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How Panama Papers are just the tip of the iceberg

by April 9, 2016 General

A tax haven has one of these three characteristics: It has no or a very low-rate income tax. It has bank secrecy laws. And it has a history of non-cooperation with other countries on exchanging tax information. Central America’s second largest economy has all three. Poonam Khaira Sidhu on how the Panama Papers are just the tip of the iceberg

The Panama Papers are merely the tip of the iceberg, with 11.5 million files from the database of the world’s fourth-largest offshore law firm, Mossack Fonseca, tumbling out last weekend. But to provide some perspective, 400,000 corporations and foundations are domiciled in Panama.

And then again, this is also only one of the many financial centres used by the rich and famous to offshore their wealth. It also highlights the impact of Base Erosion and Profit Shifting (BEPs), conservatively estimated at an annual revenue loss of $100-240 billion.

The stakes are clearly high for governments around the world. The impact on developing countries as a percentage of tax revenues is being estimated to be even higher than in developed countries. So, if there is a poster boy for BEPs, it is the Panama Papers.

How Panama Papers are just the tip of the icebergThe G20 had identified the Automatic Exchange of Information (AEoI) as the new international standard in 2014 as a response to checking BEPs. Since then, 132 jurisdictions have committed to this standard on exchange of information ‘on request’. Of these, 96 jurisdictions will introduce AEoI within the next two years, including almost all the renowned international financial centres such the Cayman Islands, Bermuda, Hong Kong, Jersey, Singapore and Switzerland. But Panama had so far refused to make the same commitment.

According to the Washington-based Citizens for Tax Justice, a tax haven has one of these three characteristics: “It has no income tax or a very low-rate income tax; it has bank secrecy laws; and it has a history of non-cooperation with other countries on exchanging information about tax matters.” Panama has all three.

Partners Juergen Mossack and Ramon Fonseca incorporated more than 113,000 British Virgin Island (BVI) companies, but also branched out to the tiny Pacific island nation Niue where, by 2001, they were contributing 80% to Niue’s budget. There are no reporting requirements for non-resident Panamanian corporations. Panama does not allow ‘piercing the corporate veil’. Panamanian corporation’s share certificates can be bearer (owner) in form.

Directors or officers of corporations can be of any nationality, resident in any country, and need not be present in the country to establish a corporation or be shareholders. All this explains the popularity of Panama and the BVI as offshore centres before the RBI’s Liberalised Remittance Scheme in 2004.

The RBI governor has pointed out that although not all accounts would be illegitimate, violations would require verification. Investment in offshore structures could result in violations under the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act 2015 with effect from July 1, 2015, the Foreign Exchange Management Act 1999, the Prevention of Money Laundering Act 2012, the Prevention of Corruption Act 1988, the Income Tax Act 1961, the Sebi Act 1992, and the Companies Act 2013.

US AND PANAMA TREATY In 2008, the US Government Accountability Office reportedly stated that 17 of the 100 largest American companies were operating a total of 42 subsidiaries in Panama. A favourable bilateral investment treaty (BIT) between the US and Panama was signed in October 1982 and a Trade Promotion Agreement (TPA) entered into force in October 2012. Thus, even after the introduction in 2004 of the RBI’s Liberalised Remittance Scheme, an offshore structure like a Panama corporation was a tax-efficient structure particularly for purchase of property abroad.

It helped owners borrow cheaply abroad, avoid European Estate Duty, and capital gains by simply selling the shares of the company to transfer the property rights. The favourable TPAs require the US to waive ‘Buy America’ requirements for procurement bids from foreign firms incorporated here and the BIT helps business.

NEW LEGISLATION All this is going to change in a post-BEPs scenario. Britain is bringing in legislation to tax capital gains when the ultimate beneficial owner of a tax haven entity changes. Almost 100 jurisdictions have joined the Multilateral Convention on Mutual Administrative Assistance in Tax Matters. The use of bearer share companies is on the wane and the beneficial ownership rules have been strengthened to ensure that information is accessible by tax authorities.

As a result of the OECDs Peer Review process, member countries and jurisdictions whose legal and regulatory framework for the exchange of information is not yet up to international standards, or jurisdictions where a lack of information on beneficial ownership of corporate and other entities is facilitating illicit flows, have been identified. The Indian government has announced the constitution of a special multi-agency group comprising officers from the investigative unit of the Central Board of Direct Taxes and its Foreign Tax and Tax Research division, the Financial Intelligence Unit and the RBI.

The RBI governor has pointed out that although not all accounts would be illegitimate, violations would require verification. All remittances made before 2004 would raise a red flag since this was before the RBI’s Liberalised Remittance Scheme.

Similarly, from the financial year 2011-2012 onwards, all resident taxpayers were required to disclose their foreign assets and income earned outside India, even if they were not liable to file their returns. If they have not disclosed details of income earned outside India, of foreign bank accounts and peak balance of that account, of foreign interest in any entity with total investment in rupees, of immovable property with total investment, of concerns in which the person has signing authority, of any other overseas asset, of trust in which individual is a trustee, in their returns of income, it shall be deemed to be un-disclosed income with penal consequences as per the Income Tax Act 1961.

The odds of being found out hiding your money in a tax haven in an age of digital transparency are at an all-time high. And the fallout of being found out in a leak or a hack — and being labelled a tax avoider, the loss of reputation and dignity built over a lifetime all in a twitter-second — makes one wonder whether it’s really worth the taxes saved. Wouldn’t one rather pay taxes and stand proud? It’s a personal call.

The writer is an LLM from the University of Michigan Law School, USA. The views expressed in this article are her own