- Triplet 10 - USA Stop Tax Haven Abuse Act, 2009: A brain-storming session for us

Triplet 10

USA Stop Tax Haven Abuse Act, 2009: A brain-storming session for us

By Shiva Kant Jha

March 20, 2009

ON March 2, 2009 Senator Levin introduced the Stop Tax Haven Abuse Act, 2009 (the ‘Bill'), and on the next day a companion bill was introduced in the House of Representatives. Netizens can go through the text of the bill, and its excellent Summary released by Levin himself on that day. An expert has summarized its effect thus:

“contains numerous provisions generally intended to prevent US taxpayers from holding assets in accounts of financial institutions located in so-called tax havens without disclosing the existence of those accounts to the Internal Revenue Service, as well as certain other provisions intended to address perceived abuses of offshore tax planning.”

The purpose of this leaf in this Triplet is to shed some light on some of its provisions which even we should consider. The major provisions of this Bill are:

(i) Establishment of rebuttable presumptions for entities and transactions in Offshore Secrecy Jurisdictions;

(ii) The provision of an initial list of 34 Offshore Secrecy Jurisdictions, and the grant of authority to the Treasury Secretary to add or subtract from the list using certain criteria;

(iii) Authorization of special measures against foreign jurisdictions, financial institutions, and others that impede U.S. tax enforcement; [This complements §311 of the Patriot Act.]

(iv) The treatment of foreign corporations managed and controlled in the United States as domestic corporations for income tax purposes;

(v) Provisions granting power to the US authorities to investigate involving Offshore Secrecy Jurisdictions, and contains specific provisions to increase disclosure of offshore accounts, transactions, and entities;

(vi) Provisions to prevent misuse of foreign trusts for tax evasion, and ensure transparency in the US-managed (directly or indirectly, or any analogous device), the offshore private funds, including hedge and private equity funds.

(vii) Codification of the economic substance doctrine;

(viii) Limitation on legal opinion protection from penalties with respect to transactions involving Offshore Secrecy Jurisdictions

The provisions like the above, and many others of remedial measures, are sought to be enforced under severely enhanced penal sanctions.

First, the Presumptions. The US Bill seeks to prescribe presumptions to help the administration to deal effectively with the problems posed by the tax havens and the offshore finance centres. ‘These presumptions are needed in civil judicial and administrative proceedings, because the tax, corporate, or bank secrecy laws and practices of these jurisdictions make it nearly impossible for U.S. authorities to gain access to needed information. Presumptions may be rebutted by clear and convincing evidence. No evidence may be accepted from a non-U.S. person unless the person appears to testify in the proceedings.'

We have good reasons to believe that our government is not serious and sincere in protecting its national interests from loot the through the foreign routes. An instance of this remissness is deserves to be mentioned. Our Government mandated administratively the statutory authorities to be under blinkers. The CBDT No. 789 dated April 13, 2000 raises legal presumptions that the Certificate of Residence granted by the Mauritian tax authorities would establish the ‘residence' of its holder, and of the ‘beneficial ownership'. What the section 33 of The Mauritius Offshore Business Activities Act 1992 does in granting confidentiality against disclosure of information about beneficial ownership the Circular No. 789 does by creating a conclusive presumption. The holder of a Certificate of Residence is to be presumed as the beneficial owner of income. This illustrates the practice in tax havens to grant this certificate for fee in order to preclude any investigation into the question of residency of the entities operating from or through their jurisdictions. In Monaco a Carte de Sejour (residency permit) is granted on complying routine formalities which include an evidence of some deposit in a Monegasque bank. Would our Government get some enlightenment from the above, and consider withdrawing the above Circular?

