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2 May 2016

Ef­fec­tive­ly com­bat­ing tax fraud, de­vi­ous tax avoid­ance and mon­ey laun­der­ing

Further steps towards a fair international tax system and more effective action against money laundering

  • The German government is in favour of a fair international taxation system in which aggressive tax planning, tax evasion and money laundering have no place. The recent revelations in the Panama Papers offer an opportunity to push for this goal forcefully on the international stage. Now is the time to achieve further progress.
  • Experience has shown that if we want to fight tax evasion successfully, we need a coordinated global approach. That is why German Finance Minister Wolfgang Schäuble has launched another global initiative against tax fraud, devious tax avoidance and money laundering, which will complement existing initiatives. This article describes the action plan in more detail. The focus is on making business and trust arrangements more transparent for the authorities responsible on a global level.

1 Background

It has been clear for some time that gaps in the coordination of tax policies among different countries are being comprehensively exploited, sometimes with criminal intent. Significant progress has recently been made, both in the fight against international tax fraud and in the fight against legal but unfair tax planning. Germany’s initiative and insistence have been instrumental in this. Almost 100 countries have committed to the new standard for the automatic exchange of financial account information that was agreed at the Berlin tax conference in October 2014. As part of the Base Erosion and Profit Shifting (BEPS) project against aggressive tax planning by multinational corporations (a joint project of the G20 that was largely initiated by Germany in 2013), 15 actions were adopted whose systematic implementation is now being monitored by the Organisation for Economic Co-operation and Development (OECD).

The recent revelations about the legal practices involving letterbox companies in Panama over many years are further confirmation that Germany was right to push for an agreement on international steps against tax fraud and unfair tax practices. The recent events have provided us with good reasons to take further determined steps along the path we have chosen. For this reason, the German Finance Minister drew up an action plan and presented it for international coordination at the spring meeting of the International Monetary Fund (IMF) in Washington. It has already led to renewed close cooperation with important European partners, the OECD and the IMF. The final declaration issued by the G20 at the IMF spring meeting urges all countries, financial centres and overseas territories to participate in the automatic exchange of tax and financial data.

2 Content of the action plan

The German Finance Minister’s action plan includes the following measures:

1. “Panama must cooperate. Panama needs to join the system of automatic exchange of information as quickly as possible and develop its company law in such a way as to allow companies that are inactive and lacking in substance – and their shareholders – to be identified. Shareholders or managers must be obliged to provide proof on a regular basis of the economic activities their company performs. We require full transparency. The OECD should develop criteria for the purpose of identifying companies that are inactive and lacking in substance. We need to be able to distinguish between harmless shell companies and so-called letterbox companies. If Panama does not cooperate quickly, we will push for certain financial activities carried out in Panama to be outlawed internationally.”

We want to persuade Panama to accept the international standard for the automatic exchange of financial account information, also known as the Common Reporting Standard. Other countries that have been marketing themselves as tax havens also need to accept international transparency standards. In the meantime, the government of the Republic of Panama has bowed to mounting international pressure: On 14 April 2016, on the sidelines of the spring meetings of the IMF and World Bank, it declared its willingness to cooperate more fully.

When defining criteria for the precise identification of letterbox companies, we can build on the current work of the OECD’s Forum on Harmful Tax Practices, which examines economic substance in the case of rules that allow for favourable tax treatment under certain circumstances. According to this work, some of the key questions include:

  • Where are the activities that generate the substantial share of the company’s income actually carried out?
  • What functions do the various individuals in the company perform?
  • Where is the place of management – in other words, where are key decisions made?
  • Does the company have its own offices and communications infrastructure?
  • In the case of holding companies, what activities are actually carried out?

The action plan sets out to make entities more transparent for the authorities responsible. This includes a wide range of different legal forms and structures, including trusts (legally independent assets that are administered by trustees).

2. “We need to harmonise the various national and international black lists. To this end, we need uniform criteria that take into account tax and money laundering aspects. Lead responsibility for this must be given to an international organisation such as the OECD. The current coexistence of various lists in different regions and with different purposes hampers the effectiveness of such a system. We Europeans will take the lead by creating a joint list with the ultimate goal of achieving a global solution.”

