willing to pay higher adequately resource their taxation salaries.. The result is a skills shortage departments amongst tax officials the world over151.

This is a serious problem affecting There is also a resulting credibility issue. governments the world over, but appears If taxpayers believe that tax authorities more common in developing than will not detect what they are doing then developed countries. Issues include: there is little incentive to get such things right. · Failing to pay staff appropriately. This has two consequences: § They are easily poached by 9. Failing to establish ‘fit for purpose’ professional firms who then put administration systems the training they have to use for the benefit of the private sector PricewaterhouseCoopers recently who are seeking to minimise tax reported152 on issues relating to paying tax paid; around the world for the World Bank. § There is increased likelihood of There are various methodological corruption amongst tax officials. A problems in their work, but some recent report suggests that this observations do reflect what is happening sort of corruption is a major cause in the real world. For example, PWC of the tax gap (the difference reports that: between expected tax receipts and sums actually received) in Swaziland150.

151 Anecdotal support for this view has been provided to the author from places as far apart as Greece, the UK, Kenya and Chile. All agree that the pressure of commercial salaries is an 149 IRC v. Duke of Westminster (1936) 19 TC issue of concern with regard to retaining the 490, [1936] AC 1 quoted at best staff. http://en.wikipedia.org/wiki/Tax_evasion accessed 23-1-07 152 PricewaterhouseCoopers 2006 ‘Paying Taxes – the Global Picture’ available at 150 http://www.pwc.com/extweb/pwcpublication http://www.observer.org.sz/main.asp?id=3149 s.nsf/docid/6FE224AC0BA720BB85257214004DA 9&Section=main accessed 22-1-07 2E9/$file/paying_taxes.pdf accessed 24-1-07

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Firms in 90 per cent of surveyed countries communities on which they are charged. rank tax administration among the top This is a difficult subject, and one on five obstacles to doing business. In which it should be noted that evidence for several – including Bangladesh, Cambodia, the existence of favourable ‘Laffer the Kyrgyz Republic, Russia and curve154’ effects is almost non-existent155. Uzbekistan – working with the tax However, as Alex Cobham of Oxford bureaucracy is considered a bigger University has noted156: problem than tax rates Evidence-based analysis of the impact of The same report says: tax competition has been somewhat scarce, however. A newly-published paper In Cameroon the average annual tax from the Central Bank of the Netherlands return for businesses is 172 pages, in offers fresh insights into the ways in Ukraine, 92 and in the United States, 64. which increases in capital mobility have changed rates of corporate tax. Harry The world wide average is 35. It is clear Garretsen and Jolanda Peters157 analyse a from the surveys that this split, with sample of annual data on 19 high-income greatest complexity, number of payments OECD countries from 1981-2001, and required and overall tax rates to be found present three main findings. amongst developing and transitional economies, with smaller administration First, they confirm the reality of tax burdens in developed countries is a real competition: an increase of 1 per cent in one. But as the report noted: capital mobility is associated with a reduction in the corporate tax rate of In several Eastern European countries between one half and a third of one per simplification has not had the desired cent. impact on perceived business obstacles, in part because it focused on income tax only.

154 See This finding is consistent with the findings http://en.wikipedia.org/wiki/Laffer_curve of a report on flat taxes for the UK, which accessed 24-1-07 for an explanation of the suggested that they would, if anything . increase rather than reduce complexity in 155 Murphy, R 2006 ‘A for the UK? the tax system and could increase the The implications of simplification’ ACCA, London downloaded from opportunities for tax avoidance an http://www.accaglobal.com/pubs/publicinter evasion153. est/activities/research/publications/tech-ft- 001.pdf 24-1-07 10. Failing to set appropriate tax rates. 156 Cobham, A 2006 ‘Capital mobility and the effects of tax competition’ Tax Justice If excessive administration imposes a Focus, volume 2 number 4 available from http://www.taxjustice.net/cms/upload/pdf/T burden on business, so do tax rates that JF_2-4_on-screen.pdf accessed 24-1-07 are out of line with the expectation of the 157 Garretsen, H and Peters, J., 2006, 'Capital mobility, agglomeration and corporate tax rates: Is the 153 Murphy, R, 2006 ‘A flat tax for the UK? for real?', Netherlands Central The implications of simplification’ ACCA, Bank, Research Department DNB Working London downloaded from Papers 113 available from http://www.accaglobal.com/pubs/publicinter http://www.dnb.nl/dnb/home/file/Working est/activities/research/publications/tech-ft- per cent20Paper per cent20113-2006_tcm13- 001.pdf 24-1-07 85963.pdf accessed 24-1-07

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Their second result is that the behaviour if intermediaries did not exist? We have of neighbouring countries is important – not yet found any country where the where neighbours maintain higher rates, answer to that question is yes. Across the the pressure to cut rates is lower. Tax whole range of taxpayers, taxes and competition may be a global circumstances, tax intermediaries help phenomenon, but it is additionally their clients to avoid errors and deter effective at the local level. them from engaging in unlawful actions. So tax intermediaries are not part of the The third result is that agglomeration problem, they are part of the solution. effects matter. Larger – and hence more The study must therefore reflect the powerful – economies like the UK and positive role tax intermediaries play in Germany are better able to resist the tax administration and aim to identify pressures of tax competition. strategies for strengthening the relationship between tax intermediaries It is clear that some countries ignore this and revenue bodies. evidence. The result is that they set rates of tax that are out of line with near This issue is a challenge for all tax neighbours and as such lose revenues authorities, particularly in developing because of capital flight and tax evasion. countries where there might be fewer professional people: indeed there may not As Cobham concludes: be enough to ensure that the benefits of the existence of such a grouping can be more aggressive anti-avoidance measures obtained. It is also difficult when those and the removal of exemptions have in tax intermediaries work mainly for a some cases allowed revenues to be limited range of large clients from whom maintained (in the short-term at least). they therefore have problems of being independent. Tax authorities have to work 11. Failing to deal appropriately with closely with professional bodies and local professional people. individual tax intermediaries to overcome these problems. As Chris Davidson, Deputy Director, Business Customer Unit, HM Revenue & Customs in the UK has noted, the role of 12. Failing to engage in information tax intermediaries is vital in tax exchange, or to assist tax collection. management. He is heading the review of the work of tax intermediaries being The process of information exchange with undertaken on behalf of the OECD in other governments is time consuming. In progress during 2007158. He has said of the addition, the process of assisting another initial findings from that work159: government to collect taxation revenues due to it through the local debt and tax The importance of the role tax collection processes of another state intermediaries play in a tax system can be takes time and effort, without the tested by answering a simple question: rewards being apparent. would compliance with tax laws improve

158 See All of these issues need to be recognised http://www.oecd.org/dataoecd/38/29/374155 and acted upon if governments are to 72.pdf for details, accessed 24-1-07 seriously address the issue of stemming 159 Davidson, C, 2007, Tax Journal, 22 the flood of capital flight and tax evasion. January 2007 page 13

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Chapter 7

The role of tax intermediaries

As has been noted in the previous It must also be acknowledged that many chapter, a positive role for tax do not play that positive role. For intermediaries is vital if an effective tax example, following the budget in the UK administration is to be established. in March 2005 a spokesperson for Moore Problems exist in achieving this Stephens, an international firm of objective. accountants said to a national newspaper: The OECD think there are four categories of tax intermediary160: No matter what legislation is in place, the accountants and lawyers will find a way around it. Rules are rules, but rules · law firms; are meant to be broken. 161 · accounting firms; His firm subsequently issued a statement · other tax advisers; and suggesting that the spokesperson: · financial institutions such as banks, insurance companies and other Strongly rebuts any suggestion that he providers of tax advice or tax driven would ever countenance breaking the investments and products. law, and it was never his intention to suggest that others should do so.

In addition, any consideration of this In two sentences, however, the issue has to encompass the role of spokesperson had encapsulated what representative organisations such as many professional people seek to do, and professional institutes, trade associations see as their role. It is this part of the tax and so on. intermediaries market that creates

problems for any tax administration and It must be stressed that many of these does, in the process, encourage both organisations play a positive role in tax capital flight and tax evasion. Some of administration by helping taxpayers to the methods used to do this are explored avoid errors and to comply with the below. requirements imposed upon them by law.

Without this positive contribution by 1. Aggressive tax planning. some tax intermediaries tax revenue losses might well be greater than they are.

161 The Guardian, 18 March 2005, 160 Davidson, C, 2007, Tax Journal, 22 http://www.guardian.co.uk/business/story/0, January 2007 page 13 3604,1171759,00.html

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Accountants frequently say that tax The difference between tax avoidance planning falls into one of two categories. and tax evasion is the thickness of a The first is tax evasion, which is illegal. prison wall. The second is tax avoidance, which is legal. They say the distinction is clear, It is actually more complicated than any and unambiguous and so long as they are of the views represented. The law is, in tax avoiding and not evading then any country constructed of words and anything they do is legal. The precedents words are always open to different for this vary from tax jurisdiction to interpretations, both at a point in time jurisdiction, but many countries in the and over time (with there being no world (and a majority of the significant requirement that the law as applied take tax havens) use English law as the basis account of the use of words at the time it for much of their tax decision making. was created). It is this uncertainty which The Duke of Westminster case noted in tax avoidance (sometimes called the previous chapter provided one legal ‘aggressive’ tax avoidance165 to basis for this view. Another is that of Lord differentiate it from the legal activity Clyde who said in 1929 in the House of which the TJN calls tax compliance) seeks Lords162 that: to exploit.

No man in this country is under the The TJN seeks to differentiate the two smallest obligation, moral or other, so to activities by using the terms as verbs, and arrange his legal relations to his business not as nouns. This is possible if the terms or to his property as to enable the Inland describe approaches to the management Revenue to put the largest possible of taxation, and not the specific shovel into his stores. transactions that result from that activity. In other words, the test of It should be noted that not everyone acceptability of a transaction is primarily agrees. Lord Templeman also said in the an ex ante rather than ex post test. This House of Lords163 in 1993 that: contrasts with almost universal current legal practice where investigation is ex In common with my predecessors I regard post i.e. outcomes are all that matter. tax avoidance schemes of the kind invented and implemented in the present Using this understanding: case as no better than attempts to cheat the Revenue. · Persons who evade tax seeks to limit their liability to pay tax by what they Perhaps it is not surprising in know to be criminal means; consequence that Denis Healey, a former Chancellor of the Exchequer in the UK · Persons who avoid tax seeks to said164: minimise their liability to tax by any means believed possible, even if it is apparent that the law of one or more 162 Ayrshire Pullman Motor Services and Ritchie v. IRC (1929) 14 TC 754 163 IRC v. Fitzwilliam (1993) 67 TC at 756 (UK) 165 See for example comments attributed to Dave Hartnett at HM Revenue & Customs in 164 Quoted at the UK at http://en.wikipedia.org/wiki/Tax_evasion http://www.accountancyage.com/accountanc accessed 24-1-07. The original date of this yage/analysis/2144683/taxman-gets-tough comment has never been determined. accessed 24-1-07

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states may be abused in the process, they do not they might be liable for tax but without criminal liability arising; they have not saved their clients167.

· Persons who are tax compliant seek It is notable that in an unpublished to settle their tax liability (but no review of the Codes of Ethics of more than that sum) in the location professional institutes governing tax where it can be best determined to intermediaries the TJN was unable to find be due, at the time when it is likely any that condemned tax avoidance or that a legislature wished it to be paid aggressive tax avoidance. and only after claiming those deductions and reliefs which it is 2. The sale of ‘tax products’. clear were meant to be provided given the economic substance of the Tax products are a particular form of tax transactions undertaken by the planning, where an opportunity for tax taxpayer. abuse is identified and then sold by a tax adviser. The most notable case is that of Using this definition it is also apparent the sale of tax products by KPMG referred that the person avoiding tax is seeking to to in Chapter 3 of this report. Other firms avoid the obligations imposed by law, were also found to be heavily involved in even if that law is not broken as a result. such activities. The report of the US This makes the meaning of the term more senate committee looking at these issues accessible. said (page 9) 168:

Most accountants reject this view. A The investigation found that numerous general opinion might be that of David respected members of the American Clegg, a tax partner in Ernst & Young, business community had been heavily South Africa who said in 2006166 on behalf involved in the development, marketing, of his firm that: and implementation of generic tax products whose objective was not to It is my view that morality has no place achieve a specific business or economic in the application of tax law since purpose, but to reduce or eliminate a morality is largely subjective. Where it client’s U.S. tax liability. has a place, is in the writing of tax law in such a way that it is both clear and By 2003, dubious tax shelter sales were equitable, within the context of its tax no longer the province of shady, fly-by- raising purpose. night companies with limited resources.

This explains why accountants and other 167 For a discussion of this duty by the head tax intermediaries will use any loophole of tax at PricewaterhouseCoopers UK see available to reduce tax whatever the http://www.pwc.com/uk/eng/ins- sol/publ/tax/Rcollier-keywood.pdf accessed ethical constraint others might think 24-1-07 and especially the discussion of applicable, and indeed are pressurised to Slattery v Moore Stephens [2003] STC 1379 do so by their insurers for fear that if where a firm of accountants was found liable for not advising a client to use an offshore tax arrangement. 168 Report 109-54 to the 109th Congress (2005) ‘The Role Of Professional Firms In The 166 U.S. Tax Shelter Industry’ available at http://www.ey.com/global/content.nsf/Sout http://levin.senate.gov/newsroom/supporting h_Africa/20_Jun_06_The_morality_of_taxatio /2005/psi.taxshelterreport.GPOversion.04130 n accessed 24-107 5.pdf accessed 22-1-07

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They had become big business, assigned taxpayer from such non-disclosure. to talented professionals at the top of The legal enquiry has made their their fields and able to draw upon the actions appear legal, even if vast resources and reputations of the subsequently transpires on enquiry or country’s largest accounting firms, law in Court that this is not true. As such firms, investment advisory firms, and the most risk that they face is banks. payment of the tax found to be due and interest upon it. This practice is Some tax authorities, such as those in the commonplace amongst MNCs and is USA and UK have responded to these considered a small price to pay for arrangements by requiring the the tax advantages won. This practice registration of tax planning schemes169. explain why research has found that This has made them aware sooner of many MNCs restate their tax what is happening, and so allowed them liabilities downwards in years to prevent the use of abusive tax subsequent to those when estimates planning schemes. However, as the UK of the liability were first made171. has found, some tax advisers refuse to · If legal advice on the tax planning cooperate with such arrangements even if scheme used has not been taken in required to do so by law170. advance, or claim is simply made for expenses of dubious validity to the 3. Non-disclosure by professional business then the risk arising on firms. enquiry increases. Penalties are usually due for the non-payment of All tax authorities have limited resources tax on a return shown to be wrong in to investigate the tax returns submitted this case. However, these penalties to them. Some tax intermediaries exploit are considered the gamble that non- this by submitting tax returns in which disclosure justifies. they do not draw attention to areas of doubt in the returns they have made. As a Although full disclosure is claimed to be result they gamble on the tax authority in the approach used by many professional question not investigating the return they firms anecdotal evidence supplied to the have made. The risk they impose on their author suggests that even when this is the client varies depending upon the action declared policy of a firm it is rare that they have taken prior to submitting the this is true until enquiry arises. Few make return: disclosure in the first instance on the basis of ‘all cards being face up on the · If the client in question has taken table’172. legal advice on the plausibility of the tax planning that is inherent in the return being legal prior to submission 4. Creating artificial structures in taking place then it is commonplace which taxpayers save tax. for there to be almost no risk to the 171 See http://www.taxjustice.net/cms/upload/pdf/ 169 See for example Mind_the_Tax_Gap_-_final_-_15_Jan_2006.pdf http://www.hmrc.gov.uk/ria/disclosure- accessed 24-1-07 page 25 guidance.pdf accessed 24-1-07 172 For discussion of this concept see 170 See http://www.taxresearch.org.uk/Blog/2006/08 http://www.accountancyage.com/accountanc /01/ethics-test-for-tax-planning/. A similar yage/analysis/2172908/hmrc-beefing- logic is explored in Davidson, C, 2007, Tax disclosure-changes accessed 24-1-07 Journal, London 22 January 2007

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exploit. Transactions placed in such It appears commonplace for tax structures might include the intermediaries to create structures which following, all of which are explained mean that tax payers do not pay tax. As in more detail in chapter 2: Senator Carl Levin has said173 of this · Transfer pricing, where multiple activity: stages are added to what might otherwise be a straightforward Most are so complex that they are MEGOs exchange; – meaning “My Eyes Glaze Over.” Those · Thin capitalisation where the who cook up these concoctions count on benefits of loan finance are their complexity to escape scrutiny and shifted into low tax territories, public ire. with tax relief on interest paid

being taken in relatively high tax As Senator Levin also made clear174: territories;

Tax shelters are complex transactions · Licensing arrangements where with no economic substance other than intellectual property is relocated to provide individuals and corporations to low tax territories (where it is with large tax benefits unintended by the highly unlikely to have been tax code. created) with tax accumulating in that low tax territory as a To explain this it is important to note result175, 176; that most of these arrangements fall into · Tax arbitrage and structured one of two groups: finance177; a. The structure is created within a · Double dipping; group of companies. That means that whilst a series of complex transactions might take place, quite possibly spread over several 175 Research suggests that up to 97 per cent jurisdictions, the reality is that no of the retained profits of computer maker Apple might be located in Ireland for this property or cash really changed reason. See ownership since all the companies http://www.taxresearch.org.uk/Blog/2006/07 involved were under common /17/apple-does-a-microsoft-and-goes-for- ownership. These arrangements are secrecy-in-ireland/ accessed 24-1-07 also very hard to spot. Group 176 Another example of ‘creative’ licensing accounts presented as the corporate was to be found in the case of KPMG’s structuring of a licencing arrangement within reports of major multi-national the WorldCom group (before its bankruptcy) entities exclude all intra-group under which no less than US$20 billion was transactions from the report for the paid form high tax to low tax states for the precise reason that they do not add benefit of group companies in high tax states having access to ‘management foresight’. See value by way of involving third party http://www.fenews.com/fen37/law_and_fe/l exchange. These arrangements are, aw_and_fe.html accessed 24-1-07 for more however, those that MNCs seek to information. 177 For discussion of one such deal involving 173 US and UK banks see http://www.senate.gov/~levin/issues/index4. http://www.taxjustice.net/cms/upload/pdf/ WSJ_Border_Crossing_-_Glenn_Simpson_- cfm?MainIssue=BudgetTaxesandtheEconomy&S ubIssue=AbusiveTaxShelters accessed 24-1-07. _30_JUN_2006.pdf . The author of this chapter participated in the research of that 174 ibid article for the Wall Street Journal.

