In the debate about offshore centers, one nation has quickly become the center of attention. Even though it is not considered to be “offshore” and it was hardly named in Mossack Fonseca’s leaked client files, better known as the Panama Papers, U.S. media have increasingly recognized that the United States is as much part of the problem as it must be part of the solution when it comes to anti-money laundering and financial transparency in the fight against crime.
In January, the New York Times featured the use of shell companies in real estate purchases in Miami and New York and their potential for money laundering; Bloomberg highlighted the shifting tides in the trust service industry that sees several U.S. states taking business from the Cayman Islands and Bermuda with the promise of “confidentiality;” and several other media outlets targeted anonymous shell companies in Delaware, Wyoming and Nevada.
Professionals in offshore centers have long argued that tax evasion, money laundering and other “problems” associated with tax havens and the offshore industry are typically caused onshore. And they can as easily be remedied there by changing tax legislation and other domestic laws.
At the very least, offshore proponents have advocated, international rules and standard should be applied uniformly to establish “a level playing field.”
Even seemingly straightforward objectives like the fight against corruption, which causes agitated finger pointing by NGOs and activist groups at small island financial centers, turn out to be blocked by the inability of the largest political power in the world to fully participate in global standards.
At the Anti-Corruption Summit in London last month, the United States was represented by Secretary of State John Kerry. At the event, Kerry forcefully remarked how corruption “tears at the entire fabric of a society” and “destroys nation-states.” Yet, the U.S. was unable to sign a communique negotiated by all conference participants on concrete measures to tackle corruption.
It is just one example of America’s ambivalent role in relation to financial transparency.
On the one hand, the United States is a trailblazer for tax transparency, driven by the desire to uncover American tax cheats who use offshore bank accounts. On the other hand, its unilateral approach in the face of quickly evolving international transparency standards has caused new loopholes and made the United States more attractive as a secrecy jurisdiction.
A first effort to detect activity by its taxpayers abroad, the Qualified Intermediary regime in the early 2000s, under which foreign banks reported U.S. taxpayers who invested in U.S. securities, was unsuccessful. It failed because the account holders would go unreported if they simply blocked the account for U.S. securities or if they held the account through a corporate entity.
Then in 2008, whistleblower Bradley Birkenfeld provided an insight into how Swiss bank UBS actively helped U.S. customers evade tax.
Buoyed by the success in prosecuting UBS and its investigations, which were quickly extended to other Swiss banks, the U.S. government produced the Foreign Account Tax Compliance Act.
With the threat of punitive withholding taxes for non-participants, FATCA forces financial institutions worldwide to sift through their customer databases in search of U.S. taxpayers and their assets and report them to the Internal Revenue Service. It also plugged the holes that existed in the qualified intermediary regime.
The prospect of FATCA alone and Swiss banks falling like dominoes in their resistance to U.S. Justice Department investigations was enough for 50,000 Americans to voluntarily disclose their previously undeclared assets abroad. So far the U.S. government has raked in about US$7 billion in back taxes and fines under various voluntary disclosure programs.
The success of FATCA, in turn, caused the U.K. and other European governments to emulate the scheme. The Organization for Economic Cooperation and Development developed a standard, the common reporting standard, that is similar to FATCA. More than 90 countries have signed up to it and from 2017 will start to automatically exchange information on the taxpayers from other countries in their home jurisdiction.
The schemes put together should produce near complete global transparency around taxpayer bank accounts and other financial assets that are held abroad.
A major impediment to its success is that, in addition to Panama and Bahrain, one country is not participating: The United States.
The U.S. claims it does not need to sign on to the common reporting standard because to make FATCA work it has concluded international agreements with other nations that in practice would lead to the exchange of tax data comparable to the common reporting standard.
“The people in the tax planning world will tell you that these agreements are generally considered as something of a joke,” Bloomberg News reporter Jesse Drucker said at the Offshore Alert conference in Miami in May.
One such tax planner, Peter Cotorceanu, a lawyer with Swiss law firm Anaford, says in practice the U.S. had to severely restrict the information it can exchange on foreign taxpayers because current U.S. law limits the data that is collected by the banks and reported to the IRS.
Changes to the law, he added, are unlikely in the current political landscape.
“The IRS cannot promise to share information with other countries that it does not get from the banks.”
What the IRS gets is very sparse indeed. Banks will report interest bearing accounts and U.S. securities held by a foreigner. But if the interest bearing account is owned by an offshore entity, it will not get reported.
All a non-U.S. person has to do to avoid disclosure under FATCA is to hold a cash or a non-cash account through an entity, or block non-cash accounts for assets that produce U.S. source income, such as U.S. stocks.
Despite this significant shortfall in the amount of taxpayer information that can be exchanged by the U.S., the OECD has accepted the U.S. regime as equivalent to joining the OECD standard.
This refusal by the OECD to declare the United States a non-participating nation in the common reporting standard has produced another gaping loophole.
If a structure involves two financial institutions in countries participating in the common reporting standard, say a BVI trust that has a Swiss bank account, only one of the two – in this case the trust – will report under the common reporting standard to avoid double reporting.
Only if the trust was in a jurisdiction that is not part of the automatic tax information exchange, the Swiss bank would have to “look through” to determine who the beneficial owner of the bank account is and report it.
“Now if the U.S. is declared a participating jurisdiction, this means that U.S. structures can book their assets outside the U.S.,” says Cotorceanu. “It is really the best of both worlds.”
