Dirty money: Mistrust the trusts; The crackdown on shell companies is a good start. The next target should be trusts

Dirty money: Mistrust the trusts; The crackdown on shell companies is a good start. The next target should be trusts

Nov 9th 2013 |From the print edition

ONLY a fool holds dirty money in his own name. The world’s financial system offers safer and friendlier ways to hide the proceeds of crime. Shell companies—those with no real operations—are one, phoney trusts and foundations are another (seearticle). Belatedly, life is getting a bit more difficult for tax evaders, money launderers and those who abet them. One big move—now backed by the British government—is to oblige limited-liability companies to give details of their real owners. This newspaper has argued in favour of such a duty: limited-liability status is a kind of public subsidy (if the firm goes bust, the shareholders are not responsible for its debts). It was never meant to be a means of concealing ownership. Yet in many places it is just that: only six of 69 jurisdictions surveyed last year by Eurodad, an anti-corruption network, required all types of firm to record beneficial-ownership information.Spurred by complaints from the police, pressure from campaigners and public distaste for tax-dodgers, the British government wants not only to set up a proper registry of beneficial ownership, but also to make its contents public. If the detailed regime matches the promise, this will be an important breakthrough. But Britain should also coax its offshore dependencies into greater openness. Some are conscientious, others less so. Even official investigators can find it hard to get the information they need. America can do more to help, too: states such as Nevada apply scandalously little scrutiny to the identity of those forming companies. European governments are keen to collect more tax, but many have been less eager to make corporate ownership transparent.

Cleaning up corporate ownership will increase public confidence in the financial system. But it is only the start. The misuse of trusts and other non-corporate entities is also a big problem. These have proper purposes, such as managing charitable donations, ring-fencing employee pension plans, safeguarding assets for children or organising wills and bequests. But they too enjoy a legal advantage: they are a way of parking assets. That seems fine as long as the trusts pay tax on profits (just as companies do) and their beneficiaries pay tax on any disbursement or benefit (just as shareholders do).

Instead, trust law has become a murky world. In many places there is no rule that trusts must disclose their existence, let alone pay tax on their earnings. “Orphan assets”, no longer legally owned by the person who put the money into the trust but not yet belonging to the trust’s potential beneficiaries, offer plenty of room for abuse. Some trusts, revealingly, even have flee clauses, where the trustees are obliged to try to change the domicile of the trust if the tax police start asking questions. A structure that was set up to protect the wives of medieval crusaders has ended up being used by the sort of businesspeople who greet the Russian leader as “Vladimir”.

Swiss knives

Far better to concentrate on two simple rules. First, all trusts and foundations should be registered, just as companies are, and their beneficiaries, both actual and potential, should be disclosed. Second, the trustees and the beneficiaries should be legally responsible for reporting any disbursements or benefits, and for making sure the tax is paid on them. Both the European Union and America are tiptoeing in this direction, but Luxembourg, Switzerland and some micro-states are resisting. It would be much better if they worked together. Trusts are a useful vehicle—but not for dodgy goods.

 

The weak link

Cleaning up trusts and similar entities will hurt money-launderers—but it will need a lot of political will

Nov 9th 2013 |From the print edition

WHEN Mark Morris, a Zurich-based tax consultant with a conscience, requested a meeting with the European Commission to explain the many devious ways in which tax evaders were using shell companies and other vehicles, a bored official offered him 20 minutes. “Once I started describing all the loopholes,” Mr Morris recalls, “his eyes lit up. Two hours later he was still listening, scribbling furiously.”

Only a fool holds dirty money in his own name these days. Anyone in the know tries to conceal ownership through labyrinthine combinations of anonymous shell companies and arrangements such as trusts and foundations. Campaigners have worked hard to expose the extent of this “layering”, helping to push corporate transparency up political agendas. G8 countries backed mandatory registration of real, or “beneficial”, owners at their summit in Northern Ireland in June. Now Britain has become the first country to announce that its register would be open to the public.

The misuse of trusts, foundations and the like has drawn less interest—though some view such vehicles as a vault-sized loophole. John Christensen of the Tax Justice Network, a pressure group, terms them “one of the biggest nuts yet to be cracked.”

