The Panama connection

The Panama Papers expose, the biggest leak ever of a database, made possible by a unique journalistic venture, rocks governments, shines a light on politicians and the super rich and exposes their secretive connections with tax havens across the world.

A marquee of the Arango Orillac Building lists the Mossack Fonseca law firm in Panama City. Panama's president says his government will cooperate “vigorously” with any judicial investigation arising from the leak of a vast trove of information on the offshore financial dealings of the world's rich and famous.

What do Indian film stars, the British and Iceland Prime Ministers, a mining baron from Bellary in India and the officials of the Ethics Panel at FIFA (Federation Internationale de Football Association) have in common? The Panama Papers. It has taken the biggest leak in history, and an unprecedented coordination of the global media, to shine the light on the ways that the rich and the famous adopt to hide their wealth in locations normal folk would never even dream of. The coordinated release of the Panama Papers in early April shows how celebrities and politicians, arms dealers and art sellers and businessmen (women, too) and football players and administrators across the world used the services of an until-now unknown law firm in, of all places, Panama, to establish shell companies in tax havens across the world.

The leaks have already resulted in one political casualty. Sigmundur Davio Gunnlaugsson, Prime Minister of Iceland, was forced to resign after revelations that he and his wife had used the services of a Panamanian law firm, Mossack Fonseca, which specialises as a factory that churns out shell companies in Panama and other tax havens. British Prime Minister David Cameron, after days of stalling questions over the status of Blairmore, a fund established by his father in Panama, admitted that he gained financially but that he sold for a profit just before he assumed office in 2010. However, Cameron did not say how much of the £300,000 that he inherited was because of entities being located in tax havens. Following the revelations, 20 banks and financial firms in London have been asked to disclose their dealings with Mossack Fonseca to the Financial Conduct Authority in the United Kingdom.

Other political leaders in the Panama Papers net include Russian President Vladmir Putin, whose close friends and associates are linked to shell companies incorporated by Mossack Fonseca, and Pakistan Prime Minister Nawaz Sharif, whose family, the papers reveal, profited by mortgaging six London properties through companies owned in the Virgin islands. The revelations also link relatives of at least eight members the Chinese Communist Party leadership to tax havens, through Mossack Fonseca.

The Indian angle

The Indian Express , the sole Indian media house participating in the project led by the International Consortium of Investigative Journalists (ICIJ), revealed the use of tax havens by several Indian celebrities, industrialists and businessmen and a host of shady operators from the country. The newspaper’s investigation attempts to trace the persons behind these entities led it to slums in Mumbai, localities in Delhi which would normally not be the bases of the well-heeled, and to several small towns that would not be expected to be connected to tax havens. The investigations hint at the possible use of benami (fraudulent) identities to hide the trail of persons with networks in tax havens across the world. Among the celebrities mentioned by The Indian Express is Amitabh Bachchan, who is reported to have been made managing director of four companies in 1993 in the British Virgin Islands and in the Bahamas, both tax havens. Bachchan’s daughter-in-law, Aishwarya Rai, and her family members were also allegedly helped by Mossack Fonseca to establish a company in the Virgin Islands. Interestingly, The Indian Express investigations revealed that “internal instructions” exchanged with the law firm directed that the celebrity’s name be shortened to A. Rai “for reasons of confidentiality”. While Bachchan said his name might have been “misused”, Aishwarya Rai termed the revelations “totally untrue and false”.

The leaks began with a call from an anonymous source to the Suddeutsche Zeitung , a German newspaper, offering to provide it data from Mossack Fonseca. The eight-month-long investigations were coordinated by the ICIJ and the German public broadcasters NDR and WDR. More than 100 media organisations from around the world participated in the probe.

The leaks, contained in over 2.6 terabytes of data, pertaining to 11.5 million documents on 2,14,000 shell companies and spanning 38 years since 1977, are the biggest of their kind in history. More important than the scale of the expose is the extreme focus of the leaks since they pertain to a single source. According to the ICIJ, Mossack Fonseca, in its present form, only came into being in 1986 when Ramon Fonseca merged his small, “one-secretary” Panamanian law firm with another company belonging to a Panamanian of German origin, Jurgen Mossack, resulting in its present name.