A number of black lists are maintained both nationally, for example by France, and internationally, for example by the Global Forum on Transparency and Exchange of Information for Tax Purposes, the Financial Action Task Force On Money Laundering (FATF) and, in future, by the EU, which will prepare a black list under the fourth EU money laundering directive (EU/2015/849). These various coexisting lists, which have different purposes, criteria and levels of obligation, should be consolidated into one effective list that is as comprehensive as possible.

Europe should take the lead by creating a joint list. The fourth EU money laundering directive already envisages the creation of such a list by the European Commission. At the moment, the intended purpose of this list is to combat money laundering and terrorist financing, so it will include countries that have inadequate regimes in these areas. The list will be binding for all EU member states, but is also intended to provide political impetus outside the European Union.

However, the European Union should also direct its efforts towards developing joint criteria for a black list for fiscal purposes. The result should be a joint black list that takes into account both money laundering and fiscal aspects. An EU black list would give companies a clear message to the effect that special requirements apply when they conduct business with companies from the countries listed.

3. “One hundred countries are not enough: If possible, we need to ensure that all states and jurisdictions across the world implement the new standard for the automatic exchange of information on tax matters. To achieve this, honest countries have to step up the pressure. We need to make sure that offering a haven for illicit earnings is no longer worth it.”

Getting as many states and jurisdictions as possible to apply the new standard for the automatic exchange of information would serve to close existing gaps. As long as there are countries that do not participate in the automatic exchange of information, illegal financial flows will always be possible. For this reason, we need to step up the pressure on non-participating countries.

4. “We need a monitoring mechanism for the automatic exchange of information. The OECD’s Global Forum should monitor the systematic implementation of the exchange of information and develop effective sanctions for states that are remiss or not cooperating. A corresponding statement by the OECD would then provide a legal basis for defensive measures on the national level. In addition, we must ensure that the new standard is applied not only to new accounts but also across the board to existing accounts.”
In this area too, the German Finance Ministry’s demands go beyond what has already been achieved. So far, the Global Forum has not been involved in developing sanctions. Sanctions increase the pressure to follow international recommendations. They can also be imposed on a national level if the OECD finds that individual countries are not cooperating sufficiently.

5. “We need global registers of the beneficial owners of companies in order to make it clearer who is ultimately behind corporate structures. At the same time, company law requirements should be designed in such a way as to enable the quick identification of beneficial owners. A register of this kind has been agreed for EU member states in the EU’s fourth anti-money laundering directive. Germany will introduce this register in the near future. However, this only represents a first step towards a global solution. Here, too, it is essential that not only new companies but also existing companies are registered across the board.”

If the beneficial owners of corporate structures are not known, it is impossible to assess the tax implications or detect money laundering effectively enough. However, there is no international agreement on a register of beneficial owners. The EU has taken the lead in its fourth money laundering directive. To close loopholes, it is now essential for other countries to introduce such registers as well. Germany is in favour of high quality standards for the collection of data for these registers.

6. “We need to systematically link national registers with each other on a global basis. This also includes swiftly developing a uniform standard setting out which information should be included in national registers and how this information should be verified. In addition, tax authorities need access to this money laundering register, as is already planned in Germany, so that they can perform comparisons with the findings obtained via the international automatic exchange of information. The information in the register should also be available to relevant specialist non-governmental organisations and financial journalists. In exchange, we would expect these non-governmental organisations and journalists to also make the results of their research available to the authorities responsible.”

We need to take into account the fact that companies operate globally. By linking registers of beneficial owners across the world, it would be possible to carry out effective cross-checks of the required information, which would be particularly useful in the case of ‘chains’ of letterbox companies across several countries. The technical details of such registers now need to be defined on an international level.