A trust typically involves three main parties: a settlor (who donates the assets), a trustee (who manages the arrangement) and beneficiaries (who are to receive the funds in future). Confusingly, ownership is split: the trustee is the legal owner, while the beneficiaries or the settlor, or both, can at different times exercise beneficial ownership or control who gets the money. A common-law concept, the trust plays a big role in Britain’s offshore satellites, especially Jersey, a small island with 4,500 trust professionals. In continental Europe and jurisdictions such as Panama, foundations and anstalts serve a similar purpose.

These arrangements can be wholly legitimate: ring-fencing a company’s pension assets in the event of a takeover, for example. For minimising tax, corporate structures are generally more useful. Moreover, notes George Hodgson of the Society of Trust and Estate Practitioners: “Trustees must know the full details of the beneficial owners and typically must pass that information on to competent authorities when requested.” It is in trustees’ interest to ensure tax is paid, he adds, because they are personally liable if it isn’t.

That is true in some countries, at least in theory. But fuzziness about ownership and endemic secrecy—in many jurisdictions trusts are not obliged even to register their existence, let alone their owners—make them a tempting tool for those trying to hide money or circumvent laws. A report in 2011 by the Stolen Asset Recovery Initiative, a joint UN/World Bank project, noted that trusts crop up less commonly than shell companies in corruption investigations. But it suggested that their misuse might be underreported, because trusts often baffle investigators, who instead focus on other targets.

So-called discretionary trusts are particularly open to abuse. Their assets sit in a kind of ownerless limbo: given away, legally speaking, but without a recipient, so long as the beneficiaries are not defined. (They may even be children or grandchildren as yet unborn.) Trustees can be guided by a “letter of wishes”, which may allow the settlor to control assets even though legally they do not belong to him. Such trusts are an “important and tricky” issue for tax authorities, says Konstantin Lozev, a European Commission official.

Lucky orphans, happy benefactors

The “vast majority” of trusts in Jersey are discretionary, says Alan Binnington, president of the island’s trust-companies association. New types of ownerless structure are being created all the time. A bill awaiting parliamentary approval in Luxembourg, for example, would create Fondations Patrimoniales (private foundations). KPMG, an accountancy firm, describes this to clients as a shareholder-less “orphan entity” with “particularly attractive” tax advantages. The beneficiary can be another foundation or trust.

These discretionary structures lead a charmed life. For example, they gained a surprising exemption from the bilateral deals between Switzerland and other European countries that were supposed to flush out undeclared money.

Some countries have begun to take a harder line. France has changed its law to treat all potential trust beneficiaries as owners for tax purposes—even if they never receive a penny. Under America’s Foreign Account Tax Compliance Act (FATCA), which is to take effect next year, trusts will face many of the same Draconian reporting obligations as banks. The European Commission has proposed several amendments to its savings-tax directive, in a bid to close the loopholes that Mr Morris and others have identified. These could become part of the cross-border framework for exchange of tax information emerging under the aegis of the OECD, a rich-country think-tank.

The new EU regime would reject the idea of ownerless assets, at least for trusts managed in the EU and dependent territories (which make up most such arrangements worldwide). In effect, until the beneficiary has received money, the original owner will be deemed to have retained them and be liable for tax. The trustee will be obliged to help enforce this. So far Luxembourg has been a sticking point. Its financial industry thrives on tax-friendliness and secrecy. It says it will sign up only when Switzerland, Monaco and other non-EU European states agree to exchange information automatically. The Swiss are loth to do so unless Singapore (home to a booming trust industry) and other wealth-management centres sign up too.

Customers in search of lax regimes can move elsewhere. But even the most ingenious legal arrangements are no use without a bank account. Proposed anti-money-laundering rules in the EU and America could make banks apply stiff “know your customer” rules to trusts and foundations.

Politicians and regulators continue to squabble over the details, but the political push behind tax transparency is beginning to look irresistible. Together, the EU’s directive amendments and FATCA would amount to the biggest overhaul of the legal treatment of trusts and similar legal arrangements since trust law was first developed in the 12th century, for Crusader knights wanting to safeguard their assets while they were away in the Holy Land. The other side is short of champions.