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1 Newsletter 3 Mar 2009 Compliance / Fraud / Anti Money Laundering Newsletter Newsletter. Introduction In this newsletter we will discuss Tax evasion and Tax avoidance and try to figure out if Tax evasion is Money Laundering. We welcome comments and feedback which will help us to enhance the quality of the criminality principle. A person is liable for laundering the proceeds of crime if (and only if) the original predicate crime is indictable in the Cayman Islands (in most of the cases this means it must have been committed there) or the criminal conduct would amount to an offence indictable in the Cayman Islands had that conduct occurred in the Cayman Islands. In simple terms, this means that the original predicate offence must be a crime committed in the Cayman Islands, or that the specific conduct would amount to a crime had it been committed in the Cayman Islands. Before discussing Tax evasion and Tax avoidance we will define two basic terms: (a) single criminality and (b) dual criminality Single criminality In the UK the old definition of criminal conduct applicable to money laundering offences could be paraphrases as Conduct committed anywhere in the world, which, if it had been committed in the UK, would have constituted an indictable offence there. This is known as a test of single criminality for the following reasons: The conduct can be committed anywhere and is regarded as criminal conduct only by reference to the law of the UK, and The conduct need not be regarded as criminal in the jurisdiction where it is committed. Dual criminality Dual criminality tests require the predicate conduct to be unlawful both in the country where it takes place and by reference to the laws of the jurisdiction in which the laundering is committed. For example, The Proceeds of Criminal Conduct Law in Cayman Islands defines criminal conduct as: conduct which constitutes an offence to which this law applies; or conduct which i. would constitute such an offence if it had occurred in the Islands; and ii. contravenes the law of the country in which it occurred. These provisions represent a statutory definition of a traditional common law principle known as the dual The distinction between tax evasion and tax avoidance Tax avoidance must be distinguished from tax evasion. Tax avoidance is legal activity. It is the legal utilization of the tax regime to one's own advantage, in order to reduce the amount of tax that is payable by means that are within the law whilst making a full disclosure of the material information to the tax authorities. A tax payer, with the help of his adviser, may manage his financial affairs to take advantage of all relevant legislation and make full use of reliefs, exemptions and allowances in a lawful manner. Examples of tax avoidance involve using tax deductions, changing one's business structure through incorporation or establishing an offshore company in a tax haven. Tax evasion is an illegal activity. Tax evasion is the general term for efforts by individuals, firms, trusts and other entities not to pay taxes by illegal means. It is a criminal as well as civil wrong. It will often involve the taxpayer hiding assets, failing to declare income and/or capital gains or, making a fraudulent return by deliberately under-declaring income or capital gains to the revenue authorities of the country where he is liable to pay tax. Tax avoidance may be considered as either the amoral dodging of one's duties to society, part of a strategy of not supporting violent government activities or just the right of every citizen to find all the legal ways to avoid paying too much tax. Tax evasion, on the other hand, is 1

2 a crime in almost all countries and subjects the guilty party to fines or even imprisonment. However, many people seem to inaccurately equate legal tax avoidance with the same type of immorality implications of those who practice tax evasion. For example, there are some who point out that wealthier people, through clever tax manipulation and deductions are able to drastically keep their tax liability very low. Even the Oracle of Omaha himself, Billionaire Warren Buffet noted that he only paid a 17.7% tax rate on his $46 million of taxable income in 2006, while his own employees paid an average 32.9% tax rate. His own receptionist reportedly paid a 30% tax rate. This might not seem fair in my eyes or yours, but none of these moral questions obligate Warren Buffet or anyone else from having to pay more taxes than they are required to do so, as long as they fully comply with all existing tax regulations. If there was truly an injustice or immoral component or dichotomy to the current tax structure, it is the obligation of the government to implement a fair taxation policy. Tax evasion Dishonestly is generally present in tax evasion schemes, which generally involve either some form of deliberate misrepresentation or deceitful concealment. Activity of this kind may either be a specific statutory criminal offence within the tax laws of a particular jurisdiction or be capable of constituting a common law offence of fraud or forgery, false accounting or cheat. Tax evasion can taint legitimately earned money that is undeclared, thus rendering it the proceeds of crime. In the case of Government of India v Taylor the English House of Lords confirmed that the English Courts would not entertain any action brought in England to collect taxes that were owed to a foreign government. This principle is based upon the sovereignty of nation states. If Country X could enforce payment of its taxes against persons residing in Country Y, it would, in effect, be asserting sovereign authority over Country Y. Accordingly, Country X may seek to collect tax from an individual in Country Y, through the courts of Country Y, only if Country Y specifically allows it do so, for example through a negotiated tax treaty. The approach by a particular jurisdiction to the treatment of