Business

Sri Lanka’s tax haven plan and EU’s money laundering blacklist

By Madhusha Thavapalakumar

Stringent import restrictions and a new tax on Lanka Indian Oil Corporation (LIOC) to prevent them taking colossal sums of profit out of the country in US dollars (USD) are two of the many measures that were taken by the dollar-deprived Sri Lankan Government in late March and early April to mitigate a possible foreign exchange crisis in the country.

However, the most noteworthy, and controversial, measure the Government took was to invite expatriate Sri Lankans and local and foreign investors to deposit foreign currencies in any approved commercial bank in Sri Lanka under a Special Deposit Account (SDA) scheme that provides 2% extra interest rate per annum.  

This proved controversial because it was said that no questions will be asked about the money, no tax will be charged from accountholders, and the money will be free from foreign exchange regulations. The Sunday Morning Business learns that this invitation has received a positive response, with many foreign investors depositing their money in Sri Lankan banks.

The idea is clear. The Government wants to position Sri Lanka as a tax haven, or an “offshore financial centre”, and benefit from the potential flood of foreign currency that it would bring in, especially at a time its foreign reserves are dwindling. While being a tax haven is not illegal, it leaves the door open for certain illegal activities. Furthermore, there are certain moral complications associated with tax havens.

Coincidentally, exactly a week after the Government’s invitation to depositors, Sri Lanka was removed from the European Commission (EC)’s list of High-Risk Third Countries with Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) Strategies Deficiencies. This was achieved after over two years of serious efforts and a commitment to transparency. Now, this new tax haven plan has raised concerns that Sri Lanka could end up back on this list.

So is this a good idea or not? Let’s explore.

 

What is a tax haven?

A tax haven is a country that offers little or no tax liability for investments from foreign individuals and businesses, and shares limited or no information about investors with tax authorities.

Characteristics of tax haven countries generally include: no or low-income taxes, minimal reporting of information, lack of transparency obligations, lack of local presence requirements, and marketing of tax haven vehicles.

As European Parliament notes, tax havens have one thing in common: They make it possible to escape taxation. Distinctive characteristics of tax havens include low or zero taxation, fictitious residences (with no bearing on reality), and tax secrecy. The last two are key methods for hiding ultimate beneficial owners.

Top tax havens in 2015

There are several regulatory bodies that monitor tax haven countries, including the Organisation of Economic Co-operation and Development (OECD) and the US Government Accountability Office (U.S. GAO).

A list of some of the most popular tax haven countries includes: Andorra, the Bahamas, Belize, Bermuda, the British Virgin Islands, Cayman Islands, Channel Islands, Cook Islands, Island of Jersey, Hong Kong, Isle of Man, Mauritius, Lichtenstein, Monaco, Panama, St. Kitts, and Nevis.

Tax havens are mostly islands and their tax structure is different from one another. Luxembourg gives benefits such as tax incentives and zero percent withholding tax while Singapore charges reasonable nominal corporate taxes. The Channel Islands have no capital gain taxes and no council taxes. Mauritius has low corporate tax and no withholding tax while Switzerland has full or partial tax exemptions depending on the bank used.

 

The SDA and loopholes

According to the Central Bank of Sri Lanka (CBSL), the SDA will not be subject to any foreign exchange regulations published in Gazette Notification No. 2045/56 dated 17 November 2017 and it is anyway in contradiction to the provisions of the act.

The new Foreign Exchange Act was introduced to provide for the promotion and regulation of foreign exchange and to vest the responsibility of promoting and regulating foreign exchange in the CBSL.

As per the eligibility requirements issued by the CBSL, any Sri Lankan resident – foreign or local, dual citizens, citizens of other states with Sri Lankan origin, non-national resident in or outside Sri Lanka – funds, corporate bodies, associations incorporated or registered outside Sri Lanka or any other well-wishers, are eligible for this scheme. The aforementioned act does not mention “well-wishers” in any place.

A wide range of foreign currencies are accepted by the SDAs

Furthermore, the SDA does not comply with a minimum deposit threshold imposed by the Act as it does not have a prescribed limit. The maximum period of the deposit should be a minimum of six months and the interest is paid upon maturity. In terms of the interest rate, 1% additional per annum is paid for six-month fixed deposits and 2% for 12-month fixed deposits.

The acceptable foreign currencies are the USD, Euro, Sterling Pound, Australian dollars, Singapore dollars, Swedish krona, Swiss franc, Canadian dollars, Hong Kong dollars, Japanese yen, Danish krone, Norwegian krone, Chinese renminbi, and New Zealand dollars.  

 

Why are we doing this?

The Government is in dire need of foreign exchange earnings for its external financing as its usual dollar-earning streams have been completely or mostly cut off due to the ongoing pandemic. Export earnings, worker remittances, and tourism earnings are the top three dollar income sources of Sri Lanka. However, since the closure of the Bandaranaike International Airport (BIA) in mid-March and strict restrictions for foreign citizens on air travel by their respective countries, Sri Lanka tourism plunged to zero level, effectively not recording any earnings up to now.

