This was first published in Issue 207, June 2010 of Offshore Investment magazine and is reproduced with their kind permission.
President Obama noted that a small, five-storey office building in the Cayman Islands capital George Town, Ugland House, is officially home to more than 18,000 companies, yet only 241 people work there. According to the President it was "either the biggest building in the world or the biggest tax scam in the world". Note the language: not tax avoidance, not tax planning, but tax scam.
In the last four decades we have witnessed an increase in freedom of movement for businesses, people, money and services, at the same time as warning signs have appeared that sovereign states are losing control over such movements. Unfortunately, the development of this new global economy has created the means and the cover to move illegally-obtained assets between states at great speed and without detection.
In order to recover the funds obtained from "delinquency" e.g. tax evasion and tax avoidance, and to deter further outflows, states appear to be making a unified, global effort to introduce regulatory standards and legislation that are workable and compatible. Above all else, states seem readier to recognise that everywhere may be "offshore" to everywhere else.
Fraudsters have tended to exploit loopholes in the global banking system, in particular, tax arbitrage, once encouraged by the desire for inward investment in developing countries, island communities and even in some developed countries, e.g. the Netherlands.
The Pursuit of Offshore
The pursuit of offshore funds is a state's attempt to stem the flow of potential tax revenues escaping their grasp. This is particularly poignant when the public purse is feeling a little light, as it is in a recession. What many articles on tax avoidance ignore is the fact that England itself is offshore to other countries. In 2001, the UK Financial Services Authority, investigating the movement of funds suspected of being the proceeds of Sani Abacha's corruption, established that transactions totalling USD1.3 billion had been carried out via 42 personal and corporate account relationships linked to Abacha family members and close associates in the UK. These accounts were held at 23 banks which included UK banks and branches of banks from both inside and outside the European Union.1
State Parties are beginning to make a unified effort against such behaviour. There has been an increase in multilateral and bilateral treaties and agreements, and mutual legal assistance and international moves to increase regulation. Countries like Switzerland are being named and shamed, along with Liechtenstein, Monaco, and even our close islands of Jersey, Guernsey and the Isle of Man.
Events in 2009 and 2010, such as the purchase of the details of a number of UK residents with bank accounts in Liechtenstein and with accounts in HSBC Private Bank, have also underlined the determination of OECD member countries to tackle the long-standing problem of their citizens using structures established in the most opaque jurisdictions to help them evade tax.
Regulation
The 2 April 2009 Communiqué of the G20 contained an undertaking to strengthen international financial regulation and enforcement and to act against non-cooperative jurisdictions including 'tax havens'. It also committed to strengthen the Financial Stability Board (FSB), previously known as the Financial Stability Forum (FSF). The FSB was designed to reinforce international co-operation in implementing the principles agreed by members of the G20. It will be expanded to include Spain and the European Commission. Its new mandate will include: assessing vulnerabilities affecting the financial system; identifying and overseeing action needed to address them; and monitoring and promoting co-ordination and information exchange among authorities responsible for financial stability amongst others.
International Tax Standards
On 2 April 2009, the OECD issued a progress report on jurisdictions surveyed by its Global Forum to see whether they had implemented the internationally agreed tax standards. The report named 40 jurisdictions that had substantially implemented the standard; 31 that had committed to the standard but had not yet substantially implemented it; and eight financial centres (such as Luxembourg and Switzerland) and four jurisdictions (such as Malaysia and Uruguay) that had not yet committed to the standard.
At the G20, France and Germany made it clear that they wanted to blacklist unco-operative tax havens. The UK and US initially opposed such a measure but later relaxed their position. China strongly opposed it on the basis that the OECD would have been responsible for it (China does not participate in the OECD) but conceded it would support a UN blacklist.
In November 2009 the G20 Finance Ministers buttressed this policy by commending the progress achieved by the Global Forum on Tax Transparency.
The Forum participants agreed to establish a Peer Review Group to carry out in-depth monitoring of implementation of the transparency and exchange of information standards at the meeting in Mexico in September 2009. Notably the Forum also explored the means to accelerate negotiations of information exchange agreements through the use of multilateral instruments.