The Bill has drawn up the initial list of 34 Offshore Secrecy Jurisdictions, and it grants the Treasury Secretary to add or subtract from the list using certain criteria. The list includes Bahamas , British Virgin Islands , Cyprus , Hong Kong , Liechtenstein , Malta , Luxembourg , Singapore , and Switzerland . We too have our tax treaties with many of them. The above list is drawn up in the light of USA 's own experience. We must examine operative realities from our own observation-post. I am sure if this exercise is done the pride of place would go to Mauritius . But the most worrisome problem that we face is that our citizenry is anesthetically naïve about what is happening to our country on account of the sharp and sullied operations from outside.

The US Bill authorizes special measures against foreign jurisdictions, financial institutions, and others that impede U.S. tax enforcement on the analogy of the protocol established by the Patriot Act imposing financial sanctions on foreign jurisdictions, financial institutions, or transactions found to be of “primary money laundering concern”. This approach to protect national interest is in tune with the US view of international law which justifies actions for the promotion/protection of the US interests wherever these are.

The most important provisions in the Bill prescribe the circumstances under which the corporate shell can be ignored for the proper administration of tax laws, and steps can be taken against the scuttling of other legal provisions pertaining to law enforcement. This is proposed to be done (i) by ignoring the corporation's ‘incorporation' as the sole test of ‘residence' and (ii) by adopting the doctrine of Economic Substance in the interpretation and implementation of legal provisions. The provisions of the Bill codify and strengthen the economic substance doctrine to invalidate transactions that have no meaningful economic substance or business purpose apart from tax avoidance or evasion. Also the Bill increases penalties for understatements attributable to a transaction lacking in economic substance. In fact, these ideas illustrate the development in jurisprudence from the analytical to the functional as is illustrated by the judicial approaches in the two leading cases, one decided by the House of Lords ( Furniss v. Dawson ) [1984] 1 All ER 530 and the other decided by the U.S Supreme Court ( Knetsch v. United States) 364 US 361 (1960). Corporate personality, which ‘incorporation' brings about, is designed to operate within its permissible province. It cannot be allowed to become an impervious coverlet, a hard shell, for pursuing interests contrary to law, or public policy. The 1986 decision of the Bundesfinanzhof in German jurisdiction: the doctrine of the abuse of legal form ( Philip Baker in Double Taxation Conventions and International Law 2ed. p. 101) had been recognized

We all know that during this phase of Economic Globalization, the strategy and the stratagem of the rogue financial system is promoted mostly through treaty provisions. Our country suffers from the worst sort of ‘democratic deficit' as the tax treaties are done exclusively under the Executive's opaque system without Parliament knowing anything about them. In the USA there is to a great extent legislative supervision and control of treaty-making. Yet the USA is not comfortable with the arguments put forth by Geoff Cook, the Chief Executive of Jersey Finance: "We believe we have nothing to fear because we are not a secrecy jurisdiction. We co-operate fully with US authorities to exchange information in accordance with our bilateral agreements." The specious plea that the parties act in “accordance with our bilateral agreements" is not acceptable. In our country this argument has received even judicial approval! A sinister provision can be crafted in a treaty to promote a sinister objective pleading that there is nothing wrong as there is no transgression of treaty terms. It is high time for us to remove all the undesirable rucks through legislation as being done in the USA .

Under the US Constitution it is established that if a Federal legislation conflicts with a prior treaty, the legislation always prevails, though if a Federal legislation conflicts with a subsequent self-executing treaty, the treaty prevails. It has been authoritatively held that no agreement can derogate from the Constitution [ Reid v. Covert ILR 24 (1957)]. Hence the terms of all treaties would stand subjugated to the Act, if this Bill is enacted. In our country the law on the point is yet to be declared by our Superior Courts. The obiter observations abound; and these seem to suggest that the treaties can even override the statues. But this solution illustrates ‘democratic deficit' of the worst sort, and is contrary to the provisions of our Constitution. This issue is at the heart of the matter in the Writ Petition before the Delhi High Court ( in Writ Petition 1357 of 2007 ) questioning the constitutional competence of our Government to enter into certain treaties. Let us see what happens.

