How to play the tax game

On Oct 29 2014, finance ministers from over 80 countries signed the Multilateral Competent Authority Agreement at the OECD organized Berlin Tax Conference. As of now the agreement has 51 signatories and 30 additional countries have pledged to enforce the agreement by 2018. As the name suggests the underlying objective of the agreement is to counter money laundering activities and provide staunch unified resistance against tax evasion facilitated by building a database tracking bank accounts, transactions, assets and income held outside the local jurisdiction of the participating nations.

Among the earlier legislations that have been in place, the Bank Secrecy Act enacted in 1970 deserves mention. The Act was designed to support the US government track down incidences of money laundering and tax evasion by making it mandatory for U.S financial institutions to maintain government wide data access service with detailed information on cash transactions exceeding $10,000.

As the German finance minister Wolfgang Schaeuble pointed out the fundamental basis of the BSA is now obsolete as electronic transactions dominate the global financial transactions. In the recent past the FACTA legislation – enacted on Jul 1, 2014 made it mandatory to report identity of Americans to the IRS with all overseas transaction record exceeding $50,000.

Concerns around tax evasion has been pain point for most governments. The process of evading tax payments by routing transactions through or shifting operations to tax havens (country/territory with negligible rates of taxation) is a major source of revenue leakage for most governments. A direct consequence of tax evasion by the bigger players translates into disproportionate tax burden being borne by small and medium sized firms.

Among the countries noted for being ‘tax havens’ - Cayman Islands, the Virgin Islands and Liechtenstein are signatories to the agreement while bigger players like Austria, Switzerland, and the Bahamas have pledged to participate by 2018.

In May 2014, Credit Suisse paid a $2.6 Billion fine to the DoJ over and above $196 Million paid to Securities Exchange Commission to free itself from charges of tax fraud. The Swiss bank enabled tax by evasion wealthy Americans by filing false U.S. tax returns and hide billions of dollars from U.S. tax collectors into overseas bank accounts. This was among the rarer cases where such a large financial player pleaded guilty.

Enforcing a sound agreement exercised across jurisdictions is the first step towards countering tax evasion and more importantly money laundering activities. This initiative is particularly well – timed as the global transaction system is at an interesting juncture with crypto-currencies such as Bitcoins materializing payment processing while preserving identity of the end users.

At this point it would be to noteworthy to highlight a more a more sophisticated and legal form of tax evasion – the phenomenon of ‘tax inversion’ whereby by US corporates blatantly evade tax payments by geographically relocating business functions, acquiring large stakes in foreign companies or simply splitting companies to gain a more formidable position in tax bargaining.

The year 2014 witnessed a surge in corporate re-structuring especially among pharmaceutical companies and food chains, all centred on the motive of ‘tax inversion’. Some of the notable events which sparked debate was that of Walgreen acquiring a Swiss based drug store to save $4 Billion in tax outlays. The Burger King acquisition of Tim Hortons (Canadian coffee and doughnut chain) which effectively reduced interest rates for a highly indebted Burger King over and above shielding the Burger King shareholders from capital gains tax.

The following graphic illustrates the impact of the announcement by the Obama administration (Jul 2014) of to enact a legislation that would retroactively strip tax advantage by relocating headquarters.

Although many often point out that profit maximization is the driving force of the capitalist free market economy, and thus justifying tax inversion, the moral obligation of corporate social responsibility and giving back to the economy for reaping benefits of superior infrastructure and education system trumps the latter calling for better legislation in place.

So what are your thoughts?                                                                                             

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