2016-Issue 19 – On April 3, 2016, a news story broke that has become the saga of the Panama Papers. For about a year, journalists had been sifting through, sorting and analyzing over 11 million documents regarding the international holding company structures of clients from the Panamanian law firm Mossack Fonseca & Co. The information was originally provided to a German newspaper, Süddeutsche Zeitung, but because of the overwhelming amount of information, the International Consortium of Investigative Journalists (ICIJ) stepped in to help with teams of journalists from scores of countries that include virtually every developed and developing country.
In the United States, the Panama Papers did not stir the uproar it created in Europe and other regions, although recently the U.S. Attorney’s Office for the Southern District of New York did launch a criminal investigation and is seeking cooperation from the ICIJ. The relatively muted response in the United States may be because to date no high-profile U.S. individual has been named. It may also be that U.S. efforts to crack down on offshore tax evasion are paying off. Since 2003, the IRS has offered a voluntary compliance program, in one version or another, for U.S. taxpayers with undisclosed foreign accounts to come clean. According to the IRS, over 45,000 U.S. taxpayers have participated so far. The United States, via the Foreign Account Tax Compliance Act (FATCA), also enlisted (i.e., compelled) the aid of foreign financial institutions in its efforts to tackle offshore tax evasion. But with the annual tax gap hovering around $450 billion a year, the IRS still has a long road ahead. Accordingly, despite the Treasury’s recent success, the Panama Papers will have an impact on the United States. In any case, the rest of the world will take action to tackle the perceived abuses reflected therein and will invariably call on the United States to take similar actions.
Ultimately, the timing surrounding the leak of the Panama Papers may prove more important than the information it yields. Tax havens, professionals and bankers who enable tax evasion, and affluent individuals who opt to evade their fiscal responsibilities at home are nothing new (i.e., death, taxes and tax evasion). But are we currently witnessing the end of bank secrecy and, with it, tax evasion via convoluted international holding company structures? That seems to be the case.
Over the last 10 years, the tolerance for tax evasion and aggressive tax planning has diminished. Budgetary gaps created by the Great Recession and successive cases of potential tax evasion in recent years have taken a toll. In 2008, it was the Liechtenstein tax affair involving the sale of private bank account information to German tax authorities. Around the same time, the U.S. Department of Justice was taking on UBS and Swiss Bank secrecy to get at U.S. taxpayers hiding undeclared assets. The Department of Justice’s effort to date has resulted in approximately 80 banks joining its Swiss Bank Program.
The Panama Papers will likely entail high net worth individuals rather than multinational companies. The majority of the individuals mentioned in the Panama Papers are probably relying on international holding company structures to keep their financial affairs private, not from the tax authorities but from the general public. But, invariably, time will show that some of the individuals are relying on these structures to hide assets. For these individuals, privacy is at the heart of tax evasion and thus why privacy is the main target of government efforts. In recent years, governments have focused on bank secrecy. Such efforts brought about FATCA, the OECD’s Common Reporting Standard or CRS (i.e., global FATCA), and the EU’s Savings Directive. Once CRS is fully operational, there will be very few countries that are not automatically exchanging bank account information with resident jurisdictions. Now, as a result of the Panama Papers, the focus seems to be shifting from bank accounts to the beneficial ownership of foreign companies. Currently, there are many countries where individuals can establish a corporation without revealing the ultimate beneficial owner. More importantly, the entity’s beneficial ownership is not reported to the local tax authorities and exchanged as part of an automatic information exchange program.
In the United States, for example, certain states created favorable environments to encourage the formation of companies therein, such as Delaware and more recently Nevada, Wyoming and South Dakota. Foreign individuals can organize a limited liability company (LLC) in these and other states without revealing the ultimate beneficial owner and without obtaining a U.S. tax identification number for the LLC. The failure to report such information to the IRS creates the potential for abuse; if the IRS does not have the information, it cannot exchange it with other countries.
In order to shut the door on any such abuse, on May 5, 2016, the Treasury announced it will send proposed legislation to Congress that will require companies to report their beneficial ownership at time of formation. The Treasury also announced proposed regulations that will require foreign-owned LLCs to register with the Internal Revenue Service and obtain an employer identification number (for discussing on new regulations see 2016- Issue 16, "Treasury Proposes Regulations to Limit the Ability of Foreign Persons to Use the US as a Tax Haven"). The Treasury, via its Financial Crimes Enforcement Network (FinCEN) bureau, is also requiring that beneficial owners of LLCs be disclosed in connection with all-cash real estate acquisitions in New York City and Miami. This measure is only temporary, but based on the information gathered, the process may become standard.
Will these measures be enough to prevent U.S. legal entities from being used for tax evasion and money laundering? Maybe, maybe not, but it is a good start. Other countries are expected to take similar actions. For example, the United Kingdom created a beneficial ownership registry for U.K. companies that are not publicly listed. For a particular U.K. entity, this registry will reflect persons with significant control over that entity beyond just its corporate officers and directors. Rules focusing on beneficial ownership will likely begin to spread across jurisdictions in an effort to reduce or eliminate the privacy international holding company structures have historically enjoyed.
Curtailing privacy of beneficial ownership may prove to be a silver bullet for individual tax evasion, but determining who should have access to that information may be difficult. Making beneficial ownership information public to everyone as in the United Kingdom may go too far. Security and kidnapping are valid issues in certain countries. Even in countries where security is not a problem, financial concerns may require a certain level of privacy. In the United States, lawsuits are often driven by how deep the pockets of the defendant are. If you are judgment-proof, chances are you need not worry about civil suits. The potential threat of lawsuits in the United States has led to the rise of planning techniques aimed at protecting affluent individuals from potential lawsuits. These asset protection structures often take into account estate tax planning goals.
In the end, the structure may look similar to and even involve the same jurisdictions as those structures mentioned in the Panama Papers. However, these asset protection / estate planning structures are within the scope of the law. Accordingly, depriving a majority of law-abiding taxpayers their privacy in order to catch an unethical minority seems unfair. Information regarding beneficial ownership does not need to be made public in order to effectively prevent tax evasion or money laundering. However, governments at some point in the not too distant future will likely collect and share beneficial ownership information automatically. That quantum of privacy could be the cost of the Panama Papers.
Alvarez & Marsal Taxand Says:
FATCA unleashed on the world the automatic exchange of bank account information with regard to U.S. taxpayers. The world took notice, initially in vehement disagreement, but subsequently jumped on board and took FATCA global via CRS. As a result, bank secrecy is dead or dying. Now the focus is on beneficial ownership of entities. As was the case with foreign bank accounts, governments will begin to issue draft rules that require the collecting and sharing of beneficial ownership information.
Given where we are today, if such rules were fully implemented within the next five years, few would be surprised. Accordingly, now is the time to review any historical structures that were implemented a long time ago and that may not reflect where the world currently is in terms of tax transparency. To some extent this may be a generational issue. There are many unreported structures out there created by parents or grandparents who are now older and ready to transfer their assets to the next generation. Waiting will not make this process any easier.
The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisers. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisers before determining if any information contained herein remains applicable to their facts and circumstances.
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