Taxing matters: The G20 and offshore tax havens

Each year, hundreds of billions of dollars are illegally transferred out of developing countries.  This massive loss of domestic resources, which is far greater than aid inflows, maintains poverty, contributes to inequality, and deprives developing countries of the ability to invest in essential public goods and services.  It is only recently that the role of offshore tax havens in enabling these losses has been examined. At the April G20 meeting in London, tax havens were prominently on the agenda.

Peter Gillespie

'THE era of banking secrecy is over,' proclaimed the official communique of the April G20 meeting in London. The G20 leaders, presiding over the worst economic recession in a generation, managed to hammer out a consensus on dealing with the ailing world economy, as well as reached agreement to crack down on offshore tax havens.

While the G20 plan to rescue the global economy is seriously flawed, the leaders were quite right to target tax havens, which are central to the transparency problems associated with the current economic meltdown. Tax havens facilitate the loss of billions of dollars of tax revenues at a time when G20 countries are struggling to bail out their failing banks and industries. But it will be exceedingly difficult to put an end to tax haven abuses. After all, offshore services are utilised by the world's wealthiest people as well as the largest and most powerful corporations, and these people will not relinquish their privileges without a struggle.

Offshore tax havens are the centrepieces of a shadowy economic system that has developed since the 1960s.ÿ Today there are more than 70 tax havens, many but not all based in small states such as the Cayman Islands, Bahamas, Bermuda, Panama, the Channel Islands, Monaco, Luxembourg, Liechtenstein, Singapore and Switzerland. Offshore tax havens are secrecy jurisdictions that exist expressly to enable their clients to escape the scrutiny of regulators and tax authorities in their own countries. The service providers based in these jurisdictions are insurance companies, legal and financial firms, and the subsidiaries of mainstream banks headquartered in Geneva, London, New York and Toronto.

Tax havens are an entrenched part of the international economy. At least half of all international bank lending and approximately one-third of foreign direct investments are routed via secrecy jurisdictions. More than half of all global trade is conducted through tax havens, and half the global monetary stock is estimated to pass through them at some point. The value of offshore hedge funds is currently about $1.17 trillion. The London-based Tax Justice Network estimates that wealthy individuals hold an estimated $11.5 trillion in offshore accounts.

Banks and multinational companies routinely establish offshore affiliates to conceal their financial practices. Frequently these offshore affiliates, or international business corporations, are dummy companies that conduct no business in the offshore jurisdiction and whose presence is little more than a postal address and a bank account. Tax havens host more than two million international business corporations; one modest building in the Cayman Islands is home to more than 12,000 of these entities.  A January 2009 report from the US Government Accountability Office revealed that 83 of the 100 largest publicly-traded companies in the US, including big banks receiving bailout money, have scores of offshore subsidiaries.

Profit laundering

Offshore dummy companies are useful because they can be used for profit laundering, assigning profits and losses on paper so that taxes can be minimised. To conceal profits a company might transfer the ownership of patents, copyrights or other intangibles to an offshore dummy company and collect royalties in a low-tax jurisdiction.  In 2007, the pharmaceutical company Merck was assessed $2.3 billion in US back taxes for transferring its drug patents to a Bermuda shell company and then deducting from its taxes the royalties it paid itself.

Tax havens are also used to conceal liabilities. Before being exposed as a spectacular fraud, Enron had established a network of 3,500 dummy companies, 600 of which were registered in the Cayman Islands.ÿ When the British government nationalised the failing Northern Rock bank in 2007, officials were stunned to discover that Euro 50 billion of mortgages had been shifted to an offshore account disguised as a foundation benefiting Down's Syndrome children.

One of the most common methods of concealing corporate income and profits is through falsified transfer pricing. Today, half of all global trade is conducted among affiliates of the same parent company.ÿ Much of the trade between parent companies and affiliates is falsely priced so that companies can allocate profits in low-tax jurisdictions. A company might, for example, sell an export item to an offshore affiliate at a sharply reduced price; the affiliate then sells the item at market price with the profits remaining offshore. Alternatively, the offshore affiliate might import an item at the real market price, but sell it to the parent company at a grossly inflated price so the company has a huge cost to deduct on its tax returns.

Falsified transfer pricing by multinational corporations shifts enormous amounts of capital out of developing countries. A March 2009 report by Christian Aid (UK) found that between 2005 and 2007, falsified pricing transferred $8.5 billion out of the world's 49 poorest countries, resulting in tax losses of $2.6 billion to these countries.  Tax losses for Nigeria were calculated at $740 million, Pakistan $450 million, Vietnam $370 million, and Bangladesh $274 million. 

The Christian Aid study, however, was based only on publicly available data, and was unable to access information in secrecy jurisdictions.  The problem, therefore, is much, much larger. A December 2008 report from the Washington-based Global Financial Integrity project calculated that developing countries lose $858 billion to $1.06 trillion in illicit capital outflows every year, 10 times greater than all development assistance to the developing world.

