CCCI - Flash
Spring 2009

Economic and Financial Crisis


Pirate Bankers and the Shadow Economy
By Peter Gillespie


Each year, hundreds of billions of dollars are illegally transferred out of developing countries. This massive loss of domestic resources, which is far greater than aid inflows, maintains poverty, contributes to inequality, and deprives developing countries of the ability to invest in essential public goods and services. It is only recently that the role of offshore tax havens in enabling these losses has been examined. At the April G20 meeting in London, tax havens were prominently on the agenda.


Tax Justice

© Paul Lachine

Tax Justice


“The era of banking secrecy is over,” proclaimed the official communiqué of last month’s G20 meeting in London.  The G20 leaders, presiding over the worst economic recession in a generation, managed to hammer out a consensus on dealing with the ailing world economy, as well as reached agreement to crack down on offshore tax havens.

While the G20 plan to rescue the global economy is seriously flawed, the leaders were quite right to target tax havens, which are central to the transparency problems associated with the current economic meltdown. Tax havens facilitate the loss of billions of dollars of tax revenues at a time when G20 countries are struggling to bail out their failing banks and industries.

At the heart of the debate over tax havens, North and South, are the fundamental issues of private versus public, and the struggle for distributive justice in market-oriented systems. How can we ensure that the private wealth of companies and individuals (generated through access to the environmental commons, public subsidies, supports for infrastructure, a trained workforce, and social systems) makes a fair contribution back to the public good and to the protection of the environment?  In the context of a global agenda for human development, tax havens are an unacceptable drain of resources undercutting the ability of States to meet their obligations to the fulfillment of human rights: food, health, employment, and democratic governance.

It would not be an exaggeration to say that illegal capital flight and thefts from the treasuries of poor countries has resulted in the deaths of thousands, perhaps tens of thousands, of vulnerable people as health facilities have been dismantled and basic public infrastructure crumbled. Christian Aid estimates that if lost tax resources to developing countries were invested in health programs, it would save the lives of 350,000 children annually.  Raymond Baker, of the Global Financial Integrity Project, terms the hemorrhage of resources from poor countries the “ugliest chapter in global economic affairs since slavery.”


But it will be exceedingly difficult to put an end to tax haven abuses. After all, offshore services are utilized by the world’s wealthiest people as well the largest and most powerful corporations and these people will not relinquish their privileges without a struggle.


Offshore tax havens are the centerpieces of a shadowy economic system that has developed since the 1960s.  Today there are more than 70 tax havens, many but not all based in small states such as the Cayman Islands, Bahamas, Bermuda, Panama, the Channel Islands, Monaco, Luxembourg, Lichtenstein, Singapore and Switzerland. Offshore tax havens are “secrecy jurisdictions” that exist expressly to enable their clients to escape the scrutiny of regulators and tax authorities in their own countries. The service providers based in these jurisdictions are insurance companies, legal and financial firms, and the subsidiaries of mainstream banks headquartered in Geneva, London, New York and Toronto.


Tax havens are an entrenched part of the international economy. At least half of all international bank lending and approximately one-third of foreign direct investments are routed via these secrecy jurisdictions. More than half of all global trade is conducted through tax havens, and half the global monetary stock is estimated to pass through them at some point. The value of offshore hedge funds is currently about US$1.17 trillion. The London-based Tax Justice Network estimates that wealthy individuals hold an estimated US$11.5 trillion in offshore accounts.


Banks and multinationals companies routinely establish offshore affiliates to conceal their financial practices. Frequently these offshore affiliates, or international business corporations, are shell companies that conduct no business in the offshore jurisdiction and whose presence is little more than a postal address and a bank account. Tax havens host more than two million international business corporations; one modest building in the Cayman Islands is home to more that 12,000 of these entities.  A January 2009 report from the U.S. Government Accountability Office revealed that 83 of the 100 largest publicly-traded companies in the U.S., including big banks receiving bail-out money, have scores of offshore subsidiaries.


Offshore shell companies are used for profit laundering, assigning profits and losses on paper so that taxes can be minimized. To conceal profits a company might transfer the ownership of patents, copyrights or other intangibles to an offshore shell company and collect royalties in a low tax jurisdiction.  In 2007, the pharmaceutical company Merck was assessed $2.3 billion in U.S. back taxes for transferring its drug patents to a Bermuda shell company and then deducting from its taxes the royalties it paid itself.


Tax havens can also be used to conceal liabilities. Before being exposed as a spectacular fraud, Enron had established a network of 3,500 shell companies, 600 of which were registered in the Cayman Islands.  When the British government nationalized the failing Northern Rock bank in 2007, officials were stunned to discover that £50 billion of mortgages had been shifted to an offshore account disguised as a foundation benefiting Down’s syndrome children.
One of the most common methods of concealing corporate income and profits is through falsified transfer pricing. Today, more than half of all global trade is conductedamong affiliates of the same parent company.  Much of the trade between parent companies and affiliates is falsely priced so that companies can allocate profits in low tax jurisdictions. A company might, for example, sell an export item to an offshore affiliate at a sharply reduced price; the affiliate then sells the item at market price with the profits remaining offshore. Alternatively, the offshore affiliate might import an item at the real market price, but sell it to the parent company at a grossly inflated price so the company has a huge cost to deduct on its tax returns.


A March 2009 report commissioned by Christian Aid (UK) found that between 2005 and 2007, falsified pricing transferred US$8.5 billion out of the world’s 49 poorest countries, resulting in tax losses of US$2.6 billion to these countries. Tax losses for Nigeria were calculated at US$740 million, Pakistan US$450 million, Vietnam US$370 million, and Bangladesh US$274 million. A December 2008 report from the Washington-based Global Financial Integrity  Project calculated that developing countries lose $858 billion to $1.06 trillion in illicit capital outflows every year.


