No Strangers in Paradise

Nov 13, 2017

Judging by some of the reaction to the Paradise papers revelations, it is as if all offshore financial planning and advice is illegal, or at best operating at the very edge of legality.  This is not the case.  One of the freedoms of EU membership is the freedom to move capital across borders.  Cross-border trade and investment is fundamental to the success of any modern economy, and the U.K.’s choosing to curtail its own rights to provide cross-border financial services is one of the more bizarre consequences of the Brexit referendum decision.  Yet the argument that all of this activity may be “perfectly legal” is ringing hollow.

Is it perfectly legal?

So what is “perfectly legal”?  In this country it is legal for any taxpayer of any type to put their money wherever they want, onshore or offshore, as long as tax has been accounted for on the earnings and continues to be accounted for on the return on investment.  Also fitting into the “perfectly legal” category is the use of trusts and companies.  Seeing the use by others of trusts and companies in offshore locations creates doubt and suspicion, and some justification.  At the risk of oversimplifying, when a trust or company is created, a new legal person is created.  That new person mightn’t be subject to the same tax or other rules as the person creating it, most likely because it has been set up in a foreign country.  That opens up possibilities for secrecy, tax avoidance and tax deferral.

The Paradise Papers leak is far from unique.  It is just the latest incident in a sequence extending back at least two decades, where public disquiet has prompted political attempts to extinguish opportunities for tax avoidance using cross-border transactions.  By and large the early attempts were not particularly successful.  They relied on the capacity of the tax authorities to smell a rat.  The so-called general anti-avoidance rules and rules which mandated the disclosure of special-purpose arrangements had relatively limited effect.

More recently governments have changed tack and began to place the emphasis on cross-border information sharing among themselves.  Double taxation agreements and other international accords including EU directives put the legal framework in place; OECD initiatives such as the common reporting standard are putting the analysis tools in place.  Both Luxleaks in 2014 and the Panama Papers in 2016, both antecedents to the Paradise Papers, undoubtedly increased the momentum behind these changes.

Long Term Effects

Similarly I think a long term effect of the Paradise Papers could be to accelerate the finalisation of rules which were already under discussion.  There already exist proposals on both sides of the Atlantic to sideline traditional tax charging mechanisms on the profits of multinationals by imposing hard to avoid levies on their gross income instead.  The EU is looking at the possibility of charging such a levy on the gross income of digital economy companies.  In the US, the Tax Cuts and Jobs Act in debate at Congress would introduce a levy on some types of cross border trade between companies under common ownership, if it were to be passed in its current form. 

Also Brussels has long been muttering about creating a black list of countries which don’t play ball with cross border attempts to eliminate tax avoidance and evasion.  That list, politically sensitive and highly charged though it is, is now likely to be published in the coming weeks having been years in gestation.

Naming and shaming is undoubtedly effective as a deterrent.  We are accustomed to seeing the quarterly list of tax defaulters published in this country as a deterrent to those who evade without attempting to fix their affairs.  Collection enforcement which becomes public in any way, for instance Revenue attaching the money owed to them by business debtors (often a bank account), is commercially a kiss of death.  The more traditional tax avoidance and evasion deterrents like financial penalties pale into insignificance in comparison with the power of publicity.

Casualties

Sunday Business Post, 12 November 2017
This fear for reputation often leading to commercial damage is what provides the Paradise Papers with their power.  Public identification as being involved in the dark side of tax compliance, legal or not, is commercially damaging and career damaging.  There are casualties where there is an unmoderated and unfettered leak of information of the type seen in the Paradise Papers and the Panama papers. 

There can be good reasons for confidentiality.  Would the reaction we’ve seen to the Paradise Papers be the same if bank account details or even worse, medical records, had been leaked?  A decade ago on the other side of the fence the UK Revenue Authorities lost tens of thousands of child benefit records due to a system failure.  That cost the then HM Revenue and Customs Chief Paul Grey his job, even though there was no evidence that the records ever got into the public domain.

The likes of the Paradise papers leaks are prompting a redefinition of ethical tax behaviour as what is publically acceptable, but not by reference to the rule of law.  The ultimate sanction for not doing the right thing is to suffer the commercial and reputational damage of compliance failure should it come into the public domain.  Luxleaks, Panama and now Paradise will advance government action against unacceptable tax practices across borders.  This is an important service but it comes at a high cost to anyone named.  Leaks cannot become an acceptable proxy for the efforts of governments and their revenue authorities. 

Brian Keegan is Director of Public Policy and Taxation with Chartered Accountants Ireland