Panama Papers: Evasion and Avoidance

Attorneys from across the world consider what the future holds for businesses and individuals with foreign holdings and investments.

Panama Papers
Best Lawyers

Best Lawyers

June 30, 2016 12:00 AM

(1) What is next after Panama Papers in Colombia?

The Panama Papers were just the beginning of the emergence of a new international tax regime. Nowadays, tax transparency has become a very important issue that should not be overlooked. Colombia has signed an information exchange agreement with the United States (FATCA – IGA), has executed more than 10 double-taxation treaties, is an early adopter of common reporting standards, and has negotiated a tax treaty including an information exchange clause with Panama. It is a fact that tax transparency is an undelayable trend, one that generates some tensions when giving advice to clients in some cases, such as:

  • Families that internationalized their property many years ago, not to avoid paying taxes in Colombia, but because they were obligated due to the security problem in Colombia at the time, which has not been forgotten and may be a problem again;
  • The current political situation of our country under a peace negotiation. The Colombian government and FARC rebels are holding peace talks to end the decades-long civil conflict, but the peace agreement has not been signed, and there is much uncertainty on how the treaty will work and if it will be effective;
  • Families and individuals who have legitimate vehicles in Panama or other jurisdictions for purposes of their real estate or portfolio investments, but that are being stigmatized regardless of the fact that they declare such assets in Colombia or not;

Pursuant to the above, it is necessary to evaluate every particular situation in order to determine how tensions may affect clients’ interests and to determine the best legal alternatives.

Even though tax avoidance or tax evasion is not a criminal felony in Colombia, there are strong international standards against tax avoidance to prevent money laundering. Furthermore, in 2014, the Colombian government passed a major tax reform package that introduced a normalization surtax, similar in its effects to a tax amnesty. In accordance with such reform, the normalization surtax is triggered by the possession of omitted assets and inexistent liabilities for January 1, 2015 (10 percent tax rate), January 1, 2016 (11.50 percent tax rate), or January 1, 2017 (13 percent tax rate). That is, taxpayers have three years’ opportunity to regularize their assets for tax purposes in Colombia.

The normalization surtax could be a great opportunity for those taxpayers who have omitted assets or have included inexistent liabilities in their income tax returns and want to normalize their tax situation in Colombia. If taxpayers do not comply with this obligation, they can be subject to the tax penalty set for omitted assets, which would be equal to almost the entire value of the assets.

Nicolás Bernal is an associate at Brigard & Urrutia, where he is a member of the tax and trust and estates teams.

José Andrés Romero is partner at Brigard & Urrutia, where he leads the tax, transfer pricing and wealth management, and trust and estates teams. He has worked as a national and international tax advisor and in transfer pricing for well-known international firms in Colombia and New York for more than 16 years.

(2) Lifesavers in Automatic Tax Information Exchange

International transparency for tax purposes through automatic exchange of information is increasingly changing from myth to plausible reality. The era of banking secrecy and tax havens fades in the wake of international organizations whose formidable efforts have persuaded, finally, a change of paradigm regarding transnational cooperation on tax matters. Information, no longer stagnant and “safe” within zealous political borders, may now roam from jurisdiction to jurisdiction automatically or upon request. This newfound availability is desirable and welcome, especially in countries in dire need of resources whose tax revenue has been swindled for decades by large capitals irregularly kept out of their reach.

Nonetheless, these legitimate efforts by tax enforcement agents to materialize tax progressiveness and equality cannot be used as an excuse to trample the rule of law. So-called leaks like the stolen Mossack Fonseca documents, or Panama Papers, are unwarranted radicals in an otherwise smooth process, ones that distort even international standards for audits and prosecution. Official investigations based only on information thus obtained would be legally and morally questionable, to say the least. It would be sensible to stress widespread concern about the possibility of this media-driven pursuit affecting not only true tax evaders but also individuals in entirely legitimate situations.

To this effect, tax authorities worldwide must proceed with utmost caution, observing every legal procedure, rule, and standard applicable to deter unfair questioning, tainting, and sanctioning of law-abiding taxpayers.

Fortunately, this wave of international transparency for tax purposes has brought about a much-needed corollary in most jurisdictions involved: a widespread variety of voluntary asset regularization programs. Brazil is not the exception. Today, and up to October 2016, any Brazilian resident with undeclared assets abroad may be cleared of all sanctions, criminal and otherwise, as well as taxes that would be due for years past for those assets—not to mention interest and foreign-exchange charges—by filling out a simple online tax statement. This process is not without cost. Taxpayers willing to regularize their undeclared assets abroad are required to pay a 15 percent tax on the value of those assets as of December 31, 2014, as well as a 100 percent fine over the value of that tax, resulting in an effective regularization “fee” of 30 percent of the asset’s value. Counterbalancing this relatively high rate, considerable foreign-exchange gains may be drawn from the operation, given the fact that the Brazilian real has gravely depreciated since.

