BANK SECRECY - TRADITIONAL AND NEW DIMENSIONS The importance of bank secrecy 29. Bank secrecy has deep historical and cultural roots in some countries. Bank secrecy is also a fundamental requirement of any sound banking system. Customers would be unlikely to entrust their money and financial affairs to banks if the confidentiality of their dealings with banks could not be ensured. Unauthorised disclosure of such information to, for example, the persons with whom they do business (e.g., creditors, customers) could jeopardise the financial welfare of the clients of a bank. Similarly, unauthorised disclosure of matters of personal finance could also pose a threat. Thus, banks must guarantee a high degree of confidentiality in order to do business. As a consequence, bank secrecy initially arose out of the contractual relationship between the bank and its customer. This protection later was reinforced in many countries by legislation protecting the customer’s right to financial privacy. 30. Bank secrecy and the confidence which it brings to a country’s banking system can also stimulate the development of an active financial services industry. The banking and financial services sector is lucrative and growing. Bank secrecy is, however, but one factor in the growth of such services. The efficiency of the banking system, prevailing rates of interest and the general political and economic climate also affect decisions about where to seek financial services. 31. Because of the importance of bank secrecy to the stability of a country’s banking system, access to bank information by tax authorities should not be unfettered. Lifting of bank secrecy for tax administration purposes should always be coupled with stringent safeguards to ensure that the information is used only for the purposes specified in the law. Such safeguards in OECD Member countries include requiring senior level officials to approve requests to banks for information about a specific accountholder, a judicial or other formal process for obtaining the information, the imposition of severe monetary and /or criminal penalties on officials who misuse or disclose the information, or a combination of these measures. In many countries, the accountholder is notified when the tax administration seeks to obtain information about the accountholder’s account. In 20 addition, OECD Member countries have established stringent procedures to protect the information from unauthorised disclosure once the information has been provided to the tax administration. The adequate protection of taxpayers’ rights and the confidentiality of their banking information is particularly important for economies in transition that are attempting to establish sound banking and taxation systems. Protection of the information from unauthorised disclosure is essential to obtaining and maintaining confidence in the banking and taxation systems. The effects of bank secrecy on tax administration and law enforcement 32. Experience has shown over the last 50 years that inadequate access to bank information has been an impediment to tax administration and law enforcement. The scope of non-compliance with the tax laws that is facilitated by lack of access to bank information is difficult to measure precisely because there is insufficient access to the necessary information. The same problem exists in attempting to measure the extent of money laundering. Nevertheless, the FATF estimates that the size of that problem amounts to hundreds of billions of dollars annually8. Since many jurisdictions impose tax on both legal and illegal income and the proceeds of criminal activity usually are not reported as income by criminals, it is reasonable to assume that a large portion of laundered funds have escaped taxation in one or more jurisdictions.9 33. Another indication of the risk of non-compliance with the tax laws is the substantial growth of foreign assets and liabilities held by banks in OECD Member countries. Virtually all OECD Member countries showed substantial growth in the foreign liabilities held by deposit money banks, as reflected in the following chart, which is based on data compiled by the International Monetary Fund 10(see Annex I for complete data). 8. Financial Action Task Force on Money Laundering Annual Report 1995-1996. 9. Once the proceeds of illegal activity have been successfully laundered into “clean money”, they may be taxed as income derived from a different (and legal) activity, though not necessarily by the jurisdiction entitled to tax the profits of the original illegal activity that generated the income. It also is unlikely that the proper amount will be taxed. 10. Data for certain non-member countries was included as a point of comparison. Note also that the IMF includes the UK dependencies in the amounts shown for the United Kingdom. 21 United Kingdom Japan France Germany Luxembourg United States Belgium Netherlands Italy Switzerland Spain Austria Sweden Canada Australia Portugal Korea Denmark Greece Finland Norway New Zealand Ireland Turkey Mexico Poland Hungary Iceland Singapore Bahrain Neth. Antilles Barbados 0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 1996 1980 Deposit Money Banks -- Foreign Liabilities (US$ bill) Source: IMF International Finance Statistics Yearbook, Vol. L. 1997. 