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· Creation of ‘orphan companies’ · Splitting employment contracts. to hide the liabilities of a This arrangement is common in company off its balance sheet, an countries with unusual residence arrangement which usually rules, such as the UK, where involves potential abuse of offshore income is not taxed if charitable principles. not remitted to the country of residence if the recipient is not a

long term or habitual resident of b. The structure is created for a private the country in which they live. In company or for an individual. In this that case if they work case the arrangement is very likely to internationally part of their salary involve an offshore structure. Options is paid offshore for their include: ‘overseas’ work and only part is · Setting up offshore trusts; subject to tax in the country of · Setting up offshore companies to residence. This arrangement has, assist the taxpayer to hide their for example, been very popular identity or the source of their with bankers in the City of income, or to avoid obligations London, where bonuses were e.g. those arising under the EU expected to reach £19 billion in Savings Tax Directive which apply 2006182. It is likely that at least to individuals but not to part of these were paid offshore companies178; to avoid tax. · Arranging for the ‘re-invoicing’ of international transactions179; 5. Supporting the credibility of the offshore world. · Creating an offshore pension

arrangement180; There is little doubt that the largest firms · Providing offshore debit or credit of accountants and lawyers working in card payment facilities so that the offshore world do their best to steer the remission of offshore funds to clear of illegal practices. It is equally a persons country of residence clear that some less reputable firms cannot be traced181; promote the sale of services which whilst themselves legal do assist those who wish to evade tax, launder money or undertake criminal activities related to 178 For a competent explanation see drugs, slavery and other wholly abusive http://en.wikipedia.org/wiki/European_Union _withholding_tax accessed 25-1-07 activities. It is not by chance that almost any story of international crime or 179 For an example of a company that clams to offer ‘re-invoicing’ services (which are a corruption has an offshore element to it. blatant form of transfer pricing abuse) see http://www.offshoreinc.net/reinvoicing.html The presence in tax havens of accessed 24-1-07 international banks and accountants 180 An example of such an arrangement serves to legitimise the offshore world. As which does, however, have few of the characteristics many would think should be found in a pension arrangement can be found http://www.ptclub.com/offshorecreditcard.h at tml accessed 25-1-07 http://www.closepb.com/Trust/pension/inde x.htm accessed 25-1-07 182 http://www.guardian.co.uk/executivepay/sto 181 A candid description of the uses to which ry/0,,1851785,00.html accessed 25-1-07 such cards can be put can be found at

Closing the Floodgates www.taxjustice.net 77 appendix 3 shows, these firms operate quite extensively in the offshore and tax · Deloittes admitting to a presence in haven space. 29 havens whilst apparently working in 33 according to search havens. Appendix 3 was work undertaken specifically for the purposes of this All testing was done in the week ending report. The TJN identified 72 tax havens 26 January 2007. in its 2005 publication tax us if you can. It may be possible to now delete both Perhaps unsurprisingly all the firms were Nauru and Niue from that list183. Brunei present in all the major havens. What and Ras al Kaimah on the other hand was not anticipated was the surprising might be added184. The list is, however, reluctance of three of these firms to for practical purposes complete. acknowledge their operations in the mid range, and especially the minor havens. Unsurprisingly the largest firms of PWC in particular appear not to accountants all operate in the major acknowledge their activities in all the financial centres that provide as many minor havens in which they seem to have opportunities for tax leakage as do the a presence on their web site. major havens, which is why they are on the list. What is more interesting is their In January 2007 Loughlin Hickey, concentration in those centres more worldwide head of tax at KPMG said185: readily recognised as havens, of which there are 63 in all, but of which 18 are I want to highlight signs that tax and considered insignificant because of their corporate governance is an emerging limited impact. This leaves 45 active issue, it is a global issue, and it is likely havens. to set new standards for transparency in tax across the whole world. KPMG’s website says they work in 38 of these havens. An alternative test, In practice, however, the largest firms of undertaken using the Google search accountants in the world operate in engine found their presence in 41 of locations where opaqueness and not them. Similar searches for the other big transparency is the hallmark of trade, four firms found: taxation and regulation. Until the leading firms change their attitude towards · PricewaterhouseCoopers (PWC) working in these locations, or are seen to admitting to their presence in 25 be publicly demanding changes in the havens but appearing to have a standards of transparency which operate presence in 38; in the offshore world, the new standards of transparency outlined by Loughlin · Ernest & Young admitting to a Hickey will not happen. presence in 38 havens, but with only 37 of these being capable of 6. Supporting tax competition. confirmation by search engine testing; Tax competition is not a naturally occurring phenomenon. It has been 183 Jason Sharman in ‘The Future of promoted by those who benefit from it. Offshore’ 2007 (forthcoming) suggests both have ceased to operate as havens. 185 184 Ibid, and Tax Justice Focus, Volume 2, http://www.kpmg.co.uk/news/detail.cfm?pr= no.3 2788 accessed 26-1-07

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Most especially it has been promoted by Chowdhury, head of tax at the accountants acting in what they perceive Association of Chartered Certified to be their own interests and those of Accountants, which has members their clients. throughout the world, has made presentations which unambiguously The large firms of accountants have been highlight the cases of Ireland and major exponents of tax competition. Singapore as locations that bring benefits Take, for example, the following extract from low taxes186. from a press release issued by KPMG Canada in November 2006: 7. Failing to provide an appropriate New research covering 86 countries, lead. including Canada, has confirmed that low corporate tax rates can help to give a The difficulties which the largest firms country a significant competitive have encountered in keeping their own advantage over economic rivals, and are tax practices legal or ethically acceptable connected with higher than average are well documented187. The most economic growth. comprehensive review of this issue is to be found in The Role of Accountancy But the advantage tends to be short term Firms in Tax Avoidance: Some Evidence and has to be backed up with a good and Issues by Prem Sikka of the University legal and economic infrastructure and of Essex, UK and Mark P. Hampton, targeted incentives if countries are to University of Kent,UK. The reader is attract long term private sector recommended to read that paper for a investment. fuller insight into this issue188.

This conclusion comes from a study by What is clear is that the failure of the KPMG International, which analyses accounting firm Andersens only international movements in corporate highlighted a malaise which is tax rates for the past 14 years, drawing commonplace throughout the largest on the annual surveys the organization firms of accountants. Whilst there have has conducted since 1993. been substantial statements made about new management systems and The findings point to the economic compliance amongst these firms what is growth enjoyed over this period by also true is that their offshore activities countries like Ireland, Norway, Sweden, continue, and their revenues continue to and Denmark, and draws a parallel rise, not least for taxation services. In between this success and a favorable 2005/06 the top 50 firms of accountants corporate tax regime. The outstanding example has been Ireland. 186 See for example http://www.ceccar.ro/_b/ro/pp13.pdf The position is unambiguous: KPMG 187 See for example, ‘Race to the Bottom: support tax competition. The presence of The Case of the Accountancy Firms’ by Jim all these firms in the significant tax Cousins MP, Austin Mitchell MP and Professor Prem Sikka (University of Essex) available havens of the world is the clearest from evidence of that belief. http://visar.csustan.edu/aaba/RacetotheBott om.pdf accessed 26-1-07 The same sort of message comes out of 188 Available from the professional institutes of http://www.essex.ac.uk/AFM/research/worki accountants. For example, Chas Roy- ng_papers/WP05-03.pdf accessed 28-1-07

Closing the Floodgates www.taxjustice.net 79 in the UK saw their tax fees rise by more manipulate the law for advantage. I than 8.5 per cent to just short of £2 can’t understand that logic. billion (US$3.8 billion) whilst an estimate by the TJN - based on the published The point is well made. Firms earning the results of the Big 4 accountancy firms - level of fees indicated have a duty to suggests their combined total taxation show leadership in tax compliance and fees exceeds US$16 billion. even if their past misdemeanours are behind them, whilst these firms continue Nor have the problems gone away. On 26 to promote tax competition and the January 2007 it was reported that in a secrecy spaces that allow it to take place court hearing in Texas, USA: it is not clear that they are doing so.

KPMG admitted that through the actions of former partners and employees it prepared fraudulent tax returns for clients; drafted false statements to support the tax shelters; issued opinions that were false; concealed the tax shelters and the facts regarding them from the Internal Revenue Service; failed to locate and produce documents sought by the IRS, and misrepresented to the IRS KPMG’s role in creating the tax shelters.

What was significant was that the offences continued until 2002 i.e. well after the time that these issues were first noted. As Dennis Howlett, who runs what is probably the best read accounting blog, noted189:

It doesn’t matter which way KPMG attempts to spin this or divert attention away, the extent and number of admitted offences spells out one thing: systematic law breaking that continued after the original offences were committed.

I know there is a large majority of professionals who see tax avoidance as a business cost. But when set out in these stark terms, it is hard to understand how advisors can justify that position when they must know they’re attempting to

189 http://www.accmanpro.com/2007/01/27/kp mg-admits-96-tax-violations/ accessed 28-1- 07

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Chapter 8

The role of the tax havens

Where is the tax haven world190? What characterises a tax haven? There are more than seventy tax havens in the world. Those recognised by the TJN The OECD defined ‘harmful preferential in its publication tax us if you can191 are tax regimes’ (which might otherwise be used as the basis for Appendix 3 to this considered to be those undertaken by a report. To this list can be added Brunei, tax haven) as having the following key Ras al Khaimah, (and for the brave features193: Anjouan192). A number, shown as ‘notional havens’ might be deleted i) No or low effective tax rates because it is likely that very little activity ii) “Ring-Fencing” of Regimes takes place there even if they have tax haven characteristics. iii) Lack of transparency iv) Lack of effective exchange of It is important to note that the terms ‘tax information haven’ and ‘offshore’ are often used interchangeably, but it would be entirely mistaken to think that the places involved Other factors the OECD considers relevant are all small, palm-lined islands. Many are: are major financial centres, such as London and New York. What characterises v) An artificial definition of the tax base the offshore world of tax is not where it vi) Failure to adhere to international is, but what happens there. transfer pricing principles

vii) Foreign source income exempt from 190 The widely acknowledged best residence country tax introduction to the subject is ‘The Offshore viii) Negotiable tax rate or tax base World’, , Cornell University Press, 2003. A more descriptive approach is taken by ix) Existence of secrecy provisions William Brittain-Catlin in ‘Offshore: The Dark Side of the Global Economy’ Farrar Strauss and x) Access to a wide network of tax Giroux, 2005. Perhaps the most rigorous treaties review of the reaction of the tax havens to xi) Regimes which are promoted as tax attempts to regulate them is ‘Havens in a Storm’, J C Sharman, Cornell University Press, minimisation vehicles 2006. xii) The regime encourages purely tax- 191 Available from driven operations or arrangements http://www.taxjustice.net/cms/front_content.p hp?idcat=30 accessed 30-01-07

192 Sharman, J, ‘The Future of Offshore’ 2007 193 OECD, ‘Harmful Tax Competition – an (forthcoming) Emerging Global Issue’, OECD, Paris, 1998

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and EU member states. But, bilateral These are useful indicators. What they agreements have limited impact and mean in practice is: the scope of exchange allowed under these agreements is still decidedly 1. Secrecy. The primary product of the limited in many cases. tax haven is secrecy. This secrecy usually extends to: In addition, it is worth noting that a. Banking secrecy, or if that is not these exchange arrangements tend to available the ability to hide the be with the major economic powers ownership of a bank account in the world. As has been noted by behind trustees; the Chile195:

b. The ownership, management and In 2004 Chilean tax authorities constitutional details of contacted 34 jurisdictions [from the companies; OECD ‘blacklist’] requesting c. The accounts of companies in full cooperation with tax authorities on or in part; the same basis as the OECD. Of the d. All trust arrangements. 34 jurisdictions contacted, only ten bothered to respond and of these only five were willing to exchange 2. Use of nominees. The use of information. What is evident is that nominee arrangements is allowed to individual or isolated actions will not ensure that whatever information is reduce the problem. required to be filed on public record, and sometimes even with relevant The message is clear, only authorities, can be anonymised. The multilateral approaches to presence of professional or other information exchange can solve this people who are willing to accept issue and ensure that information is payment for the provision of nominee available to all those who require it, services is, of course, a necessary and most especially in developing requirement in this case, but one countries. where supply is rarely found to be lacking; 4. Low or no taxes. This is the one area where the ‘race to the bottom’ can 3. Limited or no information exchange truly be said be happening. Some on request being made from tax or territories such as Cayman have long other authorities in other countries, offered no direct taxation. Others, even if a criminal offence is being such as Jersey, Guernsey and Isle of 194 investigated . It has to be noted Man, who have in the past offered that this situation has improved rates (largely at the choosing of the recently as a result of bilateral taxpayer) of between 0 and 20 per agreements between many tax cent are now moving to 0 per cent havens and the USA and agreements corporate taxation. The trend is between those engaged in the EU STD everywhere downward for corporate tax rates as the havens seek to outdo 194 Comprehensive information on information exchange is available from the 195 Concept Paper on Tax Havens - A OECD. See ‘Towards a Level Playing Field’ contribution prepared by the GT-7 / Chile for published as the ‘2006 Assessment by the the Technical Group Gt-7 Meeting January Global Forum on Taxation’ 10-11, 2007 Santiago, Chile

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each other (which they do, without significant number included who are concern for their well-being as a in a position to use this law197. group, this being the one and only area where it can be said that states 5. The availability of structures do compete in the world). designed to exploit these opportunities and professional The same can also be said of personal service providers who facilitate taxation. It is generally true that tax their use. These structures and their havens do not charge those using use are noted in more detail later in their services to tax on capital gains, this chapter. wealth, gifts or inheritances. In addition they offer either no income 6. A charade of activity. So significant taxes or more commonly low or is this issue that it forms the next capped tax rates to those claiming to section of this chapter. reside there. Switzerland pioneered capped tax payments in the 1930s. The idea is now being copied by the The offshore charade Isle of Man (which is also extending it to its banking sector, which will be According to LowTax.Net198 the following the only corporate activity taxed businesses are most commonly located there soon) and Jersey and Guernsey offshore: are looking to follow suit. · trade marketing and distribution; As worryingly, the same situation can be reproduced in major financial · financial holding and investment centres, such as the UK. The UK’s activities; 196 ‘domicile laws’ mean that any · corporate financial and management person with a country of origin other services; than the UK, or with a parent with such a country of origin may claim to · offshore banking; live in the UK but have intention to · offshore financial services; eventually leave. In that case they are only taxed on their income arising · ship management; in the UK and income arising outside · licensing and franchising royalty the UK when and if it is remitted to collection; the UK. This encourages people in this situation to accumulate their · professional services; assets offshore. This is a blatant and · insurance. abusive tax practice as bad as many

seen in the more conventional It is clear that most of these are havens. It is unsurprising that the list administering activities undertaken of the richest people in the UK has a

197 http://www.timesonline.co.uk/section/0,,210 8,00.html 196 See 198 A web site that promotes offshore activity http://www.hmrc.gov.uk/pdfs/ir20.htm#domi http://www.lowtax.net/lowtax/html/obruses cile accessed 31-1-07 for an explanation .html accessed 31-1-07

Closing the Floodgates www.taxjustice.net 83 somewhere else or are providing services of Bono’s recording rights to a to those who are doing so. Netherlands based tax structure. These rights were not created in the The reality is that almost nothing territory in which they are now happens ‘offshore’. Offshore is a charade located. Their relocation there is an where activities are recorded as taking artificial legal exercise. It is, however place although they actually happen important to note again that a major elsewhere. So, and for example: financial centre acting as a haven, in this case the Netherlands, is a. The £187 billion of funds held in facilitating this by setting tax rates as Jersey in September 2006199 were not low as 5 per cent on royalty income. really located there. A population of about 90,000 people undertaking c. The ‘professional services’ provided almost no genuine capital intensive offshore are frequently a charade. entrepreneurial activity could not For example, in common law trustees generate a meaningful return on that are meant to be responsible for sum, which amounts to more than £2 managing the assets they control. million per head. They do not need However, in jurisdictions like Jersey to. The cash is actually on the London arrangements are being created to money markets and merely ‘booked’ ensure that trustees are pure as being held in accounts in Jersey. nominees for persons who buy their This can, of course, only happen services to present the appearance of because the UK allows payment of a trust being in existence. In reality, interest to Jersey without tax being however, no such arrangement has deducted at source, this being the been created and the assets remain complicity of the major financial under the control of the owner, who centres in these arrangements. remains located elsewhere. For details see appendix 5. It should be b. There is no evidence of the noted that whilst the practices development of trade marks and involved may be entirely legal in licences offshore. Nor is there any Jersey, the establishment of trusts in sign that a major university or such locations by persons who can research facility has ever developed still secure the benefit of the income major technological breakthroughs in arising to the ‘trust’ is only legal if the locations where many patents are that income is declared on the located for tax purposes. The settlor’s tax return in the country management of these assets offshore where that person is ordinarily is an artificial activity. The resident. development of the licensed property happened elsewhere. The charade described in appendix 5 is designed to ensure they need not A good example might be the make such declaration but if the recently much publicised relocation financial services provider knows that this is happening their assistance in making such arrangements will be the 199 http://www.jerseyfinance.je/_support/uploa facilitation of tax evasion, and that is dedFiles/Quarterly per cent20report per money laundering and so criminal, cent20for per cent20period per cent20ended even in those locations. This is why per cent2030th per cent20September per cent202006 per cent20- per cent20Final.pdf the rules on looking through these accessed 31-1-07 types of activity have to be changed

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so that they are assumed to take untrue, as noted, that assets are really place ‘onshore’. located in such places, but there is another step that needs to be understood A discussion of the issues regarding in this process. The offshore locations the creation of offshore trusts in the also deny that the assets are located in Isle of Man and the problems that their territories. flowed from these for the users of those arrangements can be found on The law of Jersey might help the Tax Research UK blog200. demonstrate this. As Richard Murphy noted in his report to a States of Jersey d. The offshore operations of many Scrutiny Committee in June 2005202 when MNCs are also a charade. For discussing the concept of in example, many such companies seek Jersey’s taxation law: to locate their group finance functions in tax havens to exploit tax The “make believe” world of Jersey [is] advantages and, maybe, thin apparent. In section 123 (1) a company is capitalisation arrangements as resident in Jersey if “its business is described in chapter 4. However as managed and controlled in the Island” Jim Stewart of Trinity College, Dublin but in section 123 (A) (9) “the office of has shown201, in the period 1998-2003 director of an exempt company shall be treasury management firms located in deemed not to be an office exercised the Dublin Financial Services Centre within the Island”. It is, of course, the owned by MNCs located outside case that the directors of a company Ireland had high financial flows and manage and control it. That is their job. declared high profits as a per cent of As such if the directors are in Jersey or revenues but median employment is meet in Jersey all common sense says zero. In other words, these that directors working in Jersey make a companies did not actually undertake company resident there. This is the their activities in Ireland. It was a common standard of tax law in places legal fiction that allowed them to that are not tax havens. But section 123 book their profits in this location. (A) (9) says otherwise in the case of Effective management control must Jersey. have been elsewhere as there was no one to do it in Ireland. This is why the In fact, the key word here is ‘deemed’. rules on corporate residence have to Of course Jersey knows that companies be changed so that this fiction can no using this arrangement are by all normal longer be abused. tax management standards located in Jersey. It suits them to suggest otherwise. What they never choose to ask Offshore: not what it claims to be is the obvious follow on question, which is ‘if the company is not located in The idea that assets are located Jersey, where is it?’ Again, the reason is ‘offshore’ is a convenient fiction. It is obvious. They know that the answer is ‘nowhere’ purely because of the fiction 200 they have created, but that is not an http://www.taxresearch.org.uk/Blog/2007/01 issue they wish to address. The result is, /04/trust-me-im-a-trust-company/ 201 202 See page 12 http://www.taxresearch.org.uk/Documents/J http://www.taxresearch.org.uk/Documents/4 imStewart2006.pdf 180-12935-2962005.pdf accessed 31-1-07

Closing the Floodgates www.taxjustice.net 85 however, that for tax purposes these This use in insurance terms is worrying. companies are indeed ‘nowhere’. Anyone insuring with such an entity cannot be sure what assets might be used There is a second dimension to this issue. to cover their risk. No doubt that is the As awareness of the risk of information intent of those using them. More worrying exchange has arisen in the offshore though is their further possible use, of world, measures have been taken to limit which some are now becoming aware205: its effectiveness. Perhaps the most worrying is the creation of ‘cell The astute offshore practitioner can companies’ and the ability of offshore employ an offshore protected cell companies to entirely relocate company as an effective asset protector themselves between countries, leaving no and privacy enhancer. trace of themselves in their previous country of location. With an offshore insurance corporation, it is market practice that provides Protected Cell Companies (PCC) were tangible benefits; with the protected cell first provided by Guernsey in 1997203. company, it is the structure of the entity That territory has a specialisation in the itself -- think of a house with a locked provision of offshore re-insurance front door, and rooms inside, each with a arrangements. In effect a PCC operates as separate lock and key. if it were a group of separate companies except all are part of the same legal Protected Cell companies have -- in entity. There is, therefore a ‘parent concert with other entities -- been used level’ which provides management to construct what has been called "an services for the company but in addition impenetrable wall" against creditors and there are a number of further segregated prying eyes. Whilst these claims can only parts called cells. Each cell is legally be tested by time, this novel use of a independent and separate from the PCC for asset protection and financial others, as well as from the ‘parent level’ privacy is an interesting approach and a of the company. valuable piece of intellectual property.

As has been noted204: This is the logic of offshore: professional people use legislatures to create The undertakings of one cell have no structures that they can sell to those bearing on the other cells. Each cell is wishing for secrecy, the only realistic use identified by a unique name, and the for which is the evasion of obligations assets, liabilities and activities of each arising under the laws of other countries. cell are ring-fenced from the others. Guernsey is no longer alone in supplying If one cell becomes insolvent, creditors these companies. They are now becoming only have recourse to the assets of that commonplace. Information exchange particular cell and not to any other. arrangements will have to take them into account.

