Hardly a day goes by now without headlines about tax avoidance and evasion in the Western media, and it will stay there as the UK hosts the G8 Summit in Northern Ireland in June, where it will take the lead, with France and Germany, in putting tax evasion and avoidance on the agenda for the subsequent G20 meeting. This is the more important forum, as the proceeds of tax abuse move all over the world, and the problem can only be tackled on a properly global basis. In the meantime, the attraction of the UK for people seeking to hide all types of ill-gotten gains isn’t likely to go away, though the methods used are likely to change as tax secrecy is gradually eroded.
Why is Russia such a significant source of criminal money?
There are few countries which have as many people with as much money at stake as Russia and the other former Soviet States, thanks to some extent to the close links between the States, not least the dual or multiple nationalities held by many people. Russia’s kleptocratic state offers unique opportunities for a wide range of players to profit from the country’s vast natural wealth and its world class and highly competitive armaments industry, with the global networks these create. These contacts are very often in regions outside the Western political orbit and in sectors, such as defence, which are in many countries off limits to law enforcement, as opposed to political, oversight.
Seeing through the mist. London and the UK are popularly not identified as tax havens, when in fact they are. Photo (cc) Wikimedia Commons/Nuty350. Some rights reserved
All Russian private companies operate to some extent under licence from the state. Naturally, this offers enormous opportunities for corruption and fraud by both officialdom and the private sector. The Magnitsky case demonstrates this in a nutshell. Tax Service officials immediately approved multi - million dollar tax refunds within a system where such refunds are the subject of strict approval criteria and resulting frequent and significant delays, and the current investigative reporting of the case is giving due emphasis to the question of where the share taken by corrupt officials might have ended up.
So how can everyone involved in corruption in Russia get their share, and get it out of Russia into a safe place as insurance against possible changes at home? And how can that be done while avoiding new Russian anti-corruption laws and regulations, such as the recently proposed legislation banning public officials from holding accounts with foreign banks? One answer is: by the use of shell companies set up in or from London.
The people behind shell companies, and those involved in the transfer of both tax and non - tax related criminal funds, seek to confound law enforcement action by passing them through a chain of transactions which, crucially, involve locations seen as “clean”, or with a plausible claim to be clean. London and the UK are popularly not identified as tax havens, when in fact they are. London is also a relatively safe haven for assets, especially property. When held in the UK, such assets can only be subject to freezing or confiscation after due process, with especially high thresholds for the actual forfeiture of physical assets. There are therefore strong incentives for large scale criminals to transfer money through the United Kingdom, both to and from traditional tax havens, and to use these transfers to buy assets in the UK.
‘When held in the UK, assets can only be subject to freezing or confiscation after due process, with especially high thresholds for actual forfeiture ... There are therefore strong incentives for large scale criminals to transfer money through the United Kingdom’
Owning such assets in the UK (and other EU states) also has the enormous collateral benefit of enabling non - citizens to obtain permanent residence status, and thereby free movement in the EU and visa free travel to North America. At the higher end of the criminal scale, Russians can also demonstrate plausible personal links with the UK, as much of the proceeds are used to pay for schooling at some of the UK’s most prestigious and expensive schools and universities. Many schools are in fact heavily dependent on this income.
How do shell companies work?
A shell, or brassplate, company is one set up to provide a legal existence in a country where it has no real physical presence or trading structure. The registered address is typically that of a lawyer, accountant or professional company formation agent. The creation of shell companies by company formation agents is essentially unregulated in the UK, and so, unlike banks, they can’t be sanctioned for breaching anti-money laundering regulations. The UK excels at the provision of shell companies: it is not unknown for one formation agent to have several thousand companies registered at one address. Many of these will be “active”, at least to the extent that funds transfer through them. Others are dormant, ready to be activated, often as direct or indirect successors to previous active companies which have ceased trading and transferred to them their “assets” and “activities”.
The shell company is often intimately linked with tax evasion, as well as the transferral of proceeds from other crimes, particularly fraud and corruption but also drugs trafficking and illegal arms dealing. It is particularly suited to cross-border transactions, as the sheer number of the companies in the chain eventually exhausts regulators and investigators. Shell companies in the UK will typically have no long term assets, holding deposits for only a few days before transferring them elsewhere. The key is that the source or destination appears to be the clean UK. Funds originating from the ex-Soviet States frequently arrive in the UK from another EU state, often Cyprus or the Baltic States, especially Latvia. Funds returning from a typical Caribbean tax haven follow the same route in reverse, for final transmission to Russia or other ex- Soviet states.
