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Clear and Present Danger: Money Laundering and Tax Havens Countries June 14, 2013

Posted by maskokilima in Sekolah, Tax.
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Introduction

The most common financial crimes concerned by all government in the world today are Money Laundering and abusive Tax Havens. The social and economic consequences of these crimes are very serious. Schneider and Windischbauer (2008) state that two to five percent of the global GDP (about $590 million to $1.5 trillion) stems from illicit sources need to be laundered[1]. According to American and British government, by tracking money linked to financing of planned attacks, terrorist attacks in Bali and Heathrow was successfully thwarted (Kumar & Campbell 2009). On other hand, abusive tax havens are blamed for hiding untaxed income from both tax authorities and law enforcement (Manning 2005). From those examples, we can see how big the social and economic effects of money laundering and tax havens because they are related with crimes, drugs and terrorism.

This paper will discuss money laundering and abusive tax havens, the characteristics, examples of money laundering and tax havens activities, regulatory reforms, investigations and regulatory activities to combat money laundering and tax havens in Indonesia.

Money Laundering

Chaikin (1992, cited in Chaikin 2008, p 273) describes money laundering as:

“the process whereby the ownership or control of assets and income is obscured or concealed from tax authorities, law-enforcement agencies or private parties, who have a legitimate interest in discovering the true beneficial owner or controller of such assets/income.”

On the other hand Manning (2005, p 309) simply defines money laundering as “washing proceeds so as to disguise their true source.” From those definitions we can conclude that the main objective of money laundering is to change the character of money (from bad source to legitimate source) while sheltering it from detection and taxation.

Money laundering itself originates from the US describing the Mafia’s attempt to ‘‘launder’’ illegal money via cash-intensive washing salons, controlled by company acquisitions or business formations (Schneider & Windischbauer 2008). However, in USA money laundering was not considered a crime until the 1980s, when Congress passed a series of law that made it a crime (Manning 2005). Though anti-money laundering efforts were initially aimed at thwarting the proceeds of illegal drugs trafficking, today, a range of profitable criminal activities are targeted including the illegal sales of weapons, human trafficking, fraud, political corruption and the financing of terrorism (Newland, 2008).

abc money launderingLaundering dirty money attracts not only criminals but also legitimate business corporation. According to Blum, Levi, Naylor and Williams (1998)[2], criminals must launder the money flow for two reasons. The first is that the money trail itself can become evidence against the perpetrators of the offence; the second is that the money per se can be the target of investigation and action. On the other hand, legitimate business corporation might also have recourse to the techniques of laundering whenever they need to disguise the payment of a bribe or kickback. In fact even Governments make occasional use of the same apparatus, evade the impact of sanctions or covertly fund political interference in some rival state (Blum et al. 1998).

Money laundering basically shows the following three stages: placement, layering and integration (Wells 2003; Schneider & Windischbauer 2008). Figure 1 shows the Money Laundering stages. The first stage, placement, is when the cash come from illicit source being placed into the financial system. This money is then converted into book money (primary and secondary deposit) which is finally followed by a layering process. The second stage are used to veil the origin of the money by creating complex financing transactions between different states and piling up several layers of dealings. The last stage will convert the money into outwardly visible assets through investments in a business, industrial enterprise or tourism project, and the expected result is no connection between the fund and the crimes behind the crimes.

Tax Havens

            Tax havens are applied to countries, jurisdiction and territories that offer favourable tax regimes for foreign investors (Dharmapala 2008; Kudrle 2009). However, Organization for Economic Cooperation and Development-OECD (2010a) states at least four factors for identifying tax havens. The four factors are no or nominal tax on the relevant income; lack of effective exchange of information; lack of transparency; and no substantial activities. Further the OECD (2010a) explains that no or nominal tax on the relevant income is not sufficient in itself to classify a country as a tax haven.

            Manning (2005) explains the characteristics of tax havens countries as follows:

  1. Exchange control

Tax haven countries have little or no exchange control in their jurisdiction. It is common in tax haven countries to differentiate exchange control regulation between residents and non residents. In general residents are subject to exchange control, while non residents are not. This affords both organized crimes and multinational companies the ability to easily and quickly transfer funds without any interference.

