What's the fuss about offshore entities?

 

What's the fuss about offshore entities?

"Multinational entities are facing increasing pressure by civil society organization's and from international organization's like the OECD to stop aggressive tax planning and profits shifting. The usual justification for this pressure is that tax avoidance practices rob home countries (usually third world countries) of much-needed revenues. It is hard to see a reason why the same ethical standard should not be applied to politicians and political office holders who supposedly act in the public interest."

Introduction

Recently, the International Consortium of Investigative Journalists (ICIJ) leaked the Pandora Papers, which named over 50 African politicians and public officials in various dealing in offshore entities. The records came from 14 offshore services firms from around the world, which according to the ICIJ; set up “shell companies and other offshore nooks for clients often seeking to keep their financial activities in the shadows”.[1]

At the same time, the ICIJ declaims any liability or implication that those named in the Papers have breached any law. In fact, the ICIJ admits, “there are legitimate uses for offshore companies, foundations and trusts. We do not intend to suggest or imply that any persons, companies or other entities included in the ICIJ Power Players interactive application have broken the law or otherwise acted improperly merely by engaging in offshore activities”.[2]

What are offshore entities?

Ordinarily, an offshore entity is an entity that is located in a different country from the country where its beneficial owners reside. However, an offshore entity is not simply a controlled entity located or carrying on business overseas (like a foreign subsidiary). What makes an offshore entity one is the fact that its assets, profits or incomes are substantially derived from business activities or transactions conducted in a different jurisdiction.

Since offshore entities have minimal business activities (hence the name, shell companies), their promoters do not usually consider factors like physical infrastructure or a strong regulatory framework in the offshore jurisdiction. Instead, promotors of offshore entities have other factors that are important to them e.g. low set up costs, low compliance costs, low or no taxes, minimal or no disclosures etc. – typical features of tax havens

By their features, offshore entities are corporate vehicles for tax avoidance – legally permissible arrangements to minimise one’s tax liability. Tax avoidance is legal and it still rings true that, “no man is…under the smallest obligation moral or otherwise so to arrange his legal relations to his business or to his property as to enable the Inland Revenue to put the largest possible shovel into his stores…And the taxpayer is in like manner entitled to be astute to prevent, so far as he honestly can, the depletion of his means by the Inland Revenue”[3].

However, while this statement may have been true without qualification when it was made about a century ago, the modern trend in international tax governance has tended towards combating aggressive tax avoidance. The Base Erosion and Profits Shifting (BEPS) Project and its Inclusive Framework (to which Nigeria is a signatory) aims to address issues of profit shifting and tax avoidance. Multinational entities are facing increasing pressure by civil society organisations and by international organisations like the OECD to stop aggressive tax planning and profits shifting. The usual justification for this pressure is that tax avoidance practices rob home countries (usually third world countries) of much-needed revenues. It is hard to see a reason why the same ethical standard should not be applied to politicians and political office holders who supposedly act in the public interest. 

At the same time, offshore entities are lawful structures for estate planning. An investor may want to take advantage of a favourable or enabling regulatory regime in an offshore jurisdiction, for example, the regulatory sandbox for FinTechs in Nigeria.

However, the features of offshore entities also make them a ready tool for escaping local laws and regulations particularly those combating illicit financial flows, money laundering and the financing of terrorism. Offshore tax havens are conducive for these activities but do not provide the sole incentive. Offshore entities by themselves can offer opaque and virtually impenetrable legal arrangements.

Offshore entities and transparency

Arguably, the biggest argument against offshore entities is not that they shield taxable profits from tax authorities. It is that they provide an avenue for financial secrecy, and secret finances tend to be used to finance illegal activities. Laws and regulation aimed at combating money laundering, terrorism financing and other illicit activities rely heavily on disclosure and reporting mechanisms to manage the risks from illicit financial activities. Offshore entities on their part, may not only obscure beneficial ownership but also build opaque structures virtually impenetrable to regulatory authorities. Take trust for example. Ideally, a trust involves a legal arrangement allowing one person to vest an asset in a second person who holds and manages it “in trust” for a third person. However, depending on the arrangement, all three persons may be one person. It is possible for the settlor of a trust to set up a trust of assets with the same settlor as trustee and yet the same settlor as beneficiary.

