Offshore Financial Centres - Treasury Contents


Supplementary memorandum from Deloitte

  Please find below our written response to the two questions we agreed to come back to the Treasury Select Committee on.

  We consider that we should also bring to your attention the fact that the audit of US Qualified Intermediaries forms part of our service line offering, and we may therefore be perceived as having a financial interest. However, as set out in the attached paper, we have recommended that any change to the UK tax information gathering powers be subject to full and open consultation, and we would expect this to include consideration of the compliance costs and appropriate enforcement mechanisms.

Question 51: Which offshore centres haven't done enough to combat terrorist financing, and why?

  Some years ago the Financial Action Task Force (FATF)[312] drew up a "blacklist" of jurisdictions it considered to be non-cooperative in the fight against money-laundering and terrorist financing. In 2000 this had 15 names on it: by 2006, following changes in legislation and supervisory practices, all of these had been removed. Although this signals a big improvement in compliance, there remain some detailed improvements that are still judged necessary.

  The FATF set out Nine Special Recommendations (SR) on Terrorist Financing providing the basic framework to detect, prevent and suppress the financing of terrorism and terrorist acts. FATF monitors the implementation of the SRs and assesses the effectiveness of counter-terrorist financing systems in FATF member jurisdictions through the mutual evaluation process. So far, 20 detailed country reports have been issued as part of the third round of mutual evaluations, which commenced in 2005. Overall, the results point out that more work needs to be done on the part of FATF member countries in combating terrorist financing. A summary of the third round evaluation reports are set out in Table 1 at the end of this document. As will be noted from the table, in the main, this evaluation did not focus on those jurisdictions which would traditionally be viewed as Offshore Financial Centres (OFCs). Indeed, the findings demonstrate that it is not just these traditional OFCs which need to take further action in this respect.

  The biggest problem areas for countries with respect to FATF assessments seem to be SR VII on wire transfer rules[313] and SR IX on cross-border activities,[314] with nine and five countries respectively scoring Non-Compliant on these SRs.

  It is not just FATF member countries who have less than perfect records of compliance with SRs. IMF's Detailed Assessment Reports on Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) [http://www.imf.org/external/ns/cs.aspx?id=175] also point out some problems, particularly regarding SR VII and SR IX.

  Concerns about the potential risks posed by OFCs in aiding terrorism financing have been frequently raised and have in recent years been addressed by several international organisations.

  Liechtenstein was the latest country to be reviewed by the IMF in relation to compliance with Combating Terrorist Financing (http://www.imf.org/external/pubs/ft/scr/2008/cr0887.pdf). While the report was on the whole quite positive, and praised Liechtenstein for its quick response to any concerns raised by the IMF, the terrorist financing regime does not appear to have been put to much use to date. For example, since 2001 a total of five reports have been submitted to the government in relation to the monitoring of terrorism-related assets.[315] (To place this in context however, FATF had some similar conclusions in its recent report on Russia. As stated earlier, this issue is one that faces both "onshore" and "offshore" centres.) In addition, the IMF has evaluated Liechtenstein's compliance with SR VII on wire transfers[316] and SR IX on cross-border cash movements[317] as inadequate, with not even minimum requirements in these areas being met.

  In its recent assessment report by the International Monetary Fund (IMF) Bermuda was marked as Non Compliant with two SRs, namely SR VII and SR IX.[318] The IMF was particularly critical of Bermuda's lenient policy towards cross-border declaration and disclosure procedures. It was noted that although seizures of cash by customs officers occur on a limited basis, currently no disclosure or declaration system for either incoming or outgoing transportation of currency is in place. However, it should be noted that around 50% of travellers to Bermuda travel to the US and need to clear US customs in Bermuda. Therefore, effectively 50% of Bermudan travellers are subject to border controls on cash. In addition, legislation was put in place in March 2008 enabling Bermuda Customs to put border controls over cash in place, and regulations giving effect to that legislation are currently being developed.

  The scale of civil and criminal money fines was also reported as not sufficiently dissuasive. The March legislation, referred to above, increased the scale of civil and criminal penalties.

  Finally in relation to Bermuda, the authorities were said not to have undertaken a review of laws and regulations related to non-profit organisations to ensure that they cannot be misused for financing terrorism.

  The Cayman Islands are generally seen to have been making good progress in relation to terrorist financing, with their compliance with all nine FATF SRs assessed as either Partially Compliant or Largely Compliant.[319] The following is taken from the 2007 Caribbean Financial Task Force (CFATF)[320] assessment:

  "In terms of the overall Anti-Money Laundering (AML)/Combating the Financing of Terrorism (CFT) compliance culture prevailing in the Cayman Islands, it was evident to the assessors that the country in general and the financial service providers in particular all have a keen sense of awareness of AML/CFT issues. Additionally the financial service providers displayed a healthy compliance culture based on an appreciation of the reputation risk of AML/CFT for the jurisdiction. The strong compliance culture was also demonstrated by the financial service providers' proactive co-operation with the authorities in implementing AML/CFT measures".

