Nigel Morris-Cotterill investigates the growing pressure from wealthy countries for tax havens to help them fight tax evasion in the guise of combating money laundering.
One of the primary tenets of banking in all free jurisdictions is that you tell no-one about your customers’ affairs.
There are three ways in which this principal is brought about – by reliance on case law (the most common are the Tournier Rules, formed in the English courts but now applied, almost unchanged, across most of those countries that base their law in English Common Law), express contract terms or legislation.
The fact that banks are under a duty to maintain confidential the affairs of their customers is one of the reasons that banks have been able to develop their savings and securities businesses and even safe deposit businesses. It is often thought that, after the lawyer, priest and doctor, the banker is the most secure repository of information.
However, there has been a steady erosion of the principles of bank confidentiality for several years. And a widely recognised distinction between two strands of customer protection has developed – on the one hand there is client confidentiality and on the other bank secrecy. The generally held view is that client confidentiality is good and bank secrecy is bad.
But in recent months, successive governments and intergovernmental bodies have launched attacks on both bank secrecy and client confidentiality, in effect seeking to remove the distinction. At the same time, the same governments and intergovernmental bodies have also eroded the distinction between tax evasion and tax avoidance, in some cases by implication and in some cases expressly.
The rights of individuals to the protection of their privacy in financial matters is now under threat, not just in relation to tax investigations conducted domestically, but internationally, too.
The influence of the US Treasury is clear as international groups line up to publish reports on the prevention of international tax crimes, the EU finance ministers are pushed in the direction of US style income tax laws by UK Chancellor of the Exchequer Gordon Brown and, increasingly, financial services centres, which have agreed to put in place legislation to assist in money laundering prevention, find the agreements they reached to put those laws in place were Trojan horses.
It is important to realise that the current trend towards easier access to banking information is an acceleration of a process that has been going on for some time. Even so, the changes are driven by a change of emphasis. Now, access to bank accounts is driven not by those trying to control drugs trafficking, terrorism, child prostitution, corruption and the like but by the demands of tax collectors.
Recent reports from the Organisation for Economic Co-operation and Development (OECD), the Financial Action Task Force (FATF), European finance ministers meeting at Tampere, Finland, the UK, French and German governments and the Financial Stability Forum claim to establish that the offshore industry is in general poorly regulated, has excessive bank secrecy, provides facilities for money laundering and, most allege, are fundamentally oriented towards reducing the legitimate tax collection of other jurisdictions.
As a result, there is a significant upsurge in the demands by a small number of countries for all other countries to take steps to change their laws to permit access on an administrative, that is non-judicial, basis. The OECD first drew attention to the problems of bank secrecy nearly 15 years ago.
The report then produced emphasised that criminal and civil investigations were hampered by the practice in some jurisdictions of legislating that there were no circumstances in which banks were permitted to release information even where a court order was obtained (for example, the Cook Islands). However, legislation such as this is rare – provided that the local court is satisfied, often on the balance of probabilities, that an offence has been committed, it will generally order the release of bank information.
Also, the extension of mutual legal assistance treaties and Memoranda of Understandings have meant that information is accessible in a range of investigations. These investigations have generally been large-scale frauds, trafficking in drugs or people and the like. Rarely, however, has corruption or tax evasion featured on the list. These two are offences against the state, whereas the others are offences against the common morality.
However, in the past two years, governments and inter-governmental bodies have made a significant move to address the issue of tax evasion and have eroded the distinction between evasion and avoidance. They have chosen soft targets that they have lumped together under the title “offshore financial centres” (OFCs).
For the past 10 years, the offshore industry has been constantly under fire with claims that it was facilitating the laundering of proceeds of drugs trafficking and other offences, such as racketeering. Many offshore centres have created systems for combating the laundering of such offences.
But the offshore industry, at least at the reputable end, makes its money out of providing facilities not for evasion of tax, but for its postponement and thereby leveraging wealth accumulation by reference to gross returns. Tax is payable by the taxpayer on repatriation of that wealth, at least under one common model of revenue assessment.
However, the US does not have that basis of assessment. US citizens are liable to tax on their current year income wherever in the world it arises. The UK has announced (Treasury Discussion Paper February 2000) that it wants all EU residents to be liable to tax on income wherever it arises.
This would change the basis of taxation that is common in a number of EU states, including the UK. The net effect of this is that any income accruing offshore would be liable to tax, even if it is not repatriated. This remains liable to taxpayers admitting to their offshore income.
So the OECD, the EU and the UK Treasury hatched a plot: they will require banks and other financial services organisations to make cash transaction reports and will pressure their dependencies to agree to make the reports to the taxpayer’s home jurisdiction.
The OECD and the FATF have declared their intention to press non-members to join. In addition in 1999, the G7/G8 with input from the G20 created another sub-group – the Financial Stability Forum. The premise for the FSF is to examine financial services systems to identify weak points in regulatory and other systems with a view to preventing collapses in the banking sector.
However, its first task was to conduct a review of offshore financial centres. The result was that OFCs are, commonly, badly regulated, have featured in a number of significant banking failures and aid money laundering. No significant evidence is produced to support this contention.
