In a recent paper, revised and published as a blog post, I argued that tax avoidance by multinationals should be included in the official definitions of illicit financial flows (IFFs).

I argue that a broad definition of IFFs is essential, since they all use the offshore tax haven and secrecy system, which indeed multinationals helped to construct, for the purposes of avoidance of tax as well as financial regulation. This system is used for three types of financial flows:

  • criminal, e.g. storing the proceeds of crime or corruption, and evading tax;
  • unlawful, e.g. facilitating tax avoidance schemes, many of which are unlawful;
  • immoral, e.g. concealing assets from family or business associates.

The argument generally made for excluding the latter two categories from the definition of IFFs is that they are ‘perfectly legal’. The term ‘illicit’ is etymologically much wider than ‘illegal’. Regardless of this, in my view it would be unsound, and lead to bad policy, to adopt a restrictive definition. Tax avoidance is not ‘perfectly legal’ – it can be challenged by tax authorities, if they have the political backing and resources to do so, and may be found unlawful. As perceptions of tax avoidance have changed, there has been both strengthened enforcement and greater efforts to reform and improve the legal rules.

A key part of these efforts is to remove the justifications advanced for using offshore structures. It is often hard to draw lines between activity which is criminal, unlawful, or merely immoral. Restricting the efforts to improve regulation to criminal activities alone would allow them to be used for dubious activities, and so lend legitimacy to these offshore structures and facilities. As in other areas of law enforcement, a policy of zero tolerance is important in fostering a culture of compliance, instead of one which considers that anything is allowed which is not clearly criminal.

What is ‘Offshore’?

In my paper I explained ‘offshore’ as follows:

‘Offshore devices or structures all involve using the laws or facilities of another country to obtain an advantage not possible under the law that should apply. Private persons’ bank accounts, financial information and other aspects of their personal affairs are generally protected in all countries by laws on confidentiality and privacy, which can only be overridden in specified circumstances, when there is a public interest. There is a network of tax treaties aimed at preventing double taxation, and in any case countries wishing to attract investments generally provide inducements, not excess taxation. Resorting to an offshore arrangement always involves trying to get around an inconvenient law – dodging the law.’

I could have gone further, to explain in more detail (as I have elsewhere, going back to the extensive discussions in my book published in 1992) that these offshore structures generally involve exploiting definitions of residence, often taking advantage of facilities specifically aimed at non-residents, or at foreign-source income. Many of these structures are highly complex, but ordinary people have no difficulty in grasping that there is something ‘dodgy’ about setting up a double-Irish Dutch-sandwich.

The term offshore is by now widely understood, and since the 1970s regulators have been trying to deal with the problems it creates by improving regulatory coordination. This requires coordination not only between countries, but also of different types of regulation. For example, until recently, the main efforts to deal with the problems caused by offshore finance were led by financial regulators, who naturally focused on dealing with money-laundering and banking prudential requirements. While this helped to improve financial security, it also allowed jurisdictions to claim a stamp of international approval, while maintaining levels of banking secrecy that thwarted the efforts at tax cooperation.

Following the great financial crisis, the G20 leaders in 2009 declared that ‘the era of banking secrecy is over’. Much has been achieved since then, but more is still needed to deliver on this pledge. This includes improving exchange of information and cooperation between bank regulators, financial information units and revenue authorities. The drive to introduce greater transparency about beneficial ownership of companies and other legal entities is also a common objective. These regulators all share also the concern to find ways to strengthen the standards of professional responsibility of the corporate service providers, to ensure that they do not act as facilitators or enablers of evasion or avoidance.

The arguments for a narrow definition

A different view has been argued in a paper by Maya Forstater, published by the Center for Global Development (CGD). The paper objects that the term offshore is ‘overly sweeping’, since ‘[e]verywhere is “offshore” to everywhere else’. This is indeed true: offshore is a technique or system for choosing a suitable jurisdiction to avoid another country’s laws.This is why it is better to use the concept of the ‘offshore system’. It is now widely understood, for example, that high standards of transparency should apply not only to the small island jurisdictions generally targeted as havens, but also to leading financial centres notably the USA, which maintains unacceptable levels of secrecy for legal entities.

The paper by Forstater also finds difficulty with my defining offshore by reference to avoiding the law which ‘should’ apply to a person or a transaction. It argues that:

‘A wealthy international family which owns properties in several countries, a multinational enterprise managing risk, assets, and inventories across borders, or a joint-venture involving investors from several different countries all face choice of jurisdictions to use for legal structures and financial assets in the ordinary course of their affairs—and whichever they choose will be “offshore” to some parties.’

