The Impact of the Paradise Papers on Finance and Corporate Banking

Picture of paradise

The Paradise Papers

A vast amount of information about how corporates and HNWIs avoid tax by placing their assets in low-tax jurisdictions. 13 million files, covering a huge span of years from 1950 to 2016, over half linked to Appleby, an offshore legal service firm. There does not appear to have been illegality involved, just aggressive tax planning.
Only one – Indian - criminal case has yet arisen. But when the First Minister of Jersey says that the Paradise Papers highlighted the need for an approach to taxation that ensures that people pay what is due, and for transparency, you can perhaps tell that the political ground is moving ahead of current legislation.

Tax Avoidance

The stakes are high: US economist Gabriel Zucman estimates that tax avoidance, mainly the use of tax havens, costs the US $70 billion annually (almost a fifth of corporate tax revenue), whilst $8.7 trillion, or 11.5% of the world’s GDP is placed beyond the reach of hungry tax authorities worried about funding ever-increasing health, education and social service budgets.

The Tax Justice Network 3 Point Plan

What might start to happen? The Tax Justice Network (TJN) has a three-point plan that can no longer to be disregarded as wishful thinking. Rather, corporates can start to envisage this world and plan for it.

The first is common reporting and shared information. Back in 2014, the OECD, worried about exactly the activities disclosed in the Paradise Papers, created a global standard, the Automatic Exchange of Financial Information in Tax Matters (AEOI) and the Common Reporting Standard (CRS). 102 countries have signed up, including China. The TJN wants to drag countries such as the USA, Switzerland and the offshore tax havens into the AEOI. That does not seem entirely unlikely, the only question is by when. Once this happens a significant reason for tax havens starts to evaporate: the EU is already in the process of introducing a formal blacklist for them.

Second, beneficial ownership transparency, following the UK lead with publicly available registers, for example the Persons of Significant Control register and the requirements of the EU Money Laundering Directive The EU is working on a Tax Intermediaries Directive which will place additional disclosure and common reporting pressure, so that the identity of beneficial owners of companies, trusts, and partnerships is always available for scrutiny by tax authorities. Thanks to the Paradise Papers, we now know that the Russian bank VTB is heavily involved in FB and Twitter, and that the UK Monarchy invests in a company, BrightHouse, which rents furniture at high interest rates to poor consumers and has been fined by regulators. We also know that one UK council bought a shopping centre for £32.5m through a Luxembourg company, with a saving of £1.6m stamp duty. Another purchased a business centre for over £200m through an offshore company, avoiding about £10m of tax. Nothing illegal in any case: but the EU thinks we should at least know this kind of information without needing leaks to tell us. Other jurisdictions are coming to agree although the US is slow to conform. But there are important conflicts of interest that will need working out: data privacy and beneficial ownership registers do not necessarily align, for example. Are the public entitled to know where the members of U2 puts their earnings? Ethically perhaps yes, if those same members make political statements. But legally? And what if they say nothing about politics? What then?

Thirdly, country-by-country reporting by multinationals, so that governments can correlate economic activity with tax paid. It it’s earned here, tax should be paid here, is the mantra. The EU Commission wants this as soon as possible. Quite evidently, opinion is moving against the kind of aggressive tax planning so successfully carried out by companies such as Apple. French lobbying group ATTAC claimed in its letter to the company, for example, that until 2014 three Apple subsidiaries had no declared tax residence, which enabled them to pay no more than 0.005% of profit taxes. With changes in Irish tax law, Apple moved these companies to Jersey thereafter, but no more tax was forthcoming. Nike, similarly, Nike, allegedly shifted trademark licensing profits to a subsidiary in Bermuda, helpful to reduce US corporate tax, however much Bermudan authorities protest their compliance with the US Foreign Account Tax Compliance Act (FATCA]. Here, then, US authorities may be more supportive.

UK’s Diverted Profits Tax

This kind of corporate action inspired legislation such as the UK’s Diverted Profits Tax (DPT), which may now find much more favour worldwide as well as much more detailed examination in finance training. DPT enables the UK tax authorities to assume corporate equivalent to those that the authorities estimate as payable under UK corporation tax, had the group not planned aggressively to avoid them. As a further disincentive, DPT is levied at 5% higher rate than corporate tax. In essence, it is designed to make tax planning pointless.
Jersey is planning a similar ‘substance’ test for tax residence. As taxes along these lines are introduced worldwide, gradually this will mean the end for tax havens. The prospects for this actually occurring are now much greater than ever before. Leading tax avoidance experts now report that they are frequently employed as gamekeepers, no longer as poachers, advising governments worldwide on how to close the very loopholes they themselves have taught their clients to use. Bermuda is already saying, don’t think of us as a tax haven. Rather, look at the business environment, portfolio diversification, experienced service providers, and – they claim - call - pragmatic, respected, and accessible regulation. They are starting to plan for the future already.

Tax implications for Corporate Finance

Taxes such as DPT will also bring significant implications for corporate finance. Key to many finance training courses has always been the tax transparency enjoyed by limited partnerships and the anonymity provided by trusts. Both may now eventually be placed into question. Structures designed for tax efficiency may be replaced by those designed exclusively to bring about optimum operational efficiency, for example the use of Chinese Walls to evaluate divisional performance and use of capital, or the need for independence in conducting due diligence investigations. The shift to strategy for financial training courses may be one of the most significant long-term outcomes of the Paradise Papers and everything surrounding them now and in the future.