This writer hopes that our Government learns some good lessons from the US Bill, and frames statutory provisions to settle norms to ensure transparent conduct in the affairs emanating from the tax havens and offshore finance centres. It should also endeavour to seek revision of treaty terms. Something deserves to be done before it is too late.


Our Dismay

Misuse of Indo-Mauritius Double Taxation Convention

DURING the last term in office Mrs Gandhi was too much fatigued and too much pre-occupied with political problems to understand how the system was being massively abused by businessmen, politicians and bureaucrats to further their ends. Corruption was endemic in our system but during these fading years of Mrs. Gandhi's regime it grew alarmingly. Perhaps some persons wielding powers worked for closer co-operations with tax havens so that their fruits of corruptions could be kept safe, and in due course laundered into our system well washed of taints. Need for foreign exchange was made the ground for so doing. Prime Minister Mrs. Indira Gandhi visited Mauritius . The Indo-Mauritius DTAC was negotiated in August 1982 though the Government of India notified its commencement in the domestic jurisdictions in 1983. Both India and Mauritius had their reasons to adopt the OECD Model of tax treaty. The obvious reason was that both the countries were facing balance of payments crisis. Mauritian economy was in under severe economic constraints. “For its size, Mauritius was one of the world's most indebted nations, with debts amounting to Euro 432 million in March” [ Britannica Book of the Year 1984, p. 521]. There are good reasons to believe that the lobbyists, the politicians and the bureaucrats had a conscious design to misuse the Mauritius route. It is a different matter that what was a mere trickle in the early eighties became a flood in the 1990s and thereafter. After the opening up of our economy and the onset of globalization the treaty shoppers and other masqueraders turned the DTAC into a rogue's charter. Mauritius facilitated such operations by transforming itself as a tax haven and an offshore financial services centres tailor made for the operators in India. It evolved a legal regime ensuring secrecy, and provided all the scope for tax minimization and evasion.

There are good reasons to believe that the Income-tax Department was greatly worried to prevent the misuse of the Mauritius route, but it could do nothing for long on account of continuous discouragement by the political bosses, and the tough lobbying by the Mauritius government and those who profited by sailing with it. But some remarkable officers did their duty well in March 2000. They dexterously investigated twenty four cases of FIIs and passed quasi judicial orders. A hue and cry was raised by the lobbyists. The share market was manipulated to stress their point that such order would jolt our economy and would create immediate and obvious road blocks to the economic develop. And then the CBDT issued Circular No. 789 of April 30 of 2000 directing the Assessing officers not to investigate the affairs of the non-residents operating through Mauritius, and to treat them the residents of Mauritius accepting the certificates of residence as granted by that country What happened in India was very precisely stated by Dr. Sol Picciotto at the a Seminar on Money Laundering, Tax Evasion and Financial Regulation Transnational Institute at Amsterdam:

“Investments through Mauritius accounted for the largest share of foreign direct investments (FDI) into India at nearly 40% of the total, between 1991 and 2002. Under the India-Mauritius tax treaty of 1983, India relinquished the right to apply taxes on capital gains (including on sale of shares) to residents of Mauritius (which does not tax such gains). An attempt in 2000 by some Indian income tax officers to challenge the application of this exemption to investments using `shell' companies, on the grounds that they should not be treated as bona fide residents there, resulted in a sharp fall of capital inflows, causing the Finance Minister to issue a Circular specifying that a certificate of residence issued by the Mauritian authorities would be sufficient to claim the treaty benefit. ….”

Writing in 2007 the Professor updates the account thus:

“The Indian government has attempted to establish arrangements with the authorities in Mauritius to ensure that they do not issue certificates to entities controlled by Indian residents, but it is hard to ensure that this effectively blocks round-tripping.”