It is hard to see how creating a complex structure involving intermediary entities formed in jurisdictions such as the British Virgin Islands or the Bahamas, and taking advantage of loopholes such as differences in the definition of residence, is just a simple matter of making a ‘choice of jurisdictions to use … in the ordinary course of their affairs’. Such structures are obviously designed for the clear purpose of avoiding inconvenient rules, especially tax. I am however pleased that the paper does not deploy the other argument made by defenders of the offshore system, that regulatory competition creates a desirable pressure on countries to relax regulation seen as oppressive, such as high taxation. This more clearly shows the intention of the unscrupulous wealthy to obtain benefits by legal trickery rather than straightforward administrative and democratic political processes.

The paper further argues that:

‘The role that international financial centres play in mediating investment, enabling people to diversify their assets, and supporting global commerce are also critical benefits to society. Too little is known about how much of what takes place offshore is beneficial, defensible, or objectionable, and bundling these categories together under the “illicit” umbrella will not support greater clarity and understanding.’

This statement suggests scant knowledge of the extensive academic research into the phenomenon of offshore, and the history of policy initiatives towards it. Little credibility can be given to an argument for a narrow definition of IFFs which rests on the view that ‘too little is known’ about how these flows move through the financial system, and what is needed to try to prevent its use for objectionable purposes.

Avoidance and Morality

Underlying my argument for a wide approach to defining what is ‘illicit’ is the understanding that law is fuzzy, or in more academic terms indeterminate. Hence,  elements of morality and politics inevitably come into its interpretation. Attitudes to regulation are not value-free, law is normative, as is its interpretation and enforcement. Lawyers should understand this, as they spend their time debating the meaning of legal rules, although others perhaps can be excused for thinking legal rules have a fixed and accepted meaning. Those designing or using complex avoidance structures work in the grey areas created by the inevitable indeterminacy of legal rules (see my paper here). They should be aware when they are pushing the boundaries of valid or legitimate interpretation. The argument that everything is legitimate that is not clearly criminal is an attempt to validate such techniques. Professional practice must have an ethical underpinning, a responsibility to the public not just a duty to the client. This has regrettably been greatly weakened in the past few decades.

The great financial crisis woke politicians up to this problem, and policymakers must now deliver on the necessary reforms. Civil society, including academics and independent researchers, should play an important part in this. The Forstater paper’s response to this perspective is that it ‘begs the question who holds these morals or ethics, and whether they are universal and well defined’. I find it surprising that she should take an agnostic position on the need to strengthen professional ethical standards to ensure the strong culture of compliance essential to the proper functioning of markets.

Debate in this area is important to policy formation. However, I think we should recognise that such policy debates are not innocent, they are generally to some extent and in some ways partisan. In this context, it is important that all professionals accept ethical responsibilities. This includes researchers, especially in development studies, who should subject all policy arguments to critical evaluation. This should include, perhaps even focus mainly on, the assumptions behind orthodox opinion. Civil society campaigners perform an important role in challenging the orthodox consensus. Tax justice campaigners at least make their aims explicit, which I think is preferable to claiming a spurious objectivity, as do professional providers of tax avoidance schemes. Of course, campaigners sometimes get things wrong. They typically have inadequate resources with which to investigate very well-embedded systems supported by strong vested interests. Nevertheless, scrutiny of the conceptual underpinning and evidence basis for policy prescriptions is important. For example, there has been some confusion about the transfer pricing problem, caused by use of the term ‘transfer mispricing’ (which I think is misleading), and the attempts to use customs data to quantify its scale. My paper and blog included an attempt to clarify this issue.

Development agencies and think-tanks also have a responsibility to ensure that the work they publish takes a rigorous and even-handed critical approach in these important policy areas. Indeed, if anything, stronger scrutiny should be applied to justifications given by economically and politically powerful institutions. This is particularly difficult when it might affect the prospects of funding from such institutions. Researchers fail in their responsibility if, in their eagerness to uncover the weaknesses in the policy proposals of campaigners, they readily accept trite arguments in favour of the status quo. I fear that this has occurred in this paper, which has too easily accepted the claims that practices such as tax avoidance are ‘perfectly legal’. There is also other similar published research which in my view has failed to ensure rigorous scrutiny of arguments defending the use of tax havens and the offshore system.

As the debate has progressed, it now seems that the responsible international organisations are beginning to accept the need for a wide approach to the definition and measurement of IFFs. This seems borne out by the approach adopted in the Background Paper to the expert consultation last December by the UN Office on Drugs and Crime (UNODC). In my view, this is to be welcomed. Reverting to a narrow definition limited to criminal activity would be a retrograde step.

See Maya Forstater’s response to this piece here

Sol Picciotto

Sol is an emeritus professor at Lancaster University, a Senior Adviser of the Tax Justice Network, coordinator of the BEPS Monitoring Group, and a member of the UN Tax Committee's subcommittee on dispute resolution. As a Senior Fellow of the ICTD, his research focuses on the taxation of transnational corporations with special reference to developing countries.