Global nexus The data reveal Mossack Fonseca’s ties to more than 14,000 banks, law firms, company incorporators and other middlemen, which resulted in the establishment of companies, foundations and trusts for customers in tax havens across the world. The data show that almost 40 per cent of these intermediaries were located in three countries—Hong Kong, the United Kingdom and Switzerland. The ICIJ said it “used the country categorisation contained in the leaked internal client database to describe how many intermediaries were in each country”.

P. Vaidyanathan Iyer, part of the Indian Express team investigating the Panama Papers, described Fonseca as a giant “factory” that churned out thousands of companies into which the haven-seekers could invest. “Fonseca was offering companies off the shelf to resident individuals,” he remarked in the wake of the revelations.

The output from Mossack Fonseca’s factory of registering shell companies peaked in 2005, when it facilitated the incorporation of more than 13,000 companies; but by 2015 it fell to a third of the peak level. The data also reveal that the actual lifespan of many of these companies is quite short, indicating that they are very specific-purpose vehicles. The leaks show the widespread use of “bearer” shares of companies, which make it difficult for the authorities to trace their actual beneficiary holders. The ICIJ describes Mossack Fonseca as “one of the five biggest wholesalers of offshore secrecy”. The favoured tax haven of its clients was the Virgin Islands, where one of every two of Mossack Fonseca’s clients went; the second was Panama, followed by the Bahamas and Seychelles.

The Indian government, which has faced criticism for the tardy progress in reining in the domineering presence of illicit or “black” money in the national economy—which was a key promise of Prime Minister Narendra Modi before he strode into office in 2014—quickly ordered a probe into the involvement of more than 500 Indians identified in the Panama Papers. A new agency, including officials from the Central Board of Direct Taxes, the Financial Intelligence Union and Foreign Tax and Tax Research division and the Reserve Bank of India (RBI) has been formed to conduct this operation. Meanwhile, the Special Investigation Team on Black Money, appointed under the Supreme Court’s directions, continues its probe into the black money menace.

Wrongdoing legalised It is important to appreciate that wrongdoing, in terms of adherence to the letter of the law, would be difficult to establish with the Panama Papers. The Indian regulations have themselves undergone changes in the last decade, resulting in a more permissive regime. In this sense, Indian regulators, especially the RBI, have been “behind the curve”, so to speak, of what investors or speculators were actually assuming the law to be. In effect, the modified regulations suit the interests of speculators who were indulging in tax haven shopping.

For a long time, Indians were not allowed to freely convert foreign exchange and take the funds overseas. For the first time, in February 2004, the RBI allowed, through the Liberalised Remittance Scheme, each Indian to take out a maximum of $25,000 annually for a variety of purposes—buying shares and other assets, gifting, donations, education, health, and so on. This limit was raised gradually and now is set at $2,50,000 annually, which at current exchange rates amounts to about Rs.1.66 crore. A few years after the scheme was launched, the RBI, following a review, asserted that the scheme did not allow Indian entities to establish companies overseas. But these entities conveniently assumed that since the scheme allowed the purchase of shares, it automatically also allowed establishment of companies by these entities in overseas locations.

The RBI reiterated its position in September 2010, clarifying beyond doubt that establishing companies overseas under the provisions of the scheme was illegal. However, accounting firms and chartered accountants, in collusion with law firms such as Mossack Fonseca, in brazen violation of the RBI norms, interpreted the law to mean that the prohibition applied only to cases of fresh incorporation of companies and not to the acquisition of existing companies.

In a clear case of the regulator “adjusting” the policy regime to what was in effect a fait accompli , the RBI, in 2013, notified the Overseas Direct Investment (ODI) scheme, which allowed Indian entities to invest in joint ventures or in a fully owned subsidiary in overseas tax jurisdictions. What this clearly implies is that until the ODI scheme came into being, the investments of Indian entities in offshore investment vehicles were in violation of the Foreign Exchange Management Act (FEMA). The point in all this is that until 2013 such investments were in clear violation of Indian regulations. After 2013, the issue is one of the use of tax havens to avoid and evade tax.

