The G20’s plan to tackle banking secrecy is a small step in the right direction, says Prem Sikka
TAX avoidance has undermined the tax base of many countries. Globalisation has intensified the mobility of money, while rich individuals and major companies have sought shelter for their income in tax havens offering anonymity, low regulation and low or no tax rates. Since some companies and individuals have a global income, accountants and lawyers have developed elaborate structures and transactions to enable their clients to avoid taxes in their home countries.
Developing countries lose nearly $500 billion of tax revenues each year as a consequence of tax avoidance and evasion. Around $124 billion of this, bigger than the annual overseas aid budget, is attributed to tax havens. The United States is estimated to be losing around $345 billion of tax revenues each year and around $100 billion of this relates to tax havens. Britain loses around £100 billion a year. Unofficial estimates suggest that £18.5 billion of this may relate to the use of tax havens. Given the magnitude of the lost tax revenues and the depth of the current financial crisis, many governments have become more concerned about tax avoidance and the topic appeared as a major item on last week’s G20 summit in London.
The eventual communiqué issued on April 2 stated that the G20 leaders have agreed “to take action against non-cooperative jurisdictions, including tax havens. We stand ready to deploy sanctions to protect our public finances and financial systems. The era of banking secrecy is over. We note that the OECD has today published a list of countries assessed by the Global Forum against the international standard for exchange of tax information.”
Going after non-cooperative tax havens and jurisdictions is not a new project. In 1998, under pressure from major European Union countries, the Organisation for Economic Co-operation and Development published a paper on what it called “harmful tax competition” and, in 2000, published a framework for sharing tax information. In 2002, this became the OECD Model Tax Convention (revised in 2005), which states that bank secrecy cannot be an obstacle to exchange of information for tax purposes. The OECD framework encourages nation-states to sign its Tax Information Sharing Agreement through a series of bilateral, not multilateral, treaties. Each treaty would need to be ratified by the parliament of the respective countries. It is doubtful that poor developing countries can muster sufficient political and economic clout to negotiate a treaty with larger nations. Even if that was possible, due to organised tax avoidance by multinational companies, many developing countries do not have effective tax administration structures to make the relevant requests for information
Banks in most countries pay interest gross on investments made with them. The holders of accounts may not declare that in their home countries. Under the OECD framework, governments can demand information about the cross-border investments made by their citizens and levy taxes. However, many countries, especially those with a history of bank secrecy, were not happy with the proposals. Andorra, Monaco and Liechtenstein refused to comply with the OECD standards and Austria, Belgium, Luxembourg and Switzerland had severe reservations. George W Bush’s administration did not support the OECD project and it stagnated. The incoming administration of Barack Obama has been critical of tax havens and undoubtedly this made tax information sharing – a favourite US tax policy tool – a major issue.
While any assault on tax avoidance, tax havens and banking secrecy is welcome, a number of problems remain. The G20 statement does not provide any details of possible sanctions. Can sanctions really be imposed on countries that are not members of the OECD or had no say in developing the OECD Model Tax Convention? Any country escaping the OECD framework is likely to be attractive to those who value secrecy and tax avoidance. Thus all countries need to sign up to the OECD framework and that might only be possible if the OECD membership is broadened. All that will take time, although the threat of sanctions has persuaded Andorra, Belgium, Luxembourg, Switzerland, Hong Kong, China, Monaco, and Singapore to
adopt the OECD standards. Of course, there would be debates about the
precise meaning of the standards.
With conflicting economic interests and vagaries of language, there is no guarantee that all states will reach a common understanding of the OECD framework.
The tax information sharing is not automatic. Under the OECD framework, a state will not be able to request information randomly on bank accounts held by its residents located in the other state. Each state will have a make a detailed case for requesting information from other signatories to the OECD framework. In particular, they will have to demonstrate the foreseeable relevance of the requested information. This is a formidable and costly task, especially as the affairs of many tax avoiders are shrouded in secrecy. Some states will insist that before any information is supplied, the person concerned must be notified of the request. This may give the person opportunity to raise legal objections and also cover their tracks.
The biggest shortcoming of the G20 initiative is that it only seems to apply to individuals. Corporations, partnership trusts and other business vehicles are not covered by the OECD framework. So individuals could dodge taxes by making investments through corporate entities. It is perfectly possible for British citizens to form corporate vehicles that are domiciled in tax havens even though they might trade in Britain or have directors in this country. Thus these companies are totally beyond the reach of the G20 agreement.
Curbing “tax evasion and tax avoidance” is much bigger than constraining “banking secrecy”. Many multinational corporations avoid taxes through complex corporate structures, transfer pricing and royalty programmes. For example, Bernard Madoff has hidden his loot in offshore entities. Enron used nearly 3,500 subsidiaries to avoid taxes in the US, India and Hungary. Many of these were in the Cayman Islands which do not levy corporate taxes. WorldCom devised a royalty programme by creating an asset called “management foresight”. All companies in the group were required to pay royalties. Over a four-year period, the subsidiaries paid $20 billion in royalty fees. The paying companies got tax relief on the payment of royalties. However, since the receiving company was located in a favourable tax jurisdiction it paid little or no tax on most of its income. The transaction was internal to the WorldCom group and had no net effect on its global profits, but saved millions in taxes.
The G20 have totally ignored corporate tax avoidance and accountants, lawyers and bankers who dream-up tax avoidance schemes. They can help developing countries by simply stating that all companies located in the US and the EU will pay the taxes due to developing countries, but were silent. No doubt, bigger battles lie ahead.
Prem Sikka is professor of accounting at the University of Essex
This article will be posted for debate at www.compassonline.org.uk
