Trouble in Paradise? The Paradise Papers and the Ethics of Lawful Tax Avoidance

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Posted in: International Law

Just last week, a group of investigative journalists unveiled a new source of records known as the Paradise Papers. Following on the heels of the Panama Papers, this stash of records sent from an anonymous source gives us a closer look at how wealthy individuals and multinational corporations hide their assets in offshore jurisdictions, including Caribbean island nations. As I will discuss below, the reaction to the Paradise Papers has been less explosive than it was to the Panama Papers. One key reason is that most, if not all, of the activity is legal—only one criminal indictment has been filed (in India) since the papers started making the headlines. By contrast, the Panama Papers led to the arrest of the law firm partners at the center of the controversy for money laundering relating to illicit activities.

The Panama Papers may simply be a brief “lifestyles of the rich and famous” mini-series. At the same time, the leaked documents show us pervasive patterns of the rich and powerful moving their money as a tax avoidance strategy. It may be highlighting to the less powerful citizens in many countries, that while their taxes are going pay for police, roads, and essential services, others who can move money (and often change citizenship) are not always sharing the burden. We are still in the early days of revelations, however, and the sheer number of names linked to the papers may lead to further pressure for regulatory reform.

What Are the Paradise Papers?

The Paradise Papers is the name for a leak of more than 13 million files, which span a period from 1950 up to 2016. Of those roughly 13 million documents, 6.8 million are linked to one law firm, Appleby, an offshore legal service provider. It has offices in such prime offshore locations as Bermuda, the British Virgin Islands, the Cayman Islands, Isle of Man, Jersey, Guernsey, Mauritius, and Seychelles, as well as the bustling financial centers of Hong Kong and Shanghai. Its trust arm was subject to a management buyout and is now called Estera. Appleby reportedly has 31,000 or more American clients.

The papers also include records from 19 corporate registries located in offshore “secrecy” jurisdictions such as Malta, the Cook Islands, the Cayman Islands, and Vanuatu, to name a few. The high concentration of Caribbean island states is the link to “paradise.”

These papers were received by the German newspaper Suddendeutsche Zeitun (“SZ”), who had previously received the Panama Papers. SZ partnered with the International Consortium of Investigative Journalists (ICIJ), a US-based collaborative, to coordinate a global dissemination of the documents among other journalists. This led newspapers such as the New York Times to provide front-page coverage of key discoveries.

What Do the Papers Reveal?

The papers provide a sneak peek at how major companies and wealthy individuals—political oligarchs and celebrities—stash their money. This is a veritable who’s who of the global elite, politicians from all sides, and major multinationals. Apple, for example, is highlighted in recent headlines. It needed a new tax home for two of its subsidiaries after Ireland, a former shelter for its earnings, changed its tax policy. In addition, the European Commission ordered Ireland to collect back taxes of up to $14.5 billion from Apple, finding that the previous tax agreement between Ireland and Apple was the equivalent of illegal state aid.

Apple found a new home for $128 billion on the English Channel island of Jersey instead. Since the Paradise Papers have revealed this move, Apple CEO Tim Cook has stated that this move has not reduced Apple’s tax payments in the United States. Nike, another US company, is reported to have moved its profits from licensing its trademarks to a subsidiary in Bermuda, possibly away from the clutches of the US Internal Revenue Service. The company says it’s okay. “Nike fully complies with tax regulations,” Nike told ICIJ.

Twitter and Facebook have investments that are now traced back to Russian state financial institutions. Russian billionaire Yuri Milner has major stakes in both companies. The Paradise Papers show that via a mind-boggling maze of offshore shell companies, the Twitter investment was backed by VTB, a Russian state-controlled bank often used for deals important to the Russian state.

Queen Elizabeth is also a subject of the leak. Her wealth advisors have invested 10 million pounds in a Cayman Islands fund. One of her investments is in a retailer accused of exploiting poor families in Britain via a high-interest “rent to own” business. The company, BrightHouse, charges high interest rates on furniture it rents to some of the UK’s poorest consumers. The firm charges up to three times more than regular banks for regular household items such beds and sofas, by offering customers high rates of interest over weekly installments. It was ordered to repay 14.9 million pounds by a British regulator. The consumer watchdog said the firm had not acted as a “responsible lender” since 2010.

Politicians and senior ministers from all political stripes are also implicated. For example, one of Justin Trudeau’s senior advisors, Stephan Bronfman, appears to have a trust in the Cayman Islands Trust. US Commerce Secretary Wilbur L. Ross, Jr., has retained investments in a shipping firm he once controlled that has business ties to Vladimir Putin’s son-in-law. Hollywood is also not excluded from the party. Names such as Bono from U2 and Madonna have also been leaked. It’s surprising to see someone like Bono, who has long campaigned against the tyranny of foreign debt on developing nations, to have investments tied in offshore funds.

