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No Place Left to Hide: US and Caribbean Nations Crack Down on Tax Cheats

Over the last few decades wealthy Americans have sought to stash assets in one of the many Caribbean nations commonly known as tax havens. In March of 2009, President Obama signed the Hiring Incentives to Restore Employment Act (HIRE). HIRE gives the federal government new options to find Americans who have been evading taxes by using foreign banks and elaborate offshore investment schemes. If all goes as planned, those assets will now be subject to tax.

Several Caribbean nations have developed reputations as good places where one can hide assets from Uncle Sam and avoid paying income and estate taxes. It is in these nations where the impact of the new tax laws will have the greatest impact. In order to understand the impact of the new regulations, it is important to first understand what a tax haven is though a precise definition is hard to nail down. Noted economist Geoffrey Colin Powell commented in a 2009 issue of the economist that “What … identifies an area as a tax haven is the existence of a composite tax structure established deliberately to take advantage of, and exploit, a worldwide demand for opportunities to engage in tax evasion.” Lacking from this definition is mention of strict banking secrecy laws which any proper tax haven must have in place. Even the US Govt. has struggled the pin point a definition. In its December 2008 report on the use of tax havens by wealthy Americans and American corporations, the U.S. Government accountability Office stated that it was unable to find a satisfactory definition of a tax haven but regarded the following characteristics as indicative of a tax haven:

1. zero or nominal taxes;
2. strict banking/investment secrecy laws;
3. lack of transparency in the operation of legislative, legal or administrative provisions;
4. no requirement for a substantive local presence; and
5. self-promotion as an offshore financial center.

The use of differing tax laws between two or more countries to try to mitigate tax liability is probably as old as taxation itself. However, Tolly’s Tax Havens, a definitive text on the subject of tax havens and tax evasion, suggests that Switzerland can probably lay claim to the title of the worlds first true tax haven. Swiss banks had long been a safe harbor for well-heeled families fleeing social upheaval in Russia, Germany, South America and elsewhere. In the years immediately following the First World War, several European states had to quickly ratchet up tax rates to help finance reconstruction efforts in the rubble of their war-torn cities. Because Switzerland maintained its neutrality during the war, it avoided the substantial damage to its infrastructure and the subsequent cost of rebuilding. The Swiss therefore were able to keep their taxes low and as a result, Switzerland saw a significant injection of capital into its economy. This was likely the birth of the modern tax haven. While any place that wealthy Americans have squirreled away their income will invariably be subject to a close inspection by the Internal Revenue Service, stashing assets in the following nations will garner special attention: the Cayman Islands, the Isle of Mann, Panama, Island of Mauritius, Hong Kong, Dominican Republic, Dominica, Costa Rica, Belize, Anguilla, and Andorra.

How much money, in the form of lost tax revenue, are we talking about here? The federal government estimates that nearly $1 trillion USD is hidden in countries with banking secrecy laws. The tax revenue on this trillion dollars would exceed $30 billion USD per year. Factor in European, Asian, and African nations and the dollar value of assets hidden in tax haven countries easily tops $6 Trillion USD. Helping wealthy individuals and companies shield their assets from the taxman has become big business. In the Cayman Islands alone, there are More than 93,000 investment companies registered in 2008, including almost 300 banks, 800 insurers, and 10,000 mutual funds. Furthering the point, a 2006 article published in the Journal of Public Economics concluded that 59% of U.S. multinational firms had significant assets in tax haven countries. With statistics like these, no wonder that  noted tax specialist Lee Sheppard recently observed in a widely publicized editorial that the “bill is a huge step in the right direction” because it meant that the U.S. was “getting serious about tax enforcement on cross-border investment flows in a way that we never have before.”

Under the new laws, the federal government has powerful tools to enforce the tax code and collect previously uncollected taxes. For starters, the IRS can asses a 30% tax on financial institutions that do not disclose the nature of investments held by Americans. Simply put, if a US financial institution holds assets in a foreign bank account belonging to an American and does not report those assets to the IRS, that institution will have to pay the tax. Obviously, this provision is designed to “encourage” financial institutions to turn over pertinent financial information so US authorities can collect taxes on the assets. If the threat of additional taxes is not enough, the IRS is working in conjunction with the Department of Justice to prosecute a record number of tax cheats and punish them with stiff jail sentences.