The November Communiqué called on the Forum, FSB and FATF to continue tackling non-cooperative jurisdictions by completing their peer review processes and publishing lists of NCJs.2 In March 2010 the countries participating in the Global Forum on Transparency and Exchange of Information launched the peer review process covering a first group of 18 jurisdictions: Australia, Barbados, Bermuda, Botswana, Canada, Cayman Islands, Denmark, Germany, India, Ireland, Jamaica, Jersey, Mauritius, Monaco, Norway, Panama, Qatar, Trinidad & Tobago. As at 1 April 2010, all the jurisdictions surveyed by the OECD Global Forum had committed to the internationally agreed tax standard. At that date 17 signatories had not substantially implemented the standard, of which only 5 were yet to conclude their first information exchange agreement.
The EU is also taking measures in the fight against tax havens ahead of G20 and the OECD. On 10 February, the European Parliament adopted a non-legislative resolution by an overwhelming majority (554 votes to 46, with 71 abstentions) strongly condemning the role played by tax havens "in encouraging and profiteering from tax avoidance, tax evasion and capital flight"; urging the Member States to make the fight against tax havens a priority and calling on the EU to step up its action and to take immediate concrete measures such as sanctions against tax havens, tax evasion and illicit capital flows. The resolution acknowledged that the combined efforts of the G20, UN and the OECD had produced some promising results, noting however that the results "remain insufficient to cope with the challenges presented by tax havens and offshore centres and must be followed by decisive, effective and consistent action". In particular, the resolution called for the replacement of bank secrecy with automatic information exchange that "should take place in all circumstances, including in all the Member States and dependent territories" and suggested an EU public register "listing the names of individuals and undertakings having set up companies and accounts in tax havens, with a view to unveiling the true beneficiaries shielded by offshore companies".3
On the same day the Parliament approved two proposed Council Directives: on mutual assistance for the recovery of claims relating to taxes, and on administrative cooperation in the field of taxation. The former was adopted by the Council this March and will enter into force on the 20th day from the publication in the Official Journal.4 The Directive enables tax authorities in one Member State to obtain information relevant to recovery of its claims from the authorities in other Member States and to require the requested authorities to recover a claim treating the request "as if it was a claim of the requested Member State".
The latter Directive is more far-reaching and is yet to be adopted due to strong opposition from Austria and Luxembourg. If adopted, the Directive would introduce procedures for automatic and compulsory exchanges of information for tax assessment purposes; enable officials of one Member State to participate actively in administrative enquiries on the territory of another; and prohibit Member States from refusing to supply information on the grounds that the information is held by a bank or other financial institution.5
The US confronts tax havens
On 2 March 2009, the US Congress introduced the Stop Tax Haven Abuse Act (STHAA). One of the co-sponsors of the Bill was President Obama. Title 1 of the Act, 'Deterring the Use of Tax Havens for Tax Evasion', establishes presumptions for entities and transactions. The Bill established rebuttable evidentiary presumptions in legal proceedings involving tax and securities for entities located in offshore secrecy jurisdictions.
On 27 October, 2009, Senator Max Baucus and Representative Charles Rangel introduced the Foreign Account Tax Compliance Act (FATCA) in the US Congress. The Bill was intended to clamp down on tax evasion and improve taxpayer compliance by giving the IRS new administrative tools to detect, deter and discourage offshore tax abuses.
Upon introduction of the Bill in the Congress, President Obama made the following statement:6
"I commend Chairmen Baucus and Rangel, and Senator Kerry and Congressman Neal, for moving forward on the important task of giving the government the tools it needs to crack down on Americans hiding their assets in overseas tax havens. A small number of individuals and businesses hide their assets overseas solely in order to shirk their responsibilities, even as the vast majority of hard-working Americans honor the obligations of citizenship and fulfill their responsibilities.
"Shortly after taking office, I laid out a set of proposals to crack down on illegal overseas tax evasion. The legislation introduced today would fulfill that promise, putting a stop to billions of dollars worth of abuses. I look forward to working with Congress to turn these proposals into law so that honest Americans no longer shoulder the burden of the few individuals and businesses that put profit before responsibility."
On 18 March 2010, a modified version of FATCA was signed into law by president Obama as part of the Hiring Incentives to Restore Employment Act of 2010. The Act introduces several important changes, most notably the requirement that a foreign financial institution agree with the IRS to report information about its US account holders each year, failure to do so attracting a 30% withholding tax on "withholdable payments" made to the institution. The Act also imposes a 40% penalty on any understatement of income attributable to undisclosed foreign financial asset; extends the three-year statute of limitations to six years where an omission of more than $5,000 of income is attributable to one or more reportable foreign assets; and imposes a minimum penalty of $10,000 for failing to comply with certain information reporting provisions applicable to non-US trusts.
