The Pandora Papers, a revelation of almost 12 million leaked documents, brings up many questions surrounding offshore accounts and the activities of some of the world’s most politically influential and powerful people. The Pandora Papers also raises concerns about the ease with which people can hide potentially criminal behavior behind offshore accounts.
We’ve long known how organizations and people holding accounts can employ offshore activities to hide funds or avoid taxes in their countries of origin. Although investigations have shown that these types of accounts remain the preferred methods of nefarious actors, there are also plenty of legitimate reasons that non-transparent accounts and transactions exist. The Pandora Papers have led to new calls for more transparency in global finance, the lack of which could weaken public trust in financial institutions and government entities. Naturally, this is highly relevant in the world of tax.
It’s the responsibility of governments to stop financial crimes such as tax evasion and money laundering, which often thrive in offshore financial centers. Governments also need to ensure they can tax their citizens and corporations in a fair way. This juxtaposition provides an interesting crossroads for politicians. There’s a proven need to make the world’s financial system less opaque, but making this happen has proven difficult from a political perspective.
Businesses, though, have the tools they need now.
The often-complicated connections between nefarious characters, people in positions of power, and offshore organizations can be exposed through using know-your-customer, or KYC, initiatives, robust screening technologies, and information on politically exposed persons, or PEPs.
Despite some political barriers, financial institutions are highly regulated, with initiatives like the EU Anti-Money Laundering Directives requiring these organizations to form risk-based approaches to identify PEPs and other owners, while also accounting for high-risk nations and from where wealth originates. Despite these initiatives, there can be weak parts in the protective chain. For example, designated non-financial businesses and professions (DNFBPs) might be a soft spot in the anti-money laundering (AML) and counter-terrorist finance (CFT) regulations that nations and international organizations have in place. While small, there are still several DNFBPs like legal professionals and real estate organizations that often play critical roles in clouding who owns what assets.
The Financial Action Task Force (FATF) has reported that the above professions should be subject to AML and CFT regulations. However, these professions often suffer from a lack of regulation and proper oversight. As a result, many organizations and those in positions of responsibility may not be using the necessary level of due diligence.
In the wake of the Pandora Papers leak, a cohort of U.S. legislators from both sides of the aisle have proposed a new bill to update due diligence standards. The Enablers Act would amend the half-century-old Bank Secrecy Act. This new legislation would require the Department of the Treasury to have due-diligence requirements that would apply to U.S.-based middlemen—such as real estate and law firms—who assist in the flow of foreign funds and assets into the country. Time will tell whether there’s momentum to create real change.
To Be Transparent or Not Transparent
While there are obvious reasons for concern regarding clouded offshore activity, there is nuance within the subject. From a tax perspective, it’s necessary to know the difference between tax avoidance, which is usually legal, and tax evasion, which is not. This line is, admittedly, very fine. Not every offshore activity is illicit—there are many understandable reasons why financial transactions and activities may occur in secret.
For example, a non-transparent set of transactions might come from an individual who lives under an oppressive regime that might threaten their assets. If an individual lives under a regime that is willing to take assets from its citizens in an illegitimate manner, offshore transactions can provide a method of protection. In addition, seeking lawful tax advantages, estate planning advantages, and addressing privacy concerns are all reasons that an individual or organization might make their transactions in secret. Unfortunately, not all financial institutions are set up to determine the distinct difference between these two types of activities.
However, there is a problem that can arise when viewing the issue through the lens of compliance. Offshore accounts can often be a favorite vehicle of malicious entities around the world. These transactions can assist nefarious actors such as sanctions evaders and international arms traffickers in keeping their finances away from law enforcement. Additionally, offshore activities can create layers of obfuscation in the steps of money laundering. By distancing themselves from the funds’ points of origin, criminals can more easily avoid detection.
Ethical arguments over offshore accounts and their use aside, the benefit from increased transparency is that it can help reduce transactional friction. When access to information about individuals and corporations is easier to obtain, it becomes simpler for financial institutions to conduct legitimate transactions. An above-board business can then comply with an organization’s risk protocols. Aside from creating confusion and distrust in the public space, opaque activities can mar business production and can hurt the industry in the long term.
What Comes Next
Going forward, the impetus to create greater transparency around transactions is going to be more pronounced. Countries need to determine who is going to have reporting responsibilities. For example, in Europe, accountants and lawyers bear the responsibility to report money laundering. With different rules elsewhere and changing regulations across other jurisdictions, there is the potential for complexity in the future.
More transparency in the world of financial services would undoubtedly help improve public trust. New methodologies to achieve transparency will benefit both the public and the stakeholders involved in offshore transactions and should be strongly considered by all relevant stakeholders, from governments to businesses.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Leslie Bailey is the vice president of financial crime compliance strategy at LexisNexis Risk Solutions, a provider of technology and analytics solutions that helps their customers assess and predict risk. Based in Alabama, Leslie directs marketing strategy for the LexisNexis Risk Solutions’ financial crime compliance solution in the United States and Canadian regions.
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