Business World

Thursday 27 October 2016

The Panama files cut right to the heart of the rich and powerful's divided loyalties

Published 07/04/2016 | 02:30

So-called tax havens have been a major topic of controversy
So-called tax havens have been a major topic of controversy

Money is like water, it flows to the place of least resistance. This has been the case for many years but is even more sharply in focus in the digital age when money can be flicked around a global financial system very easily.

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Few should be surprised by the revelations contained in leaked documents about the operations of a Panamanian law firm and the operations of its clients.

It is highly likely that some of the offshore companies and trusts set up by its clients began with hot money, while for others it was simply about legitimate tax avoidance and maintaining a degree of confidentiality in their legitimate business affairs.

There are lots of reasons why people set up offshore corporate structures and trusts. For large multinationals it is about conducting their international operations in a way that reduces their tax bill, while also perhaps protecting financial information from competitors or prying eyes.

For wealthy individuals it can be about tax evasion or even corruption. But equally it can be about conducting their affairs in a tax-efficient manner which doesn't break any laws.

Based on what has been published from the leaked documents so far, there isn't real evidence that wholesale tax evasion was going on.

Offshore trusts have been used for decades by the wealthy - sometimes to hid money, sometimes to protect it. Sometimes they want to pass it on to the next generation without incurring large tax bills.

Privacy can be important. But feeling the need to use a Panamanian law firm to protect it, suggests that a lot of people were taking their privacy issues to real extremes.

Very often international tax rules are put in place for the operations of big business. Sometimes the same rules and tax laws that make sense for a large global conglomerate, and are totally legal, can be used by wealthy individuals too in ways that were never envisaged.

For example, take bearer share companies. This is a company that is owned by whoever holds the shares as opposed to having a registered owner whose name appears on the certificate.

So, instead of formally registering who the new owner of a company is, you simply hand over the bearer shares to whoever has just acquired it, or whoever you want to be the owner.

The company might not even know. These structures allow the ownership of a company to remain completely anonymous, even to the directors of the company themselves and for the ownership to change by physically moving the bearer share certificates from one safety deposit box in a tax haven to the one right beside it.

This makes international tax investigations extremely difficult because it is virtually impossible to track down who owns or owned the asset.

Bearer share companies are now finally coming under major scrutiny but were only done away with in Ireland as recently as 2014.

Privacy in legitimate business dealings can still be assured. But the problem for people who want to hide money offshore is that more and more European countries and established tax havens are being dragged kicking and screaming into greater co-operation and information sharing.

This means that old reliable favourites like Switzerland, Liechtenstein and some Caribbean islands are somewhat less private than they were. This forces the clients to go to more unstable, higher risks places to source their corporate services.

It also makes it extremely difficult to crack down on international tax evasion because as long as there is some jurisdiction somewhere willing to facilitate it, the money will flow there.

The scandal around the Panama files has reached the upper echelons of the powerful in many countries, from China and Russia to Iceland and Israel. It comes at a time when there is already major debate about how corporations and wealthy individuals can use international tax laws to reduce their tax bills.

How much tax should businesses pay and where? The truth is that far too many countries are in competition with each other to win highly mobile capital and investment.

It is difficult to say you will crack down on tax avoidance while also saying you want to be the best country in the world in which to do business? Are the two contradictory? As long as there is competition for global investment flows, then to a certain extent they are.

Tighter rules benefit larger wealthier economies which are less reliant on tax as a competitive tool. Take Ireland for example. We have a low 12.5pc Corporation Tax rate, yet we have had lots of companies availing of various legitimate tax tricks to pay a lot less than that. If we close these off, but others don't, we could lose out.

International tax advisers will tell you that in the past when some US executives were coming to Ireland to work for a multi-national, they set up an offshore company, like a consultancy firm, which charged their employer for their services. This firm in turn paid the executive, living and working in Ireland, a relatively modest wage, on which he was taxed here.

The rest of his salary stayed offshore and was not taxed. This was all perfectly legal. Ireland lost out on some tax revenue but gained on multinational investment which created jobs.

The files raise serious questions for the UK, given the extent to which some of its dependency territories, such as the British Virgin Islands, are mentioned. Former UK business secretary Vince Cable said during the week that he was in favour of introducing direct rule to these places if they did not fully comply with changes on transparency and tax that might be sought from London.

But the truth is that places like the Cayman Islands, the British Virgin Islands are other dependencies like Jersey, Guernsey, Gibraltar and the Isle of Man, have all fed into the success of London's success as a global financial services centre.

There isn't real will in Westminster to rattle the cage too much.

Because money is like water, it will only flow somewhere else anyway.

The Panama files will feed into the wider debate about tax avoidance in a positive way. The files could be of enormous value to various tax authorities, while also raising questions about why wealthy people would go to such lengths, even legitimately, to protect their assets from the exchequer coffers of where they live. People are asking legitimate questions about who pays what, but that debate must be grounded in the real world.

The German philosopher Arthur Schopenhauer once said that: "Wealth is like sea-water, the more we drink, the thirstier we become."

Even if that is true, nobody has managed to come up with a workable alternative system for modern society that doesn't need wealth, and to reward those who create it.

The real problem posed by global movements of capital is getting everybody to play by the same rules when we are all competing against each other.

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