Black money crackdown: Linking offshore structures to tax evasion is case of mistaken identity

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Frictions between the two are bound to arise and sensationalism of the likes of “Panama and Paradise Papers” will accentuate challenges for legitimate tax-compliant investors and tax administrators.

The BBC noted that the name “Paradise Papers” dovetails well with the French term for a tax haven, paradise fiscal. Last fortnight, 13.4 million documents weighing over 1.4 terabytes of leaked data of an offshore law firm Appleby found its way to Wikipedia. The data leaked (by hackers) to a German newspaper comprised the most guarded investments and funding structures of over 120,000 businesses and individuals, not sparing world’s powerful monarchs, political leaders and most valued companies. The data shared with the International Consortium of Investigative Journalists (ICIJ), a network of 380 journalists working collaboratively, made headlines to rattle administrations, leading countries such as Spain and India to order official enquiries and possible investigations. The Paradise Papers, as the recent leaks are labelled, coming after the Panama Papers of 2016, are more on theatrics and less on content. The media tendency in such situations is to sensationalise news, painting all and sundry with the same brush—tax dodgers and money launderers are all treated on a par with businesses who have legitimate structures. To associate offshore structures solely to crime, tax evasion, corruption and other illicit activities is a case of mistaken identity. In contrast, most are legitimate business structures created either to avail benefit of tax treaties signed between sovereign states or state aids to locate businesses in specified jurisdictions. At times, the nature of activities demand creation of pooling structures in j

The expose revealing multinational structures motivated for tax-planning reasons has come under intense review in the recent past, as a result of OECD and G20 led Base Erosion and Profit Shifting (BEPS) initiative to roll out a series of measures called Action Points (15 in total), which are expected to bring a paradigm change in global tax landscape. The 15 Action Points, the implementation of which began in 2016, are expected to address a multitude of issues, ranging from availability of tax treaty benefits to genuine investors to avoidance of situations giving rise to stateless income and eliminating scope for double/triple deductions in multiple jurisdictions, as a result of mismatch of benefits under the domestic laws and gaps in the treaty network. More significantly, they lay new standards of transparency to smoothen the process of sharing (taxpayers) information between governments, streamlining the process of maintaining global (as opposed to country-specific) transfer pricing documentation, which tax administrations often allege as avenues for shifting profits and exploiting loopholes in current tax treaty framework.

The implementation of the ambitious BEPS initiative, which typically could have led to over 2,500 tax treaty amendments, is being achieved by OECD/G20 and about 100 nations under ‘inclusive framework’ by signing the Multilateral Instrument (MLI). The grand opening ceremony for signing the MLI—held in Paris in June this year (of which India was part)—affords flexibility (to signatories) to opt in, opt out, including exercising options for implementing the 15 Action Points, some of which are minimum standard requirements. India’s participation in the BEPS exercise coincides with the roll-out of General Anti-Avoidance Rule, changes in Budgets of 2016 and 2017, together with renegotiation of treaties with its key partners, namely Mauritius and Singapore. India’s actions at the OECD for BEPS roll-out have been largely aligned with domestic law changes, treaty negotiations, and it has gone ‘all out’ to shut doors to all forms of questionable structure. It is debatable, though, if some of India’s actions such as Place of Effective Management rules, equalisation levy and interest rate restrictions (Indian version of Controlled Foreign Corporation laws) are either unilateral or rushed measures, or should India balance its needs for growth, investment and employment with a moderately tough tax policy regime to suit its requirements instead of imitating the West, given her stage of development.

Net-net, India’s preliminary position on the MLI signals closure of most, if not all, legitimate tax planning avenues, though the Indian position has to be ratified by its treaty partners. The MLI is the first instrument of its kind and an attempt to trigger changes to a few thousand tax treaties between nations for which there is no past experience and, to an extent, it’s an experiment whose success would be tested with time and ease of implementation. Tax regimes with sophisticated administration and forming part of trade and investment blocs such as the EU will find BEPS measures easier to implement than others.

Whilst nations will settle in the new world order to implement path-breaking changes that BEPS will bring, equally important is to consider business rationale for offshore structures. Typically, all fund structures are via offshore jurisdictions motivated for creating a pooling vehicle for international investors, comprising of not just rich individuals and multinationals, but also pension funds and sovereign funds. They are not meant for tax evasion, as the investors are subject to tax liability in the state of residence leaving the offshore vehicles as pass-through non-taxable entities—just as a mutual fund is a pass-through entity and investors are taxed. If investing through offshore vehicles is viewed as tax dodging, are all investments and investors via foreign institutional funds, including sovereign funds and pension funds, abating an offence of tax evasion? Certainly not!