203 http://www.legalinfo- Information exchange has no doubt panama.com/articulos/articulos_41a.htm motivated interest in companies being accessed 31-1-07 able to relocate themselves. Most 204 http://www.offshore-fox.com/offshore- territories take time to reply to enquiries corporations/offshore_corporations_030404.ht ml accessed 31-1-07 205 ibid

Closing the Floodgates www.taxjustice.net 86 on information exchange. Corporate c. Little or no local tax liability in relocation often takes less time than it the company of incorporation on takes an offshore tax authority to deal any transaction of any sort; with an information request. As such d. No requirement to have local relocation is an obvious flight strategy in officers; the event of enquiry talking place. e. Possible exclusion from being Corporate relocation (or redomicilation, owned by local people in the or again redomiciliation, no one seems country of incorporation; sure which is correct) is allowed by the f. May be able to issue bearer 206 laws of many offshore territories . shares, meaning ownership is in Malta, The Netherlands Antilles, many of practice not recorded, although the Caribbean havens and the Isle of Man this activity is now diminishing; now allow these arrangements, as do some Swiss cantons. The danger is g. Unlimited powers to trade obvious. Capital flight becomes corporate without regulation. flight with the world populated by roving, unaccountable companies whilst the This is probably the most common havens are held hostage to lowest offshore entity. The British Virgin common denominator practices for fear Islands is the largest supplier207. that those located there will leave. This There were 707,000 IBCs based in the effectively means that realistic attacks BVI in 2005, a number increasing at on offshore have now to be focussed on the rate of almost 60,000 a year208. the suppliers of offshore services and the That is over 30 companies for every facilities that these companies use as local person209. much as on the companies themselves. 2. Trusts. The nature of a trust is explained in appendix 5210. The key The services offshore supplies characteristic of an offshore trust is that: The arrangements that characterise offshore territories have been noted a. The settlor is frequently not above. The products they supply include named or a nominee is used to the following: disguise the relationship between the settlor and the property; 1. International Business Companies (IBCs) or Corporations. These are limited companies registered 207 For details on BVI companies see offshore. They are characterised by: http://www.offshorebvi.com/bvi-offshore- a. Secrecy as to ownership; companies.php accessed 31-1-07 208 b. No requirement to file accounts, http://www.bvifsc.vg/DesktopModules/Bring2 or even on occasion to keep books mind/DMX/Download.aspx?EntryId=136&Portal and records; Id=2&DownloadMethod=attachment accessed 31-1-07 209 Population data from https://www.cia.gov/cia/publications/factbo ok/geos/vi.html 206 For an example of an agent supplying this service see 210 See also http://www.alphaibc.com/content/view/44/ http://en.wikipedia.org/wiki/Trust_(property 94/ accessed 31-1-07. ) accessed 31-1-07

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b. The trustees are usually nominees owned by an offshore trust who will do whatever the settlor (sometimes in a different territory) to instructs; place as many obstacles as possible in the way of enquiry into beneficial c. The trust deed does not specify ownership212. the real purpose of the trust

(which often states the purpose 4. Offshore ‘wrappers’. The EU Savings to be for the benefit of a charity Tax Directive (EUSTD) was introduced or such other activity as the to target funds held by EU residents trustees think fit, providing in tax havens on which interest unlimited scope for action and earned was not being declared. abuse)211; Unfortunately its use is severely d. A side letter of wishes is issued to restricted due to it not applying to the trustees which states the real funds held in trusts (as a result of the wishes of the settlor but need not opposition of the UK) and any limited be disclosed on enquiry; company, onshore or offshore. In e. An enforcer is appointed to whom addition it only applies to cash based the trustees may turn for products. If however these are based instruction if anything is to inside insurance products then that happen to the settlor. cash is itself also outside the scope of the EUSTD. Such reactions to regulation are common offshore213. The result is predictable. These arrangements are not trusts at all but 5. Reinsurance. Reinsurance is the are means to disguise the ownership process by which an insurer (or a of assets. It is important to note that large entity that self insures) pays this may not be just for tax reasons. premiums to another company to People may wish to hide assets from share its risk. If paid to an offshore their spouses, family or business re-insurance company, where the partners. They may also be seeking to premium is received tax free and avoid inheritance laws. Some may be accumulates tax free there is a seeking to avoid regulation e.g. on special benefit for the company controlling too large a part of an paying the premium: it gets tax relief industry. Tax is, however, a common on the payment but does not get motivator for this action. In all cases taxed on its receipt offshore if it the trust is almost certainly a happens to also own the offshore charade or sham. reinsurance company. This becomes, in effect, another form of transfer 3. Offshore credit card services. This pricing which is open to abuse. issue is discussed in depth in chapter 5, but is commonly provided to use funds held in an IBC which in turn is 212 An anonymous Mastercard is advertised at http://www.offshorexplorer.com/cards.php 211 As example see http://www.lorne- accessed 31-1-07. house.com/pdf/Trust_Services_CONFIDENTIAL _QUESTIONNAIRE.pdf which suggests the 213 An example of a product targeted for this nomination of the UK’s Royal National specific use made available by the Danish Lifeboat Institution for this purpose, a role in Jyske Bank can be found at tax planning which it probably did not http://www.jyskebank.com/2.0_products/2.6 anticipate. This abuse of charities is common .2_insurance_wrappers.asp?sLangID=uk in this area. accessed 31-1-07

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6. Re-invoicing. This abusive practice, Much of the private equity market is which is commonly associated with at least nominally registered capital flight and tax evasion is offshore. The attractions are little or discussed in chapter 7. no tax, especially on capital gains, an absence of regulation on investment 7. Hedge fund management. At the end management and, possibly, an of 2004 it was estimated that 55 per absence of regulation on the cent of all hedge funds were approach these companies use to registered offshore214. Hedge funds management of their assets. Relative are recognised as a major source of anonymity, for example, helps those risk in the current world financial seeking to adopt an aggressive architecture. By locating offshore approach to staff. many of these funds are virtually unregulated, increasing that risk, and Other services are supplied, such as on- untaxed, meaning they are unlikely to line gambling, but these are not usually be accountable to the society that directly tax related. they might threaten by their actions. This is an area requiring significant research. The degree to which these How much is offshore? funds are actually managed onshore whilst being registered offshore is An estimate of the funds held offshore unknown. has been provided in chapter 3. What is clear is that the offshore world is 8. Private equity finance. Private continuing to grow. The number of equity finance is a broad description companies in the British Virgin Islands is covering investment in shares not one indication of that. Another is quoted on a stock market. The provided by the table below showing the market is believed to have grown by external positions of banks in some major 20 per cent in 2005215. It is estimated tax havens. That level of exposure is that companies that have received increasing. private equity funding account for the employment of around 2.8 million people in the UK, equivalent to 19 The future of offshore per cent of UK private sector employees. So far the various initiatives to restrict the activities of the offshore world have Private equity is characterised by not in any way impacted upon its use. It investing in existing and not new is clear that a different approach is now entities. It seeks to exploit these needed if this issue is to be tackled assets, usually by fierce cost cutting, effectively. The veils of secrecy need to and then sells the companies on to be stripped away, not only through make a capital gain. information exchange agreements – as has been the focus of the OECD’s work in recent years – but more generally by requiring disclosure of beneficial 214 http://en.wikipedia.org/wiki/Hedge_fund ownerships, and by enforcing greater accessed 31-1-07 financial and legal transparency. This 215 logic is inherent in the recommendations http://en.wikipedia.org/wiki/Private_equity# we make in the following chapter. Size_of_industry accessed 31-1-07

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Table 1: External Positions of Banks – Assets in USD Billions

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Section 3: Closing the Floodgates

Chapter 9 The Next Steps

All that is required to tackle the related competition launched in 1998216, the EU problems of capital flight and tax evasion Code of Conduct on Business Taxation is political will. Although the focus of this launched in 1997217 and the EU Savings paper might appear to be on developing Tax Directive218 all have a feature in countries and tax havens, many of the common; they address a problem which is recommendations made in this paper assumed to be ‘elsewhere’. Of course that relate also to the tax and legal regimes of is true. This problem does exist countries in Europe and North America, ‘elsewhere’. But in the same manner that some of which countries are stoutly the TJN seeks to change perceptions on resistant to attempts to strengthen corruption219, we also seek to change international cooperation on tax matters, perceptions on this issue. And the new and some of which are wholly wedded to perception that is required is that tackling the notion of tax competition. the issues relating to tax evasion requires changes in domestic practice as the first necessary step that has to be taken if This reality is reflected in the others are to be asked to follow the lead recommendations made here, though this of those now willing to act. need not necessarily be an obstacle to progress. Much can be achieved within a We have set out our recommendations national context: indeed a significant under 4 headings: number of our recommendations can be undertaken by a country acting unilaterally. In many ways this is the 216 Available for download at starting point for change: few countries http://www.oecd.org/dataoecd/33/0/1904176 .pdf accessed 26-1-07 are completely free of the problems mentioned in this report and some of our 217 Available for download at http://ec.europa.eu/taxation_customs/resour recommendations will require domestic ces/documents/COC_EN.pdf accessed 26-1-07 legislation as a part of their resolution. 218 See http://ec.europa.eu/taxation_customs/taxati Previous initiatives to tackle the related on/personal_tax/savings_tax/rules_applicable problems of capital flight and tax evasion /index_en.htm accessed 26-1-07 have not begun with this perspective. The 219 See two papers by John Christensen: OECD initiative on harmful tax http://www.taxjustice.net/cms/upload/pdf/F ollow_the_Money_-_RGS-IBG__final_31-AUG- 2006.pdf accessed 26-1-07 and http://www.taxjustice4africa.net/cms/upload /pdf/Mirror_Mirror_On_the_Wall_- _10_JAN_2007.pdf accessed 26-1-07

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1. Domestic changes; 2. International changes; It is therefore vital that the language used 3. Changes to be undertaken as part of when discussing these issues is positive, the development agenda; because that reflects the benefits. What 4. The promotion of research to is actually at stake is the credibility of facilitate these changes. markets, the future of democratic government’s right to tax those to whom Each is considered in turn. they are responsible and the well being of the vast majority of the people of the Domestic changes world. Being positive about that objective is vital if these issues are to be The process of change requires progress addressed. on these issues at a domestic level:

2. Redefining corruption 1. Using the language of tax justice The weaknesses of current perceptions of It is easy for any attack on tax avoidance, corruption have been discussed elsewhere evasion, corruption or capital flight to be in this report and are further elaborated represented as: on in a paper by John Christensen attached as an appendix to this report. · an attack on business, or · the addition of another regulatory Any country can choose to broaden the burden on enterprise, or focus of debate on corruption from the · as a restriction of the rights of the ‘demand side’, which is the sole focus of individual. attention within the Transparency International definition as used by the But this misrepresents our agenda, which World Bank to the ‘supply side’ which is focussed on justice for all people. This, includes: however, has to be carefully managed if the right impression is to be given. The · The activities of governments who TJN has learned this from its own supply the secret spaces in which experience of dealing with havens, corruption can take place, which business and the lobby groups that include (but by no means exclusively) represent them. those jurisdictions categorised as tax havens; This is precisely why we now make clear what we support when explaining our · The facilitators who encourage and work, rather than what we oppose. It is enable corrupt practices by aiding and easy to be derailed when you are opposed abetting dirty money flows. This to tax havens or tax competition. There includes the bankers, lawyers, are some serious lobbies only too willing accountants and trust companies who to defend both, and they have the ear of set up and operate the enabling the media and serious financial sponsors financial structures; within the business community. · Those who undertake illicit It is much harder to be derailed when transactions related to capital flight promoting tax cooperation or and tax abuse both internationally transparency, for example. and domestically;

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beneficiaries of its activities. However, in · Those who ignore such transactions in many parts of the world: the course of their duties. · The ownership of companies need not These activities have to be tackled as be disclosed or can be disguised strongly as does the use of those services. through the use of nominees; Only by using this dual track approach will this problem be effectively tackled. Until · The names of those who manage it is developing countries are being companies, charities, trusts and other unreasonably penalised for the entities need not be disclosed or the involvement of some in their governments true identity of those fulfilling those in corruption whilst those who facilitate roles can be disguised through the use their activities remain unidentified and of nominees; unpunished. · In the event that a corporation, Furthermore, until our understanding of charity, trust or other entity is what constitutes corruption is broadened controlled by another of such in this way, the loss of taxation revenues concerns, the ultimate ownership of from developed countries because of tax the entity and how that association is corruption facilitated by places such as made is not disclosed. Luxembourg, Switzerland, the UK and the US will be more readily tolerated by This has the consequence of making society. This cannot be ignored any accountability for many transactions hard longer. to prove, and liability to taxation difficult to determine. To tackle this issue governments need to show increased commitment to A commitment to improve transparency international agencies and their work in would require governments to: tackling corruption, but must at the same time seek to change the way in which 1. Create a public register of companies corrupt practices are perceived by those and to record on it: agencies. a. A list of all incorporated companies; b. Detailed information for each 3. Putting transparency onto the company concerning: domestic agenda i. Its registered office at which official contact can be made Transparency needs to be assertively with it; placed on the policy agendas of both ii. Its constitution; national governments and the multilateral iii. Its membership and their agencies In most countries there are identifiable addresses at significant weaknesses in this respect. which they can be contacted, updated at least annually, and There is no company, charity, trust or if those members are other entity in the world that is not run by nominees or corporations the people. With the exception of charities it names of the persons for is commonplace for those people whom they ultimately act associated with it by ownership or another shall be given; form of legal entitlement to be the major

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iv. The details of the person or control of the company, persons (whether individuals including full details of or a corporation charity trust beneficial ownership if or other entity) that controls nominees are used. the corporation shall be c. A list of all companies, charities, stated and if there are 5 or trusts or other entities controlled fewer connected persons220 directly or indirectly by the who ultimately control the company, in each case with corporation then the means of sufficient identification details establishing control shall be and an address being given so that shown and the country of the entity can be identified in its location for each individual, country of incorporation or corporation, charity, trust or registration. other entity involved in that d. Its annual financial statements. process of control shall be disclosed, in each case with 2. Create a register of charities an identifiable contact containing all that information address being given; required of companies, with in this v. Its directors or other officers case provisions with regard to and if such persons are directors and other officers extending nominees the identities of to trustees and other such officials those on whose instructions and with the addition that in this they are required or are case: accustomed to act, including the country in which such a. The names of those promoting the persons are located and the charity; reasons by which they obtain b. The names and identifiable their authority to issue addresses of any individual, instruction, in each case with corporation, charity, trust or an identifiable contact other entity who, with their address being given; connected parties, provides more vi. The holders of any debt or than 10 per cent of the income of other financial instruments the charity in a year; that it has issued which does, c. The names of the beneficiaries or might foreseeably, afford receiving more than 5 per cent of the income of the charity in any year; 220 A connected person is generally d. The reason why the income of the considered to be a person’s parent, step- parent, sibling, step-sibling, child, step child charity has not been distributed or greater issue or step-issue, aunt or uncle, annually if less than 75 per cent first cousin, spouse and former spouses for a of its income has been applied to period of five years from the time of divorce having taken place and those spouses’ its stated charitable purpose. connected persons and all corporations, trusts, charities or other entities owned or controlled 3. Create a register of trusts containing by such persons, all business partners and all that information required of those of connected persons and all trustees, nominees and agents appointed to undertake companies, with in this case business on behalf of any such connected provisions with regard to directors and party, whether the person in question be a other officers extending to trustees natural person or a corporation, charity, trust or other entity created under legislative and other such officials and with the powers anywhere in the world. addition that in this case:

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· A reduction in secrecy; a. The name of the settlor or settlors · An increase in the efficiency of of the trust shall be disclosed and identifying assets under the control of all those contributing a sum more any person or other entity; than 10 per cent of previously gifted trust property shall likewise · An increase in the tax yield; be disclosed together with their · Greater openness and transparency in identifiable addresses, at least commercial transactions leading to annually; benefits for all stakeholder groups b. The trust deed shall be disclosed including enforcement agencies of all as shall all side letters, letters of sorts, employees, those with wishes and other communications environmental concern, commercial of any form (including written creditors of organisations, banks and summaries of verbal instructions other suppliers of capital, consumers, or communications issued in non- and at large. reproducible electronic format)

that give indication to the It should also be noted that the trustees or those who instruct the requirements are, in practice not onerous. trustees as to the way in which Under the ‘know your client rules’221 that the funds under their care should are an integral part of the financial be used; services culture and which are expected c. In the event that the trust shall be to be in operation in all states monitored of a discretionary nature then a by the Financial Action Task Force222 or list of all those who have the IMF223 such information has to be benefited from more than 5 per secured as a matter of course together cent of the income of the trust in with the additional information noted as any year in the previous ten years to proof of ultimate beneficial ownership shall be supplied with identifiable and the means by which such connections addresses. can be established. As such the public disclosure of this information should not impose an onerous administrative burden 4. Create a register of all other on any business which is in possession of a containing all that information bank account anywhere in the world since required of companies, and with such the information must be available other information as shall be already. appropriate to ensure that information of the type required for charities and trusts is also available, if appropriate. 221 For a discussion of ‘know your client’ Each of these registers should be available rules in general see for free public searching, on the internet http://en.wikipedia.org/wiki/Know_your_cust omer accessed 28-1-07. and at public buildings at any time. 222 For details on the FATF see http://www.fatf- Such a commitment would require an gafi.org/pages/0,2966,en_32250379_32236846 extension of disclosure rules for almost _1_1_1_1_1,00.html accessed 28-1-07 every government in the world. The 223 See, for example, advantages would be: http://www.imf.org/external/pubs/cat/longre s.cfm?sk=17047 accessed 28-1-07

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4. Changing domestic tax laws to overseas territories (mainly but not solely remove ‘tax haven’ or ‘harmful’ of the UK) for which the EU member elements. states were responsible, including their tax havens. Not all of these have been The OECD has defined harmful tax eliminated as yet, although progress is practices of the type it tended to being made. It is vital to note, however, associate with tax havens as follows224: that these issues related only to business taxation. It is likely that a greater part of i) No or low effective tax rates this abuse is by individuals. As such this review has to be extended to all taxes to ii) “Ring-Fencing” of Regimes be effective, and it is highly likely that iii) Lack of transparency most countries will have actions to take when that is done, as the EU found with iv) Lack of effective exchange of business taxation. Of course, those information countries that have not done this review for business taxes need to cover that issue Other factors the OECD thinks indicate as well, now. such practices include: v) An artificial definition of the tax base 5. Requiring all tax planning to be vi) Failure to adhere to international disclosed to tax authorities transfer pricing principles No one can seriously dispute the need for vii) Foreign source income exempt from firms to engage in tax planning. However, residence country tax tax authorities do have a duty to ensure viii) Negotiable tax rate or tax base that: ix) Existence of secrecy provisions a. The practices used are legal; x) Access to a wide network of tax b. The proposed planning is not harmful treaties to the wellbeing of the state. xi) Regimes which are promoted as tax In addition the tax authorities also need minimisation vehicles to know who has used them and how they xii) The regime encourages purely tax- have been used. driven operations or arrangements. For this reason the UK, USA and some

other countries require the advance The EU found more than 120 such disclosure of material tax planning to practices in member states when it began taxation authorities. Material is in this reviewing harmful tax practices affecting sense defined either by the value of the business taxation in accordance with its service supplied by the tax intermediary Code of Conduct on Business Taxation225. or with reference to the type of It found a further 85 in dependent and transaction proposed. The intention of disclosure regimes has been made clear by 224 OECD, ‘Harmful Tax Competition – an the UK’s HM Revenue & Customs who have Emerging Global Issue’, OECD, Paris, 1998 said226: 225 See http://ec.europa.eu/taxation_customs/resour ces/documents/primarolo_en.pdf accessed 28- 226 http://www.hmrc.gov.uk/ria/disclosure- 1-07 guidance.pdf page 11 accessed 28-1-07

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On its own the disclosure of a tax It is often forgotten that groups of arrangement has no effect on the tax companies are not taxed. The individual position of any person who uses it. companies that make up the group are However, a disclosed tax arrangement taxed. Likewise an individual and the may be rendered ineffective by entities they control, be they companies, Parliament, possibly with retrospective trusts, partnerships or whatever are not effect. taxed as one; they are taxed as separate entities. It is, therefore, relatively easy It is recommended that all governments for a group of companies or for an adopt arrangements of this sort, and put individual operating through a wide range in place penalty regimes covering: of different entities, typically spread across a variety of different countries, to a. Failure to comply; supply quite different information to b. Sourcing from offshore; different tax authorities about two or c. Schemes which a taxpayer claims to more sides of one transaction where these have generated for their own use. are in fact related, e.g. by way of transfer pricing.

6. Requiring all tax accounting to be This practice is unacceptable. Agreement disclosed to tax authorities to taxation affairs secured by way of differing disclosures means that there has Full disclosure of all relevant information been a failure to place all cards ‘face up to a tax authority is vital. This is the basis on the table’ simultaneously. This is for a relationship of trust, which is tantamount to non-disclosure and could fundamental in taxation. It is, however, constitute tax evasion. As such countries equally important that the same should seek to ensure that consistent information is disclosed to all taxation information is supplied to all countries authorities affected by a transaction. This affected by the trading of a group. It is is of particular importance within groups suggested that this would entail disclosure of companies. The benefits are: of the following data, all of which would, however be available to the Group, and a. Reduced compliance costs due to no doubt to its auditors since without it increased confidence in the being available it is unlikely that they disclosures made; could form a true and fair view of its b. Increased probability of speedy taxation affairs: dispute resolution on issues such as transfer pricing; c. Reduced risk for the taxpayer as a 1. Group structure consequence of the enhanced certainty which this disclosure will a. Parents bring; b. Subsidiaries d. The reallocation of resources by c. Associates management to more productive d. Investment holdings activity than the management of its e. Related parties taxation affairs; e. Lower administration costs because of 2. Individual company accounting the transparency of the information supplied. a. Turnover i. Third party ii. Group

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b. Expenses consolidation on inter i. Third party group transactions ii. Group iii. Profits arising from iii. Highlight tax the use of non-historic sensitive items cost based accounting c. Stock (Inventory) m. Tax i. Opening and closing i. Current tax charge data and all calculations ii. Inter group profit and accounting contained in entries supporting it valuation, opening ii. Prior year and closing data adjustments to tax d. Labour costs charge i. Salary iii. Reconciliation of ii. Social security taxable and iii. Pensions accounting profits e. Licence fees and royalties iv. Tax paid and i. Third party reconciliation of the ii. Group payment with cash f. Interest payable flow data either i. Third party published or used in ii. Group the group g. Fixed asset costs consolidated cash flow i. Depreciation statement ii. Amortisation v. Deferred tax charge iii. Profit or loss on vi. Reconciliation of disposal opening and closing iv. Inter group transfers deferred tax liability h. Provisions n. Income or expenditure not i. By type recognised in the profit and ii. Reconciliation of loss account balance sheet i. Movements in reserves movement ii. Charges made in the i. Currency exchange statement of differences recognised gains and i. Third party losses ii. Inter group iii. On consolidation 3. Group accounting iv. Reconciliation of balance sheet effect a. Details of the group j. Directors fees consolidation k. Management charges i. Details of any i. Third party company excluded ii. Group from the l. Profit pre tax consolidation, and i. Arising from third why party transactions ii. Reconciliation of the ii. Profits to be reported financial eliminated from statements of each subsidiary prior to and

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after the application The previous recommendation has dealt of consolidation with these in disclosure to tax authorities. journals to declared Public disclosure is also essential if their Group profit capacity to do harm is to be curtailed. b. Overview by country i. Turnover intra group No one knows whether the inventors of and third party limited liability corporations intended ii. Third party that limited liability should be available expenditure within groups of companies, as well as iii. Inter group when considering a group’s third party expenditure relationships but as a matter of fact iv. Labour costs limitation of liability does apply within v. Interest costs, third groups. This has the following party and intra-group consequences: vi. Other provisions vii. Profit reported in 1. Multinational groups tend to be made financial statements up of hundreds, often thousands, of viii. Profit included in the companies227; group financial 2. Most countries tax each company in a statements group individually, and not the group itself; It is stressed that this list is indicative, 3. Many of the companies in most groups not prescriptive. A country would need to are registered in territories that do adapt the required disclosure to suit its not require accounts to be made particular circumstances. available for public inspection; 4. Group consolidated accounts only It is clear, however, that obtaining this record the third party transactions of information would require (as indicated in a group of companies, but it is section 3, parts l and m) the disclosure of estimated that 60 per cent of world a company and group’s own tax trade is now undertaken on an intra- accounting. Few countries have access to group basis228. The outcome is that this data at present, and the ability of these accounts provide no meaningful groups to account for tax without having representation of much that happens to disclose what they are doing is a major in the world of commerce, or across weakness in most of the world’s taxation international boundaries; law. This lack of accounting transparency 5. Group consolidated accounts do not provides a ‘secrecy’ space equivalent to usually require a company to disclose: the offshore world, the two combining to a. Where it trades; provide significant opportunities for b. The names of all the entities abuse. through which it trades.

