FATCA, fat cats and tax

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“It’s a wrong situation. It’s gettin’ so a businessman can’t expect no return from a fixed fight. Now if you can’t trust a fix, what can you trust? For a good return you gotta go bettin’ on chance, and then you’re back with anarchy. Right back inna jungle. On account of the breakdown of ethics.”

Johnny Caspar in the Coen brother’s Miller’s Crossing would have been pleased to hear that today the OECD is announcing a way to remedy the shocking lack of ethics in the increasingly globalised globe people do business on. Like Johnny, we’re concerned about the consequences when certain parties don’t play fair. Johnny’s way of levelling the playing field is to bury the scallywags underneath it, but this being the OECD, our proposal, developed with G20 countries at the G20’s request, concerns the international tax system and how to “inject greater trust and fairness”  into it.

It’s less exciting than machine guns and hit men, but the sums involved are literally millions of times bigger than the cash the Coens’ gangsters are fighting over. The Tax Justice Network claims that $21-32 trillion are stashed offshore – the equivalent of the combined GDP of the US and Japan. That only concerns tax havens. There are also a number of other means available for what is variously called tax evasion, tax avoidance or tax planning, depending on the degree of legality. Sometimes the neutral, non-judgemental term tax dodging is used, even by the OECD. Usually though, we use more technical terms like “base erosion and profit shifting” (BEPS) to describe the mechanisms firms exploit to avoid paying what most citizens would consider “fair” taxes. As we discussed in this article, BEPS schemes themselves can be extremely complicated, but the basic idea is simple: shift profits across borders to take advantage of tax rates that are lower than in the country where the profit is made.

As we’ve discussed before, the core of the problem is that taxes are a national affair while finance is international. The OECD has been helping governments cooperate on tax collection for decades, and the Model Tax Convention serves as the basis for the negotiation, application, and interpretation of over 3000 bilateral tax treaties in force around the world. The Convention was updated in 2012 to allow tax authorities to ask for information on a group of taxpayers without having to name them individually.

These are so-called targeted requests, but automatic exchange of information is the systematic and periodic transmission of “bulk” taxpayer information collected by the source country to the country of residence concerning income from dividends, interest, royalties, salaries, pensions, and so on. Automatic exchange seems to work both to detect tax evasion and as a deterrent. Clinical trials suggest it also cures memory loss. Denmark helped 440 of its absent-minded citizens to remember foreign income after the tax administration sent them a letter announcing that it received automatic information from abroad.

More than 40 countries have committed to early adoption of the Standard for Automatic Exchange of Financial Account Information published today, committing tax jurisdictions to obtain information from their financial institutions and automatically exchange that information with other jurisdictions annually. The Standard sets out what information has to be exchanged, the financial institutions that need to file reports, the different types of accounts and taxpayers covered, as well as common due diligence procedures to be followed by financial institutions (verifying the address of account holders for instance).

According to today’s presentation, the “advantage of standardisation is process simplification, higher effectiveness and lower costs for all stakeholders concerned” (except presumably for tax dodging stakeholders).

The Standard consists of the two parts: the Common Reporting and Due Diligence Standard (CRS) describing the reporting and due diligence rules to be imposed on financial institutions; while the detailed rules on the exchange of information are in the Model Competent Authority Agreement (CAA). The CRS draws heavily on a model developed by the United States, France, Germany, Italy, Spain and the United Kingdom to implement the US’s Foreign Account Tax Compliance Act (FATCA) through automatic exchange between governments.

Of course companies and individuals who spend a fortune on experts to help them dodge taxes will try to get round the CRS. To avoid this, the financial information to be reported includes all types of investment income, account balances and revenue from selling financial assets. A wide range of financial institutions apart from banks have to report too, including brokers, certain insurance companies, and certain so-called collective investment vehicles – funds that pool money from a number of accounts. The Standard also requires those signing it to look beyond “passive entities” to report on the individuals that ultimately control the money from behind the screen of entities set up to hide where the money is actually going.

What’s the alternative to imposing a global standard? “A proliferation of different and inconsistent models would potentially impose significant costs on both government and business to collect the necessary information and operate the different models. It could lead to a fragmentation of standards, which may introduce conflicting requirements, further increasing the costs of compliance and reducing effectiveness.”

Or as Johnny Caspar pointed out, “… ethics is important. It’s the grease that makes us get along, what separates us from the animals, beasts a burden, beasts a prey”. I hope youse all agree.