  1. Banking

Most of the world’s banks have operation in tax havens. Banks offer the same type of services in tax havens as they do in other countries. However branch offices of international banks in tax havens have the ability to move funds swiftly and have better expertise in handling international transaction. Nonresident banks are only licensed to serve clients who are not tax haven residents.

  1. Bank secrecy

Secrecy is important element in tax havens. Tax haven countries have enacted various laws and set up regulatory agencies to control banking activities. The bankers are required to keep their customer’s affairs secret. Breaches of bank secrecy are a criminal violation.

  1. Stability

Political and economic stability is an important factor in tax havens. Neither businessmen nor criminal organizations want to do business with any country that is not politically and economically stable.

  1. Communications

Communications is another factor in selecting tax haven. To be able transfer funds quickly and easily, tax havens need good communication facilities. Dharmapala (2008) states that in 2004, the average telephone rate per capita in tax haven countries is 1 compare to non tax haven countries which is 0.5. Despite the total population in tax haven countries, this figure indicates that tax haven countries have good communication facilities compare to non tax haven countries.

  1. Corruption

This is a special characteristic of tax haven countries. International businessmen do not want to establish operations in tax haven country in which public official are corrupt. On the other hand, criminals have the opposite view. They want to make payoffs and kickbacks so the public officials will look the other way and will not interfere with their operations. So tax haven countries have to balance those views.

Slemrod and Wilson (2009) have additional interesting data regarding tax haven countries. From 35 listed tax havens in the world that represent 15% of total countries in the world, their total population comprise just 0.150% of the world population (Slemrod & Wilson 2009). Further, from those 35 tax havens countries, 27 of them are island nations (Slemrod & Wilson 2009). Figure 2 shows the map of tax or financial havens in the world.map financial havens

           There are many reasons for a country to become a tax haven. In fact the global community recognises that every country is entitled to run its tax system as it sees fit (ATO 2010). Some countries may offer low tax rate to attract investment and employing some of the local population or to transfer their skill to the local people (ATO 2010). However, Problems can arise when a country’s tax or financial system is secretive (ATO 2010). This lack of transparency can be harmful to the tax systems of other countries if it enables people to conceal their assets and avoid tax in their own country (ATO 2010).

Relationship between Money Laundering and Abusive Tax Havens

            Many people believe that criminals launder their dirty money in tax havens. This is based on the perception that while illicit money is being earned, criminals will attempt to ensure that it escapes the scrutiny of the authorities, including fiscal ones (Blum et al. 1998). Although tax evasion and money-laundering share several techniques and can be mutually supporting, it is important to understand that operationally they are quite distinct processes (Blum et al. 1998). Blum, Levi, Naylor and Williams (1998) state that Tax evaders under-state the earnings of their legal enterprises in their tax return, thereby paying less tax than they legally should. While criminals who launder their money, by contrast over-state the earnings of any legal enterprises they use for cover, therefore paying more tax than their legitimate front companies would normally be required.

            In addition, Mitchel (2003) concludes that although not every low-tax jurisdiction has a perfect track record, there is no evidence to suggest that tax havens are a magnet for dirty money. According to Mitchel (2003), criminals unlikely to rely on tax havens for three reasons. Firstly, it is difficult to transfer funds to tax havens unless the fund is already in bank, and if the dirty money is in bank, the laundering already has taken a place. Secondly it is significantly increases the probability of detection to transfer fund to offshore and then back onshore when the fund needed. Thirdly, terrorists are even less likely to utilise tax havens since they are motivated by hate rather than tax minimization and/or assets protection.

            Thus it can be conclude that the belief that criminals use tax havens to launder their money is not true. There is no or little relationship between abusive tax havens and money laundering.

Money Laundering Case

            This case was happen in USA in 2009 and available in Internal Revenue Service (IRS) website (2010).  The facts of this case based on evidence presented in trial and public record documents summarized by IRS (2010) as follows:

  1. From between 1998 and 2000, Shirland Fitzgerald, owner of Fitzgerald Auto Sales in Danville Virginia, used his car dealership to foster relationships with known drug dealers who trafficked in the Danville area by engaging in a scheme in which the drug dealers could purchase cars using money obtained through the sale of illegal drugs (IRS 2010).
  2. To further the scheme, Fitzgerald would disguise the identity of the true purchasers, create false paperwork and allow the drug dealers to make incremental payments of less than $10,000, avoiding the need to file a Federal 8300 form[3] (IRS 2010).
  3. Fitzgerald also structured his personal and business finances in such a way that all deposits totalled less than $10,000 (IRS 2010).
  4. Fitzgerald devised a false receipt system that showed no payments were ever made over $10,000 and created a false and fictitious interest free “financing system” that allowed the drug dealers to pay for vehicles over time (IRS 2010).
  5. In addition, Fitzgerald assisted his drug dealer associates in the sale of assets for the purpose of avoiding seizure and forfeiture of those assets by law enforcement (IRS 2010).
  6. On 11 August 2009, in Roanoke Virginia, Fitzgerald was sentenced to 140 months in prison to be followed by three years of supervised release. He was also ordered to forfeit $1 million, representing the approximate value of the funds he laundered for three large scale trafficking organization over a six-year period (IRS 2010).
  7. Eight associates of Fitzgerald were also charged for their roles in the scheme.  They have all been sentenced to terms ranging from 235 months in prison to 36 months probation (IRS 2010).

In that case, dirty money from drugs dealer was laundered through legitimate cars transaction. Drugs dealer in that case “washed” his money by purchased cars from Fitzgerald Auto Sales using the proceeds from drugs dealing. The car purchase transactions were using cash and the drug dealer made incremental payment of less than $10,000. The identity of true buyer also have been disguised by Fitzgerald, so from the cars’ registers, the law enforcement did not know the actual holder of those cars. Although US government have enacted the regulation to prevent money laundering activities such as Form 8300, this regulation was failed to prevent such thing because this form only applies to cash payment over $10,000 in one or more related transactions. By creating false paperwork, Fitzgerald could deceive the regulation and law enforcement.

 An Example of Tax Haven (Saint Lucia)   

            Saint Lucia is one of the tax havens in the world (Blum et al. 1998; OECD 2000; Dharmapala 2009), though on 19 May 2010 OECD decided to move Saint Lucia into the category of jurisdictions considered to have substantially implemented the standard on transparency and exchange of information (OECD 2010b). Therefore explaining Saint Lucia as an example of tax haven might be interesting.

            According to The World Factbook by US Central Intelligence Agency-CIA (2010), Saint Lucia is located in Caribbean. Saint Lucia is an island between the Caribbean Sea and North Atlantic Ocean, north of Trinidad and Tobago. Its population is 160,922 people (CIA 2010). Saint Lucia has an adequate telephone system, which is for international calls use the East Caribbean Fibre Optic System (ECFS) and Southern Caribbean Fibre Optic System (SCF) submarine cables, along with Intelsat from Martinique (CIA 2010).

            According to PricewaterhouseCoopers-PWC (2010), Saint Lucia enacted International Business Companies (IBC) Act of 1999. The IBC Act of St. Lucia was designed and based on other regional models and tailored to ensure effective regulation and flexibility (PWC 2010). The Act provides for the confidentiality of shareholders, directors and officers (PWC 2010). The only public records are the Memorandum and Articles of Association, the Registered Office and Registered Agents (PWC 2010).

            International businessmen who want to set up an IBC in Saint Lucia can register through internet at www.pinnaclestiucia.com or www.stiuciaoffshore.com and it takes only three to four hours to incorporate an IBC (PWC 2010). The annual fee for an IBC in Saint Lucia is $300 (PWC 2010) which is very low. IBC give many benefits such as  no minimum capital requirements for regular IBC, complete confidentiality of shareholders, directors and officers, complete exemptions from exchange controls and election to be exempt from income taxes or be liable to tax at the rate of 1% (PWC 2010).

            With so many benefits of IBC offered by Saint Lucia, it is not surprising that Saint Lucia become a major tax haven. The International Business Companies Act of 1999 provides the opportunity for international businessmen to gain low tax and perhaps evade their taxable income in their home country to Saint Lucia. The existences of no exchange control and complete confidential of shareholders, directors and officers in IBC actually make Saint Lucia become abusive tax haven because those regulations prevent other tax authorities and law enforcement to reveal the taxpayers’ assets and taxable income.

 Anti Money Laundering and Anti Tax Havens Regulatory Reform in Indonesia

            Indonesia was blacklisted as a Non Cooperative Country and Territory (NCCT) by Financial Action Task Force (FATF) an international regulatory AML body (Eddy 2005; Rusmin & Brown 2008). However, by February 2005, Indonesia was removed from that list and by February 2006, FATF announced that it no longer intended to monitor Indonesia’s AML regime (Robinson 2007 as cited in Rusmin & Brown 2008).

