In the recent crackdown against errant taxpayers, the Income-tax Department has initiated action against many Indians who had stashed their wealth in the HSBC bank in Geneva. This is similar to the action it had taken earlier against the Indian account holders in LGT Bank in Lichtenstein. Similarly, proceedings are also expected to be initiated against many tax evaders on the basis of more than 10,000 pieces of information reportedly received from the different countries. This news may be comforting to the majority of taxpayers who honestly pay their taxes and believe that the Government ought to severely punish tax evaders.
This development gives hope that such trickle would turn into a flow of information to bring back Indian black money stashed abroad after the Indian Government has entered into Tax Information Exchange Agreements (TIEAs) with the tax havens. India has so far signed TIEAs with Bermuda, Bahamas, Isle of Man, British Virgin Island, Cayman Island, Liberia, and Jersey and more TIEAs are under negotiation. India is also seeking to amend its 75 existing Double Taxation Agreements with the countries to provide for effective exchange of tax information.
However, sceptics feel that Tax Information Exchange Agreements are unlikely to make any meaningful contribution in fight against tax evasion, more particularly against offshore tax evasion. Their scepticism is because of several reasons. However, before discussing their views it may be necessary to go through a bit of background to understand the issues involved in TIEAs.
Background
The global financial crisis triggered TIEA drive. One of the fallout of the global financial crisis was that of growing realisation among the governments on the menace of tax evasion, particularly offshore tax evasion, which has resulted in massive revenue loss hitting developing countries harder, which need more funds for their development and poverty eradication. Various agencies and organisations have estimated the magnitude of the problem. For example, a non-profit organisation, ‘Global Financial Integrity’ in its report published in January 2009, has estimated that the developing countries lost between $ 858 billion to $ 1.06 trillion in illicit financial outflows in 2006. ‘Oxfam’, another non-profit organisation in a study carried out in March 2009 found that at least $ 6.2 trillion wealth of the developing countries is held offshore, depriving them annual tax receipts between $ 64-124 billion. Therefore, considering the sheer size of the revenue loss, the governments are looking to collect tax from the funds deposited in the offshore accounts, on which tax was not paid.
Role of a tax haven
Critical role played by tax havens in offshore tax evasion is well known, which often ignore and many a time aid tax evasion taking place in their jurisdiction. Tax evaders find tax havens attractive because many tax havens have developed ‘liberal’ systems, such as simple registration of a company with bearer shares, minimum capitalisation, nominal reporting requirements, provide ease of funds transfer and offer possibility of keeping ownership anonymous. Such rules make tax evasion easier. More importantly, tax havens are attractive to tax evaders because of lack of transparency and little exchange of information apart from the fact that it levies nominal tax or no tax on them. On the other hand, for a tax haven, on-going financial activity in its jurisdiction is beneficial for its survival and prosperity. It is win-win situation for both: the tax haven and the tax evaders.
OECD response
Tax administrations cannot function beyond their country’s jurisdiction, although globalisation of economy and growing international business require tax administrations to operate internationally. Tax administrations find it difficult to detect tax evasion involving tax haven because of the lack of adequate information on such transactions. Therefore, ‘Organisation of Economic Cooperation and Development’ (OECD) decided to tackle two critical elements — which make a jurisdiction a tax haven — lack of transparency and lack of or little exchange of information. The OECD, strongly supported by the G20 Nations, has aggressively promoted international co-operation in tax matters through exchange of information by promoting TIEAs with tax havens.
The OECD started its campaign in 1998 with the publication of the report ‘Harmful Tax Competition: Emerging Global Issue’ emphasising the need for effective exchange of information. Subsequently, the OECD developed a model ‘Tax Information Exchange Agreement’ which is largely followed by all nations. The OECD also devised a compliance standard for the tax havens to ensure that each of them sign and effectively implement TIEAs. This compliance standard required each tax haven to sign TIEAs with minimum 12 nations other than tax havens. As standards for monitoring their compliance, the OECD also calls for willingness on part of the tax haven to continue to sign agreements even after reaching threshold and insists on effective implementation of the TIEAs.
The ‘Global Forum’ created by the OECD member countries has devised a system to monitor jurisdiction’s standards on transparency and exchange of tax information by carrying out phase-wise peer reviews by other jurisdictions. Peer review assesses jurisdiction’s legal and regulatory framework on criteria of 10 key elements in 1st Phase of review and in Phase 2 review, examines effective implementation of exchange of tax information after a jurisdiction removes deficiencies identified in its legal and regulatory framework. The peer reviews assess the availability of ownership, accounting and bank information and authorities’ power to access as well as capacity to deliver information along with rights and safeguards and provisions of confidentiality.
So far various countries world over have signed more than 700 TIEAs. The tax havens have signed these agreements to come out of the OECD’s ‘grey list’ to avoid possible sanctions imposed on them if they fail to comply with the stipulated standard of signing minimum 12 TIEAs with the countries other than tax havens.
