New paper: Emerging Countries and the Taxation of Offshore Accounts

Last year Itai Grinberg, Associate Professor at Georgetown University Law Center in the U.S., published an important paper entitled Beyond FATCA: An Evolutionary Moment for the International Tax System, providing a comprehensive overview of the emerging international architecture of financial transparency, with different models of information exchange (see below) jostling for supremacy.

It is a most useful paper which remains relevant for analysing the rapid changes that are now underway.

Now Grinberg has a new draft working paper available entitled Emerging Countries and the Taxation of Offshore Accounts, which provides further illumination. There's far too much in here for us to summarise comprehensively, so we'll just pick out a few points that catch our attention. The abstract begins:

"A new international regime in which financial institutions function as cross- border tax intermediaries is emerging. The contours of that regime will be established during a narrow window of opportunity over the span of the next few years. The resulting regime will have especially important consequences for emerging countries. A uniform, multilateral automatic information exchange system would improve both these jurisdictions’ ability to tax the offshore accounts of their residents and their capacity to tax certain domestic-source income from capital."

Clearly, these are all issues that are dear to our hearts.

The paper skips through a recent history of information exchange, with a look at the four models. The first is the OECD's original, only slightly better than useless, "on request" information exchange model. Next comes the gold standard principle, automatic information exchange, which is currently in the ascendant partly due to the political muscle of the United States and the European Union. The U.S. and the EU each have major systems for automatic information exchange systems up and running and in the process of expansion and improvement.

The core U.S. process is FATCA, which recruits financial institutions to find out the relevant information about beneficial owners. Potentially, financial institutions a going to ferret out hidden assets wherever in the world they are held, and we think this a highly effective broad principle. It is currently mostly a unilateral system, but we are now seeing the first steps towards a broader and more multilateral framework, with the U.S. reciprocating with other changes.

The core EU process is the Savings Tax Directive, which involves governments exchanging information directly (and automatically) with each other, rather than getting financial institutions to do so. FATCA and the EU process are complementary, though some problems of 'meshing' between the two systems are anticipated as ways are found for them to coexist. Each has strengths and weaknesses although the approach of using financial institutions as cross-border tax agents to provide the information exchange is potentially very powerful. We discuss all these issues automatic information exchange extensively here.

Grinberg's new paper doesn't discuss the EU scheme in very great detail, but he emphasises two crucial issues for a working mulitlateral AIE (automatic information exchange) system which seem to be quite effectively addressed in FATCA:

• detailed and deep and thorough customer due diligence protocols and processes to identify real account owners, combined with realistic threat of financial punishment for failing to do so properly;
• a good combination of (very big) sticks and carrots to make sure that this spreads widely through the international system 

His paper also pays a good bit of attention to the dangers posed by another model: that posed by Switzerland, which as we have noted many times in the past has been the global leader in trying to sabotage progress on the main information exchange models, by putting forward its anonymous witholding tax model, which has served as a spoiler. As Grinberg puts it:

"Switzerland, which manages approximately 30% of the world’s offshore wealth, has rejected automatic information exchange in principle. This refusal is an important obstacle to implementation of automatic information exchange, both in its own right and because Switzerland often acts as a leader of other offshore asset-management jurisdictions.    In a rearguard action to prevent automatic information exchange from becoming a global standard, the Swiss have been offering anonymous withholding to a few—and only a few—large developed economies.
. . .
Automatic information exchange may plausibly be made multilateral, whereas anonymous withholding will not be, and instead could prevent a multilateral automatic information exchange system from emerging."

We don't necessarily agree with that 30% figure, but the analysis is generally correct.

And now something that has not been widely discussed.

"Tax administrations in emerging and developing economies have a significant stake in ensuring that whatever benefit the large developed economies obtain in the form of automatic information exchange is available to them, too. For these jurisdictions, a uniform multilateral automatic information exchange system could positively affect their ability to address offshore tax evasion and, further, could serve to improve the structure of their domestic information reporting and withholding regimes more generally." 

And there are risks here, of course, that current trends lead to:

"fragmented automatic information reporting to a limited number of developed economies under varying compliance rubrics, and only limited improvement for those sovereigns facing the most severe offshore tax evasion problems.
. . .
Whether FATCA will develop into a uniform multilateral system remains unclear. Instead, a fragmented automatic information exchange system that serves only the interests of the strongest states may emerge."

And that is one of the gigantic questions in international finance today.

