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During the past week, the so-called Paradise Papers that reveal the offshore tax activities of more than 120,000 people and companies have certainly brought deep embarrassment for many of them, but the implications could get more serious with prosecutions and tax reforms, according to experts at Wharton and elsewhere. The Paradise Papers were leaked from the Bermuda-based law firm of Appleby and other entities to the German newspaper Suddeutsche Zeitung, which worked in partnership with the International Consortium of Investigative Journalists (ICIJ) to make the findings public beginning November 5.
The leaks expose the activities of Trump administration officials including Commerce Secretary Wilbur Ross, and they have placed public scrutiny on companies like Apple, Twitter, Facebook and Nike, entertainment stars like Bono, university endowments and even the Queen of England.
The Paradise Papers reveal investments by Ross in a firm that appears to be a direct beneficiary of Russian President Vladimir Putin; it has Putin’s son-in-law among its investors. Eventually, Ross could face inquiries from the U.S. special prosecutor looking into Russia’s ties to the 2016 U.S. presidential election, according to William K. Black, associate professor of economics and law at the University of Missouri-Kansas City, who is also a white-collar criminologist and a former regulator. Beyond that, he said the leaks could lead to some prosecution, “but mostly at this juncture it is the embarrassment of a whole series of leaders from almost every party and social entrepreneurs [as well].”
Unlike with the Panama Papers that named few U.S. individuals or entities, the Paradise Papers name some 31,000 Americans or American addresses, noted David Cay Johnston, founder of DCReport, an online publication that covers the White House and Congress. He did not think that this would be the last such leak and said there are hundreds of law firms that specialize in work involving offshore tax havens. Johnston is also the author of the book The Making of Donald Trump and the winner of the 2001 Pulitzer Prize for Beat Reporting.
Johnston noted that on its part, Appleby has said that it has not violated any laws. “In Bermuda, it is not a crime to help Americans commit tax fraud,” he said. “That doesn’t mean it is morally acceptable, and we will see more issues raised around this kind of tax behavior.”
According to Wharton professor of accounting Jennifer Blouin, “The key issue with having these offshore accounts is secrecy and the notion that there is tax planning or avoidance or evasion.” She agreed that for Ross there likely would be some probes on that front. “In terms of how many proverbial heads are going to roll, it depends on whether these individuals were reporting this information appropriately on their tax returns. You are perfectly able to keep assets offshore as long as you report them to the Internal Revenue Service.”
“In Bermuda, it is not a crime to help Americans commit tax fraud. That doesn’t mean it is morally acceptable.” –David Cay Johnston
The repercussions of the Paradise Papers are now taking shape. An ICIJ report yesterday noted a list of actions being taken around the world, such as arrest warrants issued in Argentina and investigations ordered in countries including Chile, the Netherlands and Singapore.
Black, Johnston and Blouin discussed the implications of the Paradise Papers on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)
Fallout in the U.S.
The controversy serves as another wake-up call for the U.S. to clean up its own tax system and plug loopholes, including strengthening disclosure requirements, according to Philip Nichols, Wharton professor of legal studies and business ethics. “The Paradise Papers confirm that Nevada and especially Delaware are world-class tax havens, largely because they do not require any disclosure at all of beneficial ownership,” he said. “Transparency in accounting would go a long way.”
Nichols predicts that some of the Paradise Papers disclosures will result in prosecutions in the U.S. The Paradise Papers and the Panama Papers have made prosecution of the guilty easier, he noted. “One of the really neat things about the Panama Papers and the Offshore Leaks was that they gave prosecutors around the world ‘cheat sheets,’” he said. “Unraveling the great lengths to which these firms go to hide wealth and income takes a lot of work, and finding the right documents without some sort of whistleblower is almost impossible.” (The ICIJ’s Offshore Leaks database includes information on more than 500,000 offshore entities, and covers both the Panama Papers and the Paradise Papers.)
“In terms of how many proverbial heads are going to roll, it depends on whether these individuals were reporting this information appropriately on their tax returns.” –Jennifer Blouin
At the same time, “it is really difficult to make predictions about [likely prosecutions in] the U.S.” because of many “confounding influences,” Nichols added. “Most of the members of the Republican presidential administration are extremely wealthy, and the people who offer tax evasion schemes have very effectively created a culture among the very wealthy that normalizes and even makes obligatory some form of tax evasion,” he noted. Given that setting, “one could guess that the presidential administration does not feel a sense of outrage at the revelations in the Paradise Papers.”
The Global Enterprise Problem
Johnston agreed that it is technically legal for companies such as Apple to engage in tax planning involving overseas tax havens. Yet, the U.S. Congress has failed to create “a viable, reasonable and fair tax system” that encourages companies to repatriate all their overseas earnings, he said.
