“Tax evasion reduces public revenues, drains BOP (balance of payments), scales down investable surplus and national productivity and creates black money.” A detailed analysis of the US-UBS saga and the evil of global tax evasion.
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Author: Atasi Das
Global Tax Evasion and the US-UBS saga: looking back
Introduction
Tax is a prime source of government revenue and tax evasion is a form of corporate crime. Tax evasion reduces public revenues, drains BOP (balance of payments), scales down investable surplus and national productivity and creates black money. Business corporations and individuals who evade tax actually shift their tax burden onto the compliant taxpayers. This leads to an inequitable economic distribution.
Tax minimization and tax evasion are totally different concepts. Citizens of a country have the right to tax reduction if that is done by legal means. Tax evasion on the other hand involves intentional falsification of conducted economic activities in a bid to lower one’s tax liability or when one does not pay one’s due taxes. It grants unfair tax advantages to businesses in a competitive market structure.
Efforts are on to do away with this vice on a global scale, as reflected in the communiqué released at the April 2009 G20 summit in London.
The US-UBS saga
UBS AG, Switzerland’s biggest bank has been accused of defrauding the United States of America by allowing US citizens to hide their bank accounts from IRS surveillance [Internal Revenue Service (IRS) established in 1953 is a US governmental organization]
In February 2009, UBS paid fines to the tune of $780 million and handed over names of around 300 US clients to the American government in relation to the abovementioned tax scandal. UBS bankers had reportedly created secret accounts for the rich US clients in the names of spurious business entities in various tax havens worldwide (like in Switzerland, Liechtenstein, Panama, Hong Kong and British Virgin Islands) and had garnered revenues to the tune of $200 million annually for the bank.
However, on 19th February 2009, the day after UBS agreed to shell out the $780 million penalty, the US Justice Department filed a lawsuit against it in federal court, Miami. As per this lawsuit, US clients possessed 32,940 secret accounts holding cash and 20,877 secret accounts holding securities with the UBS. The US is seeking the disclosure of the names of over 50,000 Americans who have hid their non-taxed earnings in secret Swiss banks accounts. The US will reportedly drop the charges against UBS in 18 months time, if the concerned bank makes payments, reforms its current practices and helps prosecutors with their investigation. It is ironical that, while America is faced with the worst recession since the days of the Great Depression, the wealthiest of its citizens have evaded tax and stashed away an estimated $14.8 billion worth of assets in secret Swiss bank accounts.
On 30th April 2009, UBS AG pleaded with a US court to reject the US tax authority’s demand for more confidential information regarding its US clients, as any further disclosure on this account would lead to the violation of Swiss banking secrecy laws. IRS has made use of the ‘John Doe’ summons in this particular case, as it allows the US tax authority to investigate tax fraud committed by persons whose identities are not known due to bank secrecy rules.
Switzerland is a relatively small country and banking is one of its major industries. This well oiled ‘wealth engine’ has put Switzerland among the world’s richest nations. Standing at around $2 trillion, UBS’s balance sheet is reportedly four times the nation’s GDP. Swiss financial services reportedly account for around 12.5% of the country’s GDP. The comparable figures for the Euro nations and the United States are 5% and 8.5% respectively.
Tax evasion is a crime under the US law, but not so under the Swiss law. Tax fraud is regarded as a more serious offence under the Swiss law. However in this case, the norm of client confidentiality seems to have been misused to cover up the fraudulent acts of customers, in direct assistance with bank personnel.
The UBS saga has reportedly shaken the Swiss banking system. The tax scandal has posed substantial monetary losses for UBS and threatened Switzerland’s banking industry in general.
Tax havens
As per an OECD declaration, an ‘offshore tax haven’ is a jurisdiction, which aids in tax avoidance, which would otherwise have been paid in a country with a higher tax jurisdiction. OECD in 1998 identified 4 principal factors (as listed below), which characterizes a tax haven.
- Nonexistent or nominal tax on income
- Lack of effective information exchange
- Lack of transparency
- Absence of ‘substantial activities’
In June 2000, OECD identified more than 40 jurisdictions as tax havens. Even in the year 2002, 3 jurisdictions (Andorra, Liechtenstein and Monaco) remained on OECD’S list of ‘uncooperative tax havens’. However these three nations have agreed to implement the standard in 2009.
Tax havens mostly operate as offshore financial centres and possess a composite tax structure, which is tailor-made to meet the global demand for tax avoidance vehicles. They possess low levels of legislative and administrative transparency and very low levels of tax information exchange with foreign nations. People siphon off their money to tax havens in the lure of attractive tax avoidance instruments and high levels of financial privacy.
Tax havens encourage business corporations and wealthy economic entities to avoid paying taxes, which leads to substantial revenue losses for governments. Governments of developing nations in particular, use tax revenues for funding various human developmental works; sufficient revenue generation from taxes frees developing nations from the strings tied with foreign aid. The situation becomes worse in view of the fact that most of the poor nations earn meager tax revenues in view of the low corporate tax rates (due to the ensuing tax competition among nations for attracting foreign investment) and trade liberalization, which has practically done away with import taxes (an erstwhile source of revenue).
Transnational corporations leverage the tax havens to gain undue tax advantage over nationally based companies operating with relatively smaller scales of operation.
The offshore global financial institutions make use of banking secrecy codes and trust services to render a security blanket over the proceeds of global drug trade, illegal arms trade, fraud, political corruption and the like. Also rapid movement of portfolio capital (both in and out) in national economies occurs via offshore financial centres. This makes the domestic financial markets unstable and volatile.
