Tuesday, December 16, 2008

Tightening up on the intermediaries

When tax evasion and illicit cross-border flows happen, they invariably involve more than one set of actors. There is a demand side to this (the tax evaders and their like) and the supply side: the intermediaries who help them commit their crimes. There has been far too little attention to the demand side, of course, and even less attention to the supply side. That is now starting to change. TJN, through its senior adviser David Spencer, has just obtained an interesting determination on this.

First, some background. Intermediaries play a significant role in facilitating cross-border illicit financial flows. There are generally three categories of intermediaries:
  • Attorneys, accountants, and tax advisers (in this blog we'll call them legal and tax advisers);
  • Corporate service providers, promoters, corporate administrators and trust administrators (we'll call them service providers); and
  • Financial intermediaries, such as banks, trust companies, brokerage firms, and other financial intermediaries.
It is heartening to see that intermediaries are now being subject to greater scrutiny. The U.S. Senate Permanent Subcommittee on Investigations held a hearing in August, 2006, “Tax Haven Abuses: The Enablers, the Tools and Secrecy”. And the OECD has initiated a Tax Intermediaries Project, which took a rather collaborative, "fireside chat" approach to the problem, which we think was, while interesting, far too timid.

An interesting recent case is the U.S. Government's recent indictment of two officers of the Swiss bank UBS, for conspiring to help U.S. citizens evade U.S. income tax by allegedly helping them to open and maintain bank accounts at UBS in Switzerland, which the UBS staff knew were not declared in the United States by those U.S. persons. The U.S. Government apparently considered indicting UBS (a new paper looks at some of the strategic differences between UBS' approach and that of prior high-profile tax shelter investigations, such as the KPMG tax fraud case in New York.)

Now here is a broad question. Will other governments that want to confront capital flight from their countries (and the tax evasion that typically follows) follow the same route and initiate criminal proceedings against officials of financial institutions engaged in international private banking who help residents open and maintain secret foreign banks accounts, not declared to their tax authorities, thus helping them evade tax?

Now here is a more specific question. Some jurisdictions license and regulate intermediaries such as legal and tax advisers. Can an attorney licensed in one jurisdiction assist and counsel a client if the attorney knows, or has reason to know that the client is violating foreign law? You would think that the answer is obvious: no, of course not. But it is not so simple. The prevailing view seems to be "don't ask, don't tell."

Now we have an informal decision - which holds much promise. The New York State Bar Association has recently issued the following determination about one of its Disciplinary Rules, based on a fact situation submitted to it:

"A client who is a citizen and resident of a foreign country has consulted with you about a proposed transaction (“Transaction”) in which the client would open a bank account in his name at a New York bank, or create a wholly-owned corporation in a zero tax jurisdiction (“Offshore Corporation”) and have the Offshore Corporation open a bank account at a bank in New York.

You know or have reason to know that the client is required under the laws of the foreign country to report the proposed Transaction in his tax returns in the foreign country and/or in other reports that must be submitted to the foreign country’s government. You have learned that the client does not want to report the Transaction in the foreign country because this would result in tax liability or other legal liability in the foreign country. The client has requested your assistance to help structure the Transaction to reduce the possibility that information about the Transaction will become available to tax and/or other government authorities in the foreign country.

Your inquiry concerns the scope of Disciplinary Rule DR 7-102 (A) (7), which provides:

In the representation of a client, a lawyer shall not … (7) Counsel or assistant the client in conduct that the lawyer knows to be illegal or fraudulent.

You inquire as to whether the reference in DR 7-102 to conduct that the lawyer knows to be “illegal or fraudulent” is limited to conduct that is illegal or fraudulent under the laws of New York, or encompasses conduct that is “illegal or fraudulent” under the laws of jurisdictions other than New York.

The meaning of the admonition in DR 7-102 (A) (7) is clear: if a lawyer “knows” that a client intends to engage in illegal or fraudulent conduct, the lawyer cannot explain to the client how to engage in the conduct nor provide legal services that enable the client to achieve the illegal or fraudulent purpose.

The language of the prohibition in DR 7-102 (A) (7) against counseling or assisting the client in conduct the attorney knows is illegal or fraudulent is not limited by jurisdiction ……….. Accordingly, we conclude that the phrase “illegal or fraudulent” in DR 7-102 (A) (7) encompasses conduct that is illegal or fraudulent in New York or any other jurisdiction."


The last four words of this determination have enormous implications, which go right to the core of the tax justice network's agenda. And we are delighted to hear it.

It is remarkable that the OECD Study into the Role of Tax Intermediaries has not yet focused on these issues. Why not? (There are plenty of details to consider - look, for example, at TJN's proposals to the Group of Experts in Rome in September 2007, especially point 13).

Will governments suffering from capital flight and the resulting tax evasion began to hold intermediaries liable as conspirators, as the U.S. Government has tried to do with regard to those two Swiss UBS officials?

Will governments that license and/or regulate intermediaries in their jurisdictions (such as legal and tax advisors, and financial intermediaries) prohibit such intermediaries from helping domestic and foreign persons to violate foreign law?

And let's not forget there are two sides to this equation: the countries which receive this illicit capital, and the countries from which it is fleeing. The United States may have indicted two UBS bankers for conspiring to help US taxpayers to evade US taxes -- but what are the possible instruments in the capital exporting countries (such as Argentina, Brazil, Mexico, etc) to go after intermediaries? Brazil has taken action against certain foreign bankers. What decisions might be taken in other jurisdictions? The possibilities are enormous, and the urgency is great. As this evolves, we will bring you up to date. Watch this space.

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