Action against tax advisors
The IRS is also stepping up its enforcement alongside the activity in Congress. In March this year it reported that 4,121 criminal investigations were started in 2009, compared with 3,749 a year earlier.7 The announcement came on the heals of the New York District Court decision to sentence Robert Pfaff, a former KPMG partner, to 57 months imprisonment and $1,052,000 restitution to the IRS for concealing millions of dollars of fee income received from tax shelter transactions from the IRS.8 Just over a month earlier the same court sentenced four former Ernst & Young partners to the total of 114 months in prison, 10 years of supervised release and $275,000 fine for designing and implementing tax shelter transactions in ways intended to conceal the true facts of the transactions from the IRS.9
UBS clients plead guilty to filing false tax returns
In 2009 three UBS clients, Steven Michael Rubinstein, Jeffrey Chernick and Robert Moran, pleaded guilty to criminal informations charging them with filing a false income tax return. Chernick and Moran accepted responsibility for concealing more than $8 million and $3 million in assets in Swiss bank accounts. According to court documents and statements made during the court hearing, Rubinstein maintained a UBS bank account in the name of Hybridge International Ltd., a nominee British Virgin Island corporation. From 2001 through 2008, Rubinstein communicated with bankers at UBS about the purchase and sale of securities worth more than 4.5 million Swiss Francs, the conversion of investments from U.S. dollars to British Pounds, the deposit and transfer of funds into and out of the UBS Swiss accounts, and the repatriation of approximately $7 million into the United States to purchase property and build his personal residence in Boca Raton. Additionally, Rubinstein deposited and sold more than $2 million in South African Krugerrands through his UBS accounts.10 Rubinstein was sentenced to three years probation, of which 12 months will be served in home detention, and was ordered to pay a $40,000 fine. Chernick and Moran received custodial sentences.
This year another UBS client, Jack Barouh, pleaded guilty to filing a false tax return and is awaiting sentencing set for April this year. In his comment on the announcement, Victor S. O. Song, Chief IRS Criminal Investigations, said, "Hiding money in foreign bank accounts to evade paying taxes is a crime. The IRS will continue our efforts to bring non-compliant taxpayers into the tax system either through the voluntary disclosure program or criminal prosecution."11
The US is still pursuing information regarding thousands of UBS customers of US origin, and is also looking at customers of Credit Suisse and HSBC. In February 2010 it was reported that a Dr Silva of Virginia pleaded guilty to a conspiracy involving an undeclared Swiss bank account held with HSBC.12 The case is notable because it shows the authorities are expanding beyond UBS in their scrutiny of banks suspected of helping Americans evade taxes.
US – UBS Deal
In June 2008, the Justice Department sought an order from a federal court in Miami authorizing the IRS to request information from Zurich, Switzerland-based UBS AG about U.S. taxpayers who might have used Swiss bank accounts to evade federal income taxes. The Justice Department sought permission to allow the IRS to serve what is known as a "John Doe" summons on the bank. The move was a part of the US investigation into whether the Swiss group had helped wealthy American clients evade tax.
On 19 August 2009 the parties reached an agreement pursuant to which the IRS would receive substantially all of the accounts that it was interested in when it initiated the John Doe summons. In effect UBS agreed to hand over the 4,450 names to settle with American authorities.
The agreement's execution has stumbled on a Swiss Federal Administrative Court's ruling in February 2010, which held that bank secrecy rules could only be lifted in cases of tax "fraud" rather than tax "evasion", and has led UBS to lobby the Swiss parliament to approve the agreement.
Pending the Swiss parliamentary outcome, US nationals are voluntarily disclosing their offshore accounts. Already in November 2009 Douglas Shulman, the IRS commissioner, announced that about 14,700 individuals from about 70 different countries had voluntarily disclosed secret offshore accounts at the Swiss bank and other banks to avoid possible criminal prosecution. The number is almost double the initial amount announced in October and dwarfs the number of voluntary disclosures in 2008, when there were fewer than 100.13
Developments in the UK
In its 2010 Budget, the UK Government announced its intention to legislate to ensure that that those who fail to declare income and gains from jurisdictions that do not exchange information automatically with the UK will face tougher penalties of up to 200 per cent of the tax due. The announcement follows an order by the Treasury to appoint 1 April 2010 as the date on which section 94 of the Finance Act 2009 will come into force. The section authorises HM Revenue & Customs (HMRC) to publish the details of taxpayers where it is established that they have committed certain serious tax offences.