  However, doubts have been expressed by CFATF regarding the successful implementation and use of enacted terrorist financing laws. For example, CFATF noted that the effective implementation of recently enacted regulations in relation to SR IX could be in doubt due to inadequate human and financial resources of Cayman's Customs.

  Gibraltar has also been evaluated positively by the IMF (http://www.imf.org/external/pubs/ft/scr/2007/cr07157.pdf) and was found to be Non Compliant with only one SR.[321] However, a remark was made by the IMF regarding Gibraltar's application of its provision governing freezing and confiscating terrorist assets. It was noted that despite broad legal authorities that have been successfully applied by the law enforcement community in two cases, there is a "disconnection in the financial community concerning their affirmative obligations under the UNSCR 1267 and EU regulations".[322]

  Despite the good progress made by Bermuda, Cayman Islands, Liechtenstein and Gibraltar, it is important to point out that the Cayman Islands[323] and Liechtenstein[324] were not assessed as fully compliant with any of the nine SRs, while the other two OFCs (Bermuda[325] and Gibraltar[326]) have been assessed as fully compliant with only one SR. In some cases, countries have not had any practical experience in putting their terrorist financing systems to practice, and without specific evidence it is difficult to assess how good a system is, even though it has been positively evaluated based on how effective it seems "on paper".

CONCLUSION

  Due to the wide range of measures that are being used to assess compliance in this area, there is no simple reason why some jurisdictions have made better progress than others. However, in general terms, many countries both "off" and "on" shore do need to devote more time and attention to the combating of terrorist financing.

Table I

FATF THIRD ROUND MUTUAL EVALUATION REPORTS ON AML AND CFT—COUNTRIES ASSESSED AND THEIR SCORES ON NINE SPECIAL RECOMMENDATIONS


Australia BelgiumCanada ChinaFinland GreeceHong Kong DenmarkIceland IrelandItaly NorwayPortugal SingaporeSpain SwedenSwitzerland TurkeyUK US
SR ILCLC LCPCPC PCPCPCPC PCLCPC PCLCPCLC PCPCC LC
SR IILCC LCPCLC PCPCPCLC LCLCLC LCLCLCLC LCPCC C
SR IIILCPC LCNCPC PCPCPCNC PCLCPC PCLCLCPC PCPCC LC
SR IVLCC LCNCLC PCLCLCLC CPCLC LCCLCLC PCPCC LC
SR VLCLC LCLCLC LCLCLCLC CCLC LCLCLCLC LCPCC LC
SR VIPCC NCLCPC PCPCLCNC PCLCPC LCLCLCPC CPCLC LC
SR VIINCLC NCLCPC PCPCPCNC NCNCNC NCLCLCNC PCNCPC LC
SR VIIPCC LCLCPC NCLCLCNC PCCNC LCLCLCPC LCPCLC C
SR IXPCNC CPCPC NCNCPCPC PCCPC LCLCLCNC NCLCLC C
NC—Non Compliant
PC—Partially Compliant
LC—Largely Compliant
C—Compliant


Question 43: What is the US Qualified Intermediary regime, and how does it compare with UK section 20 notices?

  Answer: The US Qualified Intermediary (QI) Regime is a regime whereby non-US financial intermediaries (including US branches of non-US entities) who generally hold US assets on behalf of investors are required to obtain documentation from the beneficial owners in order to apply the correct level of withholding tax on income (and in certain circumstances capital gains) generated by the assets. At the end of the US tax year (1 January to 31 December), all income received by the beneficial owners must be reported to the Internal Revenue Service (IRS). If the financial intermediary chooses to enter into a QI agreement with the IRS and become a QI, these reporting obligations become less onerous: only US persons are reported separately to the IRS (detailing each person's name, taxpayer identification number and income), non -US persons are collectively reported meaning that person's individual details are not sent to the IRS. Non-US persons for these purposes include overseas corporations that are owned by US persons, and this has been identified as a potential limitation on the effectiveness of the QI regime.

  The QI regime started in 2002 when about $2bn of tax was withheld on US sourced income moving offshore. In 2003, this figure had increased to about $5 billion.

  Reportable income broadly includes both dividends and interest income (unlike, for example, the European Savings Directive (EUSD) which only includes interest income) and includes corporates and individuals (again unlike the EUSD which excludes corporates). In summary, an "offshore" (to the US) QI entity whose client is a US person would be required to report annually to the IRS on the amount of income and, in certain circumstances capital, that the US person had received during the past tax year which therefore enables the IRS to police their tax return.