TIEA
TIEAs provide for exchange of requested information even in the cases in which the conduct of the taxpayer does not constitute crime in the jurisdiction of the requested country (Tax haven). The country is also required to provide requested information which is not in its possession by gathering it. Most importantly, the TIEAs provide for obtaining information from the banks and the financial institutions regarding ownership of companies, partnerships, trusts including ownership information of the persons in the ownership chain and also information on the settlers, trustees, and beneficiaries. This is one of the most important provisions of the agreement, which make it possible, at least theoretically, to unravel ultimate beneficiaries of the tax haven bank accounts. It is too well known that beneficiaries of the tax haven bank accounts are often shielded by a deliberately created complex ownership structure consisting of a maze of entities. It is also important to note that TIEA does not place any restrictions on information exchange caused by the bank secrecy or domestic tax interest requirements.
Why TIEAs cannot be effective
Despite having the well-designed provisions in the TIEA and seriousness of the OECD and governments in dealing with tax evasion, many professionals believe that the TIEAs will not work. There are various reasons for this negative sentiment.
Firstly, there is a conflict of interests among tax haven and non-tax haven countries. Secrecy jurisdictions are hardly interested in sharing information about their customers.
In many jurisdictions, ownership and beneficial ownership information is protected by domestic law.
From the OECD’s Progress Report Tax Transparency of 2011, it becomes clear that making legal and structural changes in secrecy jurisdictions is going to be a time-consuming affair. So far, out of total 81 peer reviews launched, Global Forum has adopted 59 reports. Out of the 59 reviews completed, 42 are Phase 1 reviews and 17 are combined reviews (reviews of both the Phases conducted simultaneously). Nine Jurisdictions will move to Phase 2 after they fix the deficiencies pointed out in the peer reviews. Thus, jurisdictions have to do considerable work to enable them to exchange tax information effectively. Moreover, one of the conclusions of the Report is that the information exchange is too slow.
Secondly, there is no automatic exchange of information. The TIEA requires that for getting information on a taxpayer, the applicant country has to provide specific information of the taxpayer such as (a) the identity of the taxpayer under examination or investigation; (b) the period for which information is requested; (c) the nature of the information requested and the tax purpose for which the information is sought; (d) grounds for believing that the requested information is present in the requested country or is in the possession of a person within the jurisdiction of the requested country; (e) to the extent known, the name and address of any person believed to be in possession of the requested information; (f) a statement that the request is in conformity with the law and administrative practices of the applicant country, that if the requested information was within the jurisdiction of the applicant country, then the applicant country would be able to obtain the information under the laws of the applicant country or in the normal course of administrative practice and that it is in conformity with this agreement; (g) a statement that the applicant country has pursued all means available in its own territory to obtain the information, except which would give rise to dispro-portionate difficulties. Thus, very high amount of information is required to be furnished for making a request meaning that the tax administration should already have substantial evidence against the taxpayer rather than gathering evidence against a taxpayer to make a case of tax evasion. Very often, furnishing such information before the completion of investigation is like putting a cart before the horse.
Thirdly, a taxpayer can move his deposits from the bank account of one tax haven to another before developing of an enquiry making tax administration’s efforts futile. Lastly, experiences of some of the countries indicate little usefulness of TIEAs as they have sparingly used it for the information exchange.
It may be recalled here that the information on the basis of which the Income-tax Department has recently initiated action was not received under the TIEA. The information on Indian account holders in LGT bank Lichtenstein was provided by Germany, which in turn had bought it from the disgruntled employee of the Bank, whereas France reportedly passed on the information on the account holders of the HSBC Bank, Geneva.
Responses by other countries
Probably considering the limitations of the TIEA, some of the countries have adopted multi-pronged strategy to counter offshore tax evasion. On the one hand, US, Germany and Australia had offered Voluntary Income Disclosure Scheme and on the other, some of them have enacted specific legislations to deal with it.
The US has strengthened domestic legislation by enacting specific laws to counter offshore tax evasion by creating additional sources of information gathering.
The US introduced ‘Hiring Incentives to Restore Employment Act’ (HIRE) providing tax incentives for hiring and retaining unemployed workers also imposes 30% withholding on payment made to foreign financial institution, unless such institution agrees to adhere to certain reporting requirements with respect to US account holders. It has also enacted legislation — FATCA (the Foreign Account Tax Compliance Act) which is to be implemented from 2013 requiring non-US banks to report the accounts of US clients to the US Internal Revenue Service. There is also a proposal in the US for enacting additional law, ‘Stop Tax Haven Abuse Act’ strengthening FATCA and plugging specific offshore tax evasion schemes. Similarly, UK’s new law introduced in 2010 provides for higher penalty at 200% on offshore tax evasion.
In addition, many countries have stepped up their counter offensive by allocating more work force to investigate the cases of offshore tax evasion. It is reported that the IRS of the US had placed more than 1400 agents on a project to investigate the merchants who were directly depositing credit card sales in their offshore accounts.
Conclusion
The real challenge to willingness to exchange of information comes from the difference in the tax laws and law on confidentiality along with conflicting interests among countries. Therefore, there is a need to take additional measures along with the TIEAs. However, the measures for information gathering which may work for the countries such as the US, Germany or the UK because of their political and economic clout may not work for India. India will have to supplement its measures — legislative as well as administrative — for information gathering in its battle against tax evasion leveraging at the international level its position of a giant emerging market.
On a positive note, the biggest contribution of the TIEAs is providing legal instrument in an environment against tax evasion. With the result, tax evaders are now increasingly realising that there will be no safer havens in near future for their tax evaded funds, which is the fundamental requirement in a fight against tax evasion.