So far, as the funds follow strict KYC norms, particularly identity and source of investible monies, coupled with a stringent regulatory regime of the jurisdiction housing the fund, such concerns are unfounded and baseless. Equally important is confidentiality and protection of taxpayers’ data, an integral taxpayer right. The same principles apply for investment holding and funding structures. This, coupled with mobility of capital and availability of offshore funding, lead businesses to implement structures to tailor individual needs. The expose in the Paradise Papers prompted the Mauritius Prime Minister to condemn the ICIJ for labelling the island nation as a “tax haven”, listing down tax reforms and regulatory measures that have been taken to address transparency requirements—all aligned to the OECD BEPS recommendations that the island nation is a signatory to.

In the past decade, regulators and tax administrators have made progress to lay down new benchmarks for transparency, particularly on trust and beneficial ownership structures, which has gained unprecedented prominence in the international tax policy debate. Besides, the attention on illicit funding for illegal activities, such as drug trafficking, money laundering and terrorist funding, closer cooperation between intergovernmental agencies has become a norm in the past two decades—the emergence of transparency and information exchange can be traced back to the statements issued during the meeting of finance ministers and central bankers at the 2004 Berlin G20 meet.

The transparency debate received a renewed thrust after the financial crisis of 2008, prompting global leaders to crack the whip on offshore accounts, paving way for the OECD-led BEPS exercise. A visible outcome of the debate has led to rush in (currently estimated at almost 1,000) signing of tax information exchange agreements modeled on OECD standards. The world is witnessing India at the forefront of the debate and leading the race for signing information exchange agreements with its treaty and non-treaty partners, aligned to the larger economic goal to weed out parallel economy. The Global Forum, an OECD lead group responsible for implementation of standards via a peer review process, consists of five important pillars:

  • Availability of reliable information on requests by countries; • Information relevant for enforcement of domestic law without ‘fishing expeditions’; • Elimination of restrictions on exchange of information citing banking secrecy laws or non-fulfillment of tax criminality test; • Confidentiality of information; and • Safeguarding taxpayers’ rights.

Such path-breaking changes will have to be calibrated by tax administrators to implement domestic law changes and simultaneously adhere to commitments under the international law. Frictions between the two are bound to arise and sensationalism of the likes of “Panama and Paradise Papers” will accentuate challenges for legitimate tax-compliant investors and tax administrators. Take, for instance, the ongoing tussle between the European Commission and US technology giants, prompting the EC to assess back taxes for allegedly availing state aids. Interestingly, EU member states whose domestic laws allowed businesses to set up such structures (and, in the process, avail of tax advantages) are siding multinational giants, besides creating discomfort between tax administrations across the Atlantic. Whilst the debate will continue until the trail in the European Court of Justice achieves finality or better sense prevails on governments to negotiate an “out of court” settlement, businesses are coming under increasing scrutiny of media supported by public sympathy. Multinationals embroiled in state aid cases in EU member states find themselves squeezed between the Internal Revenue Service (of the US) and EC orders, virtually directing implementation of new transfer pricing regime under BEPS, which should logically apply for the future.

The emergence of new BEPS standards and its roll-out can be made less turbulent for legitimate businesses with greater rigour on nations implementing such measures in a coordinated and consistent manner. The US initiative to implement its Foreign Account Tax Compliance Act (FATCA) for US nationals mandating reporting requirements for foreign banks and intermediaries is extremely complex, besides imposing an extraterritorial obligation on banking institutions. Similarly, BEPS Action Point 13 on corporate tax transparency with emphasis on common global reporting template called “country by country reporting” will make wealth of information available to tax administrations across the globe. Given the trend, governments and taxpayers will need to contextualise transparency—by whom, for whom and about what: who should disclose the information (active transparency); for whom should the information be disclosed (passive transparency); and what kind of information should be disclosed. Whilst governments give contextual meaning to the above questions, let’s not lose sight of confidentiality of taxpayers’ data and safeguarding their rights. A demoralised business will hamper capital building for growth, lead to shortage of funds to meet social obligations, and curb new employment generation opportunities, particularly for emerging nations, leaving meeting of larger economic goals a mirage.

The writer is Managing Partner, BMR Legal. The views are personal.






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