  Thus, through the constant obligations of documentation, withholding and reporting, the IRS uses overseas intermediaries to identify and report US persons back to it on an ongoing basis.

  The US Government Accountability Office (GAO) recently undertook a review of the US QI regime, and their report was issued in December 2007 (http://www.gao.gov/new.items/d0899.pdf).

  The GAO made four main recommendations to the IRS:

    (1) measure U.S. withholding agents' reliance on self-certification documentation and use that data in its compliance efforts;

    (2) determine why withholding agents report billions flowing to undisclosed jurisdictions and unidentified recipients;

    (3) enhance external reviews to include reporting of indications of fraud or illegal acts; and

    (4) require electronic filing in QI contracts whenever possible.

  Regarding the third recommendation, the IRS recently held a conference call with six leading accounting firms, including Deloitte, to ask for their help in identifying foreign banks that fail to report US taxpayers' identities and earnings held in non-US bank accounts.

  We have not commented fully on these recommendations but included them to illustrate the fact that any regime is capable of improvement. As set out below, we would strongly recommend that if consideration were to be given to changing the tax information reporting regime in the UK, this should commence with full and open consultation. This process should allow for issues to be discussed and agreed in advance. Thereby, providing certainty and ensuring appropriate systems are developed to provide the requisite information from the outset.

  In contrast, section 20, TMA 1970 notices are a request for information under primary legislation giving the power to do so (under s20(8a), TMA 1970 as the recent notices were) following approval by the special commissioners where they are satisfied that the taxpayer's identity is not known to HMRC, there is reasonable grounds for believing there has been failure to comply with tax legislation, that the failure is likely to have led to serious prejudice in the collection of tax and that the information likely to be contained in the documents to which the notice relates is not readily available from another source.

  In short, the QI regime is an ongoing compliance and reporting regime where an institution has contractually agreed with the IRS to meet certain obligations. In contrast, section 20 is a tool which has to be deemed appropriate to use to gather documentation regarding potential tax evasion, and as such is a "one off" investigative tool rather than a compliance regime per se.

  Accordingly QI-type regimes would not appear to be alternatives to section 20 as they are trying to do a somewhat different job.

  In considering the possible application of the lessons of the US QI regime to the UK, policy-makers would need to take into account:

    —  administrative costs to financial institutions;

    —  differences between the UK and US tax regimes (especially in the extent to which they seek to impose withholding tax in the first place); and

    —  the practical ability of the US to drive market practice.

  However, these issues could, to some extent, be addressed in the design of any proposals for change. We would strongly suggest an open consultative approach to any consideration of such a proposal as being more likely to produce an effective result.

18 July 2008





















312   The Financial Action Task Force is an inter-governmental body whose purpose is the development and promotion of national and international policies to combat money laundering and terrorist financing. Back

313   VII. Wire transfers-Countries should take measures to require financial institutions, including money remitters, to include accurate and meaningful originator information (name, address and account number) on funds transfers and related messages that are sent, and the information should remain with the transfer or related message through the payment chain.
Countries should take measures to ensure that financial institutions, including money remitters, conduct enhanced scrutiny of and monitor for suspicious activity funds transfers which do not contain complete originator information (name, address and account number). 
Back

314   IX. Cash couriers-Countries should have measures in place to detect the physical cross-border transportation of currency and bearer negotiable instruments, including a declaration system or other disclosure obligation. Countries should ensure that their competent authorities have the legal authority to stop or restrain currency or bearer negotiable instruments that are suspected to be related to terrorist financing or money laundering, or that are falsely declared or disclosed.Countries should ensure that effective, proportionate and dissuasive sanctions are available to deal with persons who make false declaration(s) or disclosure(s). In cases where the currency or bearer negotiable instruments are related to terrorist financing or money laundering, countries should also adopt measures, including legislative ones consistent with Recommendation 3 and Special Recommendation III, which would enable the confiscation of such currency or instruments. Back

315   See paragraph 236, page 70 of IMF report. Back

316   See section 3.5.2 onwards, page 129 of IMF report. Back

317   See section 2.7, page 86 of IMF report. Back

318   See page 169 of IMF report: http://www.imf.org/external/pubs/ft/scr/2008/cr08105.pdf Back

319   See page of 149 of CAFTF report:
http://www.cfatf.org/profiles/media/Cayman%20Islands%20MEV%20-%20Final%20Report%20_2_a.pdf 
Back

320   See paragraph 9, page 12 of CAFTF report. Back

321   See page 121 of IMF report. Back

322   See page 121, Comments on SRIII, of IMF report. Back

323   See page of 149 of CAFTF report:
http://www.cfatf.org/profiles/media/Cayman%20Islands%20MEV%20-%20Final%20Report%20_2_a.pdf 
Back

324   See page 230 of IMF report. Back

325   See page 169 of IMF report. Back

326   See page 121 of IMF report. Back


 
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