7. “Banks have no business promoting aggressive tax avoidance. Services provided by banks aimed at supporting tax evasion by their clients are already subject to criminal sanctions. Under the BEPS action plan, firms that offer tax-saving models are to be subject to disclosure obligations. We will ensure that banks and consultants no longer want to take the legal risks associated with offering, or acting as agents for, such models. It is already becoming less and less lucrative to conduct business in obvious grey areas.”

It is absolutely appropriate to take a close look at the role played by banks in concealing certain activities that have recently come to light. Banks play a key role when it comes to organising financial flows to offshore jurisdictions. We need to agree on suitable measures on the international level very soon and implement them at the national level. Disclosure obligations for tax planning schemes are an important aspect of this.

8. “We need tougher administrative sanctions for companies. In many cases, it is not possible to mount successful criminal prosecutions of misconduct because there is insufficient proof of personal wrongdoing. For this reason, institutions themselves should be held responsible to a greater degree. In the future, sanctions imposed by supervisory authorities will play a greater role in Germany and Europe, as is already the case in the US. Companies in turn must obtain redress for such sanctions from the responsible parties to a greater degree.”

In practice, it has become clear that the need to obtain proof of personal wrongdoing is often an obstacle to establishing a company’s criminal liability. Even when a company is involved in illegal activities, the organisational and workflow structures sometimes make it impossible to establish proof of individual wrongdoing. The problem exists even in jurisdictions with corporate criminal liability, where penalties can also be imposed on legal persons. For example, proof of individual wrongdoing is currently needed in order to impose sanctions on companies for contraventions of administrative regulations.

Administrative penalties or sanctions under administrative law would be significantly more efficient and easier to enforce. This would allow authorities to impose sanctions by issuing administrative decisions. For example, sanctions could be imposed by financial supervisors, as is already the case in the US with the Securities and Exchange Commission. The companies affected could appeal before administrative courts. Of course, any such administrative sanctions regime would have to be in line with EU legislation and German constitutional law.

Sanctions of this kind would not only enable governments to skim off unlawfully obtained economic benefits, but would also have a greater deterrent effect.

9. “Tax evaders must not be allowed to escape sanctions by taking advantage of limitation periods. It is unacceptable for tax evaders to be able to escape punishment by deliberately concealing foreign relations until limitation periods expire. We need to work to ensure, on the national and international level, that the limitation period only begins once a taxpayer has fulfilled the (existing and new) reporting obligations for foreign relations (“suspending” the beginning of the limitation period).”

Reporting on this subject has sometimes been unclear, so it is worth pointing out that the issue of limitation periods has a criminal law component and a fiscal component. From a fiscal point of view, the relevant issue is the limitation period for assessment. The relevant issue in criminal law is the limitation period for prosecution.

In cases of tax evasion, the limitation period for assessment is 10 years,1 although the beginning and the end of this period can be suspended.2 If revenue authorities discover a case of tax evasion after the limitation period has expired, it is no longer possible to recover the tax.3 We want to ensure that limitation periods do not begin until the necessary information has been reported to the authorities responsible.

In the cases that are currently being discussed, measures to suspend limitation periods are being investigated. The aim is to expand the period in which underpaid taxes can be recovered and tax evasion can be prosecuted.

10. “We will further strengthen our anti-money laundering measures in Germany. In recent years, Germany has established strict rules and controls to combat money laundering in the financial sector. We also need such progress in the commercial sector, which largely falls under the responsibility of the federal states (Länder). The Financial Intelligence Unit, the central agency responsible for processing reports of money laundering suspicions, has been relocated from the Federal Criminal Police Office to German Customs and been given new responsibilities and significantly more staff. We will also discuss with the Länder how we can organise our federal system more efficiently to combat money laundering in the commercial sector. In addition, we need a legal policy initiative to enhance the skimming-off of profits from illegal transactions, introduce tougher sanctions, and make it easier to freeze assets.”

There is wide-spread criticism that not enough is being done to fight money laundering in the non-financial sector, for example in the real estate sector. However, this area falls under the remit of the Länder. The German Finance Ministry commissioned a research project to investigate the extent of unreported cases of money laundering. The results were presented in February 2016 together with a comprehensive raft of measures that focus, among other things, on the use of cash for money-laundering purposes.

