The release of the « Panama Papers » calls for the strengthening of the OECD Global Forum standards and rating system. But it also has implications for financial reform, trade and investment liberalisation.
The « Panama Papers » leaked by the International Consortium of Investigative Journalists (ICIJ) have exposed the business transactions of the law firm Mossack Fonseca, “one of the largest creators of offshore companies in the world”, from 1977 to date. The files refer to no less than 214 000 offshore entities created by Mossack Fonseca. So far, 140 politicians have been linked to the law firm’s business of offshore holding. While a more extensive list of clients is expected to be made public in early May, current disclosures already expose the depth and widespread use of bank secrecy, despite the many commitments by policy makers, including by the very same exposed by the Panama Papers.
The OECD was quick to react. In a statement by the General Secretary on 4 April the OECD claims to “have constantly and consistently warned of the risks of countries like Panama failing to comply with the international tax transparency standards” through the Global Forum on Transparency and Exchange of Information. “Just a few weeks ago, we told G20 Finance Ministers that Panama was back-tracking on its commitment to automatic exchange of financial account information. The consequences of Panama’s failure to meet the international tax transparency standards are now out there in full public view. Panama must put its house in order, by immediately implementing these standards”. The failure of Panama to commit to automatic exchange is indeed mentioned in the OECD report to the G20 Finance meeting in Shanghai in February (namely on pages 11 and 18).
On 8 April, the OECD announced an emergency meeting of the Joint International Tax Shelter Information and Collaboration (JITSIC) Network “to explore possibilities of co-operation and information-sharing, identify tax compliance risks and agree collaborative action, in light of the “Panama Papers” revelations”. The JITSIC is a newly created entity of the OECD Forum on Tax Administration, a subsidiary body of the OECD Committee on Fiscal Affairs. It comes as a surprise considering that the Forum on Tax Administration has never worked on tax evasion in the past and that, presumably, the most relevant OECD forum to address the Panama papers would be the Global Forum on Tax Transparency. At the time of writing, that Global Forum has yet to react.
The Panama Papers suggest a more comprehensive response by the OECD. The leaks have implications for the OECD tax transparency standards, which obviously need to be strengthening, but they also have implications for other policy areas, including financial governance and regulation, investment policies and trade liberalisation.
The need for tougher tax transparency standards
The failure of Panama to commit to automatic exchange covers only one aspect of the problem. Before you can automatically exchange something, that something needs to be made available to tax administrations in the first place through a robust domestic legal and regulatory framework. That is precisely why the effectiveness of the Global Forum rests on two legs: (i) implementation of the new international standard on automatic exchange of information between tax authorities (the “AEOI”) but also (ii) compliance of the domestic regulatory framework with 10 “essential standards” on exchange of information on request (“EOIR”) — including transparency over beneficial ownership. Under the EOIR, countries are rated through a two-step peer review process: “Phase 1” the legal and regulatory framework, “Phase 2” the implementation of this framework in practice. The two systems — AEOI & EOIR — go hand in hand and both are essential to effective tax transparency — despite the much higher prominence of automatic exchange in the media. To quote an Italian tax administrator at a G20 tax symposium in 2014: “Information on request is a pistol, automatic exchange is a machine gun. Automatic exchange is a risk assessment tool, upon request is used to target at-risk taxpayers”.
While Panama received a bad mark for failing to commit to the AEOI automatic exchange system in the OECD report to the G20, it is — surprisingly — doing quite well under the EOIR rating system on its regulatory framework: it passed Phase 1 successfully (meaning that the legal framework is considered in place). A closer look at Panama’s rating shows that Phase 1 was completed successfully, despite failing to comply with 3 of the 10 essential standards. In particular “availability of information” (standard A2) in the accounting system was deemed to be “not in place”, beneficial ownership (A1) was considered in place but with reservations. Yet, if all of the 10 standards of the Global Forum are essential, A1 and A2 are arguably even more essential than others. In particular, the use of trusts, foundations and bearer shares which protect full anonymity over ownership (the owner is the one who holds, literally, the share) are among the standard techniques to ensure opacity over beneficial ownership.
The case of Panama is not isolated. Other jurisdictions have been given a green light despite failing to meet the beneficial ownership standard: Dominica, Dominican Republic, Marshall Islands, Morocco, El Salvador, Hong Kong, Romania, United Arab Emirates, to mention a few. Within the OECD, Switzerland, Poland, Turkey are failing to meet the standard as well, as is Costa Rica which is in a pre-accession process. In a note comparing the Global forum rating with the EU list of tax havens and the TJN Secrecy index rating, the TUAC concluded that “Over 80% of jurisdictions are considered fully compliant or largely compliant with the Global Forum’s standard. However, less than 50% of the rated jurisdictions scored a “fully compliant” rating regarding “availability of ownership information” (category A)”.
That is a perhaps a first lesson of the Panama papers: the need for a tougher rating system by the Global Forum. A more stringent one that would leave no compromise on transparency over beneficial ownership and request full compliance with relevant Global forum standards (A1–3).