the proceeds of foreign tax evasion can be ascertained from an analysis of the test of criminal conduct within the jurisdiction. Where the jurisdiction imposes a dual criminality test regard must also be had to the criminal law of the foreign country concerned. For example in Guernsey, the Criminal Justice Law 1999 contains a single test of predicate conduct that applies to conduct that would either constitute an indictable offence in Guernsey or, if the offence took place outside Guernsey, would constitute such an offence were it to have taken place in Guernsey. Tax evasion is considered as an indictable offence under the revenue law of Guernsey. Thus where a service provider in Guernsey formulates a knowledge or suspicion of foreign tax evasion on the part of the client, it is under an obligation to make a report to law enforcement in Guernsey. The position in the Cayman Islands is somewhat different. The Proceeds of Criminal Conduct Law applies dual criminality test. There are two schools of thought within the Cayman Islands about the interrelationship between foreign tax evasion and the test of criminal conduct. The majority view is that, as the Cayman Islands is a nil tax jurisdiction, meaning that it does not levy any form of direct taxation, tax evasion is therefore an offence that cannot be either recognized or committed in the Cayman Islands. Consequently, acts of foreign tax evasion are not capable of satisfying the dual criminality test within Cayman Islands all crimes money laundering legislation. The minority view is that, because certain forms of tax (tourist tax, stamp duty and import duties), are recognized within the jurisdiction, and it is a criminal offence to unlawfully evade these types of tax, tax evasion in its widest sense is an indictable crime in the Cayman Islands that is therefore capable of predicating an offence of money laundering within the Cayman Islands. Therefore an individual who has unlawfully evaded tax abroad may be indicted for a common-law offence such as cheat or fraud. The above argument represents also the majority view in Bermuda, where a nominal payroll tax is imposed. It is a criminal offence to evade payroll tax in Bermuda, 2

3 and accordingly the majority view in Bermuda, which has a single criminality test within its all-crimes money laundering legislation, is that the evasion of foreign tax is capable of predicating a money laundering offence in Bermuda. A further alternative view of the position in the Cayman Islands and other nil tax jurisdictions with dual criminality tests is that, even if tax evasion is not a crime in such jurisdictions and an individual who has unlawfully evaded tax abroad may not be indicted for the crime of tax evasion, he may be indicted for the common law offence of cheat or fraud, or for any of the theft offences, such as deception, false accounting or forgery. These types of offence are very much a crime in the Cayman Islands and, therefore, the dual criminality test is met. It could, therefore, be argued that an individual perpetrating a foreign tax fraud would, by his conduct, have committed the crimes of fraud, deception, and false accounting, etc. if his conduct had occurred in the Cayman Islands. So a service provider who facilitates the retention and conceals the source of foreign tax evasion is, therefore, guilty of money laundering. Hot Money At the development stage of anti money laundering legislation, certain commentators sought to distinguish between dirty money and hot money. Dirty money is basically money that is derived from crime. Hot money is derived from a civil wrong, which may or may not involve traditional fraud or dishonesty but which involves conduct lacking in integrity. For instance, the money may have been earned lawfully but becomes hot when the owner tries to disguise or hide its provenance in order unlawfully to evade taxes or exchange controls; or, alternatively, tries to disguise its provenance to frustrate lawful claims being made against those assets in, for instance, a lawsuit brought by creditors or in divorce proceedings. The objective of modern international anti money laundering legislation has thus been extended further to combat not only overt criminal activity but also tax evasion. There is a modern extended role for anti money laundering legislation to combat tax evasion and other fiscal crime. Governments in the developed, high tax, industrialized jurisdictions have realised that the same money laundering strategies implemented against drug trafficking and organised crime could help in the fight against international tax evasion and fiscal crime. Examples of tax fraud Tax evasion involves a taxpayer cheating the revenue authorities. Dishonesty must generally be present. The scheme to evade tax will include fraud, either a deception a deliberate dishonesty such as a misrepresentation of income, earnings, profits, assets, etc. on the taxpayer s annual tax return, supporting statements and/or accounts, or a deceitful concealment of income and/or assets, etc. The type of tax fraud illustrated above is a criminal offence. It is often an offence contrary to the relevant tax legislation in the jurisdiction where the taxpayer is obliged to pay his taxes. It may also be an offence contrary to the general criminal law, particularly if the taxpayer makes an actual misrepresentation to the revenue authorities, for instance, in his accounts or on his tax return. In such a case the taxpayer could find himself criminally liable for offences of fraud, forgery, false accounting or deception. Money Laundering Laws and Tax crimes This is a hotly debated topic relating to whether money-laundering laws do or even should relate to tax crimes. The issue here revolves around two main issues. The first of which is whether tax offences are a predicate crime within any particular jurisdiction. In many areas of the world, governments do not raise tax revenue through income tax; hence evasion of income tax cannot be a crime. This is exemplified by the island of Jersey. Secondly, a basic principle of international law is that one country cannot enforce the tax laws of another. The former is not applicable to the EU as all the governments of the EU do raise tax revenue through charging income tax. The latter does pose a problem, though the question of whether tax laws are a predicate offence for the purposes of money laundering laws is a question of the express position of the antimoney laundering laws, or the interpretation of those laws by the Court. In most countries, including the EU, that have all crimes anti-money laundering laws, it is 3

