So Long Banking Anonymity . . .

. . . It's been good to know ya.

It looks like the G20 Summit will put the final nails in the coffin of anonymous banking in sensible jurisdictions such as Switzerland, Luxembourg, Barbados, and the likes. That's a shame. I've noticed that when people start discussing these jurisdictions they start to confuse tax havens and anonymous banking, and the purposes that each serve.

The bourgeoisie seem to be a popular target right now, and tax havens tend to be associated with organized crime, privileges of the extremely wealthy, and philandering husbands hiding assets from their suspicious spouses. Sure, these things happen, but tax havens and anonymous banking serve important functions. I'm going to run through the purposes of tax havens and anonymous banking, and then I'm going to link to a couple of summaries on recent developments in China regarding the use of tax havens.

Tax Havens

What is the difference between a taxidermist and a tax collector? The taxidermist only takes your skin. - Mark Twain

The other day I was on the phone with an old friend and he started fuming about tax havens and corporate fat cats. I changed the subject. I like to gesticulate when describing the purpose of tax havens, and that is difficult over the phone. It is also difficult over the internet, but here we have the benefit of charts:


Tax havens are an integral part of facilitating investments with investors from more than one country. The above is an example for a real estate fund from one of my courses. In the above example the holding companies at the bottom buying and selling real estate in their various jurisdictions are subject to income tax on their gains in those jurisdictions. This money then goes to the Cayman Fund where tax will be minimal to non-existent. A return on investment is then distributed to the feeder funds which are typically pass through entities where income tax will be paid by the individual investors. This results in two layers of tax: one for the government where the property is bought and sold, and one government where the money ends up. If the Cayman Fund was setup in a non-tax haven jurisdiction, then the investors would be subject to a third level of income taxation for the government where that fund is formed.

Tax havens don't avoid tax. Taxes are still being paid on the income, and they're being paid in the jurisdictions where the money is being made, and where the investors reside. The haven merely allows a neutral place for the investors to pool their cash for investments around the world without being needlessly taxed. A lot less harmful than we're typically led to believe.

Banning tax havens would be a nice punitive measure against making money, but I can't think of any reason of fairness for why a third level of tax should be levied because it would be a third tax on the exact same income. The third level of tax might even discourage some international investments form taking place. That would be bad because it would slow the velocity of the spread of wealth around the world. And tax havens are good because they facilitate international investment with tax on the income being paid in the most appropriate jurisdictions

Banking Anonymity

I've got nothing to hide. - Anonymous

The other day, one of my professors was railing against the demise of banking anonymity. I was discussing this with a friend, and I admitted that I was confused about the benefits of banking anonymity. He sent me a link to the second most downloaded paper from SSRN--a paper that was printed in the San Diego Law Review as part of a symposium on privacy, 'I've Got Nothing to Hide' and Other Misunderstandings About Privacy by Daniel Solove. Here's a gem from the paper:

As one comment to my blog post noted: "If you have nothing to hide, then that quite literally means you are willing to let me photograph you naked? And I get full rights to that photograph--so I can show it to your neighbors?"

The paper never explicitly discusses banking anonymity. Instead, the author presents his Taxonomy of Privacy, and he argues that privacy is not just an individual right, but has value to society. The main social benefits of privacy are that it prevents the "chilling of socially beneficial behavior (for example, free speech and association," and it prevents "power imbalances that adversely affect social structure (for example, excessive executive power)." As privacy decreases more intrusive regulations limit the kinds of decisions people can make about their lives. Solove argues that privacy regulations are not about balancing individual rights against the social problems that privacy can cause, but balancing the social pros and cons that privacy brings to society.

In finance, limitations have an adverse effect on entrepreneurship. Though there are many bad things that banking anonymity facilitates, these must be balanced against the entrepreneurial creativity that anonymity affords. A simple form of the balancing test is whether making it more difficult for criminals to launder money is worth the price of chilling entrepreneurial activity?

As for adverse imbalances of power, it might help to look back on the origins of banking anonymity laws. From the Straits Times and the asiatax blog:

European politicians conveniently forget the origins of offshore financial centres. Switzerland - by far the biggest in this business - offered international banking services for centuries. And the Swiss thrived not by attracting money from crooks but, rather, by earning the confidence of law-abiding individuals.

At a time when the rest of Europe was constantly embroiled in warfare and when private property was frequently nationalised or just stolen, the Swiss remained an oasis of stability, a place where one’s assets were secure.

The current Swiss bank secrecy legislation was enacted during the 1930s, in order to prevent agents of Nazi Germany from snooping on people.

Yes folks, the slippery slope is just THAT slippery.

Developments in China
In just about every income tax treaty that China has, the PRC retains the option to disregard the application of the treaty if the terms of the treaty are being abused. In a blog post at Sheppard Mullin's China Law Update, the author discusses a recent decision on tax treaty abuse which was subsequently endorsed by the State Administration of Taxation in Notice No. 1076 of 2008. Here are the conclusions offered by the author:

China will now focus on the purpose or motive for a commercial transaction in order to combat tax treaty abuse. Foreign investors should pay careful attention to commercial arrangements that might be considered a mere attempt to avoid, reduce, or delay tax. In order to prove a valid purpose, foreign investors should be prepared to demonstrate, with appropriate documentation, the economic substance of companies located in jurisdictions with which China has entered into tax treaties.

At asiatax blog, the author discusses the implications of Tax Notice 81 of 2009. This tax notice has to do with the application of special withholding taxes on dividends for special purpose vehicles located in the tax havens of Singapore, Hong Kong, Mauritius, Barbados, and Ireland. Here is the author's summary of the notice's rule:

The tax authorities are now empowered to scrutinise not just the form but also the substance of the ownership structures of SPVs to satisfy themselves that the investors have bona fide residence in the tax havens and that the SPVs are not merely established for the purpose of avoiding tax or remitting funds out of China.