Useful links

OECD work on exchange of information for tax purposes

OECD Centre for Tax Policy and Administration

OECD work on BEPS

OECD work on transfer pricing

OECD work on aggressive tax planning

Net losses: tax crime and fishing

Pirate treasure
Pirate treasure

Earlier this year, the Parkham Women’s Institute in the south of England invited Colin Darch to speak about piracy. To get into the spirit of things, the ladies came equipped with eye patches, parrots, cutlasses, shiver-me-timbers accents, and all the usual pirate paraphernalia.  Mr Darch came to talk about being hijacked off Somalia and held hostage for 47 days. But whether the word “piracy” conjures up visions of Somali speedboats and AK47s or peg legs and the skull and crossbones, fish are probably pretty far down the list of things that spring to mind when somebody mentions pirates.

And yet, most of the “pirates” on the high seas today are involved in pirate fishing, or illegal, unreported and unregulated (IUU) fishing as it is known. As we said in the Insights book on fisheries While Stocks Last? these pirates are neither the vicious thugs portrayed by Robert Louis Stevenson nor the seductive rascals so beloved of Hollywood. All they have in common with the heroes of swashbuckling romances are ruthless, unscrupulous masters, and harsh and dangerous working conditions with more chance of getting killed than of getting rich. The International Transport Workers’ Federation gives numerous horrifying examples from fishers’ contracts. Chinese fishers from Yongchuan County in Sichuan province not only had to pay $470 to secure a place on a boat, they had to agree to have their appendix removed before going to sea and to pay $47 for the operation themselves. And remember, these are the ones who had a contract.

Fish piracy takes several forms. The “illegal” in IUU fishing is when vessels violate the laws of a fishery. “Unreported” is fishing that is undocumented or misreported to the relevant national authority or regional fisheries organisation. “Unregulated” fishing describes fishing by vessels without nationality, or vessels flying the flag of a country that isn’t a member of the regional organisation governing that fishing area or species. This is particularly attractive since many of the states offering flags of convenience are also tax havens. If you click on the unambiguously named www.flagsofconvenience.com, you’ll see how easy it is to move vessels from one register to another, even for a few months. The fact that some of the countries proposing flags are completely landlocked doesn’t seem to stop them having extensive fleets.

IUU fishing is also big business, but like any illegal activity it is hard to know exactly how much it is worth. According to some estimates, a quarter of the fish taken from the Antarctic fishing area could be IUU catches. The media regularly report scams involving millions of euros worth of fish, such as the six Scottish trawlermen convicted in 2010 of landing 15 million euros worth of illegal herring and mackerel over a three-year period.

Pirate fishing destroys the livelihood of other fishers and threatens the existence of fish species. Combating it is hard because the penalties for those caught are low compared with potential gains, and even catching them is difficult given the vast areas of ocean to be covered, the limited means of anti-piracy authorities, and the complicity of some states and customers, like the wholesalers those Scottish fishers sold their “black landings” to.

The method used in this case was “forensic accounting”, that revealed unexplained discrepancies between actual and declared incomes. Again, you probably never think of accountancy and tax inspectors when you think of the fight against piracy, but it’s a battle that’s been going on for centuries. Rudyard Kipling’s “Gentlemen” were being hunted down by King George’s tax men in the eighteenth century for smuggling brandy, tobacco and other illegal cargoes. Their modern counterparts are not just stealing fish, they’re also involved in people trafficking and drug running.

Tackling tax crime is one way of combating IUU and associated criminal activities. A report to the Third OECD Forum on Tax and Crime  taking place in Istanbul on 7-8 November discusses the extent of the problem, the form it takes and what can be done about it. Offences include the evasion of import and export duties on fish and fish products transported across national borders; fraudulent claims for VAT repayments; failure to account for income tax on the profits from fishing activity; and evasion of income tax and social security contributions and false claims for social security benefits by fishers and their families.

The complexity of the fisheries sector and the number of participants means that a broad range of actions need to be taken at various levels, ranging from technical training for local tax people to international cooperation such as sharing of information. Such recommendations may sound vague, but in preparing the report, the discussions between specialists from tax administrations, customs administrations, fisheries authorities and law enforcement “already yielded significant benefits through the sharing of experiences and analyses, highlighting further areas for research and, in a number of cases, leading to specific international co-operation in tackling actual cases of tax crime and illegal, unreported and unregulated fishing”.

The authors give concrete examples. For instance a large cash withdrawal made from a bank to pay a cash bonus to the crew of a fishing vessel was analysed by tax officials using the money laundering model found in the 2009 OECD Money Laundering Awareness Handbook for Tax Examiners and Tax Auditors (the very name strikes fear into the heart of the most ruthless pirate). The case also involved the sale of a fishing quota, which was illegal in itself. The sale was made via a company registered in an offshore jurisdiction through a bank account in an onshore financial centre. This led to a “multilateral tax compliance action” being undertaken by three countries, which demonstrated that each of the three had a different picture of the facts underlying the case. By working together, each country was able to apply its laws based on a clear understanding of the real transaction.