7. Getting the accounting for tax right – the IASB agenda 227 BP Group is estimated to contain about ‘Secrecy spaces’ are required if 3,000 companies at present based upon its most recent data filed with the Registrar of corruption is to take place. Tax havens Companies in the UK. provide one such space. Subsidiaries 228 See inside groups of companies are another. http://www.oecdobserver.org/news/fullstory. php/aid/670/Transfer_p

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The resulting ‘secret spaces’ have been standard that tackled the issue for all little explored229 but tax administrators companies subject to International around the world know the problems that Financial Reporting Standards whatever this situation creates in terms of sector they work in233. This proposed establishing group structures, internal standard, which has been widely supply chains, cross charging mechanisms circulated, calls for disclosure of the and all the related issues that flow from following information: these, with consequent opportunity for capital flight and tax abuse. 1. A list of the names of all the territories within which the group has Campaigners for transparency in the subsidiary or associated companies, extractive sector have been particularly without exception; aware of this issue. The work of the 2. The names of all subsidiaries and Publish What You Pay coalition230 (PWYP) associates in each territory, without prompted the Extractive Industries exception; Transparency Initiative231 (EITI). This has developed significant awareness of the 3. The following information on a need for any government to account for consolidated country-by-country basis, the funds paid to it. But it quickly became without exception: apparent that all the EITI was doing was a. Turnover in total; to account for what companies declared they owed. There was no way of knowing b. Third party turnover; whether the sum paid had any relation to c. Third party costs excluding those of the sum actually due. The truth and employment; fairness of the payment is not assessed by the EITI reconciliation process. As d. Interest, royalties and licence fees campaigners came to realise, knowing paid; that 95 per cent of the revenues e. Profit before tax; companies have declared are accounted f. Tax charge on profits split between for by governments is of relatively little current and deferred tax; value if the declared payments are only half the real sum due. g. Other taxes or equivalent charges due to the government of the territory in The TJN has worked with PWYP to tackle respect of local operations; this issue. The first result was a proposal h. The actual payments made to the for an international accounting standard232 government of the country and its for the extractive industries. This was agencies for tax and equivalent subsequently expanded to be a proposed charges in the period; i. The liabilities owing locally for tax 229 A paper on this subject is forthcoming from Ronen Palan and Richard Murphy, both of and equivalent charges at the the Centre for Global Political Economy at the beginning and end of each period as University of Sussex. shown on the balance sheet at each 230 http://www.publishwhatyoupay.org/ such date; 231 http://www.eitransparency.org/section/about eiti 232 233 http://www.publishwhatyoupay.org/english/o http://www.taxresearch.org.uk/documents/ia bjectives/ias.shtml s14final.pdf

Closing the Floodgates www.taxjustice.net 100 j. Deferred taxation liabilities for the It is our hope that all governments will country at the start and close of the back this submission in its broadest form, period; in which it applies to all entities subject to International Financial Reporting k. Gross and net assets employed; Standards. Put simply, there is no quicker l. The number of employees engaged, win available in the entire arena at this their gross remuneration and related time to expose data on who is trading costs; where within groups of companies. m. Comparative data where appropriate in each case. In our opinion this standard would radically transform international accounting practices, provide data This is not complete profit and loss previously unavailable to governments account information, but it should be throughout the world on the activities of sufficient to ensure that questions may be groups with operations located within asked of any group that undertakes their territories. Implementation of the substantial intra-group transactions giving proposed standard would provide rise to risk for taxation authorities, or incentive to improve corporate behaviour shareholders come to that (a point which at the highest level in a way that nothing we think has considerable significance in else could achieve. view of the extensive use of offshore and intra-group transactions to distort 8. Protecting professional advisers reported results in many of the recent who do not wish to use offshore corporate failures).

There is a widespread belief amongst This proposal was put to the International accountants, promoted in no small part by Accounting Standards Board (IASB)234 in the biggest firms, that they have a duty to 2006 and more than 50 per cent of all minimise the tax paid by their clients. submissions on this and related topics to be discussed by that Board were This duty has been reinforced by law on supportive of the submission. This did not occasion, as has been noted in the mean that it has been adopted as a chapter of this report relating to tax standard at this time, but the IASB was intermediaries. persuaded that the arguments submitted had merit and said in November 2006 There can be no sense in a government that: supporting law within its country that

requires tax intermediaries operating The Board will continue to examine the there to provide advice to their clients on merits for a requirement of country-by- means available to subvert the income country disclosure as suggested by stream of that country, from which they supporters of the Publish What You Pay probably hold a licence to operate. campaign. A group of Board members will discuss this issue with other interested In consequence it is essential that organisations.235 countries seek to protect those tax

intermediaries who wish to practice tax compliance from legal claim arising from 234 http://www.iasb.co.uk/ doing so. This might be by making it 235 legally acceptable for any tax http://www.iasb.org/News/Press+Releases/IA SB+issues+convergence+standard+on+segment+ intermediary to make clear in their reporting.htm

Closing the Floodgates www.taxjustice.net 101 contract for services to be supplied that should be wary (at least) of the use of they do not supply services in connection offshore structures, or of being involved with: in their supply or management. a. Tax avoidance (as defined in this This is unsurprising. As Professor Prem report); Sikka et al have noted236: b. Trusts, other than those used for the In advancing the ‘professionalising’ protection if children, the aged and claims, the UK accountancy bodies the infirm or for charitable purposes emphasise that their members have and then only so long as the intention command of practical and theoretical is not to secure tax advantage by education, engage in ethical conduct, doing so; serve the public interest and act in a c. The insertion of artificial steps into socially responsible way. transactions for the sole purpose of securing a tax advantage; However, such claims are routinely d. Offshore services of any sort. problematised by scandals which highlight the highly partisan role of accounting and accountants and failures of accounting In addition, it should be possible for them education. Rather than a radical review to require that their clients agree in of accounting education, the professional advance to full disclosure of all relevant bodies seek to rebuild confidence in information required for proper appraisal accounting and their jurisdictions by of their taxation affairs by all relevant (re)affirming that accounting education is tax authorities on a consistent basis or will be devoted to producing reflective without risk of liability of inappropriate accountants through educational disclosure of information arising. processes focused on sound education, principles, ethics, professional These recommendations would enable tax scepticism, lifelong learning practitioners who would prefer to practice opportunities, distinguishing between tax compliance, as many do, to reject the private and public interest and serving current pressure to recommend aggressive the public interest. These promises tax avoidance strategies. presuppose that students on professional accounting courses are exposed to such values. . . beyond a technical and 9. Encouraging local professional instrumental view of accounting, there is bodies representing tax little discussion of theories, principles, intermediaries to adopt Codes of ethics, public interest, globalisation, Conduct which make clear that tax scandals or social responsibility to avoidance is unacceptable produce socially reflective accountants.

The TJN has not been able to find a single There is clearly a major weakness in the provision in the ethical codes issued by role of the professional bodies who work professional bodies representing tax intermediaries which suggests tax 236 Professionalising Claims And The State avoidance is inappropriate conduct for a Of UK Professional Accountancy Education: member of that body to undertake. Nor Some Evidence Sikka, P, Haslam, C, Agrizzi, D, Kyriacou, O 2005, Accounting Education, Vol. has it found any such codes which 16, No. 1 available at suggests that the members of that body http://www.essex.ac.uk/afm/research/workin g_papers/WP05-05.pdf accessed 28-1-07

Closing the Floodgates www.taxjustice.net 102 in this area when addressing this issue. interpreted will also evolve since tax This has to be addressed through legislation cannot continually be constructive debate between relevant amended and be effective. authorities and those bodies, and between the members of those bodies themselves. In addition, the following issues impact on There is also a significant issue needing to the clarity of legislation: be considered by those who design and supply the curricula used in the training of · Governments frequently wish to these professions both at universities and provide taxpayers with choice in the for professional examinations. way in which they can construct legitimate economic transactions e.g. The TJN and the Association for the benefit of using a piece of capital Accountancy and Business Affairs237 will be equipment can be secured by building publishing a proposed Code of Conduct for it one’s self, or by buying it, leasing it the management of taxation in the Spring in the long term, hiring it in the short of 2007. term or even by barter. All have an almost infinite number of variations possible within them. All require 10. Introducing general anti- differing rules. The sheer complexity avoidance provisions of the real world means that taxation legislation must either seek to restrict One of the most consistent themes in the way in which real economic discussion about taxation in the twenty transactions are undertaken or be as first century has been the increasing complex as the reality that people volume and alleged complexity of tax create. Enlightened governments have legislation. There have been widespread not chosen to restrict commerce, but calls for simplification of tax codes and the consequence is increased absolute for greater clarity as to their meaning. volumes of legislation and, in consequence, further boundaries Clarity is a desirable attribute of good tax between the ways in which legislation. It helps tax payers know what transactions can be treated. This their obligations are. The greater the gives rise for opportunity for degree of legal clarity, the less chance misinterpretation that requires there is for dispute as to its clarification within the legislation. interpretation. Absolute clarity, let alone certainty, is not possible in taxation · Some accountants and lawyers have legislation for the following reasons: sought to abuse the boundaries of the law for their own advantage in 1. The meaning of all words is, to generating fees and for the advantage varying degrees, ambiguous; of those they represent. This practice has given rise to an almost universal 2. Taxation uses words in special ways, world-wide growth in the volume of the interpretation of which is peculiar tax legislation designed solely to to its needs; tackle this issue. In the UK the TJN has estimated that at least 40 per 3. The meaning of words, both in general cent of all UK tax legislation in the and in particular, changes over time so that the way in which legislation is

237 http://visar.csustan.edu/aaba/home.htm

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period 2004 – 06 created anti- legislation taxpayers would need to be avoidance provisions238. able to apply for a ruling in advance of a transaction as to the likely treatment it · It is accepted that this volume of anti- would receive for taxation purposes, avoidance legislation has made it always assuming they did what they difficult to keep track of the purpose claimed was their intention. of some law, even for the experienced reader. 11. Changing the basis of legal There are three ways to challenge this interpretation in tax cases so that an issue of complexity. The first, as noted equitable and not legal basis of above is to change the attitude of construction of the law is used taxpayers, their advisers and governments towards the payment of tax. It is regularly As has been discussed in this report, cast by all as a “bad” thing. This is not governments too often require that true. Secondly, the claim by some tax taxation law be applied by their Courts professionals that they have a duty to using a ‘legal’ rather than an ‘equitable’ minimise their client’s tax liabilities has basis of interpretation of the law. As to be challenged. those who first promoted this idea recognised, the outcome can be tax Thirdly, and as importantly, governments injustice. Application of this approach is, have to embrace the idea of ‘purposive in addition, the foundation of the whole legislation’ in which they state the intent tax avoidance industry. of the legislation they pass. To ensure that this is effective they must, however, The use of an equitable basis of couple that with a general anti-avoidance interpretation of the law would principle (GANTIP) that examines the fundamentally change the way in which intentions of the taxpayer as revealed tax law was applied by the Courts of a both by the structure of the transactions country and would promote tax they undertake, the outcomes they seek compliance rather than tax avoidance. As to achieve and any evidence available as such this method of legal interpretation to their motives before or after the should be required of taxation courts. transaction occurred to see if their intention coincides with the purpose of the legislation from which they have 12. Enhanced government sought advantage. If it is clear from accounting evidence procured in this way that the legislation was not intended to supply the The logic of the Publish What You Pay benefit the taxpayer is seeking to procure campaign has been that governments in from the transaction they are undertaking developing countries rich in mineral and then the claimed benefit should be other natural resources should be held denied. accountable for the funds paid to them by

major corporations. The purpose has been To ensure that the case load of litigation twofold: does not become burdensome as a consequence of such a system of taxation 1. To ensure that corruption is exposed, as far as is possible; 238 http://www.taxresearch.org.uk/Documents/T JNresearchnote12-06.pdf accessed 15-12-06

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2. To ensure that funds entrusted to a and targets can be set for dealing government are used to be best with it; effect. Few countries publish measure of their These objectives are as appropriate in ‘tax gaps’. This is the estimated developed countries and those without difference between the tax revenues they mineral resources as they are in those collect and what should be collected if countries that Publish What You Pay there were no: target. In addition, it is apparent that a government cannot operate opaquely if it · Tax evasion; is requiring transparency of others. · Aggressive tax avoidance; As such governments should ensure that: · Non-payment of taxes due.

· They provide clear, easily accessed information on budgets as well as The USA is a notable exception. It both income received and the way in which actively recognises the existence of its tax 239 it is expended, provided on a timely gap , estimates what it is (between basis and in consistent and readily US$312 billion and US$353 billion in tax 240 understood formats, in which year 2001) and asks what might be done 241 outcomes are also compared with about . Even so, the US definition of the expectations; tax gap is itself deficient. It is:

· They relate this information in such The difference between the tax amounts fashion that an individual can taxpayers pay voluntarily and on time and 242 comprehend how they relate to the what they should pay under the law. income, expenditure and activities of government and this must be This does not take into account: explicitly highlighted in the data published by governments; · Tax lost due to tax competition; · Tax lost offshore. · Their reporting recognises that well being matters as much as GDP; As a result the loss is likely to be higher · The distribution of income and the tax than that reported. burden is recognised as an important issue and is highlighted in all reporting.

239 See, for example Only if these changes happen can http://taxprof.typepad.com/taxprof_blog/200 governments realistically ask the same of 7/01/senate_holds_he_1.html accessed 28-1- corporations and other legally created 07 entities. 240 http://www.irs.gov/newsroom/article/0,,id=1 37247,00.html accessed 28-1-07 13. Publication of ‘tax gap’ 241 See, for example, http://budget.senate.gov/democratic/testimo measures at national level so that ny/2007/Brostek_taxgap012307.pdf accessed the scale of the problem is known 28-1-07 242 ibid, page 1

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The point remains though that without the structures nominally located offshore some estimate of the problem there is are actually under the effective day to neither a target to address (although day management of companies, and closing the tax gap altogether is, we individuals in other countries. As the US stress a known impossibility – tax evasion Senate report into offshore published 1 will always exist) or a means of holding August 2006 noted: anyone to account for progress. Offshore “service providers” in tax As the United States Government havens use trustees, directors, and Accountability Office also says in its officers who comply with client directions report to the Senate in January 2007: when managing offshore trusts or shell corporations established by those clients; Simplifying or reforming the tax code, the offshore trusts and shell corporations providing IRS more enforcement tools, do not act independently. and devoting additional resources to enforcement are three major approaches, As a result the Senate report but providing quality services to recommended that: taxpayers also is a necessary foundation for voluntary compliance. Such steps as U.S. tax, securities, and anti-money periodically measuring non-compliance laundering laws should include a and its causes, setting tax gap reduction presumption that offshore trusts and goals, evaluating the results of any shell corporations are under the control initiatives to reduce the tax gap, of the U.S. persons supplying or directing optimizing the allocation of IRS’s the use of the offshore assets, where resources, and leveraging technology to those trusts or shell corporations are enhance IRS’s efficiency would also located in a jurisdiction designated as a contribute to tax gap reduction. tax haven by the U.S. Treasury Secretary.

We would endorse those sentiments and The authors of this report endorse this believe that research into and the recommendation. If it were adopted, promotion of accountability for the ‘tax those offshore trusts and companies gap’ is an essential part of every would be subject to tax in the country governments taxation system if this issue from which the direction was issued. is to be tackled effectively and the funds needed for development are to be raised We have two further proposals: to achieve the Millennium Development Goals. a. It should be for the taxpayer to prove that such control does not exist; b. The existence of a commercial 14. Redefining what ‘residence’ activity within the trust or offshore means for both individuals and other company should not be a reason for exclusion from this provision (as it is entities to make it easier to define at present under the ‘controlled trusts and corporations held through foreign company’ tax laws of many nominee arrangements as being countries243. managed from the territories in which effective control takes place 243 For a description of the UK’s definition of a controlled foreign company see As has been noted in the chapter on http://www.hmrc.gov.uk/manuals/intmanual/ offshore, many (possibly a majority) of intm202010.htm accessed 28-1-07

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countries of which it is a member to c. Controlled foreign company laws ensure that this disclosure is made should be extended to individuals so wherever the account is opened; that they can be charged to tax on b. The Requirement could be extended the income of companies, trusts and to the providers of credit card other entities that they control services. Mastercard is a US quoted located offshore where this is corporation. Visa is owned by the currently not possible. banks who supply its cards244. Both are used for money laundering and tax These would add additional opportunity to fraud, although neither does of course address this problem. engage in such activity itself, or in any way encourage it. However the possibility that restrictions on the 15. Create an obligation for financial international use of such cards for institutions to disclose ownership of what are deemed to be criminal foreign registered entities for whom payments domestically has been they act. proven to be possible in the USA where the Unlawful Internet Gambling

Enforcement Act, passed in November US Senators Coleman and Levin 2006245 made use of such cards to pay recommended as follows in their August for on-line gambling an offence, even 2006 Senate report: where the payment was to an offshore

provider. The possibility of extending Congress and the IRS should make it clear this restriction to limit the use of that a U.S. financial institution that cards registered in tax havens has to opens an account for a foreign trust or be considered as a serious possibility, shell corporation and determines, as part and the providers should be asked to of its anti-money laundering duties, that actively engage in this debate. the beneficial owner of the account is a

U.S. taxpayer, must file a 1099 form with respect to that beneficial owner. 16. Sanctions should be applied to This recommendation is quite clearly tax havens unwilling to cooperate intended to take disclosure on beneficial with domestic governments seeking ownership beyond that suggested here in to recover tax legitimately due to recommendation 3 above for domestically them. registered corporations. The intention is obvious: knowing who owns domestic Lack of willingness to cooperate in this corporations is useful, knowing the case might include: ownership of those operating offshore with links to your own country is even more important. 244 According to Business Week in 2005 ‘MasterCard processed US$1.03 trillion in The recommendation could be adopted by transactions last year, less than half of Visa's other countries. Extension should also be US$2.27 trillion. AmEx is a distant third, at considered: US$414 billion.’ http://www.businessweek.com/magazine/con tent/05_49/b3962112.htm accessed 28-1-07 a. As a condition of a banking licence to operate in a country this requirement 245 See http://www.msnbc.msn.com/id/15118962/ for could be placed on the group of some discussion of this Act, accessed 28-1-07

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· A lack of willingness to engage in There is evidence to support this last automatic information exchange; suggestion. In that case this form of · Failure to exchange data on a timely action is now possible unilaterally with basis; the expectation of cumulative benefit. · Failure to hold the data needed to ensure effective information exchange One of the sanctions that might be can take place (including the names imposed on territories not willing to of beneficial owners, copies of cooperate could be the application of tax accounts and tax returns, details of withholding on territories made to that distributions including dividends, country or territory. Whilst attempts salaries, loans, the provision of would be made to circumvent such benefits in kind or plain straight sanctions it is a simple fact that if tax forward cash advances made to withholding at source were to be applied persons in the country of enquiry); to the payment of interest from the · A willingness to impose appropriate London money markets to the banks that regulation on offshore entities holds billions in deposits in the Channel registered in their territory. Islands, the Isle of Man and Cayman much of the attraction of these locations would Senators Coleman and Levin suggested the disappear overnight. following in these cases:

Congress should authorize the Treasury 17. Apply tougher sanctions on Secretary to identify tax havens that do those not willing to comply with not cooperate with U.S. tax enforcement taxation law efforts and eliminate U.S. tax benefits for income attributed to those The range of sanctions available here are jurisdictions.246 considerable, and too often they have been used inappropriately. There are To this Bob McIntyre of Citizens for Tax frequent claims in major tax Justice has added the following: administrations that sanctions are applied to the less well off who have made minor Not only deny all deductions for transfers errors in computing their tax liabilities to tax havens that refuse to disclose whilst those who simply evade taxes, activity by U.S. residents automatically, either domestically or through the use of but also make it illegal for U.S. financial offshore are ignored. In addition large companies to deal with uncooperating tax companies who secure legal opinion (often havens. Some argue that we would need at considerable expense) to justify their to get every other non-tax-haven real aggressive tax avoidance cannot be country on board with this type of penalised in many tax jurisdictions. proposal, or otherwise people will route Finally, it is often difficult to penalise tax their transactions through real countries intermediaries for their part in into the tax havens. But as noted, other unacceptable tax planning. Each of these countries are likely to be eager to join us has to be addressed. Suggestions for in this effort. In fact, the OECD’s new change might be: model treaty envisions this result. · A shift in the emphasis of tax audits away from those who are seeking to 246 Quoted in comply with the law, but who might http://www.ctj.org/pdf/mcintyretaxgaptesti make minor technical errors whilst mony.pdf page 4 accessed 28-1-07

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doing so towards a focus on aggressive UK. If such registration were required tax avoidance and outright tax it should be a condition that: evasion; · The registration should apply · The reduction of penalty risks for to all parts of the registered those who are tax compliant, firm. As such, if the registered including those advisers who firm had associated firms, encourage this practice, and a focus members of its group or on higher penalties for those who seek related activities in other to break the law; countries, including in tax · The assumption that funds that have havens then registration been secured using tax evasion would require that the firms mechanisms have been money in other countries would be laundered and as such should be bound to comply and provide forfeited as the proceeds of crime. If information required by the it is not possible to prove which part tax authorities in the country of a sum has arisen as a result of tax in which registration had evasion and what part has not (e.g. taken place as if they too where an account might include a were located there. The legal capital sum placed offshore to which fiction that multinational interest on which tax has been evaded firms of accountants who has been added) then the entire sum share names, market their should be frozen until the taxpayer services on a unified basis and can prove what, if any, part might even share common have been legitimately secured in a management structures are transaction which had been subject to entirely unrelated entities (as taxation as required by law. is still commonplace amongst, · Failed tax avoidance schemes should and for example, the Big 4 be assumed to have constituted tax firms of accountants) has to evasion and be subject to sanction as be ended once and for all. In such. Prior clearance mechanisms for a global world international proposed transactions as professional firms have to be recommended in this report make this accountable. The withdrawal equitable; of a firms licence to operate · The removal of the defence of having and the imposition of secured legal opinion to justify sanctions, including criminal aggressive tax avoidance when it is sanctions akin to those for clear that the transaction in question assisting money laundering is not tax compliant and would breach should be used in the case of the requirements of a general anti- non-compliance in these avoidance provision, with penalties cases, including for failure to being due in such cases as a result; disclose such relationships if · Making it a requirement that all tax they exist. agents operating within a state and · The disclosure of tax planning wishing to sell services into a state be should be mandatory; registered before being allowed to · The participation of a firm in provide taxation advice. This is the assisting submission of a tax case, for example in the USA and return which did not make Australia but is not required in the disclosure of all relevant material information required

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to ensure that a tax liability cash they are willing to commit to tax was appropriately determined collection. The logic of this approach is would be liable to sanction as hard to fathom. As Bob McIntyre of well as withdrawal of the Citizens for Tax justice has argued before firms licence as well as that of a Senate committee: those personally responsible so that they cannot then With additional funding, the IRS could transfer to another firm and devote more resources to international carry on as before (which in tax evasion, partnership document most cases will be the most matching, capital gains under-reporting, significant sanction of all); serious research and an array of other · The failure to disclose tax critical enforcement activities. According transactions consistently to to IRS estimates, it could collect from different tax authorities US$5 to more than US$30 for every dollar should also be subject to spent on improved enforcement. sanction on the part of the firm involved. If enforcement changes deter people and companies from even attempting abusive tax sheltering activities, then the rate of 18. Increase the resources available return could be even higher.248 to taxation departments to ensure that the measures recommended in The logic appears irrefutable. We endorse this report can be implemented. the suggestion.

In the USA it has been reported that:

According to the National Taxpayer’s International changes Advocate, “On a budget of about US$10.6 billion, the IRS currently collects about Perhaps surprisingly, but altogether US$2.24 trillion a year. That translates to consistently with the theme of this report, an average return-on-investment (ROI) of the range of issues that need to be about 210:1. . . . [F]ormer Commissioner tackled internationally is shorter than Rossotti reported the IRS was receiving that needing domestic attention. They sufficient resources to work only 40 include: percent of some 4.5 million accounts receivable cases each year. IRS research estimated that with an additional 1. Working to change the US$296.4 million, the agency could collect international definition of US$9.47 billion. That translates to a corruption. return on investment of 32:1.”247 This is an extension of the same theme at Despite this obvious, and attractive rate a domestic level. It would require of return many governments, including engagement with the United Nations, those of the UK and USA are reducing the World Bank, IMF, Transparency International, and other agencies to 247 National Taxpayer Advocate’s 2006 achieve this objective; Annual Report to Congress, Dec. 31, 2006, pp. 442 & 444 quoted at page 7 http://www.ctj.org/pdf/mcintyretaxgaptesti mony.pdf accessed 28-1-07 248 ibid

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uncooperative with regard to taxation 2. Asking the IMF to enhance its matters would be based upon an objective Reviews of Standards and Codes matrix determined by the territory in (ROSCs). question’s:

These reviews are considered of · secrecy provisions concerning significance by all covered by them249. corporate law; They do not, however, cover all the areas · secrecy requirements regarding trust where action is needed and the review law; should be subject to additional testing to determine: · banking secrecy arrangements, and a. Which countries are willing to over- the willingness of the state to over- rule banking secrecy in cases of ride them when required; suspected tax fraud; · the availability of information to b. Which countries and territories exchange; actually hold the data required to · the willingness to exchange answer enquiries from other states information; on: · the speed with which information i. Beneficial ownership; exchange takes place; ii. Income received; · the speed with which assistance is iii. Tax paid; provided to ensure the effective recovery and repatriation of assets iv. Remittances made; illegally transferred from jurisdiction c. Which countries do in practice to jurisdiction as required by model exchange such information; taxation treaties; d. How long they take to do so. · willingness to promote enhanced standards for international tax This data could then be used in collection and international tax association with that noted in the next enforcement. section. Once confirmed these rankings would then be used to determine what appropriate 3. To use the data assessments counter-measures were required with undertaken by the OECD included in regard to states which refuse to cooperate ‘Towards a Level Playing Field’ in international taxation matters. Possible published as the ‘2006 Assessment courses of action need to be researched by the Global Forum on Taxation’ to (see section 4 of these recommendations). create a new ‘black list’ of uncooperative states with regard to The provision of direct assistance to international taxation. developing countries

This objective basis for determining The focus of this report is on closing the which states are and are not in practice floodgates which are presently allowing

the loss of considerable sums of taxation 249 See http://www.imf.org/external/np/rosc/rosc.as due. These losses are, inevitably, higher p for more information on these procedures.

Closing the Floodgates www.taxjustice.net 111 in the developed world than the 7. Technical help in developing taxation developing world as income and taxation measures to mitigate the effects of levels are higher in the developed world. tax avoidance and evasion; However, the reason for taking this action 8. Practical assistance in the supply of is argued to be that the additional information where mispricing is revenues earned can be used to achieve believed to have taken place at cost the Millennium Development Goals and to to the country in question; assist the developing countries of the 9. The supply of similar information, world to break free from aid dependency, without request where it is believed which in turn reduces the political that capital flight is taking place; accountability of their own governments. 10. The development of automatic information exchange regimes For achieve this shift to self-dependence between developed and developing on the part of developing countries, direct countries. assistance is required for: This list is indicative of what is possible. 1. The training of tax officials in The governments of developing countries developing countries including the are as much free agents as any other, and payment of salaries sufficient to make this report recognises it is for them to corruption or commercial sector assess their needs, determine their poaching unlikely; strategy and to ask for assistance if they 2. The provision of appropriate IT see fit. For too long one of the problems systems to developing country tax they have faced has been that tax authorities; solutions have been imposed upon them. 3. The promotion of locally appropriate This has to change. It is, however, accounting systems to enhance tax appropriate to note that the transfer of declaration. These may be quite appropriate expertise, technology, different from those used in information and support to the taxation developed countries; authorities of these countries is bound to 4. The design of taxes suited to local be of benefit to them in developing strong circumstances. This might require and predictable income streams based on abandonment of the current IMF taxation. conditionality that has required the abandonment of tariffs and the There is one further way in which promotion of the idea that VAT and developed countries can assist in this other indirect taxes are the solution process. When negotiating double tax to all taxation problems when it is treaties with developing nations they apparent form experience on the might offer to use the UN model tax ground that this is not the case. treaty rather than the OECD model tax 5. Support for identifying financial treaty as a basis on which to work. The crime; UN model tends to favour developing 6. Assistance for initiatives such as the countries as it has a bias to source based Extractive Industries Transparency taxation inherent within it. Initiative250, and their expansion to all material sectors of the economy; To promote research

If this report has proved anything it is that 250 See http://www.eitransparency.org/section/about in many vital areas insufficient is known eiti accessed 28-1-07 about the scale of the problems of capital

Closing the Floodgates www.taxjustice.net 112 flight and tax evasion. For example too endorse any effort that can be taken to little is known about: research these issues more fully.

14. Funds held offshore; In addition this report has provided the most comprehensive list of 15. Capital flight flows; recommendations on how this problem 16. The actual target destination of can be tackled ever published. These foreign direct investment; recommendations require fuller appraisal 17. What is happening in the tax havens to test their operational practicability: (although research over recent years has helped); 11. Mechanisms on promoting automatic information exchange for individuals, 18. The extent to which information trusts and bodies created by statute sharing is taking place; law; 19. The cost that offshore and other tax 12. What an appropriate Code of Conduct planning activities impose on for the professions might look like; governments; 13. Practical mechanisms to prevent trade 20. The size of the tax gap around the mispricing, including those referred to world; by Simon Pak in his chapter 21. The structure of the world’s major 14. Alternatives to the current ‘arm’s corporations and the degree to which length principle’ basis for their decisions are tax driven; international corporate taxation 22. The economic impact of trade which is now outmoded; mispricing; 15. Methods of accounting for 23. The role of tax competition in governments which might development and the potential costs communicate key information to that have arisen from it; taxpayers to induce greater tax compliance; 24. The real role of the tax intermediaries and their professional bodies in 16. Appropriate accounting systems for promoting tax avoidance, and what use in developing and other countries can be done about it; that might assist tax compliance; 25. The impact of the tax losses arising 17. Ways in which tax codes might be from offshore and other tax planning simplified whilst broadening the both on income distribution per head taxation base; and also on distribution by gender and 18. Means of successfully introducing between ethnic and race groups; general anti-avoidance principles into 26. The impact of tax planning on trade taxation law; and the loss of welfare that might 19. The possibility of creating a world tax result from the distortions that tax authority and what powers it might planning and tax driven corporate need to regulate this sector; structures add into the trade mechanisms of the world. 20. Ways in which taxes might be charged on MNCs on a global basis.

This list is, like that in the previous section, indicative. The authors strongly This is an ambitious programme. However, action in this area has the greatest

Closing the Floodgates www.taxjustice.net 113 possibility of raising the funds needed to and in particular the IMF and World Bank, pay for the Millennium Development to tackle the fiscal termites in the global Goals, to fund stable developing countries financial architecture has nurtured a tax and to provide the security needed as environment in which crime pays. governments move on to face the growing Determined measures are needed to roll problem of global warming. This agenda back this criminogenic environment and might be bold, but the problems re-establish public respect for the identified are huge in scope and bold integrity and equity of national tax measures are called for. The failure on systems. the part of the international community,

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Chapter 10 Tackling harmful tax practices

David E. Spencer JD LLM, Attorney

The seminal 1998 report “Harmful Tax tax havens and into OECD member Practices: An Emerging Global Issue” of countries, and in particular the OECD the Organization for Economic financial centres. Cooperation and Development (“OECD”) played a pioneering role in focusing · Although the OECD has repeatedly attention on tax avoidance/tax evasion in emphasized “effective exchange of the international context. That 1998 information”, the OECD Proposals OECD Report resulted in the OECD’s would only require exchange of Proposals on Harmful Tax Practices, information upon request. However primarily transparency and exchange of exchange of information upon request information requirements. These OECD does not constitute effective Proposals have been analyzed and exchange of information. Automatic debated within the structure of the exchange of information would be OECD, primarily in the OECD’s Forum on more effective, but there are Harmful Tax Practices. technical problems in implementing automatic exchange of information. However, the OECD’s Proposals on The OECD has made significant Harmful Tax Practices have not been efforts in trying to resolve the implemented: technical problems in automatic exchange of information. · The OECD’s Proposals would impose on jurisdictions designated by the In view of the failure of the OECD OECD as tax havens, obligations of Proposals, the forum, the message and transparency and exchange of the players have to change. information that some OECD member countries, in particular the OECD financial centres, were not willing to 1. The United Nations accept for themselves. The tax havens rebelled, using a “level Since the Monterrey Consensus of 2002, playing field” argument. The OECD the United Nations has called upon capitulated, and has in effect developing countries to mobilize converted the OECD Proposals into a domestic resources for development. voluntary program which each OECD The World Summit Outcome of September designated tax haven may or may not 2005 adopted by the General Assembly of implement. the United Nations also emphasized that developing countries have to mobilize · The OECD’s Proposals did not domestic resources for development. But confront or even admit a major the massive capital flight from third problem in the international financial countries into OECD financial centres and architecture: Capital flight from into other tax havens financial centres, third countries into OECD designated

Closing the Floodgates www.taxjustice.net 115 and the resulting tax evasion and loss of other countries. Thus, governments tax revenue in developing countries in onshore and offshore financial severely undercuts the ability of centres knowingly aid and abet developing countries to mobilize corruption. domestic resources. Indeed the 2005 World Summit Outcome confirmed that The International Financial Institutions “We therefore resolve… to support efforts (World Bank, IMF, African Development to reduce capital flight and measures to Bank, Asian Development Bank, Inter- curb the illicit transfer of funds.” American Development Bank, European Investment Bank, and European Bank for Developing countries and countries which Reconstruction and Development) are are not financial centres have been preparing a uniform framework for remarkably passive in the United Nations preventing fraud and corruption. That about the capital flight issue. The Group uniform framework should include capital of 77 and China should emphasize this flight and the resulting tax evasion within issue at the United Nations, and adopt a the definition of corruption. more dynamic and forceful position at the United Nations, whether it be in the Civil society has to focus on this issue, General Assembly, ECOSOC or in the UN and publicize this issue. Also, Committee of Experts on International governments of developing countries and Cooperation in Tax Matters. of countries which are not financial centres have to bring this aspect of 2. Tax Evasion/Tax Avoidance and corruption within the scope of the United Capital Flight as Corruption Nations Convention Against Corruption.

The TJN has noted that civil society groups like Transparency International 3. The GT-7 have focused on corruption in developing countries, without considering that The problem of capital flight to OECD financial institutions and governments in financial centres and other tax haven the OECD financial centres and other tax financial centres, and the resulting tax haven financial centres are key evasion was discussed in the two papers facilitators and participants in capital that form the basis of the GT-7 program. flight and tax evasion/tax avoidance These were the Landau Report251 which clearly constitute forms of commissioned by President Jacques corruption. Examples include: Chirac and the Lula Report252, Action against Hunger and Poverty. · Corruption by financial intermediaries that knowingly encourage and Although the GT-7 has focused on facilitate capital flight and the “solidarity type taxes”, the volume of tax resulting tax evasion. evasion resulting from capital flight is · Public sector corruption by the governments in the onshore and 251 offshore financial centres that http://www.conservationfinance.org/Docume provide bank secrecy and other nts/CF_related_papers/Landau_commission_a confidential treatment in tax rticle2.pdf accessed 26-1-07 matters, which facilitates and 252 encourages capital flight from other http://www.cttcampaigns.info/documents/br azil/Report-final per cent20version.pdf countries and tax evasion in those accessed 26-1-07

Closing the Floodgates www.taxjustice.net 116 much more serious: The TJN has While continuing their laudable efforts to estimated that the lost tax revenue implement solidarity type taxes, the GT-7 annually from capital flight is about countries should focus on the much more US$255 billion on a world wide basis. serious problems: the loss of tax revenue due to capital flight and the resulting tax evasion.

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Chapter 11 Capital Flight and Tax Avoidance through Abnormal Pricing in International Trade – the issue and the solution

Simon J. Pak, Ph.D. Academic Division Head and Associate Professor of Finance The Pennsylvania State University, School of Graduate Professional Studies

In June 2005, the U.S. imported 32,000 analysis of the U.S. merchandise import GM of scrap gold from Mexico and paid and export data published by the U.S. US$825,000. What is interesting about Government reveals abnormally low this import is that the unit value of the priced U.S. imports and abnormally high scrap gold US$25.78/GM (equivalent to priced exports are quite common US$801.85/oz) is substantially higher than the price of pure gold at the time, For example, total exports from the Czech about US$14.16/GM (equivalent to Republic to the U.S. were reported to be US$440.85/oz.) The U.S. importer clearly US$2.21 billion in 2005. This sum did overpaid for the scrap gold, sending however represent an estimated capital to Mexico and reducing taxable underreported amount through abnormally income. low prices of US$1.25 billion when calculated as deviations from lower In August 2005, the U.S. imported 46 quartile prices. Congo’s 2005 total export million GM of gold doré253 from Peru at to the U.S. were reported to be US$262 US$1.79/GM (equivalent to million with an estimated underreported US$55.54/oz), paying a total of US$82 amount of about US$35 million. In fact, the million. The median price for gold doré total underreported amount in all of the is US$12.47/GM based on an analysis of U.S. imports from all countries was the 2005 U.S. import data. The Peruvian estimated at approximately US$202 billion exporter sold gold doré at an abnormally in 2005 through abnormally low priced low price, sending capital to the U.S. in imports. [See table 1] the form of valuable commodity equivalent to about US$574 million in In 2005, the Philippines imported a total of value for a mere US$82 million payment US$6.9 billion worth of merchandise from and reducing taxable income. the U.S. The estimated over-reported value of the Philippines’ imports from the The two examples above are not U.S. was US$1.1 billion through abnormally particularly unusual. A detailed statistical high priced imports from the U.S. when measured as deviations from upper quartile prices. Similarly, Malaysia’s 2005 253 Gold doré (pronounced gold doh-rey) is a bar of semi-purified gold (e.g. bullion) imports from the U.S. included

Closing the Floodgates www.taxjustice.net 118 approximately US$1.4 billion as an Abnormally low priced import transactions estimated over-reported amount. In fact, may reflect attempts to avoid or reduce the total over-reported amount in all of import duties or the dumping of foreign the U.S. exports to all countries was produced goods at below market prices as estimated as approximately US$50 billion a means of driving out domestic in 2005 through abnormally high priced competition.255 exports. [See table 2] Similarly, abnormally low priced export The underreported amount of US$202 transactions may be utilized to avoid billion in the 2005 U.S. merchandise income taxes by reporting lower revenue imports and the over-reported amount of resulting in a smaller amount of taxable US$50 billion in the 2005 U.S. merchandise profits reported. They may facilitate exports represent 12.1 per cent of total capital flight and money laundering by U.S. imports and 5.5 per cent of total U.S. shipping valuable merchandise at prices exports respectively. substantially lower than true market value. This has the effect of sending valuable Abnormally priced imports and exports merchandise instead of money through may be due to recording or clerical errors seemingly legitimate export transactions. in customs documents, heterogeneity of Abnormally high priced exports may also products within a give harmonized be used to exploit export subsidies commodity code classification, or false available from several developing countries invoicing. Physical inspection and/or with export incentives. investigation by the customs authority are necessary to determine the exact Abnormally priced import and export explanation for each abnormally priced transactions can be detected easily using a trade. statistical approach, such as “price filter matrix.” A price filter matrix can be False invoicing facilitates capital constructed by calculating median price, movement, money laundering, and duty or upper quartile price, and lower quartile income tax avoidance. Abnormally high price for each harmonized commodity code priced import transactions may be used to by country using the most detailed import avoid income taxes by reporting high cost and export database collected and of goods sold resulting in a smaller amount maintained by a customs agency of a of taxable profits reported. They may country. Mean and standard deviation of facilitate capital flight and money prices may be calculated instead of median laundering through remittances disguised and upper/lower quartile prices. as seemingly legitimate payments for merchandise imported which has The price filter matrix constructed may substantially lower value than being then be used to set an upper bound and a reported. They may also conceal illegal lower bound of prices to determine each commissions that are hidden in the inflated import and export transactions as prices.254 abnormally high or abnormally low.

The price filter matrix can be built for each commodity code and trading country 254 De Boyrie, M., Pak, S.J., and Zdanowicz, combination, may be effective in J.S. Money Laundering and Income Tax identifying abnormally priced import and Evasion: The Determination of Optimal Audits and Inspections to Detect Abnormal Prices in International Trade Journal of Financial 255 Ibid Crime, Vol. 12, No. 2, 2004.