Meanwhile, worker remittances dropped drastically as global lockdowns necessitated by the global pandemic have either forced companies to layoff their employees or send them home on compulsory no-pay leave or to slash their salaries. Furthermore, export earnings too is expected to witness a massive drop this year due to the hardship in getting down the required raw materials from other countries and sending exports to international markets as most of them are either still closed or opened only partially.

These myriad difficulties compelled the Government to think of alternative options for dollar income and they finally came up with a controversial SDA offering higher interest rates and so much freedom, that could potentially make Sri Lanka a tax haven, providing long-term solutions to foreign exchange issues.  

 

The benefits of being a tax haven

Being a tax haven can result in enormous benefits for developing economies, including the possibility of achieving a higher employment level as tax incentives attract businesses to invest in the country. This is particularly attractive to countries with a narrow resource base that tend to have chronic unemployment problems.

According to the Corporate Finance Institute (CFI) in Canada, tax havens benefit by way of attracting capital to their banks and financial institutions that can be used to build a thriving financial sector.

Some of the 50 biggest US companies that have stashed approximately $ 1.6 trillion offshore include Microsoft, IBM, General Electric, Pfizer, Exxon Mobil, Chevron, and Walmart. These 50 companies earned over $ 4.2 trillion in profits globally, but used offshore tax havens to lower their effective overall tax rate to just 25.9%, which was well below the US statutory rate of 35%, and even lower than the average levels paid in other developed countries, according to the CFI.

Apple Inc. is an American multinational technology company that has $ 214.9 billion offshore money and the company uses Ireland as a tax haven. CFI states that Apple would have owed the US Government $ 65.4 billion in taxes if tax haven benefits were not used.

Nike, a footwear manufacturing company, holds $ 10.7 billion offshore. It uses Bermuda as a tax haven. It would have paid $ 3.6 billion in taxes if tax havens were not used.

 

The drawbacks and dangers

According to an International Monetary Fund (IMF) report, the problems created and constraints imposed by the tax haven status vary according to the degree of development of the country, the size and composition of its tax haven sector, and the kind of benefits granted to this sector. Nevertheless, leeway given by tax haven countries to depositors have the potential to attract black money into the country.

Black money has serious repercussions in an economy as it gives life to a parallel economy powered by black money, and this economy might ruin the entire economic development of a country. Furthermore, it would result in underestimation of the true size of an economy as unreported economies will be excluded from the national data.

Moreover, black money is largely attributed with tax evasion and it would result in a government failing to achieve the desired tax revenue; meanwhile, black money would certainly widen the gap between the rich and the poor and deteriorate the moral standard of that particular society.

In March 2018, it was revealed that the amount of Indian black money currently present in Swiss and other offshore banks is estimated to be $ 1,500 billion

In March 2018, it was revealed that the amount of Indian black money currently present in Swiss and other offshore banks is estimated to be $ 1,500 billion. According to the 2015 Financial Secrecy Index – a comprehensive survey on global financial secrecy – Switzerland ranks number one in the list of countries with black money, followed by Hong Kong and the US.

These countries deposit most of their black money in offshore accounts and this SDA is believed to present an easier option for them and any individual with black money.

Money laundering allows drug traffickers, smugglers, and criminals to expand their operations and effectively transfers economic power from the government to criminals, according to reports. Black money is money earned through any illegal activity controlled by country regulations.

 

Possibilities of being blacklisted

Almost all of the tax havens have made to the European Union (EU)’s blacklist of tax havens at least once, due to non-compliance with EU regulations and increased black money into the economy. Seychelles, a top tax haven, was listed amongst the 30 countries blacklisted as tax havens by the EU in 2015 and so did Nauru, a small pacific island tax haven.

Mauritius, home to more than 32,000 offshore entities, was blacklisted by the EU in 2015 and after years of stringent measures, it finally exited the list in October last year. Malta was no different as it too made it to the 2015 list and had to outlaw letterbox companies that are used for tax avoidance and hiding the identities of wealth tax payers. Dutch Caribbean island Curacao was grey-listed by the EU in 2017 for lack of transparency.

The negative effects of being blacklisted can be quite considerable, with huge inconveniences being the least of them; the more severe effects include loss of credibility and goodwill, a decline in business and clients, and financial hardship.

Despite many advantages of being a tax haven, naming and shaming by the EU is alone powerful enough to make investors lose confidence over the country.

Being blacklisted certainty discourages any possible financial transaction or investment. If a company tries to send or receive money to or from a blacklisted country, the transaction is highly unlikely to be successful. This is because the processing bank and/or funding bank will almost certainly reject the transaction, in line with rules on sanctions against the blacklisted country.

Therefore, the pertinent question now would be how can Sri Lanka become a tax haven without being listed on the money laundering blacklist or the EU’s tax haven blacklist?

