The Financial Express, September 20, 2009

You don’t have to be a millionaire to open a Swiss bank account! It takes just 5,000 Swiss francs, that’s what and swiss-bank-accounts. com claim. But given the stakes involved, it’s been quite a cat and mouse game for the world to unearth this Swiss effect and for India it’s been no different. With an alleged $500 billion to $1.4 trillion Indian money parked in the ‘Swiss tax havens’ and the continued denial by the Swiss authorities that the money “simply does not exist,” the paradox is evident.

Even as experts mull over how these figures are ascertained, there is no denying the fact that money is siphoned off to Switzerland and other tax havens not just from the developing countries but from world over. Uri Dadush, Director, International Economics Programme, Carnegie Endowment for International Peace, Washington DC, points outs, “We have to take these figures with a pinch of salt, however it is true that more often than not money is siphoned off and declarations not made. But, the bottom-line is, it is impossible to know the amount unless you have a very strong reporting system in place. There is a discrepancy in the Balance of Payments but the data is not always accurate, as the flow of money is not picked up precisely and there is a possibility of the missing data.”

Given that capital flight has complex forms, experts point out that it is important to demarcate between the legal (licit) and illegal (illicit) forms of flight. Licit flight capital is calculated as portfolio investment and other short term investments in the country but excludes longer term investments and foreign direct investment. Legal capital has a record in the books of the entities involved, earnings from interest, dividend, and realised capital gains normally returned to the country of origin. Illicit capital flight disappears from the books of accounts of the entities involved and any earnings from the capital are not recorded in the books of the country of origin.

DR Agarwal, Director, Institute of International Trade, Kolkata affirms, “The cross-border component of bribery and theft by government officials is the smallest, accounting for only about 3% of the global total. The criminal component constitutes about 30 to 35% of the total. And the commercially tax-evading component, driven primarily by falsified pricing in imports and exports, is by far the largest, at 60 to 65% of the global total.”

Illicit funds that move through world financial systems pass through an intricate process which involves placement, layering and integration. As Agarwal explains, “In the first stage the hard currency generated through the sale of drugs, firearms, prostitution, or human trafficking etc, or for sheer tax evasion, is deposited in an institution or business. Expensive property or assets may also be bought. In the second stage, the illegally obtained assets or funds are separated from their original source. This is achieved by creating multiple layers of transactions, by moving the illicit funds between accounts, between businesses, and by buying and selling of assets locally and internationally until the source of the money is virtually untraceable. Thus, the originator’s anonymity is achieved. After this in the integration stage, the funds are reintroduced into the financial system, as payment for services rendered, which makes the funds resemble legally obtained wealth.”

Monica Singhania, Associate Professor, Faculty of Management Studies, University of Delhi, shares, “It is well documented that since1960s, the US has effectively created an integrated global financial structure to facilitate the movement of illicit funds across borders. This parallel global financial structure is primarily assisted in its functioning by tax havens, now more than 85 in number. A large number of tax havens are secret jurisdictions, where business organisations can be set up behind the façade of nominees and trustees in such a manner that no one knows who the real owners and managers are. Such jurisdictions offer flexibility to nominees and trustees of disguised business organisations to exit from one secret location to another in the event that anyone comes seeking to find out who are the real owners of such businesses. Also anonymous trusts/ fake foundations and disguised companies are a party to it.”

Haven sent

Given that Switzerland is politically stable and ideologically neutral nation it has been a famous tax haven for generations due to its banking secrecy norms and attractive taxation rates for high net worth individuals. Reportedly, Swiss National Bank data from May revealed that Swiss banks held around 2.9 trillion Swiss francs in assets and 3.9 trillion francs in custody accounts including 1.1 trillion francs held for private clients. The popularity of Swiss banks continues to increase as countries around the world seek to impose even higher rates of taxation on their citizens. Since the UK announced that it would be levying 50% tax on those who earn over £150,000 from April next year, there has apparently been a marked increase in the number of wealthy Britons seeking taxation refuge in Switzerland.