This is significant because while most corporate entities are required to register, trusts (private trusts) are not required to be registered in many jurisdictions. In fact, a form of trust, secret trust, essentially keeps the object of the trust secret from not only outsiders like regulatory authorities but even the beneficiaries. Where trusts are registered, their legal structure protects them from disclosing the settlor who created the trust or the beneficial owners of the trusts. This is assuming that both settlor and beneficiary are not the same natural or legal person such that the trust object or assets are stuck in limbo legally belonging to neither settlor nor beneficiary and equally unreachable by regulatory authorities. When convoluted related entity structures are added to this mix, the result can be confusing for regulatory authorities and very conducive for international criminal activity.

Secrecy or privacy

Secrecy and privacy appear to be two distinct concepts but both are often used interchangeably in the offshore entities debate. Many of those named in the Pandora Papers have alleged a breach of their privacy. One thing is clear however – while there is a legal right to privacy, there is no right to secrecy. The Nigerian Constitution, for example, guarantees the privacy of citizens, their homes, correspondence, telephone conversations and telegraphic communications.[4] Individuals have to right to a private life and “the right to live in isolation of others…the right to protect one’s social, interpersonal relationships…from public glare”.[5] Individuals also have a right to data privacy – a subset of the right to privacy, which safeguards the right of natural persons to control the use of their personal information.

The right to privacy is not without limitations, though. A common limitation to the right to data privacy is where there is a legal basis for the collection, storage or disclosure of personal information. Under the Nigerian Data Protection Regulations (NDPR), processing of personal information in the public interest does not require the consent of the data subject.[6] Further, the law may place an obligation on people to disclose their own personally identifiable information. It may also place disclosure obligations on other persons who control the personal data of a data subject. This will not be a breach of data privacy or the right to privacy.

Disclosure obligations are aimed at preventing financial secrecy in the public interest. This is why the law imposes disclosure or reporting obligations on certain public interest entities, public officials, persons with political affiliations (Political Exposed Persons or PEPs)[7], and even high net-worth individuals (HNIs). Compared to ordinary citizens, these persons (whether they are legal or natural persons) have greater responsibility imposed by law to be open, fair and transparent presumably because the risk of financial crime is greater with them.

Another issue for debate is whether journalists like the ICIJ are breaching the private lives of the individuals, which they have exposed in the Pandora Papers. Granted that the right to privacy, data privacy and data protection is universal for all individuals, yet, the thresholds of privacy for a public person is not the same for a private person. Public persons (celebrities, politicians etc.) are subjects of public discuss and their business and personal lives are usually public knowledge.  Importantly, US and UK courts have upheld the public’s right to know, and the freedom of the press to inform about public persons who can serve as a legitimate interest to the public.[8] Notwithstanding, journalists’ right to freedom of expression are subject to them “acting in good faith and on an accurate and factual basis”.[9]

Conclusion

Offshore entities are neither illegal nor unethical in themselves. However, a problem arises when complex offshore entities are exploited to bypass financial disclosure and reporting obligations including disclosure for tax purposes. While some may argue that exploiting offshore structures to minimise taxes is legal, there is a growing consensus that tax avoidance is unethical.

Further, although offshore entities are not illegal, their often secret nature makes them a ready tool for crime. In this regard, the onus rests on regulatory authorities in home jurisdictions to tighten disclosure requirements for PEPs and other categories of high-risk persons. Thus, it is in order for regulatory authorities and law enforcement agents to investigate any person of interest named in such leaks as the Pandora Papers.

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