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Kristofer Neslund
Why Tax Information Exchange Agreements Are 'Toothless'

Despite the ominous messages being communicated to the public, taxpayers have little to fear from the tax information exchange agreements (TIEAs) to which most tax havens have rushed to commit.

July 16, 2009
by Kristofer Neslund, CPA/DBA

Offshore tax evasion is serious. As much as $11 trillion of the world's wealth is held in offshore accounts — $1.6 trillion coming from the U.S. and Canada. World tax authorities may be losing $255 billion annually; the U.S.' share is $100 billion. Senate investigations have uncovered extensive evasion, often involving multiple sham entities and jurisdictions. A Cayman Islands bank president testified that, of his 2,000 clients, 95 percent were from the U.S. and virtually all of those were engaged in tax evasion.

The IRS has made the deterrence of offshore tax evasion a top priority and has undertaken a variety of initiatives to crack down. Acquiring information about offshore activities is at their core; and such information has historically been extremely hard to obtain.

The Organization for Economic Cooperation and Development's (OECD) Model TIEA (and related treaty protocols) is being touted as the remedy for the offshore tax information deficit. Despite the recent "success" in getting havens to commit to entering TIEAs, taxpayers actually have little to fear from them.

History and Spin

For decades tax havens have been the subject of periodic outrage when some revelation momentarily captures the public's attention and requires politicians to appear to be "doing something." Until recently, little has been accomplished.

In 2008, budget deficits of a magnitude not seen since World War II, combined with extraordinary scandals at Lichtenstein's LGT and Switzerland's UBS, finally brought the world's major economic powers together in common cause to deal with the tax haven problem.

The turning point was in early 2009 in anticipation of the April 2nd G-20 meeting at which a blacklist of haven jurisdictions was to be published. Unlike ever before, the havens perceived a credible threat; and in a cascade of capitulation (leaving ever fewer non-committed jurisdictions to take the heat) most havens agreed to adopt Model TIEA. By the end of the G-20 meeting, only Costa Rica, Malaysia, the Philippines and Uruguay were still on the OECD's list of uncooperative jurisdictions.

Heard everywhere were claims of victory in the battle against offshore tax evasion. Treasury Secretary Timothy Geithner said that the new information-sharing agreements "will help bring about an end to the era of offshore accounts … being used for tax evasion." British Prime Minister Gordon Brown proclaimed, "This is the start of the end [of tax havens]." The G-20 leaders declared, "The era of banking secrecy is over."

This exuberance is unwarranted, although the Model TIEA does have some good features.

Strengths

  1. Most tax havens are now committed to providing a minimal, but uniform, level of cooperation.
  2. The agreements now extend to both civil and criminal tax matters (previously civil matters were generally excluded).
  3. It is no longer relevant whether the matter is criminal in both the requesting and requested jurisdictions. In the past, countries like Switzerland denied requests related to tax evasion (not a crime). Tax evasion is passive and includes simply filing a false tax return; tax fraud (a crime) requires an affirmative act, such as destroying records.
  4. The fact that the information is not needed by the requested jurisdiction to administer its own tax laws does not per se preclude its duty to provide the information.

But the flaws in the Model TIEA overwhelm its positives.

Weaknesses

  1. The OECD has frequently noted that havens that had agreed to adopt the TIEA failed to implement it. There is a real concern that some or many of the haven jurisdictions that rushed to announce their commitments to the TIEA were simply playing for time, hoping the furor will die down before they actually have to implement the agreements.
  2. Domestic bank secrecy laws trump these agreements. Indeed, UBS has raised Swiss bank secrecy laws as its primary defense in the current John Doe summons enforcement proceeding.
  3. Havens are exempt from supplying information they do not collect and they often collect little. The British Virgin Islands, for example, has more than 400,000 registered corporations but requires neither the identification of shareholders or directors nor the maintenance of financial records.
  4. Severe procedural restrictions are imposed to preclude "fishing expeditions" — i.e., broad, general inquiries. Automatic information sharing is expressly excluded.

    The requesting jurisdiction must:

    • Identify a specific person,
    • Identify the specific information sought and the tax purpose for seeking it,
    • Identify why it believes the information is within the requested jurisdiction and
    • Demonstrate that it has exhausted all other means for obtaining the information.

The result is a slow and unwieldy process that precludes serious real-time help to tax authorities. Offshore tax cases are complex and labor-intensive, taking 500 days longer than normal to develop. The cumbersome, low-yield information exchange process contributes to these delays and deters the IRS from aggressive enforcement. Even when the government has proven criminal activity, the process is ineffectual. The U.S. sent tax information requests to Switzerland after UBS admitted to criminal activity; it received back only 12 names (out of an estimated 52,000 U.S. accounts holding $15 billion). It is not surprising that there are only a few dozen TIEA requests each year. To be of genuine value, information sharing needs to be comprehensive, real-time and automatic.

Critics argue that the havens' rapid adoption of Model TIEA is little more than public relations, allowing them to make a show of cooperation while going about business as usual, supported by governments that are more than happy to have their taxpayers believe that offshore tax evasion has become much more dangerous.

The OECD's Model TIEA seems to have adopted a lowest-common-denominator approach — offering minimal effectiveness to gain widespread acceptance by havens, in turn allowing world leaders to proclaim a global assault on offshore tax evasion. Given the sharply opposed interests of some of their members, the TIEA's endorsement by the G-7, G-8, G-20, United Nations and EU is supportive of this view.

The establishment of a low information exchange standard for the international community could backfire. Tax havens — little deterred by their TIEAs — are likely to assert that, by having implemented the benchmark standard, they have ceased to be "tax havens." The Bahamas' ambassador to the U.S. has suggested as much on behalf of the Caribbean TIEA adopters. This assertion may be hard to counter without embarrassment; and it may become very difficult to sanction adopting havens when it becomes obvious that their behavior has not changed.

Conclusion

There are many reasons not to engage in offshore tax evasion, but the Model TIEA is not one of them.

The public has been led to believe that all it takes now to open the international information floodgate is a simple request by a tax authority. Not so. The Model TIEA is a slow, largely ineffectual, resource-intensive process that seems unlikely to be used much more in the future than it has been in the past, despite the increased number of haven jurisdictions adopting it.

Tax practitioners should be rendering advice based on the reality, not the perception, of these agreements.

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Kristofer Neslund, CPA/DBA, LLM, JD, is an associate professor of taxation at the Golden Gate University.