3 Measures for preventing money laundering

FATF has explicitly confirmed that Germany complies with all European and international standards for preventing money laundering. In fact, Germany goes far beyond these standards in a number of areas, for example the regulation of electronic money and group compliance of institutions, in which German institutions’ foreign subsidiaries and branches are required to observe German anti-money laundering laws even in offshore locations.

Nevertheless, it remains true that economic crimes tend to have a high number of unreported cases, and this is especially true of money laundering. Moreover, in the case of this particular offence, almost all the suspicious transaction reports registered by the Federal Criminal Police Office come from the financial sector, meaning that there is very little reliable data on money laundering in the entire non-financial sector. Under the fourth EU money laundering directive, member states are required to prepare analyses of specific money laundering risks in each sector of the economy.

In this context, the German Finance Ministry commissioned a study that set out to investigate the extent of money laundering in the non-financial sector in Germany as well as money laundering risks in individual sectors of the economy. The study was conducted by Prof. Kai-D. Bussmann from the Faculty of Law, Economics and Business at Martin Luther University Halle-Wittenberg.

3.1 The study’s approach

The results of the study are based on the one hand on 73 interviews with experts from the fields of research, police work and the judiciary as well as representatives of professional and industry associations, and on the other hand on a representative survey of 1,002 obligated parties, mostly from the non-financial sector, that are required under the Money Laundering Act to exercise a special degree of due diligence and report suspicious transactions. The study included obligated parties from the legal profession, asset management firms, insurance intermediaries, real estate agents, and traders of goods. The latter group included dealers of motor vehicles, gold/silver, pearls/jewellery, art and antiques, and boats and yachts.

The study’s extrapolations are based solely on the information provided by the respondents regarding the number of suspicious cases they reported, the typology criteria they observed that should trigger suspicious transaction reports, and their estimates regarding the financial volume of suspicious cases. For these methodological reasons, the numbers are, if anything, too low.

Only about 250 suspicious transaction reports per year were filed by the groups included in the study in the entire non-financial sector, while the total number of suspicious transaction reports including the financial sector stood at 18,000 in 2013. The study concluded that the number of unreported cases in the non-financial sector is likely to be somewhere between 15,000 and 28,000 at least, and thus in the same range as the number of registered cases in the financial sector. In other words, there is a significant discrepancy in the non-financial sector between the number of suspicious transactions actually reported and the estimated number of suspicious cases.

The financial volume of reportable but unreported cases is also substantial. The study estimated it to be between 20bn and €30bn in the non-financial sector alone. The total volume of money laundering activities in the financial and non-financial sectors in Germany is estimated to amount to over €50bn. If one includes estimated figures for companies specifically set up for money laundering purposes in sectors such as the hotel and restaurant business, gambling, and import/export, the figure is likely to be much higher, in the range of more than €100bn per year.

3.2 Risks in individual sectors of the economy

Assets that are well-suited as investments carry a particularly high risk of money laundering. This is especially true of the real estate business and the construction sector as a whole. The study showed that risk awareness among real estate agents is too low, despite the high level of risk in their industry. Risk levels are also high for developers and architects, groups that are currently not defined as obligated parties under the Money Laundering Act. Property purchases are generally accompanied by notaries and, in many cases, solicitors. According to the study, risk awareness and prevention efforts in both these groups are too low. Precautions taken against money laundering in the real estate and construction sector are generally inadequate.

High-quality works of art and antiques are another category of investment that is well suited to laundering large amounts of money. The study showed that, relative to the actual level of risk, dealers are insufficiently aware of the problem and do not do enough to tackle it. The trade in boats and yachts is also highly susceptible to money laundering. According to the study, risk levels are also high in the case of trust or custodial accounts administered by legal professionals or asset management firms, as such accounts can be used to launder large amounts of money. Precautions against money laundering are not commensurate with risk levels either in the area of high-value assets such as yachts or in the legal and asset management professions.