Corporate tax evasion and avoidance also affect Northern countries, including Canada. In 2002, Canada’s Auditor General warned that corporate “tax arrangements with foreign affiliates have eroded Canadian tax revenues of hundreds of millions of dollars over the past ten years.”  A study released in June 2008 by the University of Quebec at Montreal concluded that the five major Canadian banks avoided $16 billion in federal and provincial taxes through offshore affiliates between 1991 and 2003. A 2004 Library of Parliament report noted that between 1990 and 2003, Canadian corporate investments in Barbados increased from $1.5 billion to $24.7 billion, exceeding the GDP of Barbados by a factor of six. The report concluded that at least some of these investments could only be explained as tax avoidance measures.


In the United Kingdom, a parliamentary public accounts committee estimated tax losses due to the offshore system are at least £8.5 billion annually, although others estimate the loss as much higher. A U.S. Senate investigation of offshore tax abuse assessed the cost to the U.S. treasury as $100 billion annually.


Wealthy individuals are also escaping their tax obligations by holding their assets offshore, and some countries are vigorously pursuing tax cheats. In 2006, the German intelligence service bribed a former employee of Liechtenstein’s LGT bank to provide secret information on clients, setting off a wave of investigations of wealthy Germans for tax evasion. The Liechtenstein information also triggered tax probes in the United Kingdom, Canada, Sweden, France, Italy, the U.S. and the Netherlands.  


Tax evasion by wealthy individuals is also a serious problem in the South. A March 2009 study by Oxfam International found that at least $6.2 trillion of developing country wealth is held offshore by individuals, depriving them of $64 – $124 billion in annual tax revenues.  Raymond Baker estimates that African elites have offshore assets of $700 to $800 billion.


The Indonesian dictator Suharto looted his country and up to $35 billion found its way to the Cayman Islands, Panama, the Bahamas and other havens. Sani Abacha, the dictator of Nigeria, reportedly ordered the state treasury to transfer $15 million every day to his Swiss bank account. Mobutu Sese Seiko of Zaire and Emperor Bokassa of the Central African Republic plundered their countries to the point of starvation.


Virtually all of this looting has been done through tax havens, facilitated by well-paid accountants, lawyers and bankers. Yet public attention is only drawn to the kleptocrats, rather than to the people and institutions that enable these thefts.

What Is Being Done?

These are some of the issues behind the G20’s recent agreement to act against secrecy jurisdictions.  The G20 communiqué announced that the Organization for Economic Cooperation and Development (OECD) would immediately publish a list of jurisdictions that were not in compliance with OECD standards on transparency and exchange of information for tax purposes.


The OECD list, released on the same day as the G20 communiqué, was divided into three sections: a “blacklist” of non-compliant states, a “grey” list of jurisdictions that have committed but not yet met the standard, and a “white” list of those in compliance. Astonishingly, within days of the close of G20 meeting, the OECD blacklist was empty. Intense diplomatic pressure had successfully removed the most notorious tax havens from the blacklist.


The OECD grey zone included countries such as the Cayman Islands, Switzerland, Luxembourg, and Liechtenstein.  Both the Swiss and Liechtenstein governments were outraged to be named on the grey list.  Switzerland threatened to retaliate by not paying its annual dues to the OECD, an extraordinarily self-righteous response from a country that is the world leader in laundering thefts from poor countries.  


This is not the first time that the OECD has attempted to deal with the problem of tax evasion. In 2000, the OECD published a framework for sharing tax information that eventually became the OECD Model Tax Convention.  The Bush administration was opposed and the initiative languished.  President Barack Obama, however, is now playing a leadership role.


But there are serious flaws in the OECD framework. The OECD’s tax information sharing agreements are bilateral treaties while the challenges posed by tax havens require multilateral cooperation. In addition, under this framework a state needs to make a detailed case before requesting information from another treaty signatory.  The burden of proof is on the requesting authorities. While this assists authorities in pursuing known offenders, it will do nothing to catch tax cheats authorities don’t already know about.


But the biggest problem with the OECD approach is that it applies to individuals, not to multinational corporations, which are responsible for the majority of tax losses in Northern and Southern countries alike.  Unless ways are found to address complex corporate structures, falsified transfer pricing and profit laundering, little progress will be made.


Civil Society Is Mobilizing


Civil society organizations are calling for substantial improvements in the transparency of the international economy.  What is required is a multilateral approach to the mandatory exchange of information amongst all jurisdictions with respect to income, gains and property received by non-resident individuals, as well as corporations and trusts. Improved transparency requires that information be publicly available with respect to the beneficial ownership of companies, trusts and foundations.


Civil society organizations are calling for changes to accounting standards and country-by-country reporting of sales, revenues, profits and taxes paid by multinational corporations in their tax returns and annual reports. Improved transparency requires the development of systems to put an end to the practice of trade mispricing which deprives countries of massive amounts of tax revenues.  Ultimately, what is essential is the development of new norms of corporate social responsibility in which corporations become transparent and accountable, and take seriously their responsibilities to contribute to the public good.


Despite the flaws, the debate about secrecy jurisdictions is much further advanced than it was a few years ago. In large part this is due to the persistent efforts of civil society organizations such as the Tax Justice Network, Christian Aid, Oxfam International and others, to place these issues on the international political agenda. The debate will continue. As a coalition of tax justice organizations put it in a press release following the G20 meeting, “…this is not the end.  It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”



Peter Gillespie works with Inter Pares.



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