A PIL was filed against the noxious circular before the Delhi High Court which quashed it by holding that “an abuse of the treaty or Treaty Shopping is illegal and thus necessarily forbidden” and “No law encourages opaque system to prevail.” The Court looked into the OECD's Harmful Tax Practices Report 1998, and the Report of the FSF Working Group on Offshore Centres 2000 describing the features and uses of such centres. The Court allowed the Writ Petition with cost observing in its judgment:

“We would however like to make an observation that the Central Govt. will be well advised to consider the question raised by Shri Shiva Kant Jha who has done a noble job in bring into focus as to how the Govt. of India had been losing crores and crores of rupees by allowing opaque system to operate.”

But on appeal, the Supreme Court reversed the aforesaid decision. However, the Supreme Court appreciated that the Convention was abused, and it suggested that appropriate remedy could be provided by the Executive or the Parliament of our country. The Judgment was delivered on 07-10-2003 but till this date neither our Executive nor Parliament has done anything in the matter.

It is clear on good evidence that our government itself acted as the facilitator in turning Mauritius into a tax haven and offshore finance centre with all the features which characterize such centres world over. Dr Sol had made a deep study of the problems posed by such centres. He had discussed various aspects of the matter with me also when he had visited India , and recorded my interview me after the Supreme Court decision. Dr. Sol has made a very insightful observation while examining the question “Can Offshore be Controlled?” He writes:

“… the phenomenon of offshore operates in interaction with ‘onshore'. By providing facilities for avoiding or evading laws or regulations of other countries, it under-mines and puts pressure on them. The convenience of offshore facilities can be used both to conceal outright illegal activities, and to make it easier to negotiate the often indeterminate requirements of regulations whose ambiguities reflect legal and moral uncertainties. At the same time, as the examples in the previous section show, the facilities offered offshore have often been developed with the tacit approval and encouragement and even active support from some authorities onshore. This makes it very hard to develop clear, consistent and above all coordinated policies towards offshore.”

The aforementioned apprehension is well supported by the facts in the public domain. The Finance Minister, who had helped establish an opaque system for the goings-on through the Mauritius route, was of the BJP-led Government. The counsel who represented a Mauritian silhouette before the Supreme Court was a leading BJP politician. This Convention was made at the initiative of the Congress government which tolerated its misuse by being indifferent to all criticism. It, despite its commitment in its the Common Minimum Programme, has done nothing to stop the misuse of the Mauritius route, rather it has opened some more routes. The problem has been evaded just by denying its existence. The Wikipedia has a point when it says: “Mauritius - based front companies of foreign investors are used to avoid paying taxes in India utilizing loopholes in the bilateral agreement on double taxation between the two countries, with the tacit support of the Indian government, who are keen to improve figures relating to inward investment. The use of Mauritius as a gateway to funnel foreign investments into India has always been controversial. Mauritius 's financial regime has a number of the key characteristics of a tax haven, which has helped to facilitate this.” The great Tulsi Dass counseled us not to delve too much on what is unseemly. So I proceed no further. But I would end this leaf with these lines from the Gita :

atmai 'va hy atmano bandhur
atmai'va ripur atmanah.

[ We are our own friends; we are our own foes.].


But Hope still survives

NOW it is high time for us to remove the shadow which has shrouded the reality. Those, who allowed themselves to be led by the proponents, protégées and hirelings of the neo-liberal paradigm, should learn from what is being done under the creative leadership of Obama. In Homer's Odyssey Penelope was sustained by hope till her difficult time was over. Democracy itself is sustained on hope. Concluding his Modern Democracies (Vol II p. 670 ) Lord Bryce had perceptively observed:

“Hope, often disappointed but always renewed, is the anchor by which the ship that carries democracy and its fortunes will have to ride out this latest storm as it has ridden out many storms before.”

We hope that our Government would not be able to evade the trends of times for long . The wielders of power must accept what the Delhi High Court had said: “ No law encourages opaque system to prevail.” We hope soon a new chapter would begin. - Links on Shivakantjha - Links on Shivakantjha

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