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Devil's in the details with tax cheats 

This article is published in The Business Times on 12 September 2013
Criminalising tax evasion

In 2012, the Financial Action Task Force (FATF), a global standard setting body for anti-money laundering and terrorist financing, called on governments to treat tax evasion as a money-laundering predicate offence.

This came on the back of slow or negative economic growth and the rise of government spending following the global financial crisis of the last decade.

Budget deficits for governments in the western economies of the world have risen as a result and cuts in spending alone will do little to reduce the swelling deficit. In order to generate revenue, many governments are turning their attention to tackling the issue of corporate tax avoidance and tax evasion.

Cooperation across borders

Supporting this global push to tackle the scourge of cross-border tax evasion, Singapore adopted the recommendations by FATF. In July 2013, tax crimes were officially designated as money-laundering predicate offences.

Financial institutions are now tasked with minimising the risk of "dirty" money arising from tax evasion from entering Singapore’s financial system.

In the case of banks, this may entail thwarting tax cheats from depositing profits that have evaded taxes. For trust companies, this means refraining from assisting clients in setting up dubious trust structures for the purpose of concealing taxable assets from the authorities.

Financial institutions which inadvertently allow tax cheats to slip through may run afoul of the 'Corruption, Drug Trafficking and Other Serious Crimes (Confiscation of Benefits) Act', the key anti-money laundering legislation in Singapore. Penalties range from monetary fines to jail terms.

Tax planning, avoidance and evasion – what’s the difference?

Detecting and deterring illicit activities is a complex and time consuming affair. Countless client accounts will have to be reviewed and continuously monitored. High-risk accounts will come under closer scrutiny and where necessary, have to be reported to the authorities.

For companies facing this task, help comes in the form of tax-risk indicators to identify tax fraudsters.

These indicators, developed by the Monetary Authority of Singapore (MAS), include whether a client utilises complex tax structures, or whether there is adverse tax news about a client circulating in the public domain.

Unfortunately, the devil is in the (implementation) details. Evaluating tax-risk indicators, such as whether the client has a complex investment set-up, involves much judgment.

Another question is just how complicated an investment structure should be before it triggers alarm bells. Even in situations where the client is deemed to have a complex investment structure with the aim to minimise taxation, it would be prudent to conduct an investigation.

The responsibility falls on the financial institution to make the distinction between tax planning and tax evasion.

In tax planning, the client seeks to arrange his affairs in a legal manner such that he has either reduced his income, or that he has no income on which tax is payable.

Tax evasion, on the other hand, is carried out with the intent to reduce taxes through fraudulent activities. Such activities include, but are not limited to, falsifying of tax returns, books or accounts.

Then, there is tax avoidance. While legitimate, it involves the manner in which the client arranges his affairs such that it is devoid of commercial substance. Dealing with tax avoidance is a challenge as it comes in shades of grey.

Financial institutions be aware

Financial institutions are required, by law, to only report instances of tax evasion to the authorities.

With tax avoidance issues, they have to tread with extra care as politicians and the public alike often conflates tax avoidance with tax evasion.

This confusion is further perpetuated by the intense media scrutiny on individuals and corporations which have employed tax structures to reduce their taxes, legitimately or otherwise. It is part of discussions now surrounding tax morality.

In light of this, institutions will have to carefully weigh the reputational risks of dealing with clients that employ tax avoidance strategies.

Given these considerations, financial institutions without dedicated in-house tax support will shy away from qualitative tax-risk indicators. These institutions are more likely to adopt readily operable tax-risk indicators, such as database searches for adverse tax news on their clients.

Adopting such tax-risk indicators are not without its difficulties. For example, the question of whether certain persons, such as the next-of-kin of a high net worth individual, should be included in a database search for adverse tax news.

There is also the issue of a lack of resources. Database searches are time consuming and potentially onerous in nature.

Some financial institutions may end up assigning front-line staff to assist their beleaguered compliance officers. It is therefore essential that adequate training and supervision are provided for such personnel and care must be taken to avoid potential conflicts of interest.

Financial institutions in Singapore are also required to detect and deter proceeds from serious tax offences originating from outside its borders. This is a logical requirement given the open nature of Singapore’s economy and its status as the world’s fourth largest offshore financial centre.

The challenge financial institutions face here is the task of accurately identifying and only reporting offences where the foreign tax evaded is of a type which Singapore imposes.

Safe harbour

To assist financial institutions, the MAS has introduced a safe harbour rule governing such reporting. Under this provision, financial institutions are to alert the authorities if they suspect a serious foreign tax crime, regardless of whether the crime is also criminialised in Singapore.

The authorities can certainly do more to help financial institutions, especially the ones lacking adequate resources and expertise to effectively implement the latest regulatory changes.

It is hoped that the MAS, in its regulatory oversight role, can facilitate the transfer of knowledge and expertise on combating proceeds from tax crimes. This can be most expediently achieved through the sharing of best practices among financial institutions.

Strong governance and business fundamentals remain the draw

Singapore's success as a financial centre is underpinned by high standards of financial regulation and supervision.

The country’s decisive stance on cross-border tax evasion is welcomed. However, there are associated costs with having an open and well-regulated jurisdiction. These take the form of additional complexity and operational costs, which are sometimes borne by taxpayers, individuals and corporations alike.

In taking the long term view, such attendant costs and inconveniences are perhaps necessary trade-offs for Singapore to continue to attract investors.

Taxes aside, Singapore’s attraction lies in its economic and political stability, sound regulation, rule of law and depth of fund management expertise.

This article is contributed by Mr Alan Lau and Mr Chua Kong Ping. They are partner and head of financial services - tax, and senior manager, tax, at KPMG in Singapore respectively. The views expressed are their own.
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