The secrecy offered by tax havens provides advantages for non-residents by shifting income away from its actual geographical source, and as a result reduces the tax base in the country in which they are tax residents. This key feature also provides opacity not only for tax purposes but also for illegal and criminal activities such as money laundering and a range of criminal activities.

The Financial Action Task Force (FATF) is an intergovernmental body that sets the global standards for anti-money laundering and counterterrorist and proliferation financing, and the EU refers to the FATF when preparing a blacklist of tax haven countries or money laundering blacklists. Tax evasion is a predicate offence for money laundering under these standards. That means that implementing the FATF standards supports efforts to stop tax evasion.

The FATF standards include criminalising money laundering on the basis of the Vienna Convention on the Law of Treaties and the Palermo Convention (United Nations Convention against Transnational Organized Crime [UNTOC]). Countries should apply the crime of money laundering to all serious offences, with a view to include the widest range of predicate offences. Furthermore, Countries have to ensure that financial institution secrecy laws do not inhibit implementation of the FATF recommendations.

The EU suggests regulatory measures allowing traceability and the sharing of information concerning the movement of financial transactions and other relevant information, within the framework of anti-money laundering efforts, in particular through customer due diligence obligations as they are appropriate tools for counteracting these practices.

 

How did we get in, and get out last time?

Exactly a week after the Government’s invitation to depositors, Sri Lanka was removed from the European Commission (EC)’s list of High-Risk Third Countries with Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) Strategies Deficiencies.

In February 2018, Sri Lanka was added into the European blacklist along with Tunisia, Trinidad, and Tobago. The Commission re-published their list in February 2019 with Sri Lanka being included amongst 23 countries with strategic deficiencies in their money laundering and terrorist financing regimes that, as the EU believed, might cause troubles to their financial system.

Soon after the listing, the CBSL headed by then Governor Dr. Indrajith Coomaraswamy, implemented measures under the Financial Intelligence Unit (FIU). They worked on bringing in laws to monitor areas with possible money laundering and supervision of casinos and gem businesses, into which black money is pumped most of the time.

Sri Lanka was given time until March 2019 by the Commission to fulfil the requirements and somehow, the country managed to exit the list after almost two-and-a-half years last month, while the FATF delisted Sri Lanka from its Compliance Document (aka. “the Grey List”) at its Plenary held during 13-18 October 2019 in Paris, and removed Sri Lanka from the EC’s blacklist last month.

“It is expected that the de-listing by (the) FATF and EU will negate the adverse consequences that prevailed during the previous two years and further strengthen the positive economic outlook and financial integrity of the country,” the CBSL noted in a statement soon after delisting.

 

Concerns expressed

Several bodies expressed their concern over the Government’s move to announce the SDA which has possibilities of attracting black money. The most notable institution amongst them was Transparency International Sri Lanka (TISL), a national chapter of Transparency International, a leading global movement against corruption.

TISL Executive Director Asoka Obeyesekere said that at a time when there is an unprecedented lack of parliamentary and judicial oversight on government actions, coupled with limited proactive disclosure of information, corruption risks and vulnerabilities are exacerbated. Therefore, it would be unwise for a caretaker government to implement policies which could encourage money laundering, with potentially far-reaching detrimental effects to the Sri Lankan economy.    

It is notable that an invitation was extended by then Finance Minister Ravi Karunanayake in late 2015 to local and foreign investors to deposit foreign exchange in Sri Lanka in special accounts with premium interest rates.

TISL’s opposition came exactly a week after the Government’s invitation to depositors and on the exact day of delisting of Sri Lanka by the European Commission. Therefore, the major concern of TISL was that Sri Lanka was only removed from the “Grey List” of the FATF late last year after serious measures and steps. They also mentioned that “no questions asked” policies on foreign deposits could have had a negative impact on the country’s ability to attract bona fide investment.

Furthermore, TISL noted that this contravenes FATF recommendations which set the international standards on combating money laundering, requiring reasonable measures to be taken to ascertain both sources of wealth and sources of funds.

In its report “Covid-19-related Money Laundering and Terrorist Financing: Risks and Policy Responses”, published last month, the FATF continues to recommend risk-based supervision of transactions, which would be contrary to any “no questions asked” policy. Countries with escalating money laundering exposure risk FATF blacklisting, which has far-reaching consequences on domestic banking and economic activity.

 

Conclusion

Tax havens by nature are a great way of nourishing an economy that is in dire need of foreign exchange and they are certainly not illegal but are certainly controversial. As a coin has two sides, tax havens too have their own pros and cons and in its entirely dependent on the way respective governments handle tax haven regulations.

If Sri Lanka is to make sure that they are not getting back into the European Commission’s blacklist for money laundering, the European Union’s blacklist of tax havens, or the FATF’s “Grey List” of money laundering, the country needs to take stringent actions before the European Commission or the European Union issue warnings.