The governance of banks and financial intermediaries
The Panama papers also reveal the pivotal relationship between law firms and global banks. According to the ICIJ findings, “Over 500 banks, their subsidiaries and branches registered nearly 15.600 shell companies with Mossack Fonseca”. The banks involved are not limited to the usual suspects: the small “boutique” institutions with locations in Switzerland and Luxembourg. Among the 10 banks that requested the most offshore companies for their clients, there are several global banks officially considered as systemically important by the Financial Stability Board including Credit Suisse (with 1105 offshore entities created), HSBC (2,300), UBS (+1100) and Société Générale (979), as well as the Royal Bank of Canada (378) and Commerzbank (92).
The key question is whether this is just a legacy of the past, prior to the regulatory and supervisory tightening that occurred after the financial crisis and, in particular, the US authorities’ crackdown on banks’ money laundering and tax evasion practices since 2010. According to the ICIJ, bank-related offshoring activities at Mossack Fonseca rose rapidly in the run up to the 2008 crisis, and indeed, the post-2010 US crackdown has “helped slow banks’ use of the offshore companies”. But it did not mean the end of it: Banks “just changed their focus [by unloading] companies onto offshore middlemen but continued to offer banking services to customers through the offshore companies”. Mossack Fonseca made new due diligence arrangements so that major banks “could insulate themselves from their customers’ offshore companies. […] Mossack Fonseca would deal with the customers directly, not through the bank [which] would put some distance between itself and the world of shell companies”.
If banks can so easily dump their due diligence responsibilities on tax onto lawyers and other financial intermediaries, then we are facing a much bigger problem than simply tax transparency and cooperation between tax administrations. The issue at hand concerns the ever increasing lengthening and complexity of the “investment chain” in the financial sector — a chain that includes multiple intermediaries between the ultimate owners and the invested entity. More specifically, it points to the role of the legal and accounting profession in the fuelling of tax evasion and avoidance — a role that did not surface in the parallel OECD process on Base Erosion and Profit Shifting (BEPS). It also suggests the need for a much greater focus on corporate tax accountability and how tax is treated as a “risk” in key OECD instruments on responsible business conduct, on corporate governance and on long term investment.
It also questions, yet again, the extent to which large banks involved in the offshoring business, which are already considered too-big-to-fail, are also “too-big-to-be-supervised”, to-be-regulated, and in the end to-be-governed. With balance sheets of the size of a country’s GDP and levels of financial complexity that far surpass anything else in the financial sector, the proposition to force a split of these groups and help achieve a smaller, more manageable financial sector, should be revisited.
The links with the free trade and investment agenda
The Panama Papers are at the core of the tax evasion debate and are closely linked to corruption and money laundering issues. These aspects are distinct from and, hence, not to be mixed up with those linked to “tax avoidance” and aggressive tax planning by global businesses, which are addressed by the separate G20/OECD BEPS Package agreed in October 2015. But there are links. The business of offshoring and of empty shell companies can serve different purposes, money laundering and tax evasion or tax avoidance and aggressive tax planning. Or both. The BEPS Action n°6 on restricting treaty benefits would be worth revisiting in light of the Panama Papers.
More fundamentally, the Panama papers might call for a rethinking on the links between tax evasion, tax avoidance on the one, and investment and trade liberalisation, on the other hand. The leaks of the Mossack Fonseca clients reveal a disproportionate number of Italian, Indian and Israeli businessmen as well as Russian and Chinese politicians. By contrast, only a handful of American names appear. A basic explanation might be that the law firm has not been too successful in penetrating the US “tax dodging market”. Another one would be that US tax evaders do not need Panama: they have enough options at home with some US States being fairly “competitive”, when it comes to tax secrecy (Delaware, Wyoming, Florida). Another explanation to the absence of US companies and individuals from the leaks could well be found in the role of the free trade agreement between the US and Panama. In other words, US businesses did not need Mossack Fonseca or any other law firm to benefit from the Panama tax secrecy regime: they had it all readily served thanks to the US-Panama FTA. US trade unions, such as the Teamster’s are making the connection. A statement by the US NGO Public Citizen in 2011 is in fact resurfacing in the social networks. Entitled “Oppose the U.S.-Panama FTA”, Public Citizen at the time argued that the US-Panama “FTA’s investment and financial services provisions would undermine U.S. policies used to combat offshore tax dodging”.
The OECD has been an ardent promoter of free trade and investment. Since 2006, it has been running “The Freedom of Investment process” under the auspices of the OECD Investment Committee to “resist protectionist pressures” and promote “open, transparent and non-discriminatory investment policies”. The interaction between tax evasion / avoidance and investment and trade liberalisation and, specifically, between investment treaties and tax treaties are rarely addressed. Last year, an OECD draft paper suggested however that “large volumes of FDI transit through third jurisdictions, especially through a limited number of small jurisdictions which offer attractive tax, regulatory or secrecy regimes. Transit countries for FDI are often relatively small economies with very high inward and outward capital flows relative to GDP and a great number of Special Purpose Entities (SPEs). Many of these countries (…) have concluded a significant number of IIAs.” (source: “The Societal benefits and costs of IIAs”, OECD draft paper, October 2015). The paper has yet to be released.
What is certain is that the OECD could do a better job at linking the tax evasion and the BEPS agenda with the investment treaty agenda.