Wellington College, Berkshire, UK. The UK's private school sector has been a large beneficiary of dodgy Russian cash. Photo (cc) Wikimedia Commons/Anthony Eden. Some rights reserved.
The reasons for the transfers are disguised by the invoicing through London of ‘royalties’ or ‘licence fees’ due from the source to a service provider, typically located in a traditional tax haven. Several ex-Soviet states, including Ukraine, have sought to clampdown on the massive tax losses arising from these practices by creating blacklists of suspect territories. Royalties and licence fees paid to these countries are no longer tax deductible as legitimate costs. But this can be circumvented by the insertion of a clean transit state and also relies on impartial enforcement and an absence of corruption within tax services.
‘The creation of shell companies by company formation agents is essentially unregulated in the UK, and so, unlike banks, they can’t be sanctioned for breaching anti-money laundering regulations.’
Once the shell is created, company formation agents provide only the most basic administration services, and very often no more than a postal address. They are typically unaware of, or say they are unaware of, the nature of the activities passing through the shell, and similarly claim to have little knowledge of the immediate owners, to say nothing of the ultimate owners. And while the British tax authorities are paying increasing attention to the use of shell companies for the transfer of UK assets to offshore locations, their activities do not usually create tax liabilities here, since they merely provide transit services. There are therefore, under current UK and international tax legislation and practice, only very limited opportunities for taking direct action against the shell companies or the formation agents.
What can be done about it- and by whom?
If London is a key factor in the problem, it follows that it can be a key factor in the solution. But all steps taken must be seen in the context of governmental and commercial relationships with Russia and its neighbours, as well as fellow EU member states and the USA and Commonwealth countries, since such measures might have serious knock-on effects. One example of this is the recent decision by a UK coroner to accept a British Government request to withhold evidence relating to allegations of Russian state involvement from the forthcoming inquest into the death of Alexander Litvinenko, citing national security issues (and instead suggested holding a public inquiry, where such evidence could be considered in private). Clearly, the decision reflects concerns about future UK-Russia cooperation on combatting Islamist terrorism, a major concern for Russia, its neighbours, EU states and the USA and Canada.
Similarly, any moves by the UK against companies linked with tax evaders and other criminal organisations might damage UK commercial interests if this led to capital flight from the UK. Depending on the organisations targeted, the actions could be seen as selective, which might negatively affect UK business interests in the ex-Soviet States. That said, recent developments in Cyprus and the approach of the G8 and G20 summits do offer some grounds for optimism that an agreement with Russia on combatting capital flight and tax evasion and their laundering through and to the EU, especially the UK, would have the significant collateral benefit of improving detection of other very serious crimes.
Other measures could include extending the existing automatic exchange of savings interest data between EU states and offshore jurisdictions to Russia and its neighbours, who could also be invited as observers of the emerging extensions of automatic data exchanges to companies, and to the presence and movements of capital sums as well as merely interest.
As British and other EU member states’ courts are reluctant to accept evidence provided by Russian legal authorities, criminal prosecutions in the EU based on Russian evidence are few, and information supplied to Russia is correspondingly very limited. Regulatory measures and civil actions are therefore likely to yield the most effective results for the foreseeable future. It might be worth considering whether EU countries’ tax and other regulatory or law enforcement agencies should agree to undertake civil or even criminal investigations against companies owned by Russian citizens and dual-nationals, based on bloc intelligence supplied by Russia and with any revenue proceeds arising being partially shared with Russia, or used to fund training and cooperation programmes.
Other UK and law enforcement agencies should be encouraged to intensify their cooperation with HMRC regarding possible tax avoidance or evasion by UK citizens who facilitate the setting up of such Russian companies. It is not unreasonable to suspect that a company formation agent or accountant who is careful not to ask awkward questions is receiving undeclared payments as an incentive. Lifestyle examinations might well reveal a lot. The position of company formation agents in relation to anti - money laundering legislation could also be reviewed, with requirements for KYC compliance being aligned more with that of banks, accountants and solicitors.
None of this will be easy, especially at a time of financial stringency, which makes the option of staffing increases unrealistic. However, the author believes that smarter working is realistic within current realities, and that slow but steady progress can be made. Hardly a day goes by now without fresh news of new initiatives being proposed, and even implemented in the field of tax related information exchanges. As the G8 Summit in Fermanagh approaches, it is not unreasonable to ask: if not now, when?