And if you’re wondering what happened after that misunderstanding at the Women’s Institute, the BBC has more.

Useful links

Evading the net: tax crime in the fisheries sector

OECD Forum on Tax and Crime

OECD work on fisheries

Are tax havens disappearing?

Countries the Financial Stability Board declared posed problems in 2011

Today’s first post is from Christian Chavagneux, Deputy Editor of Alternatives Economiques, Editor of Economie politique and author with Ronen Palan of Les paradis fiscaux, (Tax Havens) whose 3rd edition is forthcoming in 2012. Below, you will find a reply from OECD’s Pascal Saint-Amans

The fight against tax havens was one of the priorities of the 2009 G20 summit in London. Three years later, the results are mixed. To combat fraud and tax evasion by the wealthy, the G20 decided to push for the signature of treaties covering the mutual exchange of information in order to develop information exchange on demand. What can we expect from this?

According to a study by Niels Johannesen and Gabriel Zucman, the announcement of the treaties had little effect on bank deposits in tax havens. Their claim is backed up by data from French budget minister Valérie Pécresse: France made 230 requests for information to 18 countries in the first 8 months of 2011. The reply rate was only 30% and the quality of the information supplied wasn’t always of the highest quality, adding weight to the demand of international NGOs to move to a system of automatic exchange of information.

The super rich are not the only ones to take advantage of tax havens, multinationals use them too. Analysis of the geographical distribution of FDI by US firms at the end of 2010 for example shows that the Netherlands, Luxemburg, Bermuda or Ireland come out well ahead of Germany, France or China. 

The Banque de France recalculated FDI flows into and out of France eliminating fictitious flows transiting via tax havens. The result? France’s outward FDI flows dropped by 41% and flows into France by 81%! Adjusting data for several years this way shows a widening gap between traditional and corrected figures, a sign that use of tax havens is growing.

The G20 has done nothing to fight against such shady dealings which, according to Bloomberg allow Google for example to be taxed at 2.4%. To combat this, NGOs are asking for country by country reporting. In other words, multinationals would have to provide their turnover, number of employees, payroll, profits and taxes for each country they operate in. This would show the disparity between the place where an economic transaction was carried out and where it is taxed.

The G20 has abandoned the fight against tax havens as territories that facilitate financial instability. In November 2011, after months of work, the Financial Stability Board declared that only two countries posed problems: Venezuela and Libya. However, a 2008 report by the US Government Accountability Office showed that a part of the American shadow banking system that developed the toxic assets of the subprime crisis was operating out of the Cayman Isles.

The Northern Rock fiasco in the UK resulted from excess short-term debt hidden in its Granite subsidiary, registered in Jersey. Bear Stearns took hits on speculative funds partly based in the Caymans, and likewise the German firm Hypo Real Estate was destroyed by losing bets placed by its irish subsidiaries, and so on. 

Tax havens have played a leading role in all the key epsiodes of the financial crisis. As well as that, when you realise that they are the main holders of American public debt and that according to Patrick Artus of Natixis bank, “The three main holders of French debt are Luxemburg, the Cayman Isles and the UK”, it’s easy to see that these territories are involved in speculation on public debt.

Tax havens, in the service of the richest and most powerful individuals and companies, promote global inequalities. Their offer of opaque services and risk taking contribute to speculative finance and the serious consequences in terms of loss of business and jobs. Unfortunately, the G20 is still far from having done everything to control these parasitical states. 

Useful links

The article (in French) in Alternatives économiques that started this debate is here 

The Tax Justice Network’s Financial Secrecy Index

Are tax havens disappearing? Yes, but this is only the beginning

Members of the Global Forum on Transparency and Exchange of Information for Tax Purposes

Pascal Saint-Amans, Director of the OECD Centre for Tax Policy and Administration, replies to Christian Chavagneux’s article.

Christian Chavagneux is right to criticise tax havens and argues that more needs to be done to combat their negative consequences for developed and developing countries alike. But it’s wrong to imply that the G20’s actions have been ineffective since it pledged to tackle the issue in 2009.

The study he quotes by Johansen and Zucman on whether bank secrecy has ended actually answers another question, namely the effect of the G20 push for tax information exchange on the location of bank deposits. The location of the deposits themselves is not the issue – funds do not need to be repatriated to a country in order to be taxed by that country. What is important, and what the G20 initiative focuses on, is making the existence and ownership of those deposits more transparent to tax authorities.