4 almost certain that tax crimes fall within the catchall provisions. Tax offences fall on the border of what is and is not considered as laundering, this is owed to the fact that money a person lawfully receives cannot be laundered. This is exemplified by the following case. If a person receives a 1,000 for work and is liable to pay a 40% marginal rate of income tax on it and fails to declare the income, then 400 is considered as being stolen from the Treasury. Therefore, he/she does not launder the 1,000, he/she launders the 400 i.e. the tax evaded is laundered. The complication that makes this difficult to understand is that in order to retain the 400, he/she puts the whole amount of 1,000 through the laundering process. He has to show that he received 1,000 legitimately in order to evade a payment of 400. Money Laundering & Tax Evasion The most ardently debated issue regarding money laundering is about tax. Some consider money laundering is solely not paying taxes, and money laundering is tax crime. On the other hand, some think that tax evasion is criminal only in some particular occasions. When talking about taxation one should not take it in general but as attached to one or another particular jurisdiction. Also, it is important that there is a basic principle of international law that one country does not enforce the tax laws of another. Also, tax evasion is not really money laundering, but annually billions of untaxed money is laundered through banking and non-banking financial institutions to make the money appear legitimate. Lawfully received money cannot be laundered. Untaxed money can. So, money laundering is a result of tax evasion. The US Internal Revenue Service considers money laundering to be tax evasion in progress. Offshore Tax Havens & Money Laundering When discussing offshore tax havens, one s immediate associations could be about money laundering. On the other hand, when discussing money laundering, one could think of offshore tax havens again. So, are offshore tax havens laundering dirty money? And, is money laundering possible because of the existence of offshore tax havens? Well, could be, but a competent person would definitely answer No. Unfortunately, it often happens that offshore tax havens are used as shelters to promote money laundering and aiding various criminal activities not being detected by national authorities. Dirty money obtained by means of drug dealing, counterfeiting, illegal arms sales, smuggling, protection rackets, computer fraud etc. come either in cash or cheque. There s nearly nothing to do about cash. Large amounts of cash paid by cheque require the payee s bank account. If dirty money is accepted by a financial institution, this, by all means, is money laundering. So, criminals look for the place to make this with a minimal risk and they would often choose tax havens. Their number is, of course, countable, still, quite big. Just some of them are Gibraltar, the Seychelles, the British Virgin Islands, the Cayman Islands, Anguilla, Bermuda, etc. But one should not forget that there are many legitimate uses of tax havens. The first (and just one of them) is minimizing or avoiding high taxes in home country. So, there can be legitimate tax avoidance and illegal tax evasion. But let us not generalize and let us be realistic it goes without saying that money laundering can occur anywhere in the world. So, sometimes offshore tax havens and money laundering go hand-in-hand and these two can become one. On the other hand, many businessmen going offshore do their legitimate businesses and can never be blamed in money laundering because of choosing offshore. Accordingly, offshore tax havens and money laundering must not be taken as a whole (the criminal whole). OECD reports progress in fighting tax evasion It has been discussed that money laundering and tax evasion, if not one and the same, are closely linked. In October 2007, the Organisation for Economic Cooperation and Development (OECD) published 2 new reports that outlined the progress made in the organisation s campaign against tax evasion. 4

5 The report entitled Improving Access to Bank Information for Tax Purposes - the 2007 Progress Report provides the description of developments in OECD countries and 6 other countries China, the Russian Federation, South Africa, Argentina, Chile and India. These development regard access for tax authorities to bank information. The 2nd report is named Tax Co-operation: Towards a Level Playing Field Assessment by the Forum on Taxation. It offers the comparison of the legal frameworks for international tax co-operation of 82 OECD and non-oecd economies. According to the OECD, many financial centres, both onshore and offshore, are making progress in improving transparency and international co-operation to counter offshore tax evasion, but some still fall short of international standards that have been developed over the last seven years. Paolo Ciocca, chair of the OECD Committee on Fiscal Affairs and co-chair of the Forum, commented that no country can address the issue of harmful tax practices on its own as this is a global challenge requiring a global response. OECD aims to achieve it in co-operation with partner financial centres. George Papanicolaou Member of the International Compliance Association (MICA) Managing Director GP GLOBAL LTD 5