HMRC's renewed offshore compliance strategy
These developments buttress HMRC's renewed offshore compliance strategy which involves providing UK residents with incentives to voluntarily disclose their offshore tax liabilities; using data obtained from financial institutions to identify those failing to make, or making incomplete, disclosure; and investigate the latter individuals with a view to recover taxes, interests and much larger penalties or to prosecute.
In line with the strategy, in 2009 the UK saw the opening of two disclosure facilities: New Disclosure Opportunity (NDO) and Liechtenstein Disclosure Facility (LDF), offering reduced penalties as an incentive for taxpayers to come forward. The NDO closed in March this year but the LDF will run until March 2015. Crucially, the disclosure facilities were preceded by HMRC successfully obtaining an agreement from the Tax Chamber of the First-tier Tribunal to issue information notices to over 300 financial institutions requiring them to provide details of their offshore account holders, enabling HMRC to identify those failing to come forward. HMRC are expected to commence investigations into individuals it believes have underpaid tax, using the account details it is obtaining from financial institutions.
A similar disclosure exercise, targeted at customers of five UK retail banks, was staged in 2007. In addition to revealing that only about 25% of individuals declared income from their offshore accounts, the exercise yielded over £400 million in unpaid tax, penalties and interest and led to HMRC identifying 10,000 cases for investigation. This year's launch of the Tax Health Plan, a disclosure opportunity for medical professionals, is a clear sign that the trend is set to continue.
Taxing rule of law
In the midst of rumours that barristers are HMRC's next target – with the creation of a so-called Barrister Unit in HMRC's Euston Tower premises and the possible extension of the doctors' tax amnesty campaign to barristers – the judiciary is taking a tougher stance against individuals using offshore to reduce their UK tax liability. Three recent UK judgments are noteworthy.14
The first is the February 2010 Court of Appeal decision in the judicial review of the Robert Gaines-Cooper case heard together with two other similar appeals by Robert Davies and Michael James. Mr Gaines-Cooper argued that he had relied on guidance issued by HMRC (known as IR20) that set out the circumstances in which an individual would, or would not, be treated as resident in the UK for tax purposes. A key part of the guidance that Mr Gaines-Cooper relied on was that spending less than 91 days a year in the UK would mean that he could not be treated as UK resident. The Court held that if the specified number of return visits was exceeded, non-resident status would be lost, but the converse did not follow as a matter of logic or language. Accordingly, if the number of return visits was not exceeded, it did not follow that the taxpayer had left or gone abroad permanently or indefinitely. To have ceased to be resident in the UK, the taxpayer had to demonstrate a distinct break from former social and family ties within the UK. The guidance's reference to "permanently or indefinitely" required consideration of the quality of the absence.15
The second case was a claim for judicial review brought by Mr Robert Huitson, who sought to challenge under the Human Rights Act 1998 that sections 58(4) and (5) of the Finance Act 2008 were incompatible with Article 1 of the First Protocol (A1P1) to the European Convention of Human Rights (the ECHR) on the ground that the sections changed fiscal legislation regarding double taxation relief with retrospective effect, and that such retrospective amendment did not strike a fair balance as required by the ECHR and the jurisprudence of the European Court of Human Rights. The High Court held that the Parliamentary response was not disproportionate. In the Court's view it is a legitimate aim of UK public policy in fiscal affairs that a Double Taxation Agreement (DTA) should do no more than relieve from double taxation, and that a DTA should not be permitted to become an instrument by which persons residing in the UK avoid the incidence of income tax that they would ordinarily pay on their income. Parliament was therefore entitled to conclude that a rigorous application of the policy was called for and to legislate with retrospective effect, "particularly in order to ensure a 'fair balance' between the interests of the great body of resident taxpayers who paid income tax on their income from a trade or profession in the normal way, and the taxpayers, like the Claimant, who had sought to exploit, by artificial arrangements, the DTA".16
Finally, in the Prudential case against Special Commissioner of Income Tax, the claimant applied for a judicial review of two notices served under the Taxes Management Act 1970 s.20(1) and s.20(3) requiring the delivery of documents to the inspector of taxes. The notices were served by the Revenue with a view to investigating a commercially marketed tax avoidance scheme. One of the grounds for the judicial review was that the notices sought material covered by legal professional privilege. The Court held that on existing authorities for the privilege to apply to legal advice and assistance it had to be given by a member of the legal profession. The fact that litigation privilege could be claimed where an accountant acted in the preparation and presentation of tax litigation did not lead to the conclusion that legal advice privilege also extended to advice given by accountants on tax law in circumstances where, if the accountant had been a solicitor, the claim to privilege would not be one based on litigation privilege. Although Prudential had shown that accountants did what lawyers were described as doing in the cases that established legal professional privilege, the decided cases did not permit clients of accountants and other professions, apart from lawyers, to claim legal professional privilege on the basis of legal advice privilege.17
Conclusion
The "wealthy" countries must now agree how to move forward. In the recent G20 Summit, discussions were given urgency by the scandals of the last few years: UBS and the US, the high profile prosecution of KPMG partners, Germany losing money to Liechtenstein and Luxembourg and France to Switzerland and Monaco. These countries appear to accept that they each have some of the characteristics of the traditional 'offshore'. The UK is tough on money laundering but makes it easy to start up companies. It is seen as vulnerable to charges of laxity because of its relationship with its proximate islands. The US has yet to tackle those states, such as Delaware, which enable corporations to conceal the identity of beneficial ownership.