There are also examples of cash-intensive businesses such as hotels and restaurants being used as fronts for money laundering. Here too, the inadequate prevention efforts of the associated legal and asset management professions serve to increase the risk.

In the area of trade in goods, there is generally a medium level of risk in the premium segment, where risk awareness is currently completely underdeveloped. Large cash payments are common in the retail sector, offering an easy opening for money laundering. By contrast, risk levels are relatively low in the life insurance business, as money laundering compliance programmes have already been developed. (Other areas, such as property insurance products, were not included in the study.)

3.3 Recommendations and results of the study

Prof. Kai-D. Bussmann’s study concludes with the following recommendations:

  • Cash payments: Cash payments represent one of the greatest money laundering risks. The expert recommends introducing a maximum amount for cash payments, not least because similar rules in other EU member states have led to a relocation of money laundering activities to Germany. The recommended limit is in the medium four-figure range. In the meantime, the EU’s Economic and Financial Affairs Council (ECOFIN) invited the Commission to explore the need for an EU-wide upper limit on cash payments on 12 February 2016.
  • Informational material and training provided by associations: Efforts to prevent money laundering are inadequate across the entire non-financial sector. Targeted awareness campaigns need to be launched by professional and business associations in order to create the necessary risk awareness.
  • AML compliance officers, tax offices, supervisory authorities and financial institutions: Appointing an AML compliance officer has proved to be a very effective internal measure for companies in the financial sector. In particular, large and medium-sized businesses with complex divisions of responsibilities should make more use of this option – and be encouraged to do so by supervisory authorities of the Länder. In general, external measures to monitor obligated parties should be expanded. To this end, the supervisory authorities of the Länder should increase their number of on-site inspections. In the area of legal advice and asset management, more checks should be carried out by financial institutions and professional chambers, in view of the high money laundering risks associated with trust- or custodial accounts. This could minimise the risk of money laundering in cases where there is a lack of cooperation on the part of legal and asset management professionals. When checking profit/loss statements, tax offices should pay more attention to the possibility of fictitious profits. The risk that companies were set up specifically for the purpose of money laundering is highest in the case of hotels, restaurants, private amusement arcades, and import/export businesses.

Money laundering is a transnational crime. Profits from organised crime and other predicate offences are not necessarily generated in Germany; in fact, they generally come from abroad. Germany’s economic power and attractiveness have made it a magnet for international money laundering activities. This is a risk shared by all prosperous economies. In many ways, money launderers behave like investors. Like legitimate businesses, they look for lucrative and low-profile investment opportunities. The main hubs of money laundering activities are luxury goods, such as expensive watches or vehicles – but there is a particular focus on high-value assets such as works of art, which hardly decrease in value after use and are, like currencies, easy to trade.

The study shows that Germany is particularly vulnerable to money laundering because of its economic attractiveness. A large portion of the tainted money comes from abroad. In view of this risk situation, preventing money laundering should be given much greater priority when supervising the non-financial sector, which falls under the responsibility of the Länder.

4 Conclusion

Many of the measures to combat tax evasion and money laundering can only be effective if countries cooperate on a global level. We need effective global solutions. In the pursuit of this goal, more has been achieved in the past three years than in the previous 30 years – partly thanks to Germany’s initiative. That is why we are presenting the additional steps outlined here for international coordination. Germany will continue to work together closely with its European and international partners as well as the OECD.

One thing is clear: It is easy to call for global solutions, but difficult to achieve them. It is therefore crucial that political demands for far-reaching changes are made at the right time – that way, there is a realistic chance that they will be implemented. The time for the German Finance Ministry’s ten proposals is right. This was confirmed by the reaction of other countries, the OECD and the IMF at the IMF spring meeting in Washington, D.C., in April 2016.

1 Section 169 subsection (2) of the German Fiscal Code

2 See sections 170 and 171 of the German Fiscal Code

3 Section 169 subsection (1) of the German Fiscal Code

This article first appeared in German in the April 2016 edition of the Ministry’s monthly report.

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