This kind of program, allowing for compliance before prosecution, proves a sensible and pragmatic tool to incentivize cooperation. Conversely, taxpayers who still decide to take the risk are in line to experience a far broader, better funded, and more capable investigative body than the journals and news agencies involved in the Panama Papers: their newly empowered, criminal-law-wielding governments.

Henrique Lopes
is a tax partner at KLA, a law firm based in São Paulo. Henrique obtained his law degree from Universidade de São Paulo in 1990, is a specialist in state law by the same university, and concluded his LL.M at NYU in 1994. He was admitted in Brazil (OAB/SP, 1991) and in New York (1996).

Andrés Ramírez
is an economist and earned JD in Law from Universidad de los Andes, Colombia. Currently specializing in international tax law and practicing as foreign consultant in the tax law practice of KLA Law, São Paulo, Brazil. He previously assisted and supported local and international clients in the purchase and sale of different Colombian and foreign companies.

(3) A Fine Line

Due to a massive data leak, 2.6 terabytes of Panama law firm Mossack Fonseca’s documents were disclosed in the beginning of April 2016. These documents, known as the Panama Papers, show the names and addresses of approximately 214,000 shell companies and are supposed to prove the ultimate owners’ criminal activities, such as money laundering and tax evasion. They have ignited a global discussion with many questions that have not yet been answered.

Setting up a foreign shell company in a generic tax haven country is not illegal—per se. There may be legitimate reasons unrelated to taxation to set up and use such companies in order to protect assets from governmental seizure in times of political instability. A shell company preserves the beneficiary’s anonymity. However, this anonymity is very often used for illicit purposes and especially for facilitating money laundering and tax evasion.

All too often, in public discussions, tax avoidance and tax evasion are mixed up. Tax avoidance may be morally objectionable, but it is not illegal to set up a company in a tax haven country and thus avoid being taxed in a different country. However, to meet the conditions of tax approval, a company has to have significant assets and operations. If a company lacks those requirements and the operations are controlled by individuals from another country, the other country has the right of taxation. In such a case, the beneficiaries commit tax evasion by not declaring the generated income in the latter country. For Panamanian companies, this is frequently true. However, there are certainly Panamanian companies doing real business. Additionally, the requirements for tax approval vary: A holding company certainly does not have to meet the requirements of a manufacturer.

Individuals entangled in Panamanian company structures that have been affected by the Panama Papers leak will have to face criminal investigations if generated income was not declared in their countries of residence. Tax inspectors are currently evaluating the leaked data. Advisers and banks that acted as intermediaries or helped facilitate a corporate structure may also be subject to criminal investigations. Advisers and bank employees involved with those taxpayers may file a voluntary disclosure. It might be urgent to take action and seek legal advice because once the fiscal authorities have knowledge of the tax evasion, a voluntary disclosure is no longer possible.

Inextricably linked to the data leak is the question of data security, especially in law firms. In April 2016 the EU Council and Parliament adopted stricter regulations on data protection. Even today, companies exceeding a certain size are obliged to have a data protection officer. The obligation basically applies to law firms as well. The leak at Mossack Fonseca shows that legal provisions and technical measures against internal and external data theft are of immense importance. Data theft will not be utterly avoided—neither by enhancing the threat of punishment nor by establishing sophisticated technical measures. In areas where data security and protecting client privacy is paramount, there will always be employees who will succumb to financial incentives offered (e.g. the German government bought Swiss bank documents) or media attention, and thus disregard possible criminal persecution.

Jörg Schauf is partner and Andreas Höpfner is an attorney at Flick Gocke Schaumburg, Bonn, Germany. Both are specializing in criminal tax law.

(4) Transparency and SALT

Transparency in State and Local Tax (SALT) is a continued trend that is bringing an entirely new flavor to this ever-increasing, important area of tax. From leading trade groups creating task forces and issuing white papers to more public awareness and transparency in the areas of economic development and state and local government tax incentives, and from governmental and private sector financial disclosure to heightened transparency in day-to-day SEC disclosures, SALT seems to have a different taste of late.

Over the last several years, the Council on State Taxation (COST) and the American Bar Association Section of Taxation Committee on State and Local Tax have shined much-needed light on the topic of transparency in state and local tax matters overall. COST now includes as a part of its annual “score card” a ranking for each of the 50 states on the subject of transparency in state and local tax enforcement and administration. Often seen as the benchmark for a state in terms of fair and balanced rankings, the addition of transparency is significant.

Likewise, the ABA SALT Committee’s Transparency Task Force has worked diligently in conjunction with governmental attorneys, private sector attorneys, businesses, and tax media to highlight the critical need and provide a forum for consistent, open discussion regarding transparency in state and local taxation.

