International breakthrough in battle against tax evasion

By Claus Rosenkrantz Hansen, CBS Library

Attempts by companies and individuals to hide profits in tax havens such as Luxembourg and Bermuda have for a long time provoked resentment in government circles. In the last couple of years, as the financial crisis left treasuries empty and the need for funds to cover national budgets acute, this resentment has grown more pronounced.

Efforts to reduce legal and illegal tax dodging have been on-going for some time. So far, however, the policy mechanisms in place have failed to reduce the impact of low- or no -tax jurisdictions and their bank secrecy laws.      

Flow of information
This situation is about to change. FATCA – or The Foreign Account Tax Compliance Act – is an American initiative introduced in 2010 and appears to be part of the cure for tax avoidance and fraud.

Duncan Wigan is an assistant professor at Department of Business and Politics at CBS. His research focuses on the international political economy and international tax issues. In his opinion the FATCA initiative constitutes a decisive breakthrough because it provides tax authorities with actionable information via a mechanism that circumvents the historical obstacle to effective policy; namely, the sovereign prerogatives of states.

Access to information is key. One reason for the popularity of tax havens is their promise of secrecy vis-à-vis other national authorities.

“FATCA represents a move from limited to automatic exchange of information. This is the key difference. No information equals no power of taxation. It is that simple. This new initiative will ensure an inflow of information without, and this is important, an initial request for this information from a national tax authority," Wigan axplains.

"The OECD has relied on request-based models embodied in their bi-lateral Tax Information Exchange Agreements since 1998. Demanding that authorities name suspected account holders when requesting information is like asking fishermen to name fish individually before casting the net. These agreements have never generated the quantity and quality of information necessary for national authorities to collect due taxes. This will change with the introduction of the new strategy.”

Private companies as tax inspectors
FATCA signals to the rest of the world that conducting business in America involves playing by American rules. Foreign Financial Intermediaries (FFIs) holding the accounts of U.S. citizens or corporate entities with substantial U.S. ownership are obliged to feed U.S. tax authorities (the IRS) with information about those accounts. Any FFI which fails to do so will be punished by a 30% withholding tax on all U.S. source payments. In effect non-participation in FATCA means non-participation in the large U.S. market.

Therein lies the novelty and the breakthrough. Instead of trying to cajole or coerce sovereign governments to cooperate on matters of international taxation and ensuring the absence of free rider states U.S. policy deploys U.S. market power and the carrot of market access to persuade private companies to act as tax inspectors on behalf of the U.S. government. The obstacle of mutually exclusive fiscal authority has therefore potentially been transcended. The effect is dramatic: Suddenly the automatic exchange of tax information with the U.S. is a fait accompli.

The EU to follow the American lead
The European Union has also started to move on the issue. After introducing the first, somewhat limited, multilateral automatic information exchange system in the Savings Tax Directive (2005) the EU has recently accelerated its policy development.

A 2012 Action plan forsees the extension of the Saving Tax and measures to curb corporate profit shifting. These are reaching fruition at the same time as so called ‘son of FATCA’ agreements are signed between EU governments, EU tax havens, EU dependencies (such as Jersey) and the U.S. It seems that FATCA is in effect being internationalized and the automatic exchange of information the norm.

This development affects tax havens. Because secrecy is their trade, a general introduction of compulsory and automatic exchange of information leaves them with little to sell.

Countries in need of money
The new initiatives leave no doubt that anti-tax evasion efforts have intensified in recent years. But why now? The backdrop, of course, is the financial crisis and the ensuing massive public cutbacks. Tight budgets and widespread austerity policies have highlighted distributional conflicts over who pays and how much.

In other words, there is a political need to, at least, demonstrate that everyone pays a fair share. This need coupled with a broad consensus that fiscal systems and interactions between them foster inequity has prepared the ground for a revitalization of anti-tax evasion efforts. In this context tax havens have been fingered as the major culprits.

An alternative explanation, and one that is of course difficult to empirically verify, is that the major financial centres, all of which are considered to be tax havens themselves by some, are acting to bring business back home.  In the difficult post-crisis situation it is significantly harder to make a profit; first, new regulations have added to the cost of transacting, and second, technological innovations have rendered some services so cheap that turnover has dropped.

On the face of it the new regulations are prompted by a sense of justice and fairness – but they may also be about failing financial market earnings. In Wigan´s opinion this may be one of the key motivations behind the new initiatives: through regulation services provided in ‘offshore tax havens’ may come back to the bigger ‘onshore tax havens’.

“We are dealing with a whiff of double standards here. Research by Jason Sharman of Griffiths University indicates that countries such as the UK and US are the best and easiest places to establish shell companies the chief purpose of which is to camouflage ownership and avoid taxation. This makes the ethical tones of UK and US tax haven containment policies ring hollow”, Wigan explains.

More info ...
Assistant professors Duncan Wigan and Eleni Tsingou – both from the Department of Business and Politics at Copenhagen Business School (CBS) - work on the ‘Global Wealth Chains’ project – a NOK 7 million project funded by the Research Council of Norway’s NORGLOBAL TaxCapDev programme.

Wigan is chief researcher for the project team and Tsingou is preparing a book length monograph on anti-money laundering policy.

Also participating in the TaxCapDev project are 11 further researchers from the UK, Norway, Kenya, Thailand, the United States, Argentina, South Africa, the Caribbean, and Australia.