How the rich run rings around the taxman

The Guardian, April 12 2002

Gordon Brown may want to keep a close eye on Mohammed Al-Fayed. In particular, he may want to watch the legal action which the controversial owner of Harrods launched last year against the Inland Revenue. There are people in Whitehall who say it may take the lid off another scandal involving gross tax avoidance by the rich.

The immediate cause of the legal action is that, in the course of his libel dispute with the former Tory MP Neil Hamilton, Al-Fayed talked about having cash which, the Inland Revenue claimed, he should not have had. The result was that the Inland Revenue cancelled an arrangement under which he had been allowed to pay them a fixed rate of tax each year (£250,000) without declaring what his detailed earnings were. Al-Fayed is suing them for breaking the arrangement, which had been in place for many years. And it is that arrangement – known as a ‘forward contract’ – which may conceal a scandal.

Our information is that the Inland Revenue has agreed a series of forward contracts with a number of wealthy and powerful individuals who have used off-shore havens to conceal their earnings with such skill that the Inland Revenue simply cannot assess their true tax liability. And so, in these cases, the tax man has been forced to admit defeat, to abandon the normal process of tax assessment in favour of simply negotiating a regular annual payment.

Effectively, the Inland Revenue has allowed this elite group of the wealthiest taxpayers to opt out of the system: they are not required to provide a full declaration of earnings of the kind that every other tax payer in the country has to provide and, more important, they are allowed to pay only a fraction of the tax which they are believed to owe.

The Liberal Democrat MP for Lewes, Norman Baker, has just tabled a series of Parliamentary Questions, asking how many of these forward contracts have been agreed by the Inland Revenue. He also wants to know when they were first introduced and on what grounds they have been agreed. He has also tabled questions about the use of non-domicile status, the loophole for wealthy foreigners highlighted by the Guardian in yesterday’s investigation into the tax affairs of the richest man in Britain, Swedish-born entrepreneur Hans Rausing.

Both of these loopholes are linked to the world of off-shore havens. To understand the full impact on the Treasury of their use, you have to appreciate the sheer scale of the growth of off-shore investment. Essentially, the havens charge an annual fee for the right to register in their jurisdiction; in return, they demand no tax, impose no rules and guarantee secrecy. Years ago, a few of them were developed for the benefit of wealthy individuals: Germans hid their assets in Switzerland; Austrians turned to Liechtenstein; the British to the Channel Islands. Now, with the tidal movement of cash which has been unleashed by the globalised economy, they have boomed. At the last count, the International Monetary Fund had identified 69 of them.

The amount of cash which they handle is staggering – all of it potentially diverted beyond the reach of main stream governments and their revenue collectors. Bankers estimate that a third of the gross domestic product of the entire planet is now chanelled through them. Slightly more than half of the money that is passed around the globe each day moves through their accounts, and the flow is said to be increasing by up to 15% a year. There are now something like three million corporations which have no identifiable owner, and the OECD estimates that 60% of world trade consists of transfers made within multinationals, passing their profits to anonymous subsidiaries in tax-free jurisdictions.

The Cayman Islands, where we found some of the Rausing family money, has a population of only 35,000 but it has become the fifth largest financial centre in the world. It is the home to some 57,900 corporations and trusts (more than one for every native man, woman and child), as well as 600 banks including 46 of the world’s top 50. Most of them exist only as nameplates on a local accountant’s door, simply paying a licence fee for the privilege of saying that they are based in a country which guarantees to charge them no tax and to disclose no information about their owners or their accounts. And business is booming – in 1999, the Caymans reported that the number of ‘off-shore entities’ registered there had soared by 51%.

All this has daunting implications for mainstream states. How can their courts prosecute a company if its directors are unknown, or fine a company whose assets are beyond their jurisdiction? How can their governments attract capital to their economies when they are committed to using precisely the regime of tax and regulation from which the havens offer an escape?

Ronen Palan, a Sussex university academic, argues in an unpublished book, The Offshore World, that this mass sale by off-shore states of a fictional ‘right of abode’, is attacking the very power base of national government: “Offshore is certainly not the sole cause for the decline of the nation-state, but it must be seen as an important contributing factor to the decline.”