However, the pinch of the loss is more for the developing countries who are deprived of the much needed tax revenue. Siddhartha Mitra, Head, CUTS Centre for International Trade, Economics & Environment, Jaipur, avers, “This outflow of $1.4tn exceeds the entire annual gross national product of India. It has denied the government of approximately $0.4 trillion of tax revenues which could have been used to reduce our physical and social infrastructure deficit. Moreover, the flow of such a large amount of money within the Indian economy would have generated large multipliers for employment and incomes.”

Statistics available on Union Finance Ministry website on the country-wise approvals for Direct Investments in JVs and wholly-owned subsidiaries during 1996-2007 reveal that more than one-third of outflows out of a total of around $31,000 million is to well known tax havens like Channel Island ($5,400 million), Mauritius ($2,600 mn), Virgin Islands ($1,008 mn), Cyprus ($1,361 mn) and Cayman Islands ($104 mn). Agarwal questions, “Indian businessmen, howsoever capable, cannot think of investing $5,400 mn or around Rs 21,000 crore in Channel Island. Data is not available for FIIs, not even in terms of who are the corresponding investors.”

Tracking tax

Given that tax havens are a reality of today’s globalised economic and business landscape, Manoj Vohra, Director Research and Senior Editor, Economist Intelligence Unit, shares there are two sides to them. “They can promote tax competition, driving governments towards better tax policy. On the other hand, if abused and opaquely regulated, tax havens can cost the exchequer vast sums of money, forcing governments to keep tax rates high. Presently, the second argument seems more convincing. But it doesn’t make the first argument invalid!” Vohra further adds, “Tax structure minus abuse would result into transparent tax competitive regimes, which is healthy for a global, free-market economy.”

Sudhir Kapadia, Tax Partner, Ernst &Young says, “The proposed Direct Tax Code has stringent General Anti-Avoidance Rules (GAAR) where under any transaction entered with the sole objective of obtaining tax benefits can be termed as ‘impressible’ by tax authorities and these could be re-characterised to reflect their true commercial import. However, it’s important that provisions such as GAAR are applied more against tax evaders rather than genuine business transactions which may have resulted in legitimate tax savings.”

Kapadia adds, “The crux of the challenge is to gather robust data that will meet the standards of legal defence and complete the process of conclusively establishing tax evasion in a timely manner. A ‘National Information Registry’ should be established wherein all the current data generated within various agencies of government can be compared and gaps established to then nail down offenders. For example, importation data with customs, forex payment data with RBI, cash withdrawals data with banks, VAT data on various high value purchases etc. The investment which government will make in such an effort would be more than justified by increased tax revenues from tax evaders.”

Experts opine strong institutional mechanisms, international cooperation, uniform international regulatory system and transparency in the international financial transactions may help in stemming the cross-border transfer of illicit capital.

NK Jain, Secretary and CEO, The Institute of Company Secretaries of India, points out that the membership of Financial Action Task Force (FATF) would help India become part of international initiatives against money laundering. Jain advocates how the FATF is engaged in continuous and comprehensive efforts both to define policy and to promote the adoption of counter measures against money laundering. “It has made 40 + 9 recommendations to combat the problem. Adoption of these recommendations would help the international community in increasing transparency in the financial system. The Task Force on Financial Integrity and Economic Development has also developed a Five-Point Plan to increase transparency within the global financial system which addresses issues of trade mispricing, country-by-country reporting, beneficial ownership and automatic exchange of tax information.”

Kapadia suggests that India should enter into ‘tax information exchange’ agreements with key tax treaty partners like Switzerland wherein specific data on suspected tax evaders can be asked for and obtained by Indian Government. With the recent deal to disclose details of about 4,450 American clients of UBS to US authorities there have been similar demands from Indian quarters as well.

The G20 recently announced that it was ‘ready to use countermeasures against tax havens from March 2010.’ But Dadush is cautious, “Very few countries have the economic and political clout like the US to enable disclosing of such information. And the G20s call is not in the nature of a ‘binding agreement’. This is a long term process and will require a coordinated global effort.”

Given that Switzerland is reeling under tremendous pressure to enter into ‘exchange of information’ agreements in addition to ‘Double tax avoidance treaties’ India has all the more reason to push for them. The challenge, however, is that Switzerland remains just one among the many tax havens globally.

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