34. There has been a similar amount of growth in the foreign assets held by deposit money banks in OECD Member countries, as reflected below. United Kingdom Japan France Germany Luxembourg Belgium Switzerland Netherlands Italy Spain United States Austria Sweden Canada Denmark Portugal Korea Finland Australia Ireland Turkey Norway Greece Poland Mexico New Zealand Hungary Iceland Singapore Bahrain Neth. Antilles Barbados 0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 1996 1980 Deposit Money Banks -- Foreign Assets (US$ bill) Source: IMF International Finance Statistics Yearbook, Vol. L. 1997. 22 35. The growth of both the foreign assets and liabilities held by deposit money banks certainly does not by itself establish that non-compliance with the tax laws through the use of foreign banks is on the rise. However, this growth does demonstrate that the amount of cross-border flows through financial institutions in OECD Member countries is increasing. As a result, tax administrations in OECD Member countries now are more likely to need to have access to information held by foreign banks than in the past in order to administer their taxes effectively.11 Globalisation and Liberalisation of Financial Markets 36. One of the elements that has fuelled globalisation in the last decade has been the liberalisation of financial markets, a trend which the OECD has promoted. This liberalisation was in part a response to the threat to financial markets posed by offshore financial centres. Such financial centres in the 1960’s and 1970’s were able to attract foreign financial institutions by offering a minimally regulated banking system and minimal taxation at a time when technological advances made them more readily accessible. As capital flows to offshore financial centres threatened to undermine the traditional financial markets, a number of regulatory reforms were undertaken to level the playing field between onshore and offshore banking.12 Exchange controls were eliminated. Some countries established markets to compete directly with the offshore financial centres. In addition, efforts were made to harmonise the regulation of financial markets on a global basis.13 37. The resulting liberalisation and harmonisation of financial markets greatly facilitated the free flow of capital across national borders, which improved the allocation of capital and reduced its cost. Liberalisation also 11. Note that the information in the above charts only reflects foreign assets and liabilities held by deposit money banks. Five countries (Ireland, Mexico, Spain, Sweden, and Switzerland) also have other banking institutions that have foreign assets and liabilities. The total foreign assets and liabilities held by deposit money banks and other banking institutions in these countries is shown in charts that appear in Annex I. 12. “Offshore banking” generally is understood to mean a bank that accepts deposits and/or manages assets denominated in a foreign currency on behalf of persons resident elsewhere. 13. 1995 Report on Globalisation of Financial Markets and the Tax Treatment of Income and Capital. 23 encouraged the growth of non-bank financial intermediaries (e.g. investment funds, pension funds, insurance firms). 38. Although the liberalisation of financial markets has facilitated economic growth, it also has increased opportunities for non-compliance with the tax laws. Once most of the non-tax barriers to the integration of financial and capital markets had been removed, individuals and legal entities gained access, at little or no cost, to banking systems around the globe through which to conduct both legitimate and illegitimate transactions. This access has made it easier for them to avail themselves of the benefits offered by jurisdictions that limit access to bank information for tax purposes. It also has made it harder for tax administrations to detect non-compliance unless they have adequate exchange of information with the relevant jurisdictions. 39. One of the ways taxpayers typically seek to protect the nature of their transactions is through the use of wire transfers to or from jurisdictions that have more restrictive access to bank information for tax purposes. Although domestic regulations may require banks to obtain information identifying the sender and the recipient of funds transferred by wire, if the funds are sent to or from a jurisdiction that denies tax authorities access to bank information, there is no way to verify the identity of the foreign sender or recipient of the funds. The tax authority usually will be able to verify only the domestic end of the transaction. Without information about both ends of the transaction, it has proven difficult for the tax authority to determine the true nature of the transaction and the character and source of the income. The problems presented by wire transfers pale in comparison to the problems tax administrations will face as electronic banking becomes more widespread because in many cases the tax authorities will not have access to information about either end of the transaction. Electronic Commerce and Electronic Money 40. Globalisation and liberalisation of financial markets may have paved the way to increased access to cross-border banking, but the significant advances in electronic technology are what have accelerated access to anonymous and instantaneous cross-border banking. Even without the liberalisation of financial markets, the new technologies would have permitted this to occur. 