Tax in Developing Countries: Increasing Resources for Development

Written evidence submitted by STEP

Summary

· Our comments are primarily focused on issues related to the effectiveness of international efforts to promote tax disclosure and transparency as they apply to private individuals.

· Tax evasion is a criminal offence and STEP fully supports the work of tax authorities in pursuing tax evaders.

· Tax information exchange agreements (TIEAs) are a powerful disincentive to anyone trying to evade taxes by hiding their money in another country and represent a proportionate OECD level response to the problem of tax evasion.

· The overall number of information requests is likely to be limited and highly targeted. This is fully in line with widely recognised best practice for tax authorities, which is to take a targeted, risk-based approach to investigations.

· Tax authorities in many developing jurisdictions would find it extremely difficult to process effectively the amount of information coming from any early shift from information exchange on request to automatic information exchange.

· There are significant concerns regarding the ability of the authorities in some jurisdictions to ensure that information received under TIEAs is kept securely and not abused.

· There is a growing risk of an administrative cat’s cradle of inconsistent unilateral extraterritorial tax initiatives following in the footsteps of the FATCA initiative from the US. This will add significantly to the costs encountered by international capital flows, hampering both investment financing and employment creation in the developing economies.

The Society of Trust and Estate Practitioners

The Society of Trust and Estate Practitioners (STEP) is the worldwide professional body for practitioners in the fields of trusts and estates, executorship and related issues. STEP members help families secure their financial future and protect the interests of vulnerable relatives. STEP has over 17,000 members around the world, with branches in 10 EU member states, North America and Australasia as well as a range of international financial centres (IFCs). STEP promotes the highest professional standards through education and training leading to widely respected professional qualifications.

Many STEP members specialise in advising families with significant family businesses. Often such families will have complex financial affairs across a range of jurisdictions reflecting the spread of their business interests. Tax is clearly one of the many issues that have to been taken into account when giving advice to such circumstances, even if succession planning rather than tax is usually the primary motivation for families seeking professional advice in this area.

As well as advising families on issues such as succession planning and tax, STEP members regularly give advice on charitable and philanthropic structures. For example, trusts, foundations and similar structures which have been established with the assistance of STEP members are the typical vehicles used to fund the work of NGOs and others working in areas such as development. Given the international spread of both their funding sources and their activities, many of the structures used by such organisations are established in IFCs.

As the Organisation for Economic Co-operation and Development (OECD) study into the role of tax intermediaries (2008) stated, 'tax advisors play a vital role in all tax systems, helping their clients understand and comply with tax obligations'. All citizens should pay the tax they are legally obliged to and STEP members help their clients pay the right amount of tax. Tax evasion is a criminal offence and STEP fully supports the work of tax authorities in pursuing tax evaders. We equally believe that all citizens have the right to seek professional advice to guide them through the tax maze.

The likely effectiveness of international efforts to promote tax disclosure and transparency

Our comments are primarily focused on issues related to the effectiveness of international efforts to promote tax disclosure and transparency and, more specifically, the issues as they apply to private individuals. Others are better qualified than us to comment on the issues as they apply to companies.

a. Tax Information Exchange Agreements

STEP has worked constructively with the OECD and others on initiatives to improve the transparency and effectiveness of tax systems. Over recent years the main focus has been on the growing number of tax information exchange agreements (TIEAs) between various jurisdictions under the auspices of the OECD Global Forum on Transparency and Exchange of Information for Tax Purposes. STEP believes that TIEAs are a proportionate and sensible OECD level response to the problem of tax evasion.

In our view TIEAs are a powerful disincentive to anyone trying to evade taxes by hiding their money in another country. Those seeking to keep their affairs secret are likely to be very wary of any agreement which creates the possibility that authorities will be able to obtain information on them. Moreover, as the number of jurisdictions joining the TIEA network grows, the options for avoiding the risk of exposure by simply moving assets from one jurisdiction to another are diminishing rapidly. A 2009 STEP research report found that the overwhelming majority of senior advisers (69%) agreed that "secrecy in offshore banking will die", while over 90% agreed that, that as high net worth clients strove to ensure that they were globally tax compliant, they would require tax advice on a global, not just local, basis. [1]

Moreover since a major restructuring of the Global Forum in 2009 the momentum of the organisation’s work to build an effective tax information framework has accelerated notably. Significant progress has been made in terms of expanding the number of jurisdictions committing to the global standards on effective exchange of information. Over 700 TIEAs have been signed between a wide range of jurisdictions. A peer review process has also been launched to ensure first that jurisdictions have the legal and regulatory structures and mechanisms in place to allow for effective information exchange and, subsequently, to test that information is indeed being exchanged effectively. It remains relatively early days in this process, however, and the great majority of the 80-plus reviews launched have been Phase 1 reviews. Nevertheless, over 30 jurisdictions have already proposed or introduced legislative changes in the wake of their Global Forum Peer Reviews.