Certain segments in state and local tax have received much more scrutiny. For example, effective December 15, 2015, the Governmental Accounting Standards Board (GASB) made its GASB 77 effective. This pronouncement is designed to provide heightened transparency at the state local government level as it relates to a governmental entity promising to forego tax revenues in return for something of benefit. In other words, it’s designed to provide disclosure of the financial impact of a typical incentive deal made by a state or local government. Governmental entities must now disclose the gross dollar amount of taxes abated, a brief description of the nature of the involved abatement, other commitments made by the government beyond abating taxes, and other important items.

Many states have also been adopting enhanced transparency in economic development state and local tax incentive matters, having been pushed by many pro-disclosure organizations over the past several years. During 2013 and 2014, 10 of the 50 states legislated in the area of transparency concerning the evaluation of the effectiveness of tax credits and incentives at the state and local tax level.

These legislative acts are without question a meaningful step toward improving the transparency of tax credit and tax incentive programs offered in such jurisdictions, which will, everything else being equal, likely lead to more debate and discussion with respect to whether or not the underlying programs are or have been successful.

Mark F. Sommer leads the tax and incentives practices at Frost Brown Todd LLC, in Louisville. A nearly 30-year private practitioner and a frequent commentator and presenter on SALT issues nationwide, Mark is a fellow in the American College of Tax Council and was named State Tax Notes’ 2015 Practitioner of the Year.

(5) Panama Papers: Tax Evaders Beware!

The release of the Panama Papers is a stark reminder that no financial secret is ever too safe, particularly for those U.S. taxpayers with unreported foreign accounts and assets anywhere in the world. The Panama Papers place concepts of tax fairness and transparency at the forefront and call into question the differences between tax avoidance and tax evasion.

The massive law firm data breach of secretive financial information identifying numerous high-ranking government and public officials around the world known as the Panama Papers was recently disclosed online by the International Consortium of Investigative Journalists (ICIJ). The ICIJ searchable database provides information on more than 200,000 offshore entities, including data about companies, trusts, foundations, and funds incorporated in 21 tax havens from Hong Kong to Nevada and Wyoming, and links to people in more than 200 countries and territories.

A criminal inquiry into several of the 200 U.S. citizens named in the Panama Papers has been launched. In an apparent effort to respond to criticism that the U.S. is a tax haven not requiring identity disclosure of bank account owners and beneficiaries, the Obama Administration recently announced proposed rules aimed at reducing international money laundering and tax evasion, as well as new regulations on customer due diligence requirements for financial institutions.

Tax avoidance can be thought of as a legitimate way to reduce taxes, using methods approved by the IRS. Individuals and businesses reduce their taxes by taking legitimate deductions or by sheltering income through prescribed methods, such as utilizing tax deferral plans like individual retirement accounts or 401(k) plans or tax credits for expenditures. On the other hand, U.S. tax evasion, in the most basic form, is the illegal practice of not paying taxes by failing to report income earned or by reporting expenses not legally allowed.

An offshore company or entity can be a logical and legitimate decision for various international business transactions. ICIJ reports that there is no direct evidence of wrongdoing by Mossack Fonseca & Co.; however, the failure to declare certain interests in foreign financial accounts and assets by U.S. persons can potentially bring about significant civil—and even criminal—penalties.
Individuals who are out of compliance are always at risk of being divulged. Leaks of perceived confidential information from an internal database of a law firm, trust company, or financial institution can occur anytime, anywhere. The U.S. maintains an active “whistleblower program” that can net an informant up to 30 percent of the additional tax, penalty, and other amounts collected.

The IRS maintains a special “Offshore Voluntary Disclosure Program” (OVDP) that permits taxpayers to disclose previously undeclared interests in foreign financial accounts and other assets, pay required taxes, interest, and penalties, and provide information about their offshore holdings. In return, participants receive protection from criminal prosecution and a reduction in potentially applicable tax penalties. The IRS maintains other, more streamlined procedures designed to encourage non-willful taxpayers into compliance. For these streamlined procedures, “non-willful conduct” has been specifically defined as “conduct that is due to negligence, inadvertence, or mistake, or conduct that is the result of a good faith misunderstanding of the requirements of the law.”

The Panama Papers investigation by the ICIJ represents the largest media collaboration ever undertaken. Most individuals (and their professional advisors) will sleep better if they move to comply. Waiting is simply not a viable option.

Charles Rettig is a principal at Hochman, Salkin, Rettig, Toscher & Perez, representing clients in tax matters throughout the U.S. specializing in voluntary disclosures of previously undeclared interests in foreign financial accounts as well as domestic tax issues, Federal and state civil and criminal tax controversy matters and tax litigation, including sensitive issue tax-related examinations, appeals and investigations for individuals and business enterprises.

Michel R. Stein is a principal at Hochman, Salkin, Rettig, Toscher & Perez, specializing in tax controversies, as well as tax planning for individuals, businesses, and corporations. For almost 20 years, he has represented individuals with sensitive issue civil tax examinations where substantial penalty issues may arise, and extensively advised individuals on foreign and domestic voluntary disclosures regarding foreign account and asset compliance matters.

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