41. One of the newest challenges to tax administration is in the area of electronic payment systems designed to facilitate Internet electronic commerce. These fall into three main types: 24 − credit and debit cards coupled with security systems such as Secured Encryption Technology (SET); − stored value cards, including “smart” cards; and − electronic money, including forms of electronic cash and cheques. 42. These types of systems also can be categorised as accounted or unaccounted systems. Accounted systems have independent audit trails, often use a third party intermediary to complete the transaction and one or all the parties to the transaction can be identified. Unaccounted systems are those which operate like cash; there is no audit trail, no independent intermediary and no identification of the parties to the transaction. 43. Credit and debit card systems usually are accounted systems. However, if taxpayers are able to obtain credit cards from jurisdictions that do not meet the standards established in paragraph 21, tax authorities will be prevented from having access to some or all of the information about the transactions undertaken with these systems. 44. Stored value cards are configured in a number of different formats, some accounted, others unaccounted. As noted above, unaccounted cards present particularly substantial challenges to effective tax administration. Because they effectively operate like cash, but without the constraints of bulk or concerns about security for large amounts, they represent a similar, but greater, challenge than that presented by the current cash economy. This challenge is compounded if the card is issued by a bank in a jurisdiction that restricts access to bank information for tax administration purposes. Accounted stored value cards, like debit and credit cards, also will present difficulties for tax administration if they are issued by banks in jurisdictions that restrict access to bank information for tax administration purposes. 45. Like stored value cards, electronic money also can be issued in accounted and unaccounted forms. As a result, the difficulties that arise with stored value cards will also arise with electronic cash and cheques. 46. These payment systems, particularly when combined with encryption technology, have the potential to further complicate and obfuscate the audit trail needed by tax administrations to administer and enforce the tax laws. The Committee, in the context of its work on electronic commerce, is considering ways to ensure that these payment systems can be developed to assist the growth of electronic commerce without creating new opportunities for taxpayers to escape their tax obligations. 25 47. It will be of little use to tax administrations if identification and other systems are developed to increase the transparency of electronic commerce (including banking) if bank secrecy or other laws prevent access to such information for tax purposes. Given the significant potential for an increase in cross-border banking through electronic means, restrictive bank secrecy in foreign jurisdictions is likely to pose a more significant barrier to tax administration than in the past. Money Laundering and Tax Crimes 48. Lack of access to bank information greatly facilitates the success of money laundering schemes which are used to process the proceeds of crimes to disguise their illegal origins. Money laundering techniques also are used to conceal illegally and legally earned taxable income from tax authorities, which act may be a crime in many OECD Member countries, depending on the circumstances. A recently issued report commissioned by the United Nations Office for Drug Control and Crime Prevention discusses the links between money laundering and tax evasion and suggests that the size of the tax evasion problem is some multiple of the amount of the proceeds of all types of crime.14 49. Money laundering, like criminal tax offences, has been made easier with the technological advances that facilitate the movement of funds across borders and continues to be a problem of serious concern to all countries. All OECD Member countries except Korea (which is waiting for legislative ratification of the anti-money laundering bill proposed by its government) have taken measures to relax bank secrecy or have enacted measures specifically to combat money laundering. Most of these efforts are directed at curbing money laundering connected to non-tax offences, although some of those efforts have had positive spillover effects for tax administration purposes. 50. Many of the advances in this area can be attributed to the work of the FATF. In 1990, the FATF issued a report containing 40 recommendations on actions to be taken to combat money laundering (hereafter referred to as the FATF Recommendations). Notably, none of the recommendations refers to the use of money laundering in connection with tax crimes. In fact, the Recommendations as originally drafted, referred to money laundering only in connection with narcotics trafficking offences. However, in 1996, the FATF extended the money laundering predicate offences beyond narcotics trafficking because its members recognised that non-drug-related money laundering was 14. Financial Havens, Banking Secrecy and Money Laundering, June 8, 1998. 