In the case of Apple, it might be worth considering that it generates two-thirds of its income overseas, Blouin said. ”How do you tax a global enterprise when our systems just haven’t kept up with the concept of intangible assets and how income is generated now for these types of entities?” she asked. She noted that Ireland, for example, has kept its tax rates low to attract U.S. and European multinationals and their intellectual property assets. She said that would be an appropriate strategy for a company that is generating business in Ireland and has employees there.
“Many companies, including Apple, literally turned a profit off the income tax system by deferring their taxes and siphoning profits out of the U.S. to offshore pockets,” said Johnston. “They obtained zero-interest loans from the U.S. government equal to the unpaid taxes. You invest that money over time and with compounding, eventually you turn a profit.”
Apple denied that it was an offender. “Apple believes every company has a responsibility to pay its taxes, and as the largest taxpayer in the world, Apple pays every dollar it owes in every country around the world,” the company stated.
Black highlighted the exposures in the leaks relating to investment strategies by universities. The papers reveal investments many high-profile university endowments have made indirectly in hydrocarbon businesses. “This was deliberately used not just for tax avoidance, but also for secrecy purposes, because universities knew that their students and many of their alums would be furious if they discovered these facts.”
“Unraveling the great lengths to which these firms go to hide wealth and income takes a lot of work, and finding the right documents without some sort of whistleblower is almost impossible.” –Philip Nichols
Indeed, the Paradise Papers reveal “the extent to which some managers use secretive accounts to evade the directions or desires of their constituencies,” said Nichols.
Blouin noted that because universities are tax exempt, there’s no case for tax evasion. Moreover, “there would be a lot of public outcry” if universities were required to invest only in domestic investments, she said. It would be perfectly in order if the universities reinvested the proceeds from their overseas investments to aid students or for academic purposes. In the case of the University of Pennsylvania, for example, its tuition income covers only 30% of the total revenues, and “a big chunk of it comes from other places,” she added.
“You are allowed as a non-profit to earn tax-free profits from investing so long as you do not use leverage, that is you don’t borrow money,” Johnston said. However, “by going offshore to the hedge funds, nonprofits like university endowments are getting around that rule. It is improper and Congress should put a stop to that.”
The impact of the Paradise Papers is likely to be stronger in Europe than in the U.S. According to Nichols, “it is conceivable that reaction to the Paradise Papers will cause European countries to change the practices of dependent territories.” He noted that the Panama Papers “were very embarrassing for the U.K. because so many tax havens are British protectorates or territories.” Although then-Prime Minister David Cameron responded to the scandal, including hosting a conference on corruption, the British vote to leave the European Union eclipsed that and almost everything else, he said. Now, the BBC is covering the Paradise Papers extensively and without sparing the Queen, and there is “serious condemnation, by both governments and by the peoples across Europe, of tax avoidance by wealthy business firms,” he added.
Nichols noted that media coverage of the Paradise Papers has been more extensive in Europe and in South America than in the U.S. However, that does not necessarily reflect the public sentiment, he suggested. “It seems undeniable that regular people in the U.S. are getting pretty tired of the special treatment to which wealthy people seem to feel entitled, and may at some point take action.”
Johnston said the U.S. needs fundamental tax reform including “vastly better accounting disclosures … on what’s going on with corporate taxes.” Blouin noted that the Organisation for Economic Co-operation and Development (OECD) is attempting to push “country-by-country reporting” to prevent companies from using transfer-pricing mechanisms to dodge taxes. Those attempts are to ensure that multinational companies disclose their global activities according to where their people are and their sales are.
“Mostly at this juncture it is the embarrassment of a whole series of leaders.” –William K. Black
In the case of multinationals, Blouin agreed “there are some problems in our system that need to be fixed.” She noted the European countries have also been trying “to try and fix the system [so that] taxes are paid where economic earnings are being generated, where sales are, and where people are.” She pointed out that the Trump administration’s tax reform bill attempts to address some of those issues with proposals for a minimum tax and so forth to prevent tax avoidance.
“We need to have some rules that really grapple with how we should tax the intellectual property that’s generated here in the U.S.,” Blouin added. That would plug the loopholes by which companies artificially shift profits offshore.
According to Johnston, the Paradise Papers raise a deeper issue, beyond suspected tax evasion or avoidance. “For a tax system to have any moral authority, it has to be a system that is both progressive — the idea that the greater your benefit from society, the greater your contribution to help that society endure — and then it has to treat people equally,” he said. “What Appleby is doing is beyond the pale. It is legal, but that does not mean that it is moral. To think that legal systems can survive the utter immorality that we are seeing here without destabilizing governments in the long run and upsetting the social order, is foolish.” He added that the controversy strikes at the very heart of democracy and self-government. “It should lead sooner or later to fundamental reforms that stop this kind of behavior.”