The bank that holds the assets does not need to report because the U.S. entity that owns the assets will do so, but the U.S. entity will disclose only what is required under current U.S. law: next to nothing.
Cotorceanu has written a legal paper called “Hidden in Plain Sight” in which he explains how it is possible to legally avoid reporting under both FATCA and the common reporting standard. His conclusion: “A trust with a U.S.-resident trustee but structured as a non-U.S. trust for U.S. tax purposes is ideally suited for this purpose.”
It will avoid reporting under the common reporting standard and FATCA, and it avoids U.S. taxation.
“The result of all of this,” said Drucker, “is that a number of significant financial institutions, banks, trust companies and law firms are now actively marketing the U.S. as a secrecy jurisdiction or as they often call it, a confidentiality jurisdiction.”
Earlier this year, Drucker and Bloomberg were the first to report on trust companies like Rothschild or Trident Trust setting up shop in Nevada and South Dakota.
“These companies were moving dozens of accounts out of places like Switzerland and Cayman and other places offshore into South Dakota in December, ahead of a disclosure deadline which took effect in January,” he noted.
Drucker quoted an official of one of these trust companies he interviewed as saying, “Cayman was slammed in December, closing things that people were withdrawing. I was surprised at how many were coming across that were formerly Swiss bank accounts. But they want out of Switzerland.”
Anonymous shell companies
Trust companies are not the only product in demand in the United States. Anonymous shell companies have also been a staple, not least because 14 U.S. states do not require beneficial ownership information to be collected.
Global Witness, an organization that takes a journalistic approach to highlight the links between corruption, conflicts and environmental and human rights abuses, says it noticed the persistent and prominent role of anonymous companies in everything it investigated.
“There was not a single story that we dug up that did not involve a shell company,” Global Witness Director Shauna Leven said at the Offshore Alert event. “We think of it as the getaway vehicle for the criminal and the corrupt to clean their money that they have stolen.”
This sparked an investigation culminating in Anonymous Inc., a TV report for “60 Minutes” on CBS. In it, a representative of Global Witness posed with a hidden camera as a potential client representing a foreign official.
Dropping numerous red flags for money laundering, he asked 13 law firms how to move suspect money into the United States to buy the key components of a luxury lifestyle, such as houses, yachts or jets.
None of the lawyers broke the law or actually moved money for the client, but all except one provided advice on how it could be done.
One lawyer suggested buying a “New York LLC” and a combination of companies to conceal the ownership through several layers. “Company A is owned by company B which is jointly owned by company C and D and you own the majority or all of the shares of C and D.”
Another lawyer extolled the virtues of the U.S. legal profession. “A good lawyer knows the law and a great lawyer knows the judge,” he surmised. “Are they going to throw a case for you? No. But are they going to bend over backwards to be courteous to you. Yes, they are.”
For Ed Davis, a lawyer whose firm traces assets on behalf of creditors, an important element of the use of anonymous corporations is lawyers willing to set up those structures. “Many companies, whether in the BVI or Cayman, are set up by American lawyers,” he said.
While noting that many of these “are not illegitimate in any way, shape or form,” Davis was critical of the Limited Liability Company model, which does not have shareholders, but members.
If someone has a claim against a member who has put an asset, like a jet, into the LLC, it is only possible to access the income the member derives from it but not the asset itself, Davis said. “This is a very horrible concept that we have allowed to work its way into our corporate structure.”
When British Overseas Territories and Crown Dependencies were pressed to join an international standard for the automatic exchange of beneficial ownership information at the Anti-Corruption Summit in May, they pointed to the United States as the elephant in the room.
Cayman Islands Premier Alden McLaughlin said, “If those countries with real political clout on the world stage continue to focus only on jurisdictions that are smaller in size, while ignoring obvious jurisdictions that ought to be part of the conversation, the result will be continued failure.
“To seriously tackle corruption and not just pay lip service to it, we in this room must be committed to a standard that is truly global and to put behind us the shades of hypocrisy which are part and parcel of the global discussion of this issue for years and years.”
Contrary to Cayman’s position with regard to the common reporting standard, where it is a first mover in the automatic exchange of taxpayer information, government will not support a beneficial ownership standard that is not also supported by the United States.
The concern is that offshore companies that are subject to more stringent transparency requirements, to preserve the privacy that they have enjoyed so far, will likely follow the trend of the trust companies and relocate to any of the U.S. states that does not collect beneficial ownership data.
At the anti-corruption conference, the Chief Minister of the Isle of Man, Allan Bell, called the U.S. “a major secrecy jurisdiction and tax haven.” He pointed out that nearly 10 times more companies were registered in a single building in Delaware than in his territory.
“There is one building in Delaware which has 285,000 companies registered in that one building and they don’t know the beneficial owners of any of them,” Bell said.
Cayman Minister of Financial Services Wayne Panton said not counting the BVI, the same building in Wilmington contains more companies than all of the Overseas Territories and Crown Dependencies combined.
“I think that’s a clear illustration of the scale of the problem from a U.S. perspective.”
Speaking at a press conference after the summit, Panton said he thinks everyone is committed to developing the necessary standards to fight corruption. “The question is: Is it a global standard and is it a level playing field? That’s a necessity.”
If Cayman adopted a standard before others, “clearly that would drive some business away to jurisdiction that are less well regulated,” he said. “That in itself defeats the purpose.”