Offshore tax evasion in focus -- Mukesh Butani (29-Nov-10)

The subprime crisis followed by global meltdown has had itsshare of fallouts; yet there is a silver line which has the worldorder gearing up for a new era of financial discipline, taxtransparency and enhanced regulation. Ironically, one of thepositives borne out from the recent economic upheaval has been afocus in ensuring robust transparency standards in tax matters.

Before delving upon how critical a role tax governance andinformation exchange plays in addressing financial disorder, let mefocus on tax evasion through ''money laundering'' and how theabsence of inadequate standards in tax discipline have abated thismenace. This will put in perspective the role of domestic and crossborder tax policy, in tandem with other regulatory measures, tocombat tax evasion, whether with or without the aid of moneylaundering.

An Asian regional event hosted last week with the support fromFederal Ministry of Finance, Germany and Indian Ministry of Financehas put in motion a debate on prevention of money laundering, ingeneral and contextual role of tax treaties and taxadministration.

What''s the colour of money!

Money laundering as loosely defined is an act of ''washing''away unaccounted or illicitly sourced money through a cobweb ofcomplex transactions typically involving more than onejurisdiction. The objective being to hide the ownership or thedestination of such funds. A typical ''laundering'' scheme hasthree stages:

a) Placement stage -- the objective is to move illicit fundsaway from source location; sources can be traced to ''cashintensive'' illegal businesses such as drug trafficking, bribes,etc;

b) Layering stage -- the most crucial stage as money virtuallychanges its color here. Objective being to conceal ownership andmitigate audit trail by deploying funds in complex dealings(stocks, commodity futures, investments). Often the sheer volume oftransactions makes it difficult to trace the origin of funds. Mostcommon form of layering entails placing funds at the disposal offinancial intermediaries in tax efficient jurisdictions as it''seasier to ensure secrecy about its origin under ''de facto''banking secrecy norms.

c) Integration stage -- Its the final step wherein the''cleaned'' money is deployed for integration in the real economyand my focus here is not to deal with deployment for other forms ofcrime such as terrorism etc.

While ''launder'' of illicit funds is not a 21st centuryphenomenon, what is perplexing is the sheer size of this''industry'' - IMF forecast for June 2010 indicate that theaggregate size of money laundering is between 2 to 5% of reportedglobal GDP of $ 60 trillion making it effectively the 3rd largestindustry. The size of India''s ''parallel'' economy is equallydisturbing; unconfirmed statistics indicate approximately $ 1.5trillion stashed in offshore banks in addition to domestic cashdealings; a public interest petition filed in the Apex Courtcorroborates this estimate.

A philosophical argument particularly in emerging BRIC''seconomies that recycled laundered funds bring tangible benefits toreal economy no longer holds fort -- lawmakers and civil societyrecognises perils associated with the crime even if funds findtheir way to legitimate businesses. In the 80''s, the ChineseGovernment turned a blind eye to investments made by OverseasChinese ostensibly round tripped. India however cracked the whip onround tripping in early days of economic liberalisation.

Last week''s wider dialogue on money laundering is suggestive ofwell coordinated approach to deal with money laundering menace andimportant economies should expect spate of regulations at domesticand bilateral/multi lateral level.

G-20 communiqu and crack down on taxhavens

In April 2009, G20 released an official communiqu post itsLondon summit G20 whiplashing on offshore tax havens. The summitproclaimed an end to the ''era of banking secrecy'' and announcedIMF sanctions on tax havens unwilling to share information.

Following the G-20, OECD published a report on implementation ofinternationally agreed standard on exchange of information for taxpurposes classifying countries in black, grey and white list. In2009 report, four nations were identified in the black list, fornot having committed to globally accepted transparency standards.Latest OECD report (of November 2010), the four countries (Uruguay,Malaysia, Philippines and Costa Rica) have moved into White /Greylist for either having substantially implemented these standards orhave at least committed to such implementation.

Spate of developments in Bankingsecrecy laws

In a related development post the G-20 summit, certainjurisdictions (Switzerland, Liechtenstein, Luxembourg, and Austria)offered to relax their banking secrecy norms to exchange taxinformation with Revenue authorities of other jurisdictions.Immediately prior to this,in an unprecedented development in thehistory of Swiss Banking industry, UBS agreed to share client datawith the US IRS in a tax probe, triggering a debate on clientconfidentially and information secrecy norms. This was in pursuanceto a settlement between the Swiss Bank with the IRS investigatingtax evasion against 4,450 US nationals.