            Indonesian regulatory reform regarding AML began when Indonesia enacted Law No. 12 of 2002 on Money Laundering Crimes as amended with Law No. 25 of 2003 (Rusmin & Brown 2008). This law states that an individual that knowingly places, transfers, disburses, spends, donates, contributes, takes out of the country, or exchanges assets from the proceeds of crime to disguise or conceal their origin launders money (Article 1), and that any individual who places assets from the proceeds of crime with a provider of financial services to hide or disguise their origin faces imprisonment of between 5 and 15 years and a fine of between minimum of Rp100 million and Rp15 billion (Article 3(1)).

            Article 18-29 of the Law No. 12 of 2002 as amended with Law No. 25 of 2003 established Indonesia’s AML agency namely Pusat Pelaporan dan Analisis Laporan Keuangan (PPATK). PPATK follows the structure of Australia’s AUSTRAC or America’s FinCEN in fulfilling three functions: (1) collection data; (2) analysis of data; (3) dissemination of data and analysis to appropriate authorities in appropriate cases (Eddy 2005).

            In terms of tax havens, Indonesian Directorate General of Taxation at the end of 2008 has negotiated and implemented tax treaties with 57 countries (KPMG 2009). To prevent the use of abusive tax havens, Indonesia has terminated its tax treaty with Mauritius on January 2005 because of tax abuse by Indonesian investors (Dowjones 10 April 2006). Because of the tax abuse, more capital flows out of Indonesia than returns in the guise of foreign investment (Dowjones 10 April 2006). Indonesia also might terminate its income tax treaty with Seychelles for the same reason (Dowjones 10 April 2006).

PPATK Investigations and Regulatory Activities

            PPATK does not have independent investigative power, the enforcement of AML falls upon the police, the prosecutors and the courts (Eddy 2005). However, article 26 of Law No. 12 of 2002 as amended with Law 25 of 2003 requires PPATK to report the results of analysis of financial transactions to the police and to the public prosecutor’s office.

            In 2003 there were only 24 reports that were submitted to enforcement agencies (Embassy of Indonesia 2007). In 2006 the reports submitted to enforcement agencies dramatically jumped to 430 reports (Embassy of Indonesia 2007). Of the total number of reports, suspected corruption cases topped the list (177), followed by fraud cases (157), and banking industry crimes (27). Other cases involved document forgery (19), bribery (7), terrorism (5), tax fraud (4), currency forgery (4), illegal logging (4), gambling (3), drugs (3), child pornography (1), theft (1), and 18 other types of cases that were not identified (Embassy of Indonesia 2007).

            One of very successful investigation of money laundering crimes in Indonesia is the investigation of Lukman Hakim who was sentenced to 8 years in prison for the embezzlement of pension funds from fertilizer manufacturer Pupuk Sriwijaya (Embassy of Indonesia 2007). Since the establishment of the PPATK, only seven cases have been brought to trial and ended up with convictions under the Money-Laundering Law, while the remaining cases were tried under the Corruption Law or other legislation (Embassy of Indonesia 2007). Perhaps this is due to the police that poorly trained, ill-equipped to deal with sophisticated money laundering schemes and were reluctant to use the relatively new AML as against the relatively old criminal law (Rusmin & Brown 2008). Therefore, the assistance of AML regulation and enforcement from FATF and other industrialized countries also should be done to the enforcement bodies such as police, prosecutors and courts and not only PPATK itself.

Conclusion

            Money laundering and abusive tax havens clearly are serious problems in the world.           Money laundering is used by criminals to conceal source of proceeds from illicit transaction. So that law enforcement cannot make the relationship between the funds and the criminal activity behind the funds. Abusive tax havens can be used to make tax fraud by evading tax.

            To solved the problem, it is needed the cooperation among countries in the world and among regulatory and enforcement bodies. The role of international body such as FATF and OECD or UN to supervised country level bodies is very important. They can make guidance for all nations and coordinate the action needed to prevent and solve the problems. The shame punishment such as announcement a blacklist in terms of money laundering or tax havens should be continued.