It would not be an exaggeration to say that illegal capital flight from poor countries has resulted in the deaths of thousands, perhaps tens of thousands, of vulnerable people as health facilities have been dismantled and basic public infrastructure crumbled.  Christian Aid estimates that if lost tax resources were invested in health programmes in developing countries, it would save the lives of 350,000 children annually.  Raymond Baker, the director of the Global Financial Integrity project, calls the haemorrhage of resources from poor countries the 'ugliest chapter in global economic affairs since slavery'.

Wealthy individuals are also escaping their tax obligations by holding their assets offshore and some countries are vigorously pursuing tax cheats. In 2006, the German intelligence service paid a former employee of the LGT bank in Liechtenstein to provide them with secret data on clients, setting off a wave of investigations of wealthy Germans for tax evasion. The Liechtenstein data also triggered tax probes in the United Kingdom, Canada, Sweden, France, Italy, the US and the Netherlands. (The informant is now in hiding, as an anonymous reward has been posted for information about his whereabouts.)

In 2007, the US launched an investigation into the UBS bank in Switzerland for helping wealthy Americans avoid taxes. Services provided by UBS bank officials to US clients apparently included smuggling diamonds concealed in toothpaste tubes. UBS, the world's largest private bank, admitted to conspiring to defraud the US Internal Revenue Service and in February 2009 paid a $780 million settlement.  UBS has since resisted disclosing the identities of 52,000 American clients to the IRS.

A March 2009 study by Oxfam International found that at least $6.2 trillion of developing-country wealth is held offshore by individuals, depriving developing countries of $64-$124 billion in annual tax revenues.  Half the wealth of rich Latin Americans is held offshore; African elites are estimated to hold $700-$800 billion in offshore accounts. The Tax Justice Network calculated that if the returns on $11 trillion of individual wealth now held in tax havens were taxed at 30%, it would generate $255 billion in tax revenues globally.

These are some of the issues behind the G20's intentions to crack down on tax havens. The G20 communique stated that leaders had agreed to deploy sanctions against non-cooperative secrecy jurisdictions. The communique further announced that the Organisation for Economic Cooperation and Development (OECD) would immediately publish a list of jurisdictions that were not in compliance with OECD standards on transparency and exchange of information for tax purposes.

The OECD list was divided into three sections: a blacklist of non-compliant states, a grey list of jurisdictions that have committed but not yet met the standard, and a white list of those in compliance. Astonishingly, within days of the close of the G20 meeting, the OECD blacklist was empty. Intense diplomatic pressure had successfully removed some of the most notorious tax havens from the blacklist.

The OECD grey zone included countries such as the Cayman Islands, Switzerland, Luxembourg, Belgium and Liechtenstein. Both Switzerland and Liechtenstein were outraged to be named on the grey list. Switzerland threatened to retaliate by not paying its annual dues to the OECD, an extraordinarily self-righteous response from a country that has been the world leader in laundering the thefts of billions of dollars from developing countries. 

This is not the first time that the OECD has attempted to deal with the problem of tax evasion. In 2000 the OECD published a framework for sharing tax information that eventually became the OECD Model Tax Convention.  But the Bush administration was opposed and the initiative languished. This time, however, President Obama is playing a leadership role.

But there are serious problems with the OECD framework. The OECD's tax information sharing agreements are bilateral treaties while the challenges posed by tax havens require multilateral cooperation. In addition, under the OECD framework a state needs to make a detailed case before requesting information from another treaty signatory.  The burden of proof is on the requesting authorities, requiring them to develop a strong case before a request for financial information can be made. While this will assist authorities in cases against known offenders, it will do nothing to catch tax cheats they don't already know about.

But the biggest problem with the OECD approach is that it applies to individuals, not to multinational corporations which are responsible for the majority of tax losses in Northern and Southern countries alike.  Unless ways are found to address complex corporate structures, falsified transfer pricing and profit laundering, little progress will be made.

In addition to enhanced regulation, civil society organisations are calling for substantial improvements in the transparency of the international economy. This would include a multilateral approach to the mandatory exchange of information amongst all jurisdictions with respect to income, gains and property received by non-resident individuals, as well as corporations and trusts. Transparency includes that information be publicly available with respect to the beneficial ownership of companies, trusts and foundations. Transparency demands changes to accounting standards and country-by-country reporting of sales, revenues, profits and taxes paid by multinational corporations in their tax returns. Improved transparency requires the development of systems to put an end to the practice of trade mispricing which deprives countries of massive amounts of tax revenues. Ultimately, what is essential is the development of new norms of corporate social responsibility, in which corporations become transparent and accountable and take seriously their responsibilities to contribute to the public good.

Despite the current flaws, the debate about secrecy jurisdictions is much farther advanced than it was a few years ago. In large part this is due to the persistent efforts of civil society organisations such as the Tax Justice Network, the Global Financial Integrity project, and NGOs to place these issues on the international political agenda. The debate will continue. As a coalition of tax justice organisations put it in a press release following the G20 meeting, '.this is not the end.  It is not even the beginning of the end. But it is, perhaps, the end of the beginning.'               

Peter Gillespie works with Inter Pares, the international social justice organisation based in Ottawa, Canada. He can be reached at pgill@interpares.ca.

*Third World Resurgence No. 224, April 2009, pp 17-19