Following these developments, India upped the ante seekinginformation from the Swiss authorities under Article 26 of theExchange of information clause of the tax treaty. The Swiss howevercold shouldered India''s request for information citing Bankingsecrecy code as an impediment and absence of comprehensive TaxInformation Exchange Agreement (TIEA). Historically, Swiss secrecystrictly limited information sharing even for tax evasion unless itwas a tax fraud. However, recent bilateral treaties are designed toweaken Swiss law privacy protection related to tax evasion. Indiais yet to renegotiate bilateral treaty on information sharing andthis would be an interesting development to follow.

Growing importance of TIEA

To deal with growing focus on exchange of information andovercome an organic difficulty like India faced with Switzerland,Governments have come to realise the importance of TIEA''s.

TIEAs are bilateral agreements intended for use where a DoubleTaxation Avoidance Agreement (DTAAs) is considered inadequate forexchange of information. TIEAs though narrower in scope than DTAAs,are comprehensive on the subject and lay down detailed guidance.The 2002 OECD Model Agreement on Exchange of Information on TaxMatters serves as base document for negotiation between countries.In 2009, the model agreement was endorsed by most key jurisdictionsincluding by nations who have traditionally sought waiver underbanking secrecy and client confidentiality norms. For the record,the UN has incorporated the Model in its Model Tax Convention; thisbears relevance for Indian tax treaties as majority of Indian DTAAsare modelled on UN model

Cautious approach is recommended

Most governments on the pretext of ''de facto banking secrecy''do not permit access to information from their financialinstitutions and banks. Such hurdles could limit ability toimplement these standards. The Swiss bank and US IRS settlement inwake of the economic crisis resulted in inking of TEIA fordisclosure of American taxpayers'' details to establish taxevasion.

The skeptic in me anticipated in May 8 column that a suddendrive for information sharing could lead to an environment of''over regulation'' and may hurt credibility of informationexchange process besides harming the institution of privatebanking. Calibrated roll out of TIEA will facilitate banks toimplement rigorous KYC standards an area where the banking industryhas made material progress.

My apprehension was not exaggerated as recently the US IRSabandoned legal push to force Swiss bank UBS to disclose taxpayersdetails. The move came on the back of US dropping criminal chargeslast month against the bank after 18-month probation for sellingoffshore tax services. Presumably, disclosures made in 2009 bySwiss government and banks would have helped the US IRS arrive at acomprise solution. The US IRS'' move is caution for othergovernments to avoid an environment of ''over regulation''.

The Swiss - US saga is far from over given decisions of SwissCourts in past 2 months. A federal administrative Court ruled thatSwiss authorities may not disclose the bank account details ofpeople resorting to tax evasion. The Ruling followed another Courtholding that Switzerland's financial regulator violated Swiss lawwhen it turned over data regarding Swiss banking clients in 2009.These developments have placed the information exchange treatiesbetween the two nations in jeopardy. It is unlikely that the SwissGovernment wants confrontation with the US and hence a remedy couldbe an emergency decree (by the Swiss Government) to enforce theinformation exchange treaty, which would be beyond the scope ofSwiss court''s administrative ruling. However, this all remains tobe negotiated, else, it may lead to an international dispute.

India rushes with spate ofregulations

With the global movement to combat the might of ''parallel''economy, India has not lagged behind. The legislative amendments tothe Indian Income-tax law ( in 2009) empowering the Government tosign agreements with non-sovereign states and rush to sign TEIA areindicative of the government''s endeavors.Recent statistics revealthat the Government is negotiating limited tax treaties with 11non-sovereign states and TIEAs with 20 prioritised countries.Needless to mention, hurdles to implement such agreements are yetto be witnessed as the international tax fraternity attention isfocused on Swiss- US impasse.

Besides, the impending tax reforms (the Direct Taxes code) wouldinstitute additional checks in the domestic legislation to combattax evasion. The regulations are taking shape in the form ofGeneral anti-avoidance rules, Controlled foreign corporationregime, limited treaty override provisions and arms length pricingof transactions with specified jurisdictions.

To conclude, it is not easy to paint a clear picture on evolvinglandscape as Indian policy makers will have to keep watch oninternational developments. I would think that Institutionalisingrobust standards for transparency as means of reliable governancein tax matter alone would require attitudinal shift from countriesby forging partnerships since individual attempts would raisestress levels between nations. Whilst the international frameworksuch as OECD Forum on Transparency & Exchange of information,Financial Action Task Force (FATF)] could provide impetus,sustaining it would require behavioral alignment by countriesincluding India. Taking a cue from the recent developments betweenUS and Switzerland, it is important for India to realise thatregulations require judicious balance between sustenance ofeconomic cross border activities and need for ''just'' adequateregulations. An over-drive to ''regulate'' could indeed do moreharm than accomplish the desired objectives.

The author is a Partner with BMRLegal and was assisted by Sumit Singhania. Views are entirelypersonal.

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