The DOJ Tax Division is aggressively working with the IRS to track down those who use offshore accounts, combating abusive tax shelters, stopping tax defiers and shutting down tax schemes, especially those involving employee leasing and offshore credit and debit cards. During FY 2009, the Tax Division successfully defended refund suits against the United States representing claims of over $665 million, and collected through affirmative litigation over $260 million. Tax Division prosecutors obtained 135 convictions and guilty pleas during FY 2009. Additionally, Tax Division attorneys participated in sentencings for 133 defendants during FY 2009. John DiCicco, Acting Assistant Attorney General for the Tax Division commented: “The Department of Justice is strongly committed to promoting compliance with federal tax laws… The Department will continue to use all available law enforcement tools to recover tax revenue and to punish tax offenders. Those who promote, facilitate, or engage in off shore tax fraud plans or schemes risk penalties and, where appropriate, criminal prosecution.”

In April 2009, Robert Moran pleaded guilty to filing a false income tax return and admitted to concealing more than $3 million in a secret bank account at UBS. He was sentenced to two months in prison. In July 2009, Jeffrey Chernick, of Stanfordville, N.Y. pleaded guilty to filing a false tax return and was sentenced to three months in prison, six months of house arrest, and six months of probation. In August 2009, former UBS banker Bradley Birkenfeld was sentenced to 40 months in prison for helping an American billionaire real estate developer evade taxes. In January 2010, Juergen Homann, of Saddle River, N.J. was sentenced to five years probation for failure to file a Report of Foreign Bank or Financial Accounts (FBAR). Homann concealed more than $6.1 million in Swiss bank accounts. In January 2010, Roberto Cittadini, of Bellevue, Washington was sentenced to six months of home confinement for failing to report income from secret UBS bank accounts under his control. In February 2010, Dr. Andrew Silva of Sterling, Va. pleaded guilty to conspiracy to defraud the United States and making a false statement regarding an undeclared foreign bank. His plea carries a maximum sentence of 60 months imprisonment.

The IRS and Dept of the Treasury are not alone in cracking down on what it believes to be tax cheats. The U.S. efforts parallel similar efforts by Caribbean countries to crack down on their nations’ financial systems being used as a global destination for financial criminal activity such as tax evasion. The method which seems to be preferred by most Caribbean nations is the Tax Information Exchange Agreement, known as TIEAs. According to the Organization for Economic Development and Cooperation (OEDC), TIEAs are a way “to promote international co-operation in tax matters through exchange of information. TIEAs were developed by the OECD Global Forum Working Group on Effective Exchange of Information (“the Working Group”). The purpose is to exchange financial information between two states. The goal is to close tax loopholes. With the desired benefit of recovering lost tax revenue from wealthy individuals who flee from a medium or heavily-taxed state, to one that has lax tax laws.

So far, most TIEAs signed by Caribbean nations have been partnerships with European countries. Germany, France, the UK, Denmark, and the Netherlands each have separate agreements with many of the Caribbean tax havens, including the Bahamas, Anguilla, St. Vincent and the Grenadines, Saint Lucia, Turks and Caicos, San Marino, Uruguay, the British Virgin Islands, Grenada, Dominica, Belize, St Kitts & Nevis, Bermuda, and the Cayman Islands.

Since all of the above-mentioned TIEAs have been signed in the past year, the ultimate impact of the legislation remains unclear. It remains to be seen how impactful the above mentioned TIEAs will be. Most of them have been enacted to recently and its simply too early to tell. However, the number of European and Caribbean countries involved in theglobal crackdown on offshore tax cheats has the potential to radically alter things in so-called tax havens. These recent developments also hold the potential to change global perceptions of the Caribbean financial industry as an attractive destination for those seeking to violate their own country’s tax laws.

In the end, it appears that the days of stashing income and assets in offshore havens may be coming to an end. Domestic and foreign laws have been, are being, put into place to crack down on this behavior. The Treasury Department is likely to reap a significant financial windfall in the form of increased collections but the true winner will be the American people since they will no longer have to compensate for tax cheats who evade their fiscal responsibilities.