The justification given by those indulging in the use of tax havens is that there is nothing wrong with using smart methods of tax planning. However, this begs the question of the extreme secrecy associated with tax havens, which go far beyond taxation into issues such as the use of slush funds and kickbacks in operations of drug cartels, terrorist organisations and illegal arms trade.

The layered structure of these offshore companies is such that it is virtually impossible for the authorities in any tax jurisdiction to trace the actual owners of these entities. It is impossible to lift the corporate veil in order to separate the nominal shareholders in these investment vehicles from those actually controlling them. Entities like Mossack Fonseca provide a range of services to these entities; thus the law firm has provided nominee directors and shareholders who act as proxies for the actual beneficiaries.

The perfidy of tax havens Although the Panama Papers are unlikely to result in any convictions, their significance lies not so much in the fact that illegality has been committed as they expose the modus operandi of the rich. What it has done is to rip the mask off the faces of the rich, the famous and the powerful and make transparent their ways that would not be available to normal, decent and honest taxpaying citizens around the world. In the process, they also reveal the extraordinary abuse of tax havens by the well heeled.

A remarkable book published recently, The Hidden Wealth of Nations: The Scourge of Tax Havens by Gabriel Zucman (University of Chicago Press, 2015), throws some light on the widespread abuse of tax havens and their implications for social equity. “Tax havens with their financial opacity are one of the key driving forces behind rising wealth inequality,” says Thomas Piketty (author of Capital in the Twenty-first Century ) in his foreword to Zucman’s book. Piketty observes that tax havens undermine a fundamental facet of modern democracies, which are grounded in a social contract that requires that everybody pays taxes on an equitable basis.

Zucman estimates that about 8 per cent of global financial wealth —which Piketty considers to be at the “lower bound”—is based in tax haven jurisdictions. Moreover, there are wide regional variations within this broad picture; Zucman estimates that about 30 per cent of the wealth in Africa and about 50 per cent of the wealth generated in Russia and the West Asian economies wind their way to tax havens. Zucman suggests some kind of a global register of wealth, of who owns what in what form and where. The corollary to that would be taxes by national authorities on the flow of capital, incomes and of stocks of wealth across national frontiers. Zucman’s warning is dire. “Tax havens,” he warns, “are at the heart of financial, budgetary, and democratic crises.”

In the United States, the centre of global financial power, the problem assumes a different form. It is not so much a problem of the flight of capital to tax havens. Instead, the issue there is one of large-scale corporate tax evasion by multinational companies.

Indeed, critics of the Panama Papers, including those who have argued that the WikiLeaks revelations were far more damaging to powerful interests, especially in the U.S., have pointed to the presence of very few American entities in the database. Zucman observes that U.S. corporations are routing profits to countries such as Bermuda and Luxembourg “on a massive and growing scale”. He estimates the scale of this rerouted profit to be about $130 billion annually. The comparison of the revelations with the WikiLeaks and Snowden revelations on the grounds that the latest expose is the “biggest” is hardly fair. The release of the Panama Papers happened to coincide with the sixth anniversary of the WikiLeaks’ release of the “collateral murder” videos of the bombing of Iraq, which shook the conscience of the world and provoked outrage against the conduct of U.S. military forces in that country. Similarly, the Snowden revelations were unprecedented for exposing the scale and extent of surveillance of U.S. agencies across the world.

The significance of the Panama Papers lies not so much in unearthing “illegality” but in exposing these secret channels of investment and bringing into full public view those who would have been hid forever under a corporate veil. As the case of the RBI itself has shown, the persistent power of financial capital, which resulted in a more permissive regulatory regime, had in any case altered the notion of what constitutes illegality. In other words, the law modified itself to accommodate and suit the interests of the haven seekers.