Tax havens, secrecy and policy options

Jim Stewart: Panama is primarily a secrecy jurisdiction. The main function of the firm at the centre of the leaked documents, Mosack Fonseca, is to incorporate entities. This often involved a chain of ownership across several ‘tax haven’ type jurisdictions. A chain of ownership is used to make identification of true owners very difficult. This is one reason why this leak is of far greater significance than other leaks, for example the Luxleaks, because the web of interconnections and chain of ownership has been revealed.

The second main function of Mosack Fonseca was to provide associated secretarial services, including nominee directors which again facilitated secrecy. The firm employs 500 and provides services in 15 different countries, including the Netherlands, UK, British Virgin Islands, and the Bahamas.

It is important to note that Mosack Fonseca is one of several firms providing company formation and secretarial services in Panama and that there are many other firms providing such services in many other jurisdictions, for example the UK, Luxembourg, the Netherlands and Ireland.

Companies providing mostly providing secretarial services are likely to be implementers of complex tax and secrecy strategies which are designed elsewhere.

A setback for tax havens?

The leak of such valuable documentation is a set back for tax havens and secrecy jurisdictions and those who use them, but it will not end their use. This is because tax havens and tax haven features have become both ubiquitous and integral to financial systems.

For example, features such as low corporate tax rates; special tax regimes; relatively light touch regulation; a very flexible response to changes in corporate and tax law to suit the needs of foreign investors; ease of incorporation; and a large offshore financial centre. These features have become key aspects of industrial and economic policy in several countries such as Ireland and, for example, the Netherlands, Luxembourg, and Switzerland (sometimes referred to as the four OECD tax havens).

Is Ireland a secrecy jurisdiction?

Despite the above characteristics associated with tax havens, Ireland is not on some tax haven lists and on others is not ranked as a major tax haven, because Ireland is not a secrecy jurisdiction. It is easy to incorporate, but once incorporated, company documents must be filed and are available for public inspection online (for a fee). There are exceptions. There is a growing use of unlimited companies, which publish no financial information. Beneficial ownership may be hidden by the use of trusts, and sometimes charitable trusts. For example in a sample of 82 Financial Vehicle Corporations (FVC’s), three charitable trusts (BADB, MEDB and Eurydice) were listed as having a third share each, in 18 FVC firms, with total assets in excess of €5 billion.

Blairmore (the fund established by Cameron’s father) sought legal advice in 2008 in relation to moving the fund from Panama. Having considered Cayman Islands and Bermuda, the fund moved to Ireland. One reason for moving to Ireland is because there are no Irish taxes imposed on fund income. A. and L. Goodbody state :-

“The central principle of the Irish taxation of funds is simple; generally, authorised Irish funds are tax exempt, except to the extent that they have Irish resident investors. Ireland would not be an attractive location for funds without tax neutrality which is achieved by way of this exemption from direct tax for a fund vehicle and by way of exemptions from indirect taxes. Looking at the other popular jurisdictions for funds such as the Channel Islands, Cayman and Luxembourg, it will be seen that either they have no taxes or have a favourable tax regime to allow a fund to achieve tax neutrality”.

This is a powerful reason why Ireland is the third largest location of investment funds in the world, after the U.S. and Luxembourg. The number of offshore companies incorporated by Mossack reached a peak of 13287 in 2005 and has fallen every year since then to 4341 in 2015. This fall is likely to be mirrored by a rise in offshore companies incorporated in offshore financial centres that are not generally designated as tax havens such as Ireland, Luxembourg and the U.S. (Delaware).

Although Blairmore was not organised as a trust, the UK Government intervened in 2013 to ensure that there was little or no transparency in the ownership of trusts in an EU transparency directive introduced in 2015.

Effects

The Panama papers provide evidence for what many have suspected, the large and complex nature of tax evasion/avoidance of tax. While tax avoidance may be legal, many would argue that it should not be.

Companies undertake complex strategies to minimise their tax bills as do wealthy individuals. This means the tax take falls to the detriment of the provision of public services and tax increases on those who do not have access to expensive tax advice, or have mobile assets. As Leona Helmsley (a U.S. billionaire) is reputed to have remarked, ‘tax is only for the little people’.

The extensive use of secrecy jurisdictions has several effects:-

It hides illegal sources of wealth (drug money, arms trade, evasion of sanctions), payment of bribes, and money laundering;

It avoids regulation which may have been implemented by governments in the public interest and to ensure a level playing field;

Ultimately widespread tax evasion will undermine democracies, our elected representative system, and social cohesion. Public services that we take for granted, security, response to emergencies, rule of law, health care, education, etc, rather than expand as is necessary and required are curtailed.

What are the policy options?

There should be a reduced reliance on tax haven type features as part of industrial and economic strategy;

Tax havens are conduits; real and financial assets are invested outside these countries. These assets should be taxed.

There is a need for far greater transparency. Country by Country (CBC) Reporting as advocated by the OECD BEPS initiative and the EU are important but data should be in the public domain. A central registry of the owners of companies and trusts is also important but again should be in the public domain.

The much heralded OECD BEPS proposals are unlikely to solve deep seated problems with tax avoidance/evasion at the corporate level. The OECD proposals represent the lowest common denominator of agreement. For example, different countries have differing perspectives, for example the U.S. and other counties opposed changing transfer pricing rules.

But perhaps the most lasting effect of the leak of the Panama Papers will raise questions as to whether there will be further leaks, and the movement of assets “onshore” to low tax jurisdictions such as Ireland, Luxembourg and the U.S.

The debate and Government policy on tax systems and transparency within the EU is likely to involve a much greater focus on low tax regimes such as Ireland.

Prof. James Stewart is a member of TASC's Economists' Network.

This is Part 2 of a series on the Panama Papers. Part 1 is available to read here.

Prof Jim Stewart

Dr Jim Stewart is Adjunct Associate Professor at Trinity College Dublin. His research interests include Corporate Finance and Taxation, Pension Funds and financial products, Financial Systems and Economic Development.

He is widely published and his titles include Mutuals and Alternative Banking: A Solution to the Financial and Economic Crisis in Ireland (2013), Choosing Your Future: How to Reform Ireland's Pension System (co-author, 2007) and For Richer, For Poorer: An Investigation of the Irish pension system (2005).