Closing the Floodgates www.taxjustice.net 119 export transactions, can be used for real- ii) Employ a network of workstations time inspection of cargo, and can also be and servers at the country’s ports used to estimate the amount of over- and to facilitate the computerized under- pricing in export/import analysis of international trade transactions. The steps described above prices in real time; can be automated through the use of computerized processes. Once an import or iii) Use a printed price filter matrix if export transaction is flagged as abnormally the country does not currently priced, the customs agency will need to have computerized trade data inspect physically and investigate the entry system and need to flagged transaction in detail to determine implement the system manually; if the price of the flagged transaction is due to false invoicing or not. This approach iv) Decide who will conduct the audit will facilitate efficient customs clearance of trade documents and the and fast movement of merchandise cargo physical inspection of cargo with at the ports. suspected transactions prices. This can be done by a private A price filter matrix is calculated and used inspection firm or its customs in estimating the amounts of capital agency. movement and income shifting for 2005 U.S. imports and exports in tables 1 and 2. The dollar amounts are computed by aggregating the amount deviated from lower quartile price for every abnormally low priced U.S. import and the amount deviated from upper quartile price for every abnormally high priced U.S. export.

Countries adopting the statistical approach using a price filter matrix will be able to control and determine, by adjusting the upper and lower price bounds, both the level of physical inspection and the means of inspection that will result in the cost effective monitoring of their international trade flows.

When a country plans to implement the statistical approach in monitoring the transaction prices of international trade in an effort to minimize capital flight, duty and income tax avoidance, and money laundering, the following steps may be considered: i) Generate and update the relevant statistical price filter matrix regularly;

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Table 2: 2005 Top 25 Sources of Capital & Income Shift to the U.S. through Abnormally Low Priced Import Transactions

Amount Shifted Import 2005 Total Import (billion) Amount Ratio to Import Amount (billion) All Countries $1,670.9 $202.1 12.1 per cent Canada $287.9 $15.6 5.4 per cent China $243.5 $18.5 7.6 per cent Mexico $170.2 $10.2 6.0 per cent Japan $138.1 $31.5 22.8 per cent Federal Republic of Germany $84.8 $25.6 30.2 per cent United Kingdom $51.1 $9.5 18.6 per cent Korea, South $43.8 $6.0 13.6 per cent Taiwan $34.8 $3.8 10.9 per cent Venezuela $34.0 $0.9 2.7 per cent France $33.8 $9.5 28.0 per cent Malaysia $33.7 $1.8 5.4 per cent Italy $31.0 $6.8 22.0 per cent Ireland $28.6 $3.0 10.6 per cent Saudi Arabia $27.2 $0.8 2.9 per cent Brazil $24.4 $1.3 5.4 per cent Nigeria $24.2 $0.6 2.3 per cent Thailand $19.9 $1.3 6.3 per cent India $18.8 $1.9 10.3 per cent Israel $16.9 $1.1 6.8 per cent Russia $15.3 $0.3 2.3 per cent Singapore $15.1 $11.5 76.2 per cent Netherlands $14.9 $10.9 73.2 per cent Sweden $13.8 $2.7 19.6 per cent Belgium $13.0 $3.0 22.8 per cent Switzerland $13.0 $3.9 30.0 per cent

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Table 2: 2005 Top 25 Sources of Capital & Income Shift to the U.S. through Abnormally High Priced Export Transactions

Amount Shifted Export 2005 Total Export (billion) Amount Ratio to Export Amount (billion) All Countries $904.4 $49.7 5.5 per cent Canada $211.4 $7.3 3.5 per cent Mexico $120.0 $5.6 4.6 per cent Japan $55.4 $3.4 6.2 per cent China $41.8 $2.6 6.1 per cent United Kingdom $38.6 $3.3 8.5 per cent Federal Republic of Germany $34.1 $2.4 6.9 per cent Korea, South $27.7 $1.6 5.7 per cent Netherlands $26.5 $1.8 6.8 per cent France $22.4 $1.5 6.6 per cent Taiwan $22.0 $2.0 9.2 per cent Singapore $20.6 $1.3 6.5 per cent Belgium $18.6 $1.3 6.8 per cent Hong Kong $16.3 $1.3 8.1 per cent Australia $15.8 $1.0 6.1 per cent Brazil $15.3 $1.0 6.3 per cent Italy $11.5 $0.7 6.0 per cent Switzerland $10.7 $0.4 4.0 per cent Malaysia $10.5 $1.4 13.8 per cent Israel $9.7 $0.5 5.6 per cent Ireland $9.3 $0.5 5.7 per cent $8.5 $0.4 4.4 per cent India $8.0 $0.5 6.2 per cent Thailand $7.2 $0.4 6.0 per cent Spain $6.9 $0.4 5.6 per cent Philippines $6.9 $1.1 16.5 per cent

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Selected Bibliography

Baker, R. 2005, Capitalism’s Achilles Heel, John Wiley & Sons, New Jersey

Christian Aid UK, 2007, A Rich Seam: Who Benefits From the Commodity Price Rise?

Deneault, A. 2004, Paul Martin & Companies, Talonbooks, Vancouver

Epstein, G.A. (ed) 2005, Capital Flight and Capital Controls in Developing Countries , Edward Elgar, Cheltenham

Hampton, M.P. and Abbott, J.P. 1999, Offshore Finance Centres and Tax Havens, MacMillan, Basingstoke

Hiatt, S. (ed) 2007, A Game As Old As Empire, Berrett-Koehler Publishers, San Francisco

LeRoy, G. 2005, The Great American Jobs Scam: Corporate tax dodging and the myth of job creation, Berrett-Koehler, San Francisco

Lynch, R.G. 2004, Rethinking Growth Strategies, Economic Policy Institute, Washington D.C.

Martens, J. 2007, The Precarious State of Public Finance, Global Policy Forum (Europe)

Mitchell, A, et al, 2002, No Accounting For Tax Havens, Association for Accountancy & Business Affairs, Basildon

Murphy, R., Christensen, J. and Kimmis, J. 2005, tax us if you can, TJN, London

Oxfam Great Britain, 2000, Tax Havens: Releasing the Hidden Billions For Development, Oxford

Palan, R., 2003, The Offshore World, Cornell University Press, New York.

Rowell, A. et al 2005, The Next Gulf: London, Washington and Oil Conflict in Nigeria, Constable, London

Sharman, J., 2006 Havens in a Storm, Cornell University Press, New York.

Stiglitz, J.E. and Charlton, A. 2005 For All, Oxford University Press, Oxford

Sustainability, 2006, Taxing Issues: Responsible business and tax, London

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Appendix 1 Millennium Development Goals

The Millennium Development Goals are a the cost is utterly affordable. Whatever statement of hope, and of vision, coupled one’s motivation for attacking the crisis to the practical objective of realising of extreme poverty—, them: religious values, security, fiscal prudence, ideology—the solutions are the “We have the opportunity in the coming same. All that is needed is action.” decade to cut world poverty by half. Billions more people could enjoy the (From Investing in Development, the fruits of the global economy. Tens of Millennium Project Report) millions of lives can be saved. The practical solutions exist. The political The Goals are: framework is established. And for the first time,

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How much will it cost to meet the Despite the rhetoric surrounding the MDGs? MDGs, to date less than half the ODA resources needed to meet the MDGs have In 2001, the UN Zedillo commission materialized. This problem of insufficient estimated that an additional US$50 billion ODA has been compounded by problems would be required every year to help in the mobilization of domestic resources reach the MDGs256. Estimates from others, owing to increasing tax evasion, including the World Bank, placed the aggressive tax avoidance, harmful tax annual costs in the range of US$50billion - competition, poor fiscal policies and US$75 billion257. capital flight.

The UN Millennium Project has recently According to the UN, sub Saharan Africa, estimated that meeting the MDGs will the poorest region in the world which cost US$121 billion in 2006 rising to also has the lowest human development US$159 billion 2010 through to US$189 indicators, is not on track to meet any of billion in 2015 which will need overseas the MDGs. In fact, of the 18 indicators development aid (ODA) to nearly double measured by the UN 11 have shown no to US$195 billion in 2015258. change or worse have deteriorated. South Asia is also off track on 14 of the 18 Is the cost being met? indicators. Even in Latin America and the Caribbean about half of the indicators are Even accounting for the recent increases off track260. in ODA and the commitments made by the G-8 and the European Union, there is The way forward likely to be an annual shortfall of at least about US$50 billion even under optimistic It is important to note that the MDGs are scenarios. not an end goal in themselves but merely a small step towards tackling poverty in The MDGs and other development goals the poorest countries in the world. Even cannot be met by aid inflows alone. when the MDG targets are met, more There is a need to go back to the UN than 658 million people will still be living Monterrey Consensus which placed the in abject poverty, 520 million will be mobilization of domestic resources at the severely undernourished and 1,827 heart of the development agenda259. million will have to make do without access to proper sanitation facilities261. The MDGs are off-track This means much more needs to be done beyond reaching these goals to set 256 United Nations “Report of the High Level countries on a sustainable path to Panel on Financing for Development” (Zedillo development and this will require Report) 2001. resources which are an order of 257 http://www2.undg.org/documents/3018- Overview_of_MDG_Costing_Methodogies_- _Literature_review.doc 260 258 Jeffery Sachs, John McArthur & Guido http://mdgs.un.org/unsd/mdg/Resources/Sta Schmidt-Traub, What it will take to meet the tic/Products/Progress2006/MDGProgressChart Millennium Development Goals, Sustainable 2006.pdf Development International 2005 261 Jeffery Sachs, John McArthur & Guido 259 Schmidt-Traub, 2005, ibid http://www.un.org/esa/ffd/Monterrey/Monte rrey per cent20Consensus.pdf

Closing the Floodgates www.taxjustice.net 125 magnitude greater than the hundreds of billions required just to meet the MDGs. That is why the recommendations made in this report are so important.

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Appendix 2 Corporate tax rates

Data prepared by Richard Murphy. Sources: KPMG Corporate Tax Rate Surveys 1997 – 2005 http://www.kpmg.com/Services/Tax/IntCorp/CTR/ and the CIA World Fact Book

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Appendix 3 The world’s tax havens and the firms

that operate in them

Total KPMG KPMG E&Y E&Y PWC PWC Deloitte Deloitte Tax Havens Havens 1 2 1 2 1 2 1 2

Major Financial Centres Belgium 1 1 1 1 1 1 1 1 City of London 1 1 1 1 1 1 1 1 Frankfurt 1 1 1 1 1 1 1 Hong Kong 1 1 1 1 1 1 1 1 Netherlands 1 1 1 1 1 1 1 1 New York 1 1 1 1 1 1 1 1 South Africa 1 1 1 1 1 1 1 1 Switzerland 1 1 1 1 1 1 1 1 Tel Aviv 1 1 1 1 1 1 1 1 Sub Total: Major Financial Centres 9 9 9 8 9 9 9 9 9

Premier Havens British Virgin Islands 1 1 1 1 1 1 1 1 Cayman Islands 1 1 1 1 1 1 1 1 Cyprus 1 1 1 1 1 1 1 1 Dubai 1 1 1 1 1 1 1 1 Guernsey 1 1 1 1 1 1 1 1 Ireland 1 1 1 1 1 1 1 1 Isle of Man 1 1 1 1 1 1 1 1 Jersey 1 1 1 1 1 1 1 1 Liechtenstein 1 1 1 1 1 1 1 Luxembourg 1 1 1 1 1 1 1 1 Singapore 1 1 1 1 1 1 1 1 The Bahamas 1 1 1 1 1 1 1

Sub Total: Premier Havens 12 12 12 11 12 12 12 11 12

Mid-range Havens Aruba 1 1 1 1 1 1 1 1 Bahrain 1 1 1 1 1 1 1 1 Barbados 1 1 1 1 1 1 1 1 Bermuda 1 1 1 1 1 1 1 1 Costa Rica 1 1 1 1 1 1 1 1 Dominica 1 1 1 1 1 Gibraltar 1 1 1 1 1 Hungary 1 1 1 1 1 1 1 1 Iceland 1 1 1 1 1 1 1 1

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Labuan 1 1 1 1 1 1 1 1 Lebanon 1 1 1 1 1 1 1 1 Macau 1 1 1 1 1 1 1 Malta 1 1 1 1 1 1 1 1 Mauritius 1 1 1 1 1 1 1 1 Netherlands Antilles 1 1 1 1 1 1 Panama 1 1 1 1 1 1 1 1 Taipei 1 1 1 1 1 1 1 1 Turks & Caicos Islands 1 1 1 1 Uruguay 1 1 1 1 1 1 1 1 US Virgin Islands 1 1

Sub Total: Mid-range Havens 20 17 20 14 17 20 19 17 17

Minor Havens Andorra 1 Anguilla 1 1 Antigua & Barbuda 1 1 1 1 Belize 1 1 1 Grenada 1 1 1 1 Madeira 1 1 1 1 Monaco 1 1 Saint Lucia 1 1 1 1 1 Saint Vincent & the Grenadines 1 1 1 St Kitts & Nevis 1 1 1 The Cook Islands 1 1 1 The Maldives 1 1 1 1 1 Trieste 1 1 1 1 1

Sub Total: Minor Havens 13 9 9 0 9 6 6 1 4

Notional Havens Alderney Campione d'Italia Ingushetia Liberia Marshall Islands 1 1 Melilla Montserrat Nauru Niue Samoa Sao Tome e Principe Sark Somalia The Marianas 1 1 1 The Seychelles 1 Tonga Turkish Republic of Northern

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Cyprus

Vanuatu

Sub Total: Notional Havens 18 0 1 0 1 0 0 2 2

Total 72 47 51 33 48 47 46 40 44

Source: Tax Havens from Tax Us if You Can, a TJN publication. Source: Accountancy and Audit firms column "1" from firm's own websites. Source: Accountancy and Audit firms column "2" from Google search engine.

Research undertaken by Chris Steel BSc, ATTAC and TJN Jersey http://www.jersey.attac.org/

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Appendix 4

WORLD SOCIAL FORUM, NAIROBI, KENYA, JANUARY 2007

MIRROR, MIRROR ON THE WALL, WHO’S THE MOST CORRUPT OF ALL?

John Christensen

Abstract have been consistently ignored. The paper concludes with a number of The current pre-occupation of the World recommendations for how perceptions of Bank and G-8 countries with corruption corruption can be re-aligned to take and money-laundering is based on a account of how ‘supply side’ factors narrow definition of both issues, which influence global corruption. ignores the role of the offshore financial system in encouraging and facilitating Corruption: a game for two or more capital flight and tax evasion. In focusing players their agenda on bribery of public officials, these institutions have shaped Since the mid-1990s corruption has moved perceptions of corruption around the to the centre stage of . In concerns of multinational companies, 1995 Transparency International (TI) which, driven by the pursuit of profit, launched its international Corruption want to reduce the ‘cost’ of bribery, but Perception Index (CPI) which encouraged are unconcerned about the wider costs to the international media to give greater society arising from their own aggressive prominence to corruption whilst also tax avoidance policies and the broader exerting pressure on politicians, banks and economic impact of the globalised international funding agencies to rank banking industry which encourages rich corruption amongst the core criteria for individuals to hold their assets offshore assessing credit risk and aid-worthiness. where they can evade taxes with almost That same year, in its year-end editorial total impunity. the Financial Times nominated 1995 the International Year of Corruption and This paper examines how ideological identified the issue as a major impediment factors have shaped the geography of the to cross-border investment and growth. corruption discourse to identify Since that time a plethora of initiatives developing countries, particularly in have been set in motion at the highest Africa, as the primary locus of levels to tackle corrupt practices, most corruption, whilst concerns about how notably the OECD’s Anti-Bribery Convention the prevailing financial infrastructure (1999) and the UN Convention Against profits from handling the proceeds of Corruption (2003). Corruption has become criminal activity, including tax evasion, a central feature of the development Closing the Floodgates www.taxjustice.net 132

discourse, with key players, including the Crime has become increasingly complex, International Monetary Fund, the World frequently involving cross-border Bank and the UK Department for transactions based on the arbitrage of International Development, identifying differences between national legal or tax corruption as an impediment to growth regimes. The relative ease with which such and stability.262 Corruption is also crimes can be perpetrated undermines increasingly seen as threatening equality public confidence in the rule of law, and and social stability, harming public trust corrodes the integrity of democratic forms in state institutions and governance,263 of government. Some commentators and damaging public confidence in identify the source of this high-level business integrity.264 corruption as stemming from the divergence of capitalism away from the The deepening of globalised markets moral philosophy upon which Adam Smith since the 1970s is seen as having based his vision of free, competitive increased the opportunities for markets towards the utilitarian ideas of corruption. The emergence of globalised Jeremy Bentham: corporations with huge financial and political power relative to national “ . . his (Smith’s) vision for this new governments has provided additional economic order anticipated leaders of resources for high-level corruption. The integrity, prudence, modesty and grace rapid pace of transfer of state assets to who would operate the free-market private ownership in North and South system with a sense of justice and fair created opportunities for embezzlement play. Unfortunately, Smith’s moral of both assets and the income flows from sentiments got separated from his those assets. The globalisation of economics. The greatest good for the financial markets, and in particular the greatest number – “maximising” – creation of a poorly regulated globalised became the foundation of structure of secretive offshore financial utilitarianism, a competing school of centres, has facilitated the cross-border thought much more compatible with transfer and laundering of dirty money. budding capitalists.”265 In combination these factors have stimulated a virtual free-for-all in which Economic theory about corruption is illegal transactions have become almost underdeveloped and consequently tends indistinguishable from legitimate not to take account of the way in which transactions, and criminals are able to economic policies can create ‘criminogenic draw upon the services of a sophisticated environments’ which stimulate crime.266 ‘pinstripe infrastructure’ of legal and This is illustrated by the rapid growth of financial advisers. tax evasion which swelled in the wake of capital account liberalisation in the 1980s. The IMF promoted capital account 262 See, for example, Kaufmann, D (1997) liberalisation despite the evidence that The Missing Pillar of a Growth Strategy for offshore secrecy would hinder investigation Ukraine: Reforms for Private Sector Development in Cornelius, P. and Lenain, P. (eds) Ukraine: Accelerating the Transition to 265 Market, IMF, Washington Baker, R.W. & Nordin, J. How dirty money thwarts capitalism’s true course Financial 263 See The Fight Against Corruption, Times, 11 October 2005 Pontifical Council for Justice and Peace, 21 266 September 2006 Black, W.K. (2005) When Fragile Becomes Friable: Endemic Control Fraud as a Cause of 264 Hutton, W. (2005) The monster within Economic Stagnation and Collapse paper given us all, Editorial Comment, The Observer, 26 at the IDEAS Workshop, New Delhi, India, 19-20 June December Closing the Floodgates www.taxjustice.net 133

efforts and make tax evasion virtually cost on business, bribery and kickbacks undetectable, especially in the case of being the foremost issue of concern in this developing countries with limited respect, without paying attention to issues resources available for tax fraud such as tax evasion and trade mispricing detection. Predatory financial which involve business imposing costs on intermediaries recognised that profitable the rest of society. Concerns have been fees could be earned from selling tax expressed about the methodological biases dodging services on an industrial scale, of the CPI,268 and critics argue that the and a culture of ‘crime pays’ became index distorts the geography of corruption rampant. The intriguing question is by reinforcing negative images of whether the IMF anticipated this outcome developing countries and ignoring the but considered tax evasion a minor evil or higher level corruption of major companies whether this was an unintended and governments from the North.269 consequence of its commitment to the Washington Consensus. The CPI identifies Africa as the most corrupt region of the world, accounting for The incidence of tax evasion, and the over half of the ‘most corrupt’ quintile of scale of its impact on the revenue income countries in the 2006 index. A critical of poorer countries, has risen examination of the index, however, reveals significantly in the past three decades, that 53 per cent of the countries identified but for the greater part this crime is by the CPI as ‘least corrupt’ are offshore scarcely recognised by those who have tax havens, including Iceland and New shaped the current corruption debate. Zealand (minor players but both ranked The reason for this omission might partly joint 1st overall) and major centres such as arise from the general adoption of TI’s Singapore (ranked 5th overall), Switzerland definition of corruption as “the misuse of (7th), United Kingdom and entrusted power for private gain.”267 Operationally this definition has been interpreted in a way which largely focuses on the activities of those who hold power in the public sphere (politicians and state employees) and little attention has been paid to other power elites, including company directors, and financial intermediaries.