G20 London summit
The Group of Twenty Finance Ministers and Central Bank Governors (G-20), incorporated in 1999 is a forum for discussion of key global economic issues amongst the world’s leading industrialized and developing nations. Its latest London meet was held on 2nd April 2009.
At the London summit, the G20 forum called on all jurisdictions to abide by the set international tax standards involving tax, prudential and Anti-Money Laundering (AML) / Combating Financing of Terrorism (CFT) regulations. Countries were requested to adopt the G20 endorsed international information exchange standard. The forum also agreed to develop counter-effective measurers for jurisdictions found guilty of violating international tax transparency standards. The political leaders advocated sanctions against the non-co-operative jurisdictions’ (inclusive of the tax havens). The G2O leaders called for bringing to an end the ‘banking secrecy’ era and demanded immediate publication of the names of nations, which have failed to conform to the set international tax standards. The G20 proposed package of counter measures in the April 2009 London meet include the following:
- Both the tax payers and the financial institutions involved in transaction with non-cooperative jurisdictions will have to comply with increased disclosure requirements about the same
- Taxes will be withheld in respect of certain types of payments
- Deductions will be denied with regards to expense payments when the payees reside in non-cooperative jurisdictions
- Tax treaty policies will be subject to review
- International financial bodies and regional development banks will be asked to review their investment policies
- Added weightage will be given to the issues of information exchange and tax transparency when formulating bilateral aid programs
As per the forum, the imposed sanctions on errant nations were needed to protect the global financial system and the public finances of the G20 member nations. The G20 forum also assured about the development of the said proposals by 2009 year end.
The International Monetary Fund (IMF) and the Financial Stability Board (FSB) will be among the international bodies that will assess the status of implementation of the advocated measures by concerned jurisdictions. The Financial Action Task Force (FATF) has been asked to review the compliance process of jurisdictions adhering to the (AML)/ (CFT) standards. Both the FSB and the FATF are scheduled to place their reports before the next G20 meet of Finance Ministers and Central Bank Governors. Paris-based ‘Organisation for Economic Co-operation and Development’ (OECD), a trusted source of global socio-economic data and comparable statistics has also been entrusted with the task of following up the matter in the upcoming finance ministers’ meet in November at Scotland.
The G20 forum agreed to work on the following major areas of financial reform, as mentioned in the ‘Declaration on Strengthening the Financial System’ released on 2nd April 2009.
- Financial stability
- International cooperation
- Prudential regulation
- Scope for regulation
- Compensation
- Tax havens and non-cooperative jurisdictions
- Accounting standards
- Credit rating agencies
G20 also released an action plan named ‘The Global Plan for Recovery and Reform’ on 2nd April 2009 in London.
Offshore Tax Evasion in G20 London summit: some OECD directives
After the conclusion of the April 2009 G20 London summit, OECD released a report (dated 21 April 2009) describing the worldwide status of implementation of the internationally accepted tax norms. The report classifies international jurisdictions into four broad categories as mentioned below.
- Jurisdictions where the set tax standards have been substantially implemented
- Jurisdictions that are committed to the standard but have failed to implement it till date
- Tax havens that have not implemented the standard despite being committed to the same
- Jurisdictions that have refused to commit to the tax standard
With Costa Rica, Uruguay, Malaysia and Philippines committing to the set international tax standards all the 84 jurisdictions under OECD’s assessment have agreed on the implementation of the standard at the end of the G20 summit.
The international tax standard
The OECD formulated and G20 and UN endorsed international tax standard endorses full information exchange among nations (on request) regarding all tax issues, irrespective of existent domestic tax interest requirements or tax related bank secrecy norms. The information thus exchanged will be strictly confidential.
OECD holds that bank secrecy is not incompatible with the OECD set tax standard. The standard simply requires that it is relaxed in ‘well defined circumstances’ so that nations can respond to the request for information from treaty partners, such that, both nations can abide by their respective tax laws simultaneously.
The tax standard implementation can be done via Tax Information Exchange Agreements (TIEAs) or bilateral Tax Treaties or by multilateral agreements or through relevant domestic legislations.
India and tax evasion
As per a Global Financial Integrity (GFI) (a wing of the Center for International Policy) report, the estimated volume of capital flight into global tax havens for India, for the time period 2002-06, has ranged from $22 billion to $27 billion annually.
In a bid to lessen offshore capital flight, the Indian government has made certain types of disclosures mandatory, like the ones stated below.
- Buying or selling of property worth above Rs 30 lakh
- Credit card expenditure of over Rs 2 lakh
- Mutual fund investment over Rs 2 lakh
- More than Rs 5 lakh worth of investment on RBI bonds, company debentures and equity
The Indian government has also gone for an amendment of the Prevention of Money Laundering Act in February 2008 and took up the issue with concerned bodies like the FATF and the Asia Pacific Group on Money-Laundering and Counter-Financing of terrorism.
The recently concluded G20 London summit has proposed regulations, which on proper implementation can recover illegal black money piled in tax havens for India and boost up its foreign exchange reserves. According to the Indian tax experts, the ‘robust’ implementation of the latest G20 guidelines will go a long way in curtailing corporate profits, which are inflated via investment routing through tax havens, for the purpose of tax arbitrage and confidentiality.
The Reserve Bank of India (RBI) has pledged on 21st April 2009 that, it would update its regulations on a continuous basis so as to endorse the policies advocated by the prevalent G20 guidelines on cross border capital movement. This would increase the transparency of such transactions and help to tackle the problem of black money accumulation in tax havens.
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