As those named in the papers contend, “it’s legal.” But it isn’t a victimless act when companies and the wealthy shield their money from governments.

What’s Different? Panama Versus Paradise

Panama is considered the black sheep of the offshore world. Experts describe it as one of the least improved tax havens. The Panama Papers revealed that the country was being used primarily by the business and political elites of Russia, China, and Brazil. These are countries where the governments are closely linked to business and which are less likely to use new regulatory tools to pursue tax evaders. Hence, relatively few Americans or Europeans were caught in the Panama story. Mossback Fonseca, the law firm at the center of the leak has since been implicated in criminal activity. The Panama Papers alluded to Panama as a haven for illicit proceeds of corruption or crime.

The Paradise Papers reveal the goings on of the elite jurisdictions of the offshore world—this time in the supposedly highly-regulated more law-abiding havens of the Cayman Islands, Bermuda, Singapore, and the like. These venues have received better marks for their financial regulation by the Organization of Economic Cooperation and Development peer review process only just a few years ago—implying that this is not the playground for criminal proceeds but simply of legal tax evasion.

The Consequences of Tax Avoidance—Moving Beyond the Veil of Legality

Why are the elite using these offshore vehicles to hide their wealth? One reason is clear: avoiding higher tax rates in jurisdictions where they are located or engaging in activity. Second, they may wish to obscure the nature of their investments. Universities that are investing in fossil fuel, for example, may not want their stakeholders to know this. As Queen Elizabeth’s investment shows—it may not be desirable to be linked to certain kinds of investments. Each fund or transaction, or asset such as a yacht or jet is not subject to tax. And it’s hidden from the public’s prying eyes.

Despite new regulations designed to help governments ferret out tax evaders, the Paradise Papers show that anyone who wishes to hide their wealth can still do so. Over the past few years governments have focused in on bank secrecy jurisdictions like Switzerland—demanding more information regarding account holders. While some jurisdictions may have become less ideal, the Paradise Papers show us where on the map business is booming. This is all done through the legal vehicle of a “trust” which can shield the identity of the person for whom the trust is being established.

The papers set out the myriad ways in which companies and individuals can avoid tax using trusts and other artificial structures such as shell companies. Politicians and researchers around the world are beginning to ask whether they should be banned. Are they fair? Are they moral? Has tax avoidance gone too far? Have we crossed an ethical boundary that needs to be fixed? And even if the structures are legal, is everyone who has funds in these offshore locations declaring income and paying taxes when required to do so?

The economist Gabriel Zucman has worked to estimate how much wealth is stashed in low-tax havens and what that means for government coffers. According to his research, the United States loses close to $70 billion a year in tax revenue due to the shifting of corporate profits to tax havens. This is close to 20 percent of the corporate tax revenue that is collected annually. He notes that this is legal. He also reports that an estimated $8.7 trillion, or 11.5% of the world’s GDP is stashed offshore by wealthy households. Much of this revenue may not be reported to tax authorities. This is likely not legal.

We worry a lot about how to balance a budget and ensure that government is able to provide essential services like police, schools, roads, courts, and the like. That missing $70 billion from corporate offshore tax avoidance would go a long way. A mere $140 million could replace the lead water pipes in Flint, Michigan, one news story reports.

The Paradise Papers also shed a light on the larger inequities caused by a shifting wealth in today’s global economy. The International Bar Association’s Human Rights Institute (IBAHRI) notes that by failing to collect the revenue that is being lost through offshore tax avoidance schemes, states are failing in their obligation to mobilize all available resources towards the promotion of poverty reduction As noted in the IBAHRI’s report Tax Abuses, Poverty and Human Rights, the effects of tax evasion are experienced most in developing countries, where a huge outflow of money is leaving governments without the basic revenues needed to invest in essential services and infrastructure. Equally though, its effects are seen in advanced economies too, where recessions and major economic shifts have plunged communities into poverty. While citizens who have little resources are asked to pay their fair share of taxes, those who have wealth and privilege can move their money quickly and obscure it through the offshore system.

If we focus on the harm of tax avoidance to society, rather than how it is legally defined, then we can see that it contributes to growing inequality and increases tax burdens on resident taxpayers who cannot change their citizenship or move their money.

There is some momentum behind the idea of creating registries that would require asset owners to disclose the true “beneficial” owners of an investment, so governments, law enforcement and in some circumstances, the public, would know who is truly benefitting from a trust or shell company. The United Kingdom has led by example and published the world’s first fully open register of beneficial ownership. It still can do more by using its leverage to deal with its own crown dependencies, many of which are implicated in the Paradise Papers. As the list of who is implicated gets longer it may wake politicians up.