It is debatable whether TI intended to shape the corruption debate in this way, but the tendency to treat corruption as synonymous with bribery of public sector officials is partly due to the methodology of the CPI, which draws on the perceptions of businesses and a narrow range of think tanks. Unsurprisingly this 268 See, for example, Galtung, F. (2006) community has tended to concentrate on Measuring the Immeasurable: Boundaries and those areas of corruption which impose a Functions of (Macro) Corruptions Indices, in Sampford, C. et al (eds), Measuring Corruption, Ashgate Publishing 267 269 Christensen, J. (2006) Corruption and the www.transparency.org/news_room/faq/corru role of tax havens, Tax Justice Focus, Volume ption_faq 2, No. 3, pp7-8 Closing the Floodgates www.taxjustice.net 134

Luxembourg ( joint 11th), Hong Kong encouraging illicit capital flight and tax (15th), Germany (16th), USA and Belgium evasion by offering secretive offshore (jointly 20th). For good measure facilities and soft regulation. Barbados, Malta, and the United Arab Emirates (all tax havens) also fall into the Trying to broaden the terms of debate upon ‘least corrupt’ quintile. Not a single which perceptions of corruption are shaped African nation is ranked in the ‘least is not merely an issue of semantics. corrupt’ quintile. Corruption is a politically contested issue, defined according to the “legal or social What do these rankings tell us about the standards constituting a society’s system of current politics of corruption? And who public order.”271 Cultural norms diverge could disagree with the former Nigerian significantly, for example in the way in politician who, during protracted which commissions are paid in return for negotiations to secure the repatriation of high-level introductions, and although a assets stolen by former Nigerian process of convergence is underway, which President Sani Abacha, commented that: might ultimately allow the formulation of a globally agreed definition of corruption, It is rather ironical that the European this is not likely in the foreseeable based Transparency International does future.272 In view of these definitional not think it proper to list Switzerland as complexities, some commentators argue the first or second most corrupt nation in that debate over definition might be the world for harbouring, encouraging counter-productive, proposing instead that and enticing all robbers of public the focus of anti-corruption initiatives treasuries around the world to bring should be less concerned with their loot for safe-keeping in their dirty identification of an all-embracing definition vaults.270 and more concerned with pin-pointing the The perversity of the CPI rankings specific activities which contribute to the reflects the general confusion and undermining of public confidence in the inadequacy of the current corruption integrity of the systems of governance of discourse. Through its operational focus public and private sector activity.273 One on the public sector, and its dependence critic argues that the CPI fails to fulfil a on the perception of a somewhat biased useful role in shaping the corruption range of actors - at least some of whom discourse, concluding that: have conflicts of interest – the CPI highlights one element of corruption . . it (the CPI) should no longer be without paying sufficient attention to published in its present form as it actually other aspects of corruption, including: undermines the efforts of reformers.274 Ø the activities of the supply side infrastructure of financial 271 intermediaries who market aggressive Philp, M. (2006) Corruption Definition and Measurement, in Sampford, C. et al (eds), tax dodging schemes and facilitate Measuring Corruption, Ashgate Publishing the laundering of the proceeds of 272 See Brown, A. J. (2006) What are we crime through offshore companies, trying to measure? Reviewing the basics of trusts and similar subterfuges; and corruption definition, in Sampford, C. et al, Ø the role of governments which Measuring Corruption, Ashgate Publishing actively collude in the process of 273 Miller, W.L. (2006) Perceptions, Experiences and Lies: What Measures Corruption and What do Corruption Measures Measure? in Sampford, C. et al, Measuring 270 Former Education Minister Professor Aliya Corruption, Ashgate Publishing Babs Fafunwa quoted in This Day, 6th June 2005 274 Galtung, F (2006) op cit Closing the Floodgates www.taxjustice.net 135

These criticisms of the CPI challenge its The political economy of the legitimacy as the lead indicator used by offshore system multilateral institutions and private banks when determining the credit It is impossible to conceive of the ratings of sovereign states. In its current possibility of combating corruption format the CPI creates a distorting prism without also tackling the broader issues from which the activities of tax havens of tax havens and the offshore economy. (most of which are closely linked to Tax havens provide an ‘corruption leading industrialised countries) are interface’ between the illicit and licit excluded. This bias might or might not economies. They distort global markets be derived from an ideological slant to the disadvantage of innovation and within TI itself, but the CPI’s deficiencies entrepreneurship; slow economic growth are sufficiently grave for its by rewarding free-riding and mis- methodology, and the uses to which it is directing investment; and increase global put, to be called into question. Disquiet inequality. The corruption interface about the CPI is not diminished by the functions through collusion between close involvement of multinational audit private sector financial intermediaries and accounting firm Ernst & Young in its and the governments of states which host production. Ernst & Young has itself offshore tax haven activities. The been implicated in a wide variety of majority of these states are major corruption cases, and operates in many developed nations and their dependent 275 offshore tax havens. territories. Despite the evocative images conjured up by the term ‘offshore’, it TI is aware of the shortcomings of its would be wrong to think of offshore as index. In the press documentation disconnected and remote from accompanying the results of the 2006 mainstream nation states. CPI, TI noted that: Geographically, the majority of the 70 or . . the [corrupt] transaction is often so recognised offshore tax havens are enabled by professionals from many located on small island economies fields. Corrupt intermediaries link givers dispersed across the spectrum of time and takers, creating an atmosphere of zones. From a political economic mutual trust and reciprocity; they perspective, however, these tax havens attempt to provide a legal appearance to are inextricably linked to major OECD corrupt transactions, producing legally states, and the term ‘offshore’ is strictly enforceable contracts; and they help to a political statement about the ensure that scapegoats are blamed in relationship between the state and parts 276 case of detection. of its related territories.277 In the British economy, for example, the bulk of It has yet to be seen, however, whether offshore transactions are controlled by and how TI can adapt the CPI to create the City of London (also classified as a an international comparator index (or tax haven) albeit that many City indices) which encompasses these financial intermediaries operate out of broader concerns about corruption. centres located on UK Overseas Territories and Crown Dependencies. These centres have a tangible form, with 275 See TJN’s blog on Ernst & Young’s involvement in the CPI at: quasi independent fiscal and judicial http://taxjustice.blogspot.com/2006/09/per systems, functional banks, trust ceptions-whose-perceptions.html companies and law offices, but in 276 Downloaded from http://www.transparency.org/news_room/in _focus/cpi_2006#pr on 2nd January 2007 277 Palan, R., (1999) op cit

practice they do not function evasion is not generally included in autonomously from the mainstream definitions of money-laundering despite economies. They are primarily of use to the fact that it involves criminal activity. the City because they offer zero or We must ask ourselves why not? minimal tax rates combined with secrecy Secondly, the initiative by the OECD to arrangements (including non-disclosure tackle tax evasion through information of beneficial ownership of companies and exchange agreements has not succeeded trusts) and regulatory regimes which are to anywhere near the extent that was more permissive or less inquisitive than originally expected; ditto the European those prevailing in onshore economies.278 Savings Tax Directive, which since coming into force in July 2005 has failed The defining feature of the offshore to meet initial expectations. interface is the element of secrecy it provides, either through banking secrecy The cause of these failures lies not with laws or through de facto judicial technical problems, which are arrangements and banking practices. surmountable, but with the lack of Secrecy creates an effective barrier to political will to achieve an international investigation by external authorities,279 framework for cooperation. The and facilitates the laundering of unsurprising outcome has been a massive proceeds from a wide range of criminal increase in cross-border dirty money activities, including fraud, flows, conservatively estimated at US$1 embezzlement and theft, bribery, narco- trillion annually.280 Half of this dirty trafficking, illegal arms-trafficking, money originates from developing counterfeiting, insider trading, false countries. The vast majority of these trade invoicing, , and funds are laundered via complex offshore tax evasion. This reveals a major fault ladders operating through the global line in the financial liberalisation banking system. Despite a plethora of process. Whilst capital has become anti-money-laundering initiatives the almost totally mobile, the ability to failure rate for detecting dirty money police cross-border dirty money flows is astonishingly high, with one movements is hindered by the lack of Swiss banker estimating that only 0.01 cooperative arrangements between per cent of dirty money flowing through national authorities. This applies in Switzerland is detected.281 It is unlikely particular to attempts to tackle tax that other major offshore finance evasion. There are a number of reasons centres, including Frankfurt, London and for this. Firstly, by definition capital New York, are any better. flight involves illicit cross-border transfers which almost invariably lead to Many major companies are heavily tax evasion in the country of residence of implicated in the establishment of the beneficial owner. However, tax complex offshore financial systems explicitly designed to hinder legitimate investigation by national authorities. 278 The British Channel Island of Jersey Experienced investigators refer to exemplifies this more permissive regime. The 2005 IMF inspection identified a problem with purposeful obstruction, even in cases the lack of investment into financial crimes where there is overwhelming evidence of investigation, but no additional resource has criminal activity. For example, Patrick been allocated since that time [Herbert, C., (2007) Jersey ‘lagging behind’ in financial th crime laws, Jersey Evening Post, 4 January] 280 Baker, R., (2005) op cit, p172 279 Christensen, J. and Hampton, M.P. (1999) op cit 281 Baker, R. (2005) op cit, p174

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Smith, editor of Africa Confidential, world in the sense that its external alleges in the context of illegal oil assets (i.e. including the stock of flight bunkering and corruption in Nigeria that capital) exceeds external liabilities (i.e. oil companies or their accountants external debt).285 The chronic poverty sometimes maintain “two sets of that afflicts the region arises from the accounts. They will show you the set of fact that the assets are largely held in accounts they want the government and private hands286, whilst the liabilities officials to see. There will be another have been assigned to the African public. one locked away.”282 In March 2005 the TJN published a Over one half of global cross-border briefing paper which estimated the stock trade is routed on paper through tax of private wealth held ‘offshore’ by rich havens, and about one-third of the assets individuals, and largely undeclared in the of the global rich are held in offshore country of residence, at about US$11.5 structures. The scale of the offshore trillion.287 The annual worldwide income interface is therefore immense, though on these undeclared assets is estimated many economists nonetheless overlook at about US$860 billion, and the annual offshore in their analysis, which might worldwide tax revenue lost on such explain their inability to explain the undeclared income is about US$255 ‘uphill’ movement of capital from poor billion. This figure significantly exceeds to rich nations despite the predictions of the sums needed to finance the UN’s economic theory.283 The prospect of Millennium Development Goals. Whilst financial crises might be a primary cause the majority of this US$11.5 trillion of of capital flight, but offshore secrecy undeclared assets originates from creates a strong incentive for the rich in developed countries, a significant developing countries to retain their proportion comes from developing assets in a tax-free environment. Most countries. For example, over 50 per cent analysts agree that the awesome scale of of the cash and listed securities of rich capital flight from Africa, estimated by individuals in Latin America is reckoned the African Union at US$148 billion to be held offshore.288 Data for Africa annually, results in a permanent drain of are scarce, but most analysts assume the between 80 – 90 per cent of the capital ratio to be comparable to Latin America to offshore financial centres in Europe, or higher. The African Union, for the Caribbean or North America.284 A study of Sub-Saharan African countries, 285 Boyce, J.K. and Ndikumana, L. (2005) for example, has concluded that the Africa’s Debt: Who Owes Whom? In Epstein, region is a net creditor to the rest of the G.A. Capital Flight and Capital Controls in Developing Countries, Edward Elgar, Cheltenham 282 Rowell, A., Marriott., and Stockman, L. 286 For example, in November 2006 members (2005) The Next Gulf: London Washington and Oil Conflict in Nigeria, Constable, of the Angolan opposition party Partido Democrático para Progreso demonstrated London outside the French embassy in Luanda accusing 283 Guha, K. (2006) GLOBALISATION – A government officials of hiding “billions of share of the spoils: why policymakers fear dollars . . on the Côte d’Azur.” [Thompson, ‘lumpy’ growth may not benefit all, C., Diary, London Review of Books, volume 29, Financial Times, 28 August, p11 No.1 4th January 2007] 287 284 Raymond Baker from the Global http://www.taxjustice.net/cms/upload/pdf/ Financial Integrity program (Washington, Price_of_Offshore.pdf D.C.), quoted from oral evidence given to the UK Africa All Party Parliamentary Group in 288 Boston Consulting Group (2003) Global January 2006. Wealth Report

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example, has estimated capital flight § Tax dodging undermines public from the Sub-Saharan region at US$274 respect for the rule of law and the billion, equivalent to 145 percent of the integrity of democratic government. total regional external debt.289 This loss easily eclipses the value of aid and debt The scale of tax dodging in poorer relief promised to African leaders at last countries has stimulated a vicious circle year’s G-8 summit at Gleneagles. of decline in investment in public services like education and vocational But the figure of US$255 billion in tax training, reducing their attractiveness to revenue lost to tax evasion on assets held both domestic and foreign investors. In offshore is only one part of the equation. its latest report on Latin America, the Developing countries also lose out to tax World Bank argues that governments evasion in the domestic context (often must give higher priority to spending on from activities in the informal economy), infrastructure likely to benefit the poor from tax avoidance on cross-border and increase expenditure on education trade, and from the pressures to and healthcare. In practice a large compete for investment capital through proportion of government spending in offering unnecessary tax incentives. In Latin America is skewed in favour of the combination these issues are estimated well off, and governments are collecting to cost developing countries far too little tax, especially from the approximately US$385 billion annually in wealthy. The World Bank report tax revenues foregone.290 This clearly concludes that: “on the tax front, first represents a massive haemorrhaging of items in the agenda would be the financial resource of many strengthening anti-tax evasion programs developing countries, which undermines and addressing the high levels of sustainability in a variety of ways: exemptions.”291 § Declining tax revenue income from the wealthy and high income earners Crucially the techniques used for tax forces governments to substitute dodging and laundering dirty money other taxes (typically indirect) with a involve identical mechanisms and consequent regressive impact on financial subterfuges: tax havens, wealth and income distribution; offshore companies and trusts, § Falling tax revenues force cutbacks foundations, correspondent banks, in public investment in education, nominee directors, dummy wire transport and other infrastructure; transfers, and an absence of financial transparency. Legal institutions granted § Tax dodging creates harmful market special status and privilege by society distortions, rewarding economic have been subverted to purposes for free-riders and penalising those who which they were never intended. For follow ethical practice; example, the original purpose of trusts was to promote the protection of spouses and other family members who are unable to look after their own affairs, and to promote charitable causes. 289 See UK Africa All Party Parliamentary Group (2006) The Other Side of the Coin: Incredible as it must appear to those not The UK and Corruption in Africa, p14 familiar with the offshore economy, 290 Cobham, A. (2005) Tax Evasion, Tax Avoidance and Development Finance Queen 291 Lopez, J.H. et al (2006) Poverty Elizabeth House Working Paper Series No. Reduction and Growth: Virtuous and 129, Oxford Vicious Circles, The World Bank, p101

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charitable trusts are regularly set up in dodgers.296 The law appears to serve no offshore tax havens for the purposes of other purpose. Jersey is a dependency owning ‘special purpose vehicles’ used of the British Crown and this law would for international tax planning and for have been presented to the Privy Council hiding both assets and liabilities for approval prior to its enactment. offshore, as happened with Enron, Since these ‘sham’ trusts will largely be Parmalat and Worldcom.292 created on behalf of high net-worth people from outside the island, it is clear Many examples can be cited of how the that the UK government is not serious offshore system has been constructed to about tackling the global tax dodging encourage corrupt activities and distort industry. global markets.293 Some of the smaller tax havens have played a lead role in this The United Kingdom is often seen as a process, partly because the scale of their key player in promoting the offshore legislatures makes it easier for major interface and thereby sustaining the banks and accounting firms to influence supply side of globalised corruption. This the political processes and secure assessment is based on a number of favourable regulatory and fiscal aspects of British economic policy which treatments.294 Economically vulnerable undermine public confidence in the small island economies (SIEs) are integrity of government policy and are particularly easy for global capital to ultimately harmful to national and capture in this way because of the small international interests. These are: scale of their governments and the lack § Britain’s domicile rules which of separation of legislative and judicial provide preferential treatment to processes.295 As a result, SIEs have often high net wealth persons resident but been prepared to enact new measures to claiming non-domiciled status in promote tax and regulatory competition Britain; on behalf of the organised tax avoidance industry. The British Channel Island of § Britain’s role as a defender of the Jersey, for example, introduced a new tax haven activities of its overseas trust law in May 2006 which allows the territories and Crown dependencies, creation and operation of ‘sham’ trusts including the continued abuse of which can only serve the purposes of tax European VAT rules by the Channel Island based fulfilment industry;

§ Britain’s extensive use of tax 292 Brittain-Catlin, W., (2005) Offshore: competition to gain international The Dark Side of the Global Economy, advantage, e.g. the tax free status of Farrar, Strauss and Giroux, New York, pp55- the London Eurobond market; 76 293 § Britain’s refusal to engage with other See Sikka, P. et al (2002) No Accounting for Tax Havens, AABA, Basildon, England European Union members in defining a common basis for taxing 294 See Palan, R., (1999) Offshore and the Structural Enablement of Sovereignty, in multinational businesses; Hampton, M.P., & Abbott, J.P., . (eds) Offshore Finance Centres and Tax Havens: The Rise of Global Capital, MacMillan, Basingstoke. 296 For further detail and analysis see: 295 Christensen, J. and Hampton, M.P. (1999) www.taxresearch.org.uk/Blog/2006/06/15/je A Legislature for Hire: The Capture of the rsey-passes-law-allowing- per cente2 per State in Jersey’s Offshore Finance Centre, cent80 per cent98sham per cente2 per cent80 in Hampton, M.P. & Abbott, J.P, op cit per cent99-trusts-for-use-by-tax-evaders/

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§ Britain’s role in undermining the infrastructure for high level corruption effectiveness of the European Britain is a lead player. Union’s Savings Tax Directive by failing to advise the European Commission that the directive as Pinstriped subversion agreed would allow interest paid to trusts to fall outside the tax I have to challenge some of my own deduction provisions. This omission inherited perceptions that London is appears to have been deliberate and safe, Lagos is not. Britain is free of has left a massive loophole in the corruption, but Nigeria is not. Much of 297 Savings Tax Directive. the corruption stems from London and Washington. Many of the mechanisms Furthermore many of the legal that keep Nigerians poor – the networks subterfuges that play a part in the of offshore bank accounts that offshore interface have their origins in companies use to bleed Nigeria dry of its British law. This includes offshore trusts profits – are based in tax havens that and shell companies, and the long were set up by the British and other standing concept of the separation of the colonial powers.299 place of incorporation of a company and the obligation to pay tax. The latter Tax dodging corrupts the revenue concept remains a key element of systems of the modern state and offshore tax planning. Britain, undermines the ability of the state to therefore, could play a major role in provide the services required by its tackling the supply side of corruption, citizens. It therefore represents a higher but successive governments have baulked form of corruption because it directly at the task. We must ask ourselves why deprives society of its legitimate public this been the case and, more generally, resource and undermines public trust in why: “The whole culture of Anglo- the rule of law and the equity of the tax American finance is increasingly system. Tax dodgers include institutions subversive of regulation, taxation and and individuals who enjoy privileged democratic values, even when it remains social positions but see themselves as an 298 within the law.” The root of this elite detached from normal society and problem might partly lie with the reject “any of the obligations that unhealthy proximity between major citizenship in a normal polity implies”.300 financial intermediation businesses and This group comprises the rich and high key Whitehall departments, including income earners, plus a pinstripe and especially the Treasury, and the infrastructure of professional bankers, extent to which the main political parties lawyers, and accountants, with an have become dependent on donations – accompanying offshore infrastructure of including staff secondments – from the tax havens with quasi-independent corporate world. Overall, it is hard to polities, judiciaries and regulatory avoid the conclusion that when it comes authorities. This type of corruption to the provision of the enabling therefore involves collusion between

299 Rowell, A. (2005) Changing Perceptions, 297 Christensen, J., and Murphy, R., (2006) in Rowell, A., Marriott., and Stockman, L. The Tax Avoider’s Chancellor, Red Pepper, The Next Gulf: London Washington and Oil August, pp24-26 Conflict in Nigeria, Constable, London 298 Plender, J. (2003) INSIDE TRACK: Going 300 Reich, R., (1992) The Work of Nations, off the rails, Financial Times, 28th January New York

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private and public sector actors, who its constitutional right to manicure its purposefully exploit their privileged tax affairs.”302 None of which prevented status to undermine national tax regimes the western press, much of which is by facilitating activities which straddle controlled by owners who make the border line between the legal and extensive use of offshore tax havens, the illegal, the ethical and the unethical. from disregarding the evidence of criminality and treating Khordorkovsky as Despite the fact that many of its a victim of political repression. practitioners hold professional status, the culture of the tax dodging industry is Accountants enjoy a privileged status in wholly subversive of democratic good most societies, but they, along with practice. This spirit of disdain for public lawyers and bankers, have played a lead interest is perfectly captured in the role in shaping and promoting offshore following quote given to a national facilities for their clients. They typically newspaper in response to the 2004 justify their tax avoidance activities on financial statement by the UK Chancellor the basis that their clients are over- of the Exchequer: “Rules are rules, but burdened by the complexity of tax laws, rules are meant to be broken . . . No an argument which conveniently skirts matter what legislation is in place, the around the fact that a significant accountants and lawyers will find a way proportion of this complexity arises from around it.."301 No matter how you the need for the tax authorities to attempt to spin this statement, it is counter their own aggressive tax clearly intended to convey the message avoidance strategies.303 Some that some classes of society are beyond economists also seek to argue the case compliance with social norms. for tax avoidance on the basis of its Incredibly, none of the professional promoting economic ‘efficiency’ – a institutions of lawyers of accountants politically loaded term in almost all uses. promote ethical codes of conduct on the However, their models have generally marketing of tax avoidance structures underestimated the regressive impacts of and the use of tax havens by their the tax reforms which they promote to members. Journalists have also played a improve ‘efficiency’ and are typically role in shaping and perpetuating a based on closed economies which are degree of ambivalence towards tax wholly removed from the reality of a dodging, illustrated in the reporting in world of unrestricted capital movements, the western media of the trial of Mikhail banking secrecy and tax dodging. Khordorkovsky, former Chief Executive Officer of Russian oil giant Yukos, who Some practitioners even argue that was indicted and subsequently found directors have a duty to dodge tax: guilty of tax evasion. The evidence presented to the court was Tax is a cost of doing business so, overwhelming. The sums involved were naturally, a good manager will try to massive. There was no question that manage this cost and the risks associated Yukos executives set out to flagrantly flout the Russian tax laws, indeed former Yukos Chief Finance Officer Bruce 302 Extracted from Platts OilGram, 3rd Misamore (an American) had told the oil December 2003 press that the company had “exercised 303 See Murphy, R. (2006) at www.taxresearch.org.uk/Blog/2006/12/06/4 301 Guy Smith, tax adviser, Moore Stephens, 1-of-all-uk-tax-legislation-tackles-tax- quoted in The Guardian, 18th March 2004 avoidance accessed 15 December 2006