The information exchange agreements signed since 2009 are only now beginning to enter into force, and the expansion of each country’s network of agreements is continuing. Even so, an OECD survey of 20 rich and poor countries showed that early measures to deter tax evasion have already resulted in 100,000 individuals paying a total of $14bn in unpaid tax on assets worth between $120-150bn.

We now have commitments by all the major international financial centres to eliminate bank secrecy for tax purposes. In most cases, including Switzerland, Singapore and Austria and Liechtenstein, those commitments have already been implemented. 

Nor are governments abandoning the fight on tax havens as Christian Chavagneux suggests, including on automatic exchange of information. In 2011, the updated multilateral Convention on Mutual Administrative in Tax Matters entered into force and now has 33 signatories including Costa Rica, France, Georgia, Germany, Indonesia, Norway, Russia, the UK and the USA. The Convention looks beyond mere information exchange on request, allowing parties to engage in automatic exchange as well as international assistance for tax collection. In November 2011, we saw the G20 support automatic exchange of information as appropriate.

In February 2012, the Financial Action Task Force refined its criteria for assessing anti-money laundering frameworks, with more targeted requirements that will improve transparency. That same month, the US proposal to implement the Foreign Accounts Tax Compliance Act led to the UK, France, Italy, Spain and Germany agreeing to explore a common approach to improved reporting of bank transactions. These changes will lead to stronger domestic frameworks to ensure all relevant information is available, and tax authorities relying on broader networks of information exchange agreements can expect to benefit from these developments.

The Global Forum on Transparency and Exchange of Information for Tax Purposes already has 107 members and continues to expand its membership to cover emerging financial centres. By the next G20 Summit in Mexico in June, the Forum will have published more than 70 Phase 1 country reviews, while the Phase 2 reviews commenced in 2012 provide for an in-depth investigation into the procedures and resources available, to make sure that each jurisdiction can meet their commitments to the international standard.

The role of governments is primordial of course, but we also recognise the efforts of civil society in continuing to draw attention to the issue of tax transparency. That is why OECD initiatives like the Taskforce on Tax and Development are bringing together tax authorities, business and civil society to share proposals to move towards our common goal of fairer taxation. 

Tax havens have been around since the late 19th or early 20th centuries, depending on how you define them. They are defended by powerful vested interests and the fight against them will not be won quickly or easily. However, combined with new OECD projects to strengthen inter-agency cooperation to tackle tax crimes and other financial crimes, there is good reason to be optimistic that we will continue to build on the substantial progress made since 2009.

Useful links

OECD Centre for Tax Policy and Administration

The outcomes of the 59 country reviews published so far by the Global Forum are available on the Exchange of tax Information (EOI) portal along with an interactive map showing the network of agreements to exchange tax information:

The government inspectors

You'll pay sooner or later

Around a third of global assets are held offshore beyond the reach of effective taxation according to the Tax Justice Network. The TJN also estimates that private individuals hide $11.5 trillion in tax havens, depriving the rest of us of $250 billion a year in tax revenues.

You could do a lot with an extra quarter of a trillion a year – finance the UN’s Millennium Development goals or transform the world’s energy system to combat climate change for instance. But in the meantime, the response to the crisis and sovereign debt is increased taxes and reduced public services.

So how can we get the tax cheats to pay up? In Buenos Aires this week, tax commissioners from 45 countries plus representatives of big business and other organisations met to discuss “compliance” at the OECD Forum on Tax Administration. The Forum, created in 2002, brings together the people responsible for taxes at national level to “identify, discuss and influence relevant global trends and develop new ideas to enhance tax administration around the world”.

What have they done so far? Data from 20 countries that publish such information show that an extra $14 billion in taxes has been collected in the past two years. It’s a good start, but obviously a lot more has to be done. They’re dealing with highly mobile money that can be switched from place to place as havens become less safe and at the same time, tax administrations themselves are facing the same resource constraints as other parts of government, constraints the people they’re targeting don’t have to worry about.

The solution according to the FTA is to “work smarter” to optimise international cooperation, administration, compliance, legislation and service delivery. For an outsider like me, one of the most intriguing aspects of this is to be found in a list of publications with titles like “Guidance on Test Procedures for Tax Audit Assurance” and “Tax Reference Model – Application Software Solutions to Support Revenue Administration”. I discovered that the FTA is studying the use of social media by tax authorities.