But the immediate concern is that the havens provide a refuge from the revenue collectors on whom all governments depend. Foreign millionaires who become non-domiciled residents in this country pay no UK tax on earnings which they leave in the rest of the world and, by using trusts and banks in no-tax havens, they can ensure they pay no tax anywhere else either. Those with forward contracts are taking advantage of the secrecy of the havens: the tax man simply cannot track their global income and capital gains, and so he is forced to cut a deal.

Mohammed Al-Fayed has taken advantage of both loopholes. His birth in Egypt allows him to enjoy non-domicile status which means he pays no UK tax on any income or gains which he leaves outside the country. When he does bring cash into the UK, he has to pay tax only if it is designated income and not capital. The difficulty for the Inland Revenue has been that his affairs are concealed behind so many accounts – most of them in Bermuda, the British Virgin Islands and Panama – that they simply could not establish what was income and what was capital, and so they compromised and gave him the benefit of a flat-rate payment in a forward contract.

We are told that it is not only wealthy individuals but corporations, too, who have been able to use the almost impenetrable secrecy of the off-shore havens to force the Inland Revenue into a compromise. A former Inland Revenue special compliance officer told us that routinely the largest UK corporations now pay their tax ‘by agreement’. He said: “They submit accounts. We have no way of telling whether they are accurate or not. We could argue with almost every line but they would argue back, and neither side has the time.”

Working through the OECD and with Gordon Brown’s support, the Inland Revenue has had some success in persuading some havens to open their doors to them on money-laundering and illegal tax evasions. But tax avoidance which uses loopholes without breaking laws remains concealed by secrecy.

Part of the difficulty is that, although some of the off-shore havens will talk about changing their rules, none of them is willing to make real change on avoidance while any of the others is still running their business the old way. Simply, they will lose their income if they do. There is an international convention on trusts, but the Cayman Islands publicly advertise that they have not signed it. All 185 member states of the United Nations are supposed to be bound by a 1988 convention requiring them to adopt a list of specific measures to clamp down on abuse. At the last count, more than ten years later, only 30 of them had complied – and none of them was a tax haven.

The other part of the problem is that at the same time as the tax-raising arm of government is pleading for more power, the investment-raising arm is worried about triggering a flight of capital. Pursuing wealthy Arabs for tax, for example, the Inland Revenue has found the Foreign Office actively advising the Arabs on how to avoid it. Over the last 12 months, the National Criminal Intelligence Service has been talking to the Treasury about trying to force nominee companies in the UK to declare their real owners, but the department of trade and industry has been resisting. They say it would cost too much to administer.

In the same way, in the US last year, while the Internal Revenue Service was estimating that tax avoidance was costing the US economy more than $195 billion a year, George Bush moved into the White House on a conservative tide of lobbying to preserve the very same tax havens which were draining the Treasury. In this, he was explicity supported by his national economic adviser, Lawrence Lindsey, and the House majority leader, Dick Armey. Since then, the off-shore links of Al-Qaida have silenced the lobby, but, even now, with the Americans pressurising the havens into releasing information on illegal activity, there is every reason to think they will line up behind the Swiss who now say they will release limited information from numbered bank accounts – providing it does not concern mere tax avoidance.

In its efforts to stop the haemorrhage of funds from the US public sector, the IRS has published evidence that 2,680 citizens with incomes of more than $200,000 claimed they owed no tax; a further 13,630 in the same income bracket paid an effective rate of only 10%; and 17% of the 7,500 corporations with assets of more than $750 million filed returns claiming they owed no tax at all. Their statistics also show that the number of audits of wealthy tax payers has plummeted while audits of those earning under $25,000 has soared. In 1998, Charles O Rossotti, the commissioner of the IRS, testified before the Senate Finance Committee that non-compliance with the internal revenue code was costing every tax payer in the country more than $1,600 a year.

We asked the Inland Revenue for parallel figures for this country. They had none of them (in sharp contrast to the government’s routine publishing of figures on social security fraud). Nor did they have any estimate of the amount of UK cash in off-shore havens nor of the loss to the Treasury through the domicile rules. One senior government figure acknowledged that the wealthy were avoiding tax on a grand scale, shrugged and said: “It’s just life.”

Additional research by Max Houghton