We are still a long way from harmonious tax laws or the ability to stop businesses and businessmen relocating to more congenial tax regimes.
Footnotes
1. FSA Press Release, FSA publishes the results of money laundering investigation, 08 March 2001; see also 'Undue Diligence' How Banks Do Business with Corrupt Regimes, Report by Global Witness, March 2009.
2. G20 Communiqué 'Meeting of Finance Ministers and Central Bank Governors, United Kingdom' 7 November 2009.
3. European Parliament Resolution of 10 February 2010 on promoting good governance in tax matters (2009/2174(INI)).
4. Council Directive concerning mutual assistance for the recovery of claims relating to taxes, duties and other measures, 9 March 2010, 5567/4/10.
5. Proposal for a Council Directive on administrative cooperation in the field of taxation, 2 February 2009, COM (2009) 29 final.
6. The statement is available at http://www.financialtaskforce.org/2009/10/27/president-obama-statement-on-foreign-account-tax-compliance-act-of-2009/ .
7. Kim Dixon, US boosted financial, tax crime probes in 2009, Reuters, 11 March, 2010.
8. DoJ press release, Former KPMG Partner Sentenced in Manhattan Federal Court to 57 Months in Prison in Scheme to Defraud IRS, Saipan Taxing Authorities, and Saipan Company, 3 March, 2010.
9. DoJ press release, Two Former Ernst & Young Partners Sentenced in Manhattan Federal Court for Their Roles in Criminal Tax Shelters, 21 January, 2010; DoJ press release, Two Additional Former Ernst & Young Partners Sentenced in Manhattan Federal Court, 22 January, 2010.
10. DoJ press release, UBS Client Pleads Guilty to Filing False Tax Return: Hid $8 Million in Secret Swiss Bank Accounts, 28 July, 2009; DoJ press release, UBS Client Pleads Guilty to Filing False Tax Return: Boca Raton Resident Hid Income and Assets in Secret Swiss Bank Account, 25 June 2009; DoJ press release, UBS Client Pleads Guilty to Filing False Tax Return: Hid Assets Worth $3 Million in Secret Swiss Bank Account, 14 April, 2009; see also David Voreacos and Carlyn Kolker, UBS Tax Crimes Scorecard: Bankers, Clients and Their Enablers, Business Week, 8 January , 2010.
11. DoJ press release, Former UBS Client Pleads Guilty to Hiding $10 Million in Offshore Bank Accounts, 4 February, 2010.
12. Lynnley Browning, Case is Said to Link HSBC to US Tax Evasion Inquiry, The New York Times, 17 February, 2010.
13. Joanna Chung, Swiss hand over bank details in US bid to pierce 'veil of secrecy', Financial Times, 17 November, 2009.
14. Elizabeth Colman, After doctors, the Revenue turns on vets and lawyers, The Sunday Times, 17 January, 2010.
15. R. (on the application of Davies) v Revenue and Customs Commissioners [2010] EWCA Civ 83.
16. R. (on the application of Huitson) v Revenue and Customs Commissioners [2010] EWHC 97 (Admin).
17. R (on the application of Prudential Plc) v Special Commissioner of Income Tax [2009] EWHC 2494.
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