On the positive side, financial institutions may well play an important positive role (for once) in achieving international coherence on the rules, and it seems that this is already being felt. An announcement in February 2012 by the governments of the U.S., France, Germany, the U.K, Italy and Spain) that they had reached an intergovernmental agreement (IGA) for implementing FATCA gave the system an important international underpinning, but the announcement also revealed how the original version of FATCA was not able to steamroller its way intact through international realities and local laws. As Grinberg put it:

"The legislation’s infirmities, when juxtaposed with its political force, forced financial institutions to lobby foreign governments for a more workable regime."

But the concessions to other jurisdictions have already led to some fragmentation, and we now see three models:

• The original FATCA model, where financial institutions don't report directly to the country that needs the information;
• IGA Model 1. Here, financial institutions don't report directly to the relevant jurisdiction but instead report to their 'home' country which then transmits the information to the relevant jurisdiction - so for example a British Bank with US clients would first report to the UK government which would then transmit it to the U.S.) This model is more in line with the existing EU model; the U.S. has discussed this model with over 75 countries, though only five have actually been signed so far.
• IGA Model 2, with Switzerland as pioneer. This does not envisage automatic information exchange directly. Instead, Switzerland hands over information for consenting account holders, and only aggregated information on the non-consenting account holders. But Switzerland then agrees information 'on request' for the recalcitrant holders, in a way that is tantamount to automatic information exchange. This model is much more cumbersome.  

Even with Model I there is some fragmentation, as different implementing regulations come into force in different jurisdictions. What is more, U.S. politics (such as lobbying by some senators, along with the Florida and Texas banking industries which make large profits from Latin American dirty money) currently makes it hard for the U.S. to be truly reciprocal: it demands more than it gives in this respect. This would make its international progress harder, though the 2014 U.S. Federal budget does contain encouraging signs that full reciprocity is envisaged.

Britain seems to be lagging behind in following the U.S. example here, as they are carving out special rules for US residents instead of improving customer due diligence across the board. Britain is also signing agreements with its overseas territories and crown dependencies that are similar to FATCA but not identical. Britain's inexplicable signature of an appalling bilateral deal with Switzerland based on the "Rubik" anonymous withholding model (which we have roundly criticised many times) poses dangers for the emerging architecture, as Grinberg explains:

"The U.K. proceeded to ratify its anonymous withholding agreement with Switzerland. After the United States, the U.K. is the financial center with which Switzerland has the strongest ties.    The U.K. thus could have pressured Switzerland for arrangements similar to the information reporting agreement with the U.S.

Instead, as a result of the U.K. ratifying their anonymous withholding agreement, Switzerland argues that the U.S. agreement represents a special case.    The Swiss have thus stated that they do not intend to reprise their U.S. agreement with another jurisdiction, and that they are only interested in anonymous withholding with neighboring countries (France, Germany, Italy, and Austria).    The Swiss-U.K. agreement therefore helps establish the basis for a suboptimal equilibrium that militates against the emergence of a uniform multilateral automatic information exchange system."

These examples and others suggest that the omens in this respect are not particularly good, and we at TJN would always have expected Switzerland and the UK to play the spoiler, even if the UK has given some encouraging signs in some respects.

The UK's announcement yesterday that its Overseas Territories and Crown Dependencies would move forwards on tax transparency leave big unanswered questions. The press release trumpets that "much greater levels of information about bank accounts will be exchanged on a multilateral basis," which is in itself an improvement. But - and this is potentially a large but - gigantic secrecy jurisdictions such as the British Virgin Islands are not about bank deposits. They are about entities and structures such as secret companies. And all we get from the UK announcement on this is:

"These jurisdictions have, as well as this, committed to taking action to ensure they are at the forefront of transparency on company ownership."

We are not sure what that means. The devil may well be in the detail, and to be frank we at TJN do not trust the British government to do the right thing on tax havens, given the appalling history (also see this, a couple of pages in).

Despite all these concerns, however Grinberg does suggest the possibility of an interesting (and perhaps unlikely) confluence of interests between developing countries and large financial institutions. The financial institutions, he notes, would hate a fragmented global architecture of multiple compliance regimes, and would prefer a single uniform system - and this would also be of benefit to developing countries.

"As a result, financial institutions and emerging and developing economy tax administrators may find improbable allies in one another as they navigate the battle over taxing offshore accounts."

It's a strange but at least hopeful perspective. Strange creatures do sometimes fly. Given the sheer weight of entrenched malign interests at play here, we will not be surprised (though we will still be horrified) if the changes end up serving only the interests of rich countries, and leave poor countries wide open to those giant sink holes of dirty money.