26 “an important and growing source of illegal wealth entering legitimate financial channels”. Recommendation 4 of the FATF Recommendations now requires countries to extend the definition of the offence of money laundering to nonnarcotic “serious crimes.” Countries may thus choose to combat tax crimes by treating tax crimes as serious crimes for purposes of anti-money laundering legislation. 51. Recommendations 10 and 11 of the FATF Recommendations also are beneficial for tax administration purposes. They relate to customer identification and record-keeping rules and provide as follows: 10. Financial institutions should not keep anonymous accounts or accounts in obviously fictitious names: they should be required (by law, by regulations, by agreements between supervisory authorities and financial institutions or by self-regulatory agreements among financial institutions) to identify, on the basis of an official or other reliable identifying document, and record the identity of their clients, either occasional or usual, when establishing business relations or conducting transactions (in particular opening of accounts or passbooks, entering into fiduciary transactions, renting of safe deposit boxes, performing large cash transactions). In order to fulfil identification requirements concerning legal entities, financial institutions should, when necessary, take measures: (i) to verify the legal existence and structure of the customer by obtaining either from a public register or from the customer or both, proof of incorporation, including information concerning the customer’s name, legal form, address, directors and provisions regulating the power to bind the entity; (ii) to verify that any person purporting to act on behalf of the customer is so authorised and identify that person. 11. Financial institutions should take reasonable measures to obtain information about the true identity of the persons on whose behalf an account is opened or a transaction conducted if there are any doubts as to whether these clients or customers are acting on their own behalf, for example, in the case of domiciliary companies (i.e., institutions, corporations, foundations, trusts, etc. that do not conduct any commercial or manufacturing business or any other form of commercial operation in the country where their registered office is located). 27 52. These recommendations strengthen the requirements that financial institutions must meet regarding customer identification to deter money laundering. They reflect a recognition that access to bank information is of limited value if the necessary information has not been gathered by the bank or if the information is unreliable, particularly as regards the identity of the beneficial owner of an account. The enhancement of the type and reliability of information that financial institutions must maintain to combat money laundering also enhances the information potentially available for other law enforcement purposes if access to that information is permitted by law. As a result, these recommendations represent an important step forward in addressing the difficulties posed to law enforcement officials, including tax administrators, by money laundering and lack of access to bank information. 53. As mentioned in paragraph 17, the G7 agreed to enhance the capacity of anti-money laundering systems to deal effectively with tax related crimes. In this regard, the objectives adopted by the G7 are to ensure that obligations under anti-money laundering systems to report transactions relating to suspected criminal offences continue to apply even where such transactions are thought to involve tax offences (the “tax loophole”) and to permit money laundering authorities to the greatest extent possible to pass information to their tax authorities to support the investigation of tax related crimes and to communicate to other jurisdictions in ways that would allow its use by their tax authorities. The information should be used in a way which does not undermine the effectiveness of anti-money laundering systems. 54. The FATF has already made progress in addressing the “tax loophole” issue by adopting the following text for an interpretive note to Recommendation 15 of the FATF Recommendations: “In implementing Recommendation 1515, suspicious transactions should be reported by financial institutions regardless of whether they are also thought to involve tax matters. Countries should take into account that, in order to deter financial institutions from reporting a suspicious transaction, money launderers may seek to state, inter alia, that their transactions relate to tax matters.” The FATF work plan also includes the following project: “The FATF will, taking into account the work of the OECD’s Committee on Fiscal Affairs, examine the question of the transmission of information by members’ anti-money laundering authorities to their tax administrations.” 15. Recommendation 15 of the FATF Recommendations provides: “If financial institutions suspect that funds stem from a criminal activity, they should be required to report promptly their suspicions to the competent authorities.” 28 55. These recent developments are a strong indication that the international climate has changed with respect to access to bank information for tax purposes. There appears to be a growing recognition of the importance of bank information not only to combat non-tax criminal activity and money laundering but also to combat tax crimes.