There have also been initial indications from some jurisdictions of the number of tax information exchange requests they are receiving. To June 2011, Jersey is reported to have received 65 requests. [2] Meanwhile in 2010 the US made 160 requests for information and received 843 such requests from other jurisdictions. It is clear that, around the world, tax authorities are still building familiarisation with the new systems and few will disagree with US Government Accountability Offices conclusions that for example, the US IRS efforts "could be improved". [3]

The evidence nevertheless suggests that perceptions and behaviour are beginning to change even if the number of formal requests for information remains modest. Moreover it may be unrealistic to ever expect a huge volume of information exchange requests under the TIEA framework. The Global Forum process specifically does not allow "fishing expeditions" where blanket requests for information are made without reasonable grounds for suspicion. The overall number of information requests is therefore always likely to be limited and highly targeted. This is fully in line with what is widely recognised as best practice for tax authorities, which is to take a targeted, risk-based approach to investigations.

b. Automatic Information Exchange

The emphasis on a targeted approach to effective tax administration is a particularly important issue when it comes to the issue of moving from information exchange on request systems (such as TIEAs) to automatic information exchange (as currently found, for example, in the EU with the EU Savings Tax Directive). Even the most sophisticated national tax authorities find the volume of information generated by automatic information exchange challenging. The US, for example, receives 2.1 million data items per year on US taxpayers with overseas income as result of 25 automatic information exchange agreements. [4] Given the scale of the data flow that automatic information generates, there must be strong grounds for suspecting that tax authorities in developing jurisdictions would find it extremely difficult to process effectively the amount of information coming from any early shift to automatic exchange.

c. Data Protection Issues

Just as important as their ability to process large volumes of tax data, there are significant concerns regarding the ability of the authorities in some jurisdictions to ensure that information received under tax information exchange agreements – either on request or as a result of automatic exchange – is kept securely and not abused. STEP has voiced concern about the dangers of providing highly detailed personal financial information to jurisdictions with poor track records in terms of protecting human rights, combating corruption (often a particular issue when it comes to tax officials) or ensuring that personal data remains confidential.

In a 2010 research report, we observed that on widely accepted measures, most OECD members and most international financial centres (both large and small) enjoy relatively good standards of national governance. [5] In contrast, developing countries, particularly in sub-Saharan Africa, often score poorly on measures of good national governance owing to varying mixes of weak institutions, high levels of corruption and authoritarian regimes. There have already been instances of innocent citizens of oppressive states suffering significant losses as a result of information gained by their national governments in the course of money laundering checks of wholly legitimate transactions. [6] STEP has therefore argued strongly that, in the tax arena, TIEAs should only be agreed when countries meet explicit minimum standards on issues such as the quality of national governance.

More recently we have voiced our concern that the UK, for example, has signed a TIEA with Liberia. While we applaud international efforts to rebuild Liberia after a prolonged period of strife and instability, we believe that exchanging sensitive personal financial information with a jurisdiction which is still widely seen

as suffering from pervasive corruption requires particularly rigorous safeguards which have not yet been clearly laid out. [7]

d. The cost of unilateral extraterritorial tax initiatives

As the Foot Review found when it looked at the role of the British offshore financial centres, IFC’s "provide a gateway to route funds to other financial centres" and "make a significant contribution" to liquidity. [8] While Foot was focusing primarily on the impact of the Crown Dependencies and Overseas Territories on the UK, there is wide recognition in the economic literature that, more broadly, IFC’s play a similar role in channelling capital cheaply and efficiently to developing countries.

 

IFCs are typically characterised by good standards of governance and strong institutions. As Professor Jason Sharman has noted; "Governance and institutions are now regarded as the key determinants of economic growth, and related poverty reduction. Efficient institutions promote growth by lowering transaction costs and thereby facilitating exchange". [9] In circumstances in which many developing jurisdictions are hampered by weak institutions, however, IFC’s – with their relatively strong governance structures – have a positive role to play. As Sharman argues, "IFCs contribute by helping domestic and foreign investors in developing countries access the kind of efficient institutions necessary to drive growth, but which are often unavailable locally".

Similar broad conclusions have emerged from other studies. An IMF study, for example, has highlighted the important role Hong Kong has played in China’s rapid development and how its status as a major IFC rested not just on skilled labour, but also the "strong regulatory environment and the quality and depths of business services" it provides. [10] In a broad review of the literature here, Professor James Hines summarised the position as one in which "the evidence indicates that IFCs contribute to financial developments and stability in neighbouring countries, encourage investment, employment and other aspects of business development….This evidence appears to be quite robust, and suggests a rather different interpretation of the IFC experience than some that appear from more casual readings of history". [11]

The low transaction costs and other efficiencies that IFC’s offer is, however, now under potential threat by the costs imposed by a string of potentially inconsistent extraterritorial tax initiatives from the larger economies. The US has already moved on the so-called FATCA initiative, with recent estimates of industry

implementation costs put at around $8 billion (roughly as much as the tax initiative is expected to raise over the next decade). [12] Alongside FATCA, however, the EU has made it clear that it may well ultimately seek to bring many of the IFCs into the EU Savings Tax Directive and there have also discussions of various possible similar extraterritorial tax reporting initiatives from emerging major economies such as Brazil and India.

The danger is that a range of such initiatives will impose multiple, inconsistent reporting requirements on institutions. The resulting cat’s cradle of regulations risk driving up costs for those, such as the developing economies, wishing to access the capital flows available via the IFCs. National governments in the larger economies, judging by negotiations to date over FATCA, are relatively unconcerned by arguments over excessive costs since, in large part, these costs are borne by overseas institutions and their clients. The impact in terms of higher costs and reduced liquidity on end-users of IFC funding flows, such as the developing economies, may nevertheless be significant.

30 January 2012