India Economy

Panama Papers, so what’s new?

LOKESHWARRI S K | Updated on January 20, 2018 Published on April 10, 2016

This is just another episode in an ongoing saga. Tax evasion is an old crime in which tax havens play a key role

The Panama Papers unveiled last week created a stir due to the sheer volume of data that was leaked — 11.5 million documents or 2.6 terabytes of data — and the effort and time put in by the team of international journalists to investigate the data. The leak has claimed a few high-profile casualties already — the Prime Minister of Iceland, Sigmundur Gunnlaugsson and Chile’s head of Transparency International, Gonzalo Delaveau.

But if this revelation has taken anyone by surprise, he/she must have been marooned on a deserted island over the last 20 years. Governments across the globe have been shouting themselves hoarse about tax evasion that is making a large dent in their exchequers, for many years now. The OECD estimates annual losses from tax evasion by corporates at $100-240 billion annually.

The fight against tax evasion is gathering steam over the last five years, with governments facing a slowdown getting more aggressive with tax collections. There is also a concerted effort currently being made by many multilateral agencies to tackle this malaise with the result that tax avoidance is actually coming down. A CESIFO working paper by Andrea Buehn and Friedrich Schneider shows a declining trend of tax evasion between 1999 and 2010 for all countries. The key to addressing this issue is to tackle the tax-havens and the ecosystem that creates this thick veil of secrecy to help tax evasions. An international effort to make these jurisdictions more transparent and make them share information with other countries is the first step. However, the battle has just begun. It will be some time before this practice of using tax-havens to avoid tax is completely dispensed with.

No dearth of havens

It is no secret that there are over 80 tax havens that have been cocking a snook at governments for many decades now. These countries have nil or negligible tax on profits made by foreign companies, very lax rules for setting up companies and very stringent secrecy laws that enable the wealthy to stash their wealth in these niches, hidden from the prying eyes of the taxman. Take Panama, for instance; there are websites that offer to set up a company or foundation in Panama in just one day for $800 and $1,200, respectively. Companies set up there are not taxed on income, dividend or capital gains earned outside Panama. The country has not signed any tax treaties with any other country so that exchange of tax-related information is not possible. There are no controls on foreign exchange transfers. There is a thick veil behind which the actual beneficiaries of entities can be hidden since the rules for incorporating a company do not require the names of the owners of the funds to be disclosed.

The Panama documents are reported to reveal that Mossack Fonseca functioned as a factory producing shell companies in Panama that were then sold to politicians, industrialists, celebrities and other wealthy entities across the world. But this is just one law firm in one of the tax havens; just the tip of a large iceberg, to use a cliché. Over the last four decades, trillions of dollars have been routed through these tax havens and the list of Indians using tax havens across the globe could be many times that revealed in the Panama Papers.

The question of legality

There are opinions expressed that the purchase of companies by Indian entities from Mossack Fonseca might not be entirely illegal. That is quite possible because Indians are allowed to take money out of India since 2004 towards various purposes, including purchase of shares. Since those named by the Panama Papers only purchased the shares in the companies set up by Mossack Fonseca, they have not really violated any law.

But there are some points that the multi-agency committee set up by the Centre needs to examine. The most important is the route through which the money was taken out of India. Popular channels that are used to move money out of India include the hawala route and through over- or under-invoicing of imports, exports and other business transactions. Many of these could reveal FERA and FEMA violations. Second, the source and quantum of money that was moved out is also sure to stir a hornet’s nest; much of this could be money on which tax has not been paid.

The fight against tax evasion

The best way to tackle this issue is to enforce uniformity in tax rates across the globe so that there are no jurisdictions with unusually low rates that can be used for tax evasion. But fiscal policy is the sovereign right of a country and coercion is not possible here. The way to work around this is to make these low-tax jurisdictions increase transparency and agree to exchange information on taxation with other countries.

There are many organisations working towards this, including the OECD and the European Commission. OECD’s Global Forum on Transparency and the Exchange of Information for Tax is currently reviewing the practices of its 130 members and will soon assign a rating to these jurisdictions based on the level of transparency and willingness to share information. A new global common reporting standard is also being implemented among G20 nations to improve transparency. The 15-point action plan to be implemented under BEPS (Base Erosion and Profit Shifting) will also take focused steps towards acting against tax havens and improving transparency in reporting by multinational corporations. The implementation of FATCA (Foreign Account Tax Compliance Act) is also a step towards controlling tax evasion and avoidance.

India is also putting in a lot of thought towards checking tax evasion and the General Anti Avoidance Rules (GAAR), once implemented next year, will give the tax-men greater powers to scrutinise these transactions. The speed with which the BEPS recommendations are being implemented in India also shows that the country is serious about tackling this issue.

However, an area that not too many are looking at, for controlling tax evasion, is checks on financial institutions. While the acts of the financial institutions in tax havens are purportedly governed by the laws of that country, the parent, in most cases is headquartered in the US and Europe. The parent organisations can be asked to instruct their subsidiaries or associates to moderate their dealings in non-cooperative tax havens. By plugging the channels of money-flow, these illicit transactions can be checked. Similarly, accounting and law firms with operations across the globe too can be instructed to go slow with their operations in offshore jurisdictions.

The OECD has stated that the legal and regulatory framework for exchanging information in many countries is, as yet, not up to international standards. These countries include Guatemala, Kazakhstan, Lebanon, Liberia, Micronesia, Nauru, Trinidad and Tobago and Vanuatu; besides Panama. A global consensus needs to be arrived at to check these countries without hurting their economies.

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