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with it. This is an essential part of good professionals often use offshore tax corporate governance.304 haven jurisdictions as a ‘black box’ to hide assets and transactions from the This statement needs careful unbundling Inland Revenue Service, other U.S. to understand its underlying politics. regulators and law enforcement. 306 Firstly, a tax on profits is not a business cost but a distribution to society. This The findings of this report led Senator much is clear from how tax is reported Carl Levin, senior ranking Democrat in on the profit and loss account alongside the Senate, to conclude that: “tax distribution to shareholders. Secondly, havens have in effect declared war on the use of the word risk is revealing. honest taxpayers.” Tax havens are, of What risks arise from tax other than course, only a more visible manifestation those involving a legal challenge to an of the organised tax avoidance industry avoidance or evasion strategy? Thirdly, which functions on behalf of wealthy directors committed to business integrity individuals and corporate clients in a might prefer an ethically based approach manner explicitly intended to confront in which “the tax-planning industry is the will of elected legislatures around encouraged to establish codes of conduct the world. Tax avoidance is justified by to provide a socially responsible, rather some on the basis that it is legal, though than merely legal, dimension to the tax one widely used definition describes it as advice that is offered to transnational a course of action designed to conflict corporations.”305 Finally, there is no with or defeat the evident will of requirement under company law – Parliament.307 The scale of this assault anywhere in the world – for company on parliamentary will is massive, directors to avoid tax, especially when involving not thousands but hundreds of this involves actions that might infringe thousands of highly educated legal and national laws, and hiding these actions financial specialists operating in from the scrutiny of shareholders and jurisdictions across the globe. national authorities. As illustration of the subversive nature of In practice, much offshore tax planning the organised tax avoidance industry, involves practices which most citizens another recent US Senate enquiry would not regard as good corporate revealed internal communications from governance. Hence the secrecy in which accounting multinational KPMG which these practices are conducted. In the contained a warning from one senior tax words of the report on tax havens adviser that, were the company to published by the U.S. Senate in August comply with the legal requirements of 2006: the Inland Revenue Service relating to the registration of tax shelters, the Utilizing tax haven secrecy laws and company would place itself at a practices that limit corporate, bank and competitive disadvantage and would: financial disclosures, financial not be able to compete in the tax advantaged products market. 304 P.J. Henehan, senior tax partner of Ernst & Young, in an article published in the Irish Times on 7th May 2004 306 US Senate Permanent Subcommittee on Investigations (2006) Tax Haven Abuses: 305 Kennedy-Glans, D. and Schulz, B (2005) The Enablers, the Tools, the Secrecy, Corporate Integrity: A toolkit for managing August, p2 beyond compliance, John Wiley & Sons, Ontario 307 Lord Nolan per IRC v Willoughby (1997)

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of state in 1989 to spearhead global anti- Undeterred, KPMG went ahead with: money laundering programmes, has resolutely turned a blind eye to capital knowingly, purposefully and wilfully flight and tax evasion, and has arguably violating the federal tax shelter law.308 legitimised the tax havens which cooperated with its efforts to track the During its enquiries the Senate proceeds of narco-trafficking and Committee discovered that KPMG had terrorist funding. devised over 500 ‘active tax products’, some of which may have been illegal. In addition to corrupting financial Just four of those 500 products cost the systems by encouraging and facilitating US Treasury US$85 billion annually in lost illicit activities, offshore secrecy tax revenues, whilst KPMG booked corrupts the market system more US$180 million in fees. Speaking after generally by enabling company directors the conclusion of the Senate to engage in aggressive tax planning to Committee’s enquiries, senior ranking raise short term profitability (thereby Democrat Senator Carl Levin said that: enhancing share option values), and gain “our investigations revealed a culture of a significant advantage over their deception inside KPMG’s tax practice.” nationally based competitors. In practice, this bias favours the large The USA is ahead of the game in business over the small, the long investigating and condemning the established over the start-up, and the activities of the organised tax avoidance globalised business over the local.309 In industry. Significantly, the Senate report other words, corporate tax avoidance mentioned above was produced by a works against the operations of fair Subcommittee chaired by a prominent trade, fair competition and ethical Republican and supported by a enterprise, but until now tax justice has prominent Democrat. Nothing similar scarcely registered on the Corporate has been produced by either the Social Responsibility debate.310 Indeed, a European Commission or Parliament. recent business symposium hosted by The Commission’s attempt at combating transnational accounting firm KPMG tax evasion through the Savings Tax concluded that: "tax avoidance does not Directive, which came into force in July damage corporate reputations and may 2005, was rendered virtually impotent by even enhance them".311 So much for extensive lobbying and political corporate social responsibility! shenanigans. Both the World Bank and the International Monetary Fund have developed their own anti-corruption The corruption interface agendas, but neither institution has sought to tackle offshore banking secrecy other than where it has impacted on 309 their rigidly restricted anti-money See ‘tax us if you can – the true story of a global failure’, TJN, 2005 laundering programmes. The Financial 310 Action Task Force formed by G-7 heads See for example Christensen, J. & Murphy, R. (2004) The Social Irresponsibility of Corporate Tax Avoidance: Taking CSR to 308 the bottom line, Development, volume 47, US Senate Permanent Committee on number 3, (37-44) Investigations (2003) The Tax Shelter Industry: the role of accountants, lawyers 311 and financial professionals, Washington DC, http://www.taxresearch.org.uk/Blog/categor US Senate, p13 y/kpmg/ accessed 28 August 2006

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There is clearly an urgent need for for 65 per cent of such flows.313 The reassessment of what constitutes very least one might expect in such corruption; how it is perpetrated; and by circumstances, is that equal emphasis be whom. It is impossible to disagree with given to corruption in both private and those who, whilst deploring domestic public spheres; that greater prominence corruption involving bribe-taking and be given to how corruption can reduce kickbacks on contracts, are puzzled by tax revenues by as much as 50 per the way in which the corruption debate cent;314 and that the activities of the has focused on the bribe-taking by public offshore system should be more carefully officials whilst largely ignoring the role scrutinised to ascertain the harmful of private companies in offering bribes impacts of tax havens on the functioning and kickbacks, and the equally important of global markets and on the integrity of role of the pinstripe infrastructure which the rule of law. As Raymond Baker encourages, facilitates and profits from notes: handling the proceeds of criminal activity, including tax evasion. As one “Illicit, disguised and hidden financial expert witness described it to a recent flows create a high-risk environment for UK Parliamentary enquiry into the role of capitalists and a low-risk environment the UK in corrupt activities in Africa: for criminals and thugs. When we pervert the proper functioning of our With one hand, the West has pointed the chosen system, we lose the soft power it finger at corrupt African leaders, with has to project values across the globe. its other hand, its bankers, lawyers, Capitalism itself then runs a accountants, art dealers, health reputational risk. As it is now, many authorities, universities, estate agents millions of people in developing and and embassies have been actively or transitional economies scoff at free passively encouraging wealth out of markets, regarding the concept as a Africa into the West’s economies.312 license to steal in the same way as they see other others illicitly enriching In terms of scale, the proceeds from themselves.315” bribery, drugs money laundering, trafficking in humans, counterfeit goods The secrecy space offered by the and currency, smuggling, racketeering, offshore interface, which currently and illegal arms trading account in comprises approximately 70 tax havens aggregate for around 35 per cent of spread across the globe,316 represents a cross-border dirty money flows glaring flaw in the global financial originating from developing and architecture. This flaw is routinely transitional economies. On the other exploited by financial intermediaries for hand, the proceeds from illicit commercial activity, incorporating 313 Baker, R., (2005) Capitalism’s Achilles mispricing, abusive transfer pricing and Heel, John Wiley & Sons, Hoboken, New fake and fraudulent transactions account Jersey, p369 314 The Other Side of the Coin: The UK and Corruption in Africa, report by the Africa All Party Parliamentary Group, March 2006, p12 315 312 Baker, R., (2005) Capitalism’s Achilles Dr Patrick Darling in written evidence to Heel the UK Africa All Party Parliamentary Group, quoted in The Other Side of the Coin: The 316 TJN’s map of tax havens is at: UK and Corruption in Africa, AAPPG, March http://www.taxjustice.net/cms/upload/pdf/ 2006 mapamundi.pdf

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the simple reason that this is the most the scale of the problem and to tacking profitable fee-earning activity. It is long the failures of the financial architecture overdue that the role of the facilitators, which allow the perpetuation of these and of their professional associations practices. It is in this context that the which fail to effectively regulate their TJN calls for a wider debate about what activities, is recognised as harmful and constitutes corruption, and whether and corrupt and consequently given parity of how it can be defined and measured to attention to that paid to the bribe-taking include the activities of the supply side of less well paid officials in the world’s agencies and the offshore interface. TI poorer countries. could and should play a lead part in this process by rethinking the definition Support for a shift in the corruption employed in the CPI’s construction to debate to include the role of the supply take in a wide range of activities which side agencies is evident in the 2006 undermine public confidence in the statement of the Pontifical Council for integrity of the governance of public and Justice and Peace, which noted that: private sector institutions. The conclusion of this debate might lead to a “A ready climate for corruption is less generalised approach, with specific fostered by a lack of transparency in activities (bribery, embezzlement, tax international finances, by the existence fraud, market-rigging, insider-trading, of financial havens and by the disparity etc) being treated as distinct forms of between the level at which corruption is corruption. If TI wishes to retain the fought – often limited to the level of national comparator approach of the CPI single states – and the level at which it should extend the range of indicators corruption is carried out, usually at the used to identify corrupt practices to supranational and international include factors which facilitate corrupt levels.”317 practices such as non-disclosure of corporate beneficial ownership; the use Despite evidence that public attitudes of nominee directors and shareholders; towards corruption are hardening banking secrecy laws; the lack of throughout the world, further transparency of ownership and convergence is required before a truly beneficiaries of trusts and similar legal international definition of corruption can entities; and non-cooperation with be arrived at. In the interim it would be bilateral information exchange between preferable to identify the entire range of national authorities. Other institutional activities which involve the abuse of factors such as the framework of power and privilege for personal gain, international accounting standards which and not focus principally on those enable multinational corporations to involving the bribery of public officials in adopt elaborate aggressive tax avoidance developing countries. Comparatively strategies and to use opaque accounting speaking the losses to most of the systems and trade mispricing practices world’s poorer countries from illicit should also be taken into account, capital flight and tax evasion are likely particularly since this is an area of to considerably exceed the financial cost corporate governance where the rules of bribery, and consequently greater are set by a private sector agency which weight needs to be given to identifying is not accountable to democratic scrutiny or control. 317 Cardinal Renato Martino, (2006) The Fight Against Corruption, Vatican City, Throughout the developing world, tax October evasion and the looting of resources to

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secret bank accounts has nurtured the offshore interface, are all too aware resentment, caused unemployment, of the extent to which their own reduced investment in infrastructure and economies have become geared to public services, and shifted the tax dependence on capital flows from the burden increasingly onto middle income poorer countries. They get away with earners and poor people. But this need this because public perceptions in the not be the case. Most of these problems west have been shaped to pay no could be remedied by strengthening attention to the offshore interface. The international cooperation. Effective CPI has done nothing to change this information exchange between national situation. authorities would go a long way towards overcoming the problems of capital flight If western leaders are genuine about and tax evasion. The barriers posed by their commitment to helping African banking secrecy could be overcome by nations to effectively tackle corrupt over-ride clauses built into international practices, they should begin by treaties. The secrecy of offshore trusts addressing the structural flaws in the would be reduced by requiring global financial architecture which registration of key details relating to the enable the exploitation of fiscal identity of the settlor and beneficiaries. loopholes and offshore tax havens. They There is no reason why those who benefit need also to recognise that the culture of from the privileges conferred by using corruption which causes so much harm in companies and trusts should not accept Africa is a reflection of a similar culture the obligation of providing basic in the industrialised countries, where information about their identity. Global privileged business and political elites frameworks could be agreed for taxing regularly abuse their status for personal multinationals on the basis of where they gain. It needs also to be recognised that actually generate their profits. Policies the reality of Europe and North such as these could be implemented in a America’s commitment to ‘globalisation’ relatively short time frame. The is that they want liberalised trade on principal barrier standing in the way of their own terms but continue to use progress towards achieving these goals is fiscal incentives to distort the trade the lack of political will on the parts of system in favour of their domestic the leaders of the OECD nations, most businesses and to attract capital from notably Switzerland, the USA and the UK, developing and emerging countries. all of which are leading tax haven states. Britain stands pre-eminent in this This lack of political will stems largely respect, and should take a lead in from the fact that western leaders, who helping African nations by tackling its point fingers at corrupt politicians and own, deeply embedded culture of public servants in poorer countries whilst corruption. conveniently ignoring the harmful role of

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Appendix 5

Jersey passes law allowing ‘sham’ trusts for use by tax evaders

(Article from the blog of Tax Research LLP, written by Richard Murphy and published 15 June 2006 at http://www.taxresearch.org.uk/Blog/2006/06/15/jersey-passes-law- allowing-‘sham’-trusts-for-use-by-tax-evaders/)

I have always had a considerable problem when doing so make sure (for example) with the concept of trusts, even as a that the income goes to this third person practicing tax accountant. But I have during their life and when they die the much more of a problem with Jersey’s remaining property goes to another, new trust laws passed in May 2006 which fourth person”. All trusts are meant to allow the creation of ‘sham’ trusts where incorporate this split of roles, there is in fact no such thing, but just the responsibilities and entitlements. If they bogus impression of one. I have even more did not then there would be no need for a difficulty with this because I have no trust. The property would be owned doubt that Jersey knew the new laws absolutely by one person for their own would facilitate tax evasion. Indeed, it is benefit. hard to see what other purpose they could have. Why is this important? There are two reasons. First of all trusts are not Let me deal with the concept first though. registered. Unlike companies or Trusts are an instrument normally only partnerships which are either legal available in Anglo Saxon common law. entities, or which if trade have to disclose Wikipedia318 describes a trust as: their identity, if not their accounts, there is no requirement anywhere that I know of “a relationship in which a person or for a trust to be registered even though it entity (the trustee) holds legal title is an artificial arrangement that exists to certain property (the trust only under the rule of statute law, even if property) but is bound by a fiduciary the concept started in common law. So duty to exercise that legal control for trusts are used to assist secrecy on and the benefit of one or more individuals offshore, and especially in the latter case or organizations (the beneficiary), where nominee trustees act as trustees to who hold “beneficial” or “equitable” hold nominee shares in companies title” managed by nominee directors etc., etc. As the Swiss rightly point out this means I have simplified this slightly for clarity, that the UK and its offshore dependencies but that is a fair description. To put it do not need banking secrecy to achieve another way, one person says to a second the benefit for clients they had to “please look after this asset for me, but introduce banking secrecy for, Anglo Saxon common law countries achieve it through trusts. This secrecy is almost 318 http://en.wikipedia.org/wiki/Trust_law accessed 22-1-07 without exception harmful.

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calling them trusts with ‘reserved powers Second, and as importantly, the role of for the settlor’. What are those reserved trusts in tax planning is dubious at best. powers? Well, the settlor can tell the Unfortunately the UK has encouraged this. trustee what to do, which means the For example when the EU Savings Tax trustee only has a nominee role. And the Directive was introduced the entities for settlor can claim the property back, which whom disclosure of information would means that no gift of assets into trust has have to be made did, in the opinion of the taken place since they clearly remain in EC, include trusts. But the UK objected, the ownership of the settlor in that case. saying trusts were not entities and so And, because they can be claimed back helped massively reduce the effectiveness the settlor is always likely to be the of the Directive. It was not one of the beneficiary of such a trust. In other UK’s prouder moments. words, the settlor continues to have complete beneficial ownership of the Now I come to my main point. Because asset and there is in fact no trust in the use of a trust can prevent disclosure existence at all, just a sham that suggests of offshore interest earned under the that there is. terms of the EU Savings Tax Directive to a person’s home country of residence those In that case what is Jersey actually doing seeking to avoid such disclosure have by passing this law? It is creating a poured their cash into them. My recent situation where a person can claim they research on funds held in Jersey proves have put an asset into trust but the reality this point. And, as a matter of fact the is they have done no such thing. This is a trust market in Jersey has boomed, up by completely bogus transaction. And why 30 per cent, for example, in 2004 would Jersey want to do this now? I have according to Phil Austin, CEO of Jersey no doubt that a primary reason is to assist Finance. The reason is simple. There are a people who wish to avoid declaring their great many people who have money on income under the EU Savings Tax Directive which tax has been evaded in Jersey and or suffer tax withholding at source, which elsewhere and who do not want the is the alternative. Indeed, at a meeting I interest declared to their home state as attended recently some very senior that would lead to questioning on where people in the financial services industry the money on which the interest was paid complained about the effort they have came from as well as to questions about had to put into the process of creating the interest itself. Using a trust prevents such arrangements to assist those clients such questions arising and perpetuates the who had evaded funds offshore and who tax evasion. do not wish them to be disclosed now even though (as I suggested to them) they But note what a trust is. It is something are assisting money laundering by doing where the settlor gives the property so. These new trusts assist that objective away. This imposes a cost on the settlor. and shoot a massive hole through Jersey’s But now look at what Jersey’s doing with claim to only want legitimate business in its new trust law. These are explained by the Island. the Jersey firm of Volaw Trust & Corporate Services Limited319. Jersey will There is only one purpose for this new now allow the creation of what can only law. It is to promote secrecy, and the be called ‘sham trusts’, although they’re prime use for that is to assist tax evasion.

319 http://www.volaw.com/pg605.htm This legislation proves that the mentality accessed 22-1-07 of promoting aggressive tax avoidance and

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even of providing shelter for outright tax evasion persists in Jersey, and is, regrettably, assisted by its government, which passes legislation of this type that facilitates such arrangements.

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About the authors

Richard Murphy Organizations and various Governments focussing on multilateral debt Is a UK based chartered accountant. He cancellation, currency transaction trained in tax with Peat Marwick (now taxation and tax justice issues. KPMG) before setting up his own firm of accountants in 1985. Since 2002 he has Sony works for Christian Aid and advises worked on taxation and accounting policy Oxfam Novib and the TJN. issues. He is director of Tax Research LLP. He is a senior tax adviser to the TJN. [email protected]

Richard is a research fellow at the Tax Simon Pak Research Institute, Nottingham University Simon J. Pak is an associate professor of Business School and a visiting fellow at finance at the Penn State University, the Centre for Global Political Economy Great Valley School of Graduate at the University of Sussex. Professional Studies. His current research interest areas include international trade Contact details: price analysis, transfer pricing and capital www.taxresearch.org.uk/blog movements through over- and under- [email protected] invoicing in international trade. He and +44 (0) 1366 383500 his research partner John S. Zdanowicz +44 (0) 777 552 1797 were awarded US$2 million research grant in 2003 by the U.S. Congress to John Christensen expand their research on transfer pricing. John Christensen is an economist who was With the research grant, he and born in Jersey and was for many years Zdanowicz researched project transfer senior economic adviser to the States of pricing analyzing in detail the U.S. export Jersey. He has also been a director of an and import data. international consulting firm specialising in high level risk in the Middle East and Contact details: North Africa. He has written extensively on the economics of small island states [email protected] and tax haven abuse. +00 (1) 610-725-5343

He is director of the International David Spencer Secretariat of the TJN. David Spencer is a graduate of Harvard Contact details: College and Harvard Law School and has a [email protected] Masters of Law Degree in Taxation. www.taxjustice.net Before opening his own law firm he practiced tax and banking law at a major Sony Kapoor Wall Street law firm and at Citigroup/Citibank. He has authored Sony Kapoor works on issues relating to many articles on the OECD proposals on international finance, development and harmful tax practices and the EU governance both with Non Governmental Directive on the Taxation of Savings.

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About the Tax Justice Network

The Tax Justice Network brings together precondition for international tax justice. organisations, social movements and The network makes information available individuals working for international tax through mass media as well as through co-operation and against tax evasion and conferences and seminars, the internet, tax competition. In an era of newsletters, publications in print, globalisation, the TJN is committed to a symbolic actions, demonstrations and socially just, democratic and progressive advocacy. We base our activities on system of taxation. TJN campaigns from expertise and sound research. an internationalist perspective for a tax system which is favourable for poor TJN facilitates co-operation, people in developing and developed communication and information sharing countries, and finances public goods and between its members. The network taxes public bads such as pollution and organises international exchange and unacceptable inequality. TJN’s objectives policy debates in order to harmonise the are detailed in the TJN declaration views and concerns of our members. This (www.taxjustice.net). process forms the basis for powerful global campaigns in international tax TJN is a pluralistic, diversified, non- policy. governmental, non-party and multilingual network. Local, regional and national TJN is run by its member organisations as civil society and social movement well as individual supporters. The organisations as well as tax justice network functions on the principles of campaigners, researchers, journalists, participatory democracy, empowerment, development specialists, trade unionists, transparency, accountability and equal concerned business people, tax opportunity. TJN encourages and where professionals, politicians and public necessary supports member organisations servants are members and supporters of and individuals to participate in the the network. decision making. The network supports the building of national TJN campaigns in TJN is campaigning for social change particular in developing countries. An through public debate and education. international secretariat coordinates the Public understanding of tax matters is the network's activities.

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