The FSF has now set itself up with a system of assessment, similar to the FATF assessments for money laundering systems, to decide which OFCs have adequate supervisory standards. However, reading material from the FSF, FATF, OECD, EU finance ministers and the UK Treasury, there is a general thrust: money laundering laws, coupled with an attack on confidentiality will gain strength. Significantly, the attacks are not in investigations into corruption, drugs trafficking, sex, tourism and the offences against the common consciousness but are for tax investigations.
The first casualty is intended to be judicial intervention. The OECD Report on Bank Secrecy says there should be international access to bank accounts for tax investigations on administrative application.
No regard is paid to the high levels of corruption in public administration in so many jurisdictions, nor to the prospect of unwarranted tax demands being raised to facilitate fishing expeditions. The final check on the abuses that governments visit on the people is the court; and the OECD wishes to reduce the opportunity for a court to examine a case and decide whether a person’s affairs should be revealed to the enquiring state.
This leads to a compliance problem for financial institutions: their home jurisdiction may prevent release of information save subject to court order but they may have a branch in a jurisdiction where an administrative order is sufficient. Where there is a regulatory requirement to act according to the higher standards of duty imposed either locally or on head office, the question arises: which is the highest standard of duty? The answer depends on to whom the highest duty is owed.
Does the bank owe a higher duty to its customer or to a foreign government in a third country? Where does this leave the international financial services industry? Amazingly, the UK Treasury has said it does not consider that compliance with the cash transaction reporting it suggests will lead to any significant compliance costs.
That is not the experience of US and Australian banks, where cash transaction reporting is well established. Furthermore, the UK Treasury has not paid attention to the significant additional costs it will itself incur as a result of the making of these reports. The US department responsible for collecting internal reports received hundreds of thousands of reports a month and its computers cannot cope with the influx of data and the associated analysis.
The UK’s experience of compulsory reporting is that the National Criminal Intelligence Service, which receives only a few hundred thousand reports each year, was at one time rumoured to be so underfunded that it was begging second-hand computers from financial institutions in the City.
In Thailand, cash transaction reporting trial runs overwhelmed the system and the concept was postponed while they tried to decide what to do next. The UK Treasury also wants to re-interpret the existing counter-money laundering laws to require financial institutions to make reports of suspicions of laundering the proceeds of any serious crime including tax offences.
This is a novel interpretation of laws that have so far been seen as requiring reports only in the case of suspicion of drugs trafficking and terrorism. The Treasury wants the whole of the EU to adopt a similar approach and to press dependencies to do the same. The thrust is, therefore, to erode bank secrecy and client confidentiality, to remove judicial checks and balances so that state departments may agree access without supervision, and to give these powers only in cases of tax investigations.
It is, surely, abhorrent to give these powers to the state for its own benefit and yet to deprive those engaged in, say, pursuing drugs or people traffickers the same advantages. There are more concerns looming about the extent to which there is pressure on jurisdictions to aim at harmonisation of a wide range of criminal law and regulatory issues.
What were, until recently, veiled threats to tie aid packages to financial services reform have now become clear and forceful statements. One government and body after another says aid will be made subject to co-operation with inter-governmental bodies. The French government has gone so far as to say it would like to see sanctions against countries that do not fall into line.
There is an inexorable move to pressure sovereign states to make or amend laws to fit in with the demands of less than 20 per cent of the world’s countries, and in some cases far less than 10 per cent. It just so happens that those making the demands are, for the most part, those with the most wealth.
Aside from the aid and sanctions question, there is something of concern to bankers. The issue was raised by a banker in a so-called offshore jurisdiction which is highly regulated and with strong counter-money laundering laws. “What we need is a level playing field,” he said. “The problem is that our government has created such a strong system that we are losing business to places that have the reputation for being better regulated than we are, such as Switzerland.”
He knew the difference – he was the representative of a Swiss bank. But his concerns were not merely loss of current business but acceleration of business loss. “The problem is that we have done more than we might have been expected to do, but there are always more and more demands.”
What he did not say, but might well have added, is that the demands are made by countries that are well versed in the principles of “do as I say, not do as I do”. At the end of June 2000, the OECD and its sibling the FATF both produced reports aimed at tightening up “harmful tax competition” and assessing how countries matched up against criteria for combating money laundering, listing those that they felt fell below acceptable standards.
The two reports came out at the same time and became intertwined in the media. Countries named in one became associated with the other. It was notable that, for the most part, the countries named in one, other or both happened to be those widely recognised as offshore centres. Save for the inclusion of Israel – which usually escapes criticism despite having no counter-money laundering laws and an open banking system used to receiving flight capital – there were no surprises in the reports.
There was not, for example, any mention of Delaware, the Dakotas or Florida. Yet they feature high on any even-handed assessment of either popular money laundering venues and satisfying the so-called “harmful tax” criteria. This brings us back to the question: can we expect bank secrecy to remain in the medium to long term? The answer is yes, but in ever more shady countries with ever greater concentration of dirty money.
Will this lead to a presumption that all financial services businesses operating there are corrupt? Probably. That is, presumably, precisely what the OECD and the FATF hope will happen because then they will be able to manage the risk more easily.
Nigel Morris-Cotterill was a solicitor in the City of London and is now a money laundering prevention consultant E-mail: nigelmc@countermoneylaundering.com