Intellectual crime against Pakistan and other poor countries
Developing countries lose on all counts due to the prevalence of this system. This has been described with reference to Pakistan as under:
Illustration B: Mr B has US dollars outside Pakistan. He wants to invest in Pakistan. It is economically and practically beneficial for Mr B to make a company outside Pakistan, say in BVI, and that company invests in Pakistan. The funds move to Pakistan via a BVI company. The net effect of this entry is:
The name of actual owner of Pakistani company remains confidential in Pakistan;
The BVI company is allowed dividend and capital remittance outside Pakistan in USD. This right is not available if Mr B invests in his own name because he is a resident in Pakistan.
There is no fear of any regulatory action (including nationalization) as the owner of the company is a foreign entity.
Mr B can manage his inheritance issues avoiding Pakistan law which may require distribution under the Islamic laws.
In this situation if any Pakistani has US dollars outside Pakistan, then it is a win-win situation in all respects if the investment is not made directly. Instead the same is made using an offshore entity.
One of the biggest economic crimes that have been perpetuated in Pakistan during a seriously flawed foreign exchange regime between 1992 and 2018 was the possibility of using taxed or untaxed, legal or tainted money for investment in Pakistan using the offshore entities. This was the biggest legalized crime undertaken in Pakistan. The modus operandi is as under:
Illustration C: Mr C has Pakistani currency in Pakistan acquired through illegal means. Under the system prevalent in Pakistan Mr C was allowed to buy US dollars from the exchange companies without any limit. Once foreign currency is acquired the same is sent outside Pakistan. Thereafter, the funds available outside are brought back to Pakistan claiming a blanket amnesty under Section 111(4) of the Income Tax Ordinance, 2001. In this manner funds in Rupee account in a bank is white money. Then the transaction as referred above is again undertaken whereby Rupee is converted into USD sent to BVI and brought back as investment in Pakistani companies. The net effect of these transactions is:
Mr C owns a ‘white’ Pakistani investment where illegal money has been used, in other words tainted money has been laundered;
Mr C will receive dividends in USD;
Mr C will receive USD if shares in Pakistani company are sold;
Mr C’s illegal sources are disguised as there cannot be any action against a foreign entity which is protected by a foreign law;
Mr C can avoid inheritance laws of Pakistan to place the assets with anyone not necessarily his legal heirs under the Pakistan law.
This looks like a fairy tale. It is not so. This has been a commonly prevalent practice in Pakistan during this period. This was all due to the ‘Unholy Triangle’ in Pakistan’s economic system being (i) the Protection of Economic Reform Act 1992 (ii) the Private Foreign Currency Account; and (ii) perpetual amnesty as laid down in Section 111(4) of Income Tax Ordinance, 2001. I have written numerous articles in this newspaper to expose this corruption which has been corrected, albeit partially, in 2018. The remnants of the system are still present in the economy.
In both the examples (Illustrations B and C) Pakistan is the loser. There is a legal parking place for ill-gotten wealth with no tax incidence and protection against Pakistan law and fluctuation in exchange rate. Those who designed such policies should be questioned as this nation has been a victim of intellectual and state-sponsored corruption.
Why Panama, Paradise or Pandora Leaks?
Confidentiality of information has been the main attribute of investment through offshore tax havens. Then by way of Panama, Paradise and Pandora leaks we all see the revelation of information about offshore companies with details which are not publicly available. It is generally considered that such information has been obtained by ICIJ, an international body of journalists, from the offices of lawyers engaged in providing services for incorporation and operation of companies in offshore tax havens. I don’t think it’s a plausible answer. This is a breach of general principles of confidentiality and those who are found involved may be prosecuted under the international laws on that subject. It is my personal view that after 9/11 and recasting of the world financial system in 2008 there is a desire within the policymakers in the rich economies that the whole operational procedures of offshore tax havens are required to be reexamined. This review is instigated by the following two factors:
Liberal corporate and foreign exchange regime may assist placement of funds linked with terrorist activities in these locations;
Big corporations in the West started using these locations to avoid tax that would have been received in their countries.
On the basis of these two primary considerations there has been a move by the rich countries to discourage offshore tax havens. The leaks are the result of this strategic move. Now after the leaks the benefit of anonymity and confidentiality has effectively ended; therefore, there will be natural demise of these offshore tax havens.
New kind of offshore tax havens
In the recent past two jurisdictions have emerged as a new kind of offshore tax havens. These are the UAE and Mauritius. Both these countries possess all the attributes which were available to offshore tax havens in jurisdictions like the Cayman Island. Furthermore, unlike the other jurisdictions the UAE and Mauritius are part of the international tax treaty mechanism. This means that the UAE and Mauritius are entitled to all the benefits which are available to any other country that has a reasonable tax system. In other words, all the benefits of the treaty mechanism are available without any tax in these jurisdictions.
The biggest benefit which the UAE and Mauritius treaties provide with reference to Pakistan and India is that any capital gain arising on movable assets (such as shares in companies) in Pakistan to a UAE or Mauritian tax resident is exempt from tax in Pakistan. This huge benefit has resulted in huge loss of tax in Pakistan and movement of investment in Pakistan through the UAE without having any significant establishment in the UAE. In the case of Vodafone, the Indian authorities miserably failed in taxing the capital gain that was supposed to be taxable if that transaction would not have been routed through Mauritius. The extent of Indian attempts in this regard can be gauged by the fact that in order to tax that sum Indian legislators changed in 2018 the Income Tax Act, 1961 with retrospective effect to 1962. But they failed as treaty’s provisions cannot be ignored. The Supreme Court of India rejected the appeal.
This reflects that there is a need to reexamine the double tax treaties with these countries as domestic jurisdictions are suffering heavily due to the benefits provided under these treaties.
Pandora Leaks and proposed actions by Pakistan authorities
I wrote numerous articles on this subject in this publication from 2015 to 2016 which I later compiled in the shape of a book — Panama Leaks — A Blessing in Disguise in 2016. In one of those articles I proposed the introduction of a foreign assets declaration law in Pakistan. After the Panama Leaks and its follow-up by the Supreme Court of Pakistan two foreign assets declaration laws were introduced in Pakistan in 2018 and 2019.
Unlike the general perception these laws were not introduced only for tax reasons. These statutes were in principle enacted to provide safeguard to the foreign assets against any action by the foreign countries such as ‘Unexplained Wealth Order’ of the UK. The cost of such declarations was reasonably low and ample opportunity was provided to declare such assets. After the enactment of these laws provisions in the Income Tax Ordinance, 2001 have been suitably changed. In this situation it is required that on the basis of information available from the Pandora Leaks proper scrutiny be made to ensure that all such assets are declared. This scrutiny is however required to be conducted by a person sufficiently trained in this subject. Furthermore, as laid down in the law, all such proceedings are required to be kept confidential.
Under the law, tax proceedings of any person including a person holding a public office are confidential and no information about his tax proceedings can be revealed in media or anyone in any form. In the case of a person holding public office it is his or her moral and social responsibility to explain the position.
In 2016, I described the Panama Leaks as a blessing in disguise. Now after five years I feel I was absolutely right as the amount of foreign assets and transactions disclosed in the tax returns is substantially better than prior to 2018. These new developments by way of Pandora Leaks further strengthen that belief. There is no crime in having an offshore company. The crime is an unexplainable source of investment in such a company if the same is not out of taxed money earned through legal means.
Copyright Business Recorder, 2021