Going “listless” on tax evasion

Economic conditions are tough everywhere. Governments around the globe are scrambling to implement domestic austerity measures even as they desperately search for sources of revenue to jumpstart fragile economies still recovering from the worst global recession in history. Germany may have some help from a group of some fifty of its millionaires and billionaires (the remaining 799,950 apparently declined to participate) who have volunteered for a ten-year, ten per cent tax on their incomes to help close the fiscal gap in that country.

Absent such altruism, however, in the current economic climate new taxes and tax increases will not be a popular source of revenue for most governments. Nonetheless, the financial crisis has prompted fresh scrutiny of the extent to which taxes already on the books are being collected. In Greece, where evading taxes is virtually a national tradition, there is increasing pressure to end the practice, which costs the country roughly $27 billion annually. The UK also is clamping down on tax evaders, who cost the Treasury over £15 billion per year.

On the other side of the Atlantic, the United States, faced with record deficits brought on by two recent wars, expanding health care costs and a massive bailout of the financial services sector, can no longer ignore the $40 billion to $70 billion it loses annually to tax evasion by individuals. The culprits are mostly wealthy US citizens and residents – taxable in the United States on their worldwide income – who evade tax by not reporting income earned through accounts held in offshore financial institutions either directly or through controlled foreign shell corporations.

Financial confidentiality rules in most offshore financial centres prevent foreign tax authorities from readily accessing information about the beneficial ownership of bank accounts and shell corporations, and thus thwart US efforts to detect and prevent this sort of tax evasion.

The objective of the Stop Tax Haven Abuse Act, the last version of which was introduced in the US Senate in March, 2009 by Senator Carl Levin, was to deter offshore tax evasion by US citizens and residents and capture lost tax revenue. In most respects, the Act represented a reasonable approach to accomplishing this task. Under the Act, the creation of financial accounts, shell corporations and trusts by US persons in foreign jurisdictions would have triggered certain presumptions and rules affecting the domestic tax liability of US persons, including:

  • a rebuttable presumption that a US person creating a foreign trust, corporation or other similar entity has control of the entity
  • a rebuttable presumption that any property received from or transferred to a foreign entity by a US person is immediately taxable income
  • an extension of the permissible length of IRS audits involving foreign accounts and entities from three years to six years

The Act included information reporting requirements, as well. US financial institutions either opening accounts for foreign shell corporations beneficially owned by US persons or facilitating the creation of foreign accounts, corporations or trusts for US persons would have been required to file information returns with the US Internal Revenue Service.

None of these provisions should have been troublesome to Cayman and other OFCs if the Act had not adopted yet again the stale and ineffective strategy of singling out a group of “offshore secrecy jurisdictions” for special treatment. Each of the provisions outlined above would have applied only to entities and accounts created in one of the thirty-four “offshore secrecy jurisdictions” included on the Act’s “blacklist”. The Act defined offshore secrecy jurisdictions as those determined by the Treasury to have “corporate, business, bank, or tax secrecy rules and practices” that “unreasonably restrict the ability of the United States to obtain information relevant to the enforcement of its tax code.”

The usual scapegoat jurisdictions populated the Act’s list, which, of course, included the Cayman Islands. Although the Act did not single out listed jurisdictions for the imposition of financial sanctions – those sanctions, including being kicked out of the US financial system, would have applied to any foreign jurisdiction that impeded US tax enforcement – that fact was obscured by the very presence of yet another list of OFCs created by an onshore jurisdiction. Fortunately, the Act has languished in the Senate Finance Committee since its introduction.

Fast-forward a little more than a year to President Obama’s signing, in March, of the Hiring Incentives to Restore Employment (HIRE) Act, which included as a revenue-raising provision the Foreign Account Tax Compliance Act (FATCA). The objective of FATCA is the same as that of the Stop Tax Haven Abuse Act – eliminate tax evasion by US persons using foreign accounts and entities. The approach is starkly different, however.

FATCA does not contain a blacklist of offshore jurisdictions; nor can one find the words “offshore”, “secrecy” or “tax haven” anywhere within the text of the legislation.

Instead, beginning in 2013, FATCA will impose a thirty-per cent withholding tax on interest, dividends, rents, royalties and other payments of portfolio income from US sources to foreign financial institutions that do not provide the United States with specific information about the identity of their account holders. The jurisdiction in which the foreign financial institution is located simply does not matter.

The effect of FATCA is to permit the United States to collect the income tax it is owed on the income of US persons in one of two ways. The US person may either verifiably disclose and pay tax on income earned through foreign accounts and entities or choose anonymity under the bank secrecy rules of a foreign jurisdiction and, by default, permit the United States to collect the tax via withholding at the source of payment.

Much is still unclear about how FATCA will work in practice, but the United States has demonstrated that anti-tax evasion legislation can be drafted that does not malign offshore financial centre jurisdictions by blacklisting them and singling them out for special treatment . . . and that’s progress.

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Craig M. Boise

Craig’s research, writing and teaching focus is on US international tax policy, offshore financial centres, and offshore financial intermediation. 

Craig M. Boise
Dean Designate and Professor of Law 
Cleveland State University 
2121 Euclid Ave. LB 138 
Cleveland, OH 44115 

T: +1 (216) 687-2300
E:  [email protected]
W: http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=345018  

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Cleveland State University 
2121 Euclid Ave. LB 138 
Cleveland, OH 44115 T: +1 (216) 687-2300
E:  [email protected]