REFFERENCES

ATO 2010, Tax haven and tax administration, accessed 27-05-2010, http://www.ato.gov.au/corporate/content.asp?doc=/content/46908.htm&page=4&H4

Blum, JA, Levi, M, Naylor, RT & Williams, P 1998, “Financial havens, banking secrecy and money laundering”, Double issue 34 and 35 of the Crime Prevention and Criminal Justice Newsletter, Issue 8 of the UNDCP Technical Series, accessed 24-05-2010, http://www.imolin.org/imolin/finhaeng.html

Chaikin, D 2008, “Commercial corruption and money laundering: a preliminary analysis”, Journal of Financial Crime, Vol. 15, No. 3, pp. 269-281, 17-03-2010, ProQuest Central database

CIA 2010, The world factbook, accessed 27-05-2010, https://www.cia.gov/library/publications/the-world-factbook/geos/st.html

Dharmapala, D 2008, “What problems and opportunities are created by tax havens?”, Oxford review of economic policy, Vo. 24, No. 4,  pp. 661-679, accessed 25-05-2010, University of Wollongong Library

Eddy, JA 2005, “Legal culture, institutional design choices, and the struggle to implement an effective anti-money laundering regime in Indonesia”, The Australian journal of Asian law, Vol. 7, No. 1, pp. 1-23, accessed 27-05-2010, ProQuest Central database

Embassy of Indonesia 2007, Anti-money laundering agency reports 430 suspicious transactions, accessed 27-05-2010, http://www.indonesia-ottawa.org/economy/Economicissues/money-laundering-report-06.htm

IRS 2010, Examples of money laundering investigations-fiscal year 2009, accessed 26-05-2010, http://www.irs.gov/compliance/enforcement/article/0,,id=187285,00.html

KPMG 2009, Indonesian tax treaties quick reference guides, accessed 27-05-2010, http://www.kpmg.co.id/kpmg/pdf/Indonesian%20Tax%20Treaties%20Quick%20reference%20Guide_revised%2025%20feb%2009_low%20res.pdf

Kudrle, RT 2009, “Did blacklisting hurt the tax havens?”, Journal of money laundering control, Vol. 12, No. 1, pp. 39-49, accessed 24-05-2010, Emerald database

Kumar, LK & Campbell, JR 2009, “Global governance: the case of money laundering and terrorist financing”, Forum on public policy: A journal of the oxford round table, accessed 25-05-2010, Academic OneFile database

Law 15 2002, on the Crime of Money Laundering

Law 25 2003, on the Amendment of the Law on the Crime of Money Laundering

Manning, GA 2005, Financial investigation and forensic accounting, 2nd edn, Taylor & Francis, Boca Raton, Florida

Mitchel, DJ 2003, “US government agencies confirm that low tax jurisdictions are not money laundering havens”, Journal of financial crime, Vol. 11, No. 2, pp. 127-133, accessed 24-05-2010, ProQuest Central database

Newland, LS 2008, “Money laundering”, The American criminal law review, Vol. 45, No. 2, pp. 741-764, accessed 25-05-2010, ProQuest Central database

OECD 2000, “Progress in Identifying and Eliminating Harmful Tax Practices”, Report to the 2000 ministrial council meeting and recommendations by the committee on fiscal affairs, accessed 27-05-2010, http://www.oecd.org/dataoecd/9/61/2090192.pdf

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OECD 2010b, Tax: three Caribbean jurisdictions move up on OECD progress report,  accessed 27-05-2010, http://www.oecd.org/document/55/0,3343,en_2649_37427_45256887_1_1_1_1,00.html

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[1] This figure is based on IMF report in 1996. Although Schneider and Windischbauer believe that the result to some extent doubted, since they are irreproducible and not scientifically proven, the FATF use this figure in its publication “Money Laundering FAQ” available in http://www.fatf-gafi.org/document/29/0,3343,en_32250379_32235720_33659613_1_1_1_1,00.html.

[2] This study was conducted on behalf of the United Nations under the auspices of the Global Programme against Money Laundering, Office for Drug Control and Crime Prevention; Vienna, Austria. Final report printed December 1998.

[3] Form 8300 “Report of Cash Payments over $10,000 Received in a Trade or Business” must be lodged by any business that receives more than $10,000 in cash in one or more related transactions to IRS. Transactions are related even if they are longer than 24 hours (source Manning 2005).

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