In the US for example, the IRS has launched IRS2Go, a mobile app that lets users track the status of a refund, subscribe to e-mail updates, follow them on Twitter, and click to call a help line. Apart from providing services to the individual taxpayer, social media could also become important in another main aspect of FTA work – publicizing successes in getting tax avoiders to pay up or tax havens to close down so that those who once felt safe hiding their money feel more and more exposed to public scrutiny and public anger.

And imagine the kudos of having the tax inspector as your friend on Facebook.

Useful links

OECD Centre for Tax Policy and Administration

Tweeting on your taxes The OECD Observer looks at the social media aspect

OECD work on restoring public finances

Time for New Rules

We are publishing From Crisis to Recovery, a new book from the OECD Insights series here on the blog, chapter-by-chapter.  This book traces the roots and the course of the crisis, how it has affected jobs, pensions and trade, while charting the prospects for recovery.

These chapters are “works in progress” and their content will evolve.  Reader comments are encouraged and will be used in shaping the book.

Is there – to misquote William Shakespeare – something rotten with the state of capitalism? In the wake of the financial crisis, many people seem to think there is. According to a poll commissioned by the BBC World Service of people in 27 countries, only around one in ten believed capitalism works well. In just two of the surveyed countries did that number rise above one in five – 25% in the United States and 21% in Pakistan.

Unhappy as people were, the poll showed little appetite for throwing out capitalism altogether – fewer than one in four supported that notion. But people do want change – reform and regulation that will check capitalism’s worst excesses.

That view is shared by many political leaders. In 2009, Germany’s Chancellor Angela Merkel and the Netherlands’ then-Prime Minister Jan Peter Balkenende argued that “it is clear that over the past few decades, as the financial system has globalised at unprecedented speed, the various systems of rules and of rules and supervision have not kept pace”. In the United States, President Barack Obama declared that “we need strong rules of the road to guard against the kind of systemic risks that we’ve seen”. In the United Kingdom, Prime Minister Gordon Brown said that “instead of a globalisation that threatens to become values-free and rules-free, we need a world of shared global rules founded on shared global values”.

But what form should those rules and values take? How can we best harness capitalism’s power to deliver innovation and satisfy our material needs while minimising its tendency to go off the rails from time to time.

This chapter looks at some of the themes that have emerged in reform and regulation since the crisis began, focusing on three main areas:

►Regulating financial markets

►Tackling tax evasion, and

►Creating a “global standard” for ethical behaviour

Death and tax havens

Death and taxes are an ugly old couple with no friends. And if this man is right, soon, as John Donne predicted, death, thou shalt die.

That leaves taxes. But not only do some people not want them to die, they want them to grow vigorous and flourish. Why?

Writing in The Guardian in November 2008, OECD Secretary-General Angel Gurria pointed out that developing countries lose to tax havens almost three times what they get from developed countries in aid.

Gurria was echoing the sentiment that developing countries have many of the means they need to combat poverty and promote development, but these means are being stolen by unscrupulous companies and individuals.

According to the UN, the cross-border flow of the global proceeds from tax evasion, criminal activities and corruption totals $1-1.6 trillion per year, half from developing and transitional economies.

sums being lost to tax evasion could save the lives of 350,000 children each year

Christian Aid estimates that the sums being lost to tax evasion could save the lives of 350,000 children each year if made available to programmes fighting poverty and disease.

Not just taxes are being seen in a new, more positive light. It’s now being argued that the tax collector, eternal pariah, has a noble role to play.

South Africa’s Finance Minister Trevor Manuel told the OECD Global Forum on Taxation  that “it is a contradiction to support increased development assistance, yet turn a blind eye to actions by multinationals and others that undermine the tax base of a developing country.”

As Manuel pointed out, smaller, poorer countries with less sophisticated tax administrations are often ill-equipped to dismantle the complex structures put in place to minimise tax. He urged the OECD to help identify and diffuse best practices and mechanisms to assist and build stronger tax administrations.

Will anything be done about it? On January 27th at OECD headquarters, tax experts and development experts established a joint taskforce, stating that “We have a common understanding of the central role taxation plays in development and poverty reduction: a strong tax system is the heart of a country’s financial independence, its revenues are the lifeblood of the state itself.”

Over the coming months, we’ll see what actions follow. Governments in the developed countries will be under pressure to make taxes fairer. Especially following the bailouts and other costs of the crisis, citizens of OECD countries suffer too, in terms of higher taxes to make up for the shortfall or poorer public services due to under-financing.

Useful links

OECD Centre for Tax Policy
Global Forum on Transparency and Exchange of Information for Tax Purposes
Tax Justice Network resources page on aid, tax and development