Money laundering is the process by which illegally earned money (mostly in cash form) is filtered or laundered through the financial system. In other words, it is a process of creating the appearance that large amounts of money obtained from serious crimes, such as corruption, smuggling or terrorist activities, originated from a legitimate source.
Illegally earned money needs laundering in order for the corrupt to use it effectively. Dealing in large amounts of illegal cash is inefficient and dangerous. The criminals need a way to deposit the money in financial institutions, yet they can only do so if the money appears to come from legitimate sources. The process of money laundering generally involves three steps: placement, layering, and integration. Placement is the act of introducing "dirty money" (money obtained through illegitimate means) into the financial system in some way; "layering" is the act of concealing the source of that money by way of a series of complex transactions and bookkeeping engineering; and integration refers to the act of acquiring that money in purportedly legitimate means.
Money laundering methods involve investing in valuable mobile commodities such as gold and gems that can be easily transferred to other jurisdictions; discretely investing in and selling valuable assets such as real estate; gambling; counterfeiting; and creating shell companies. While these methods are still in play, any type of money laundering must also include modern methods that put a new spin on the old crime by making use of the technology.
To obtain dual benefit of tax exemption coupled with money laundering, the most common method the corrupt use is creating shell companies (commonly referred as "offshore companies") in tax havens. A tax haven is a country that offers foreign individuals and businesses a minimal tax liability in a politically and economically stable environment, with little or no financial information shared with foreign tax authorities. Tax havens do not require individuals to reside in or businesses to operate out of their countries to benefit from local tax policies.
Tax haven status benefits the host country as well as the companies and individuals maintaining accounts in them. Tax haven countries benefit by drawing capital to their banks and financial institutions, which can form the foundation of a thriving financial sector. Individuals and corporations benefit through tax savings resulting from tax rates ranging from zero to the low single digits versus relatively high taxes in their countries of citizenship or domicile.
The list of tax haven countries includes Andorra, the Bahamas, Belize, Bermuda, the British Virgin Islands, the Cayman Islands, the Channel Islands, the Cook Islands, Hong Kong, The Isle of Man, Mauritius, Lichtenstein, Monaco, Panama, Ras Al-Khaimah and St. Kitts and Nevis. Most of the offshore companies are located in these Jurisdictions.
The term 'offshore' simply means to be located or based outside of a nation's boundaries. For us Pakistanis, the term offshore means to be located or based outside Pakistan. Similarly an Offshore Company means a company located or based outside Pakistan.
Offshore investing is often seen doubtfully in the masses, which paints a picture of investors stockpiling their money with some illegal company located on a murky island where the tax rate is next to nothing. While it's true that there will always be instances of doubtful offshore transactions, the vast majority of offshore investing may perfectly be legal.
So, why would an individual from Pakistan will establish an offshore company? There are several reasons:
Reduced Tax Rates - Many countries (known as tax havens) offer tax incentives to foreign investors. The low tax rates in an offshore country are structured to promote a healthy investment environment that attracts outside wealth. For a tiny country with very few resources and a small population, attracting investors can dramatically increase economic activity. Simply put, offshore investment occurs when offshore investors form a corporation in a foreign country. The corporation acts as a shell for the investors' accounts, shielding them from the higher tax burden that would be incurred in their home country. Because the corporation does not engage in local operations, little or no tax is imposed on the offshore corporation. As such, making investments through foreign corporations in Pakistan can hold a distinct advantage over making investments as an individual.
Asset Protection - Offshore centers are popular locations for restructuring ownership of assets. Through trusts, foundations or through an existing corporation individual wealth ownership can be transferred from people to other legal entities. Many individuals who are concerned about lawsuits, or lenders foreclosing on outstanding debts elect to transfer a portion of their assets from their personal estates to an entity that holds it outside of their home country. Pakistan has a history of nationalising the large industrial organisations which left their owners bare hands overnight. By making these on-paper ownership transfers, individuals are no longer susceptible to seizure or other domestic troubles.
Confidentiality - Many offshore countries offer the complimentary benefit of secrecy legislation. These countries have enacted laws establishing strict corporate and banking confidentiality. However, this secrecy doesn't mean that offshore investors are criminals with something to hide. It's also important to note that offshore laws will allow identity disclosure in clear instances of drug trafficking, money laundering or other illegal activities. From the point of view of a high-profile investor, however, keeping information, such as the investor's identity, secret while accumulating shares of a public company can offer that investor a significant financial (and legal) advantage. High-profile investors don't like the public at large knowing what stocks they're investing in. Multi-millionaire investors don't want a bunch of little investors buying the same stocks that they have targeted for large volume share purchases as the small investors push the prices up.
Because nations are not required to accept the laws of a foreign government, offshore jurisdictions are, in most cases, immune to the laws that may apply where the investor resides.
Diversification of investment - In Pakistan, regulations restrict the international investment opportunities of citizens. Many investors feel that such restriction hinders the establishment of a truly diversified investment portfolio. Offshore accounts are much more flexible, giving investors unlimited access to international markets and to all major exchanges. On top of that, there are many opportunities in developing nations, especially in those that are beginning to privatise sectors that were formerly under government control. China's willingness to privatise some industries has investors drooling over the world's largest consumer market.
If we further dig down, the Pakistani Offshore Company owners may be categorised into three types. Firstly, there are resident persons who shift capital out of country into, say, Bahamas. The person sets up a trust making himself the beneficiary. The trust then establishes a company, say United Arabs LLC in the UAE. The shareholders of such company will be some individuals from UAE who will hold shares on behalf of the trust and will be nominee directors only. The United Arabs LLC then invests in some Company located in Pakistan, say United Pak Ltd (bouncing back), income of which is exempt (for eg setting up a Halal Meat Production Unit) by purchasing shares of such company and earn dividend therefrom which is withdrawn by the ultimate beneficiary after routing through the trust. There are a few issues in this mechanism which makes it illegal, for example, the resident person ultimately owns a company but he is not the owner on paper. Further, the dividend as earned by United Arabs LLC ultimately adds to the wealth of resident person but goes undeclared, which is against the provisions of section 116 of ITO as explained above. Furthermore, advance tax to be deducted from a payment to non-resident on account of dividend is same as payment to resident person as per section 152 of ITO. The rates as applicable in case of dividend are as follows:
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S.No Recipient of Dividend Rates
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1 75Y
Shareholders of a:
-Power project privatised by WAPDA -
Company setup for power generation -
Company supplying coal exclusively to power
Generation projects
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2 -Dividend received from a mutual fund 25%
-received by a company 10%
-Received by Individual or AOP
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3 Dividend received from a stock fund 12.5%
-if dividend receipts are less than 10%
capital gains
-if dividend receipts are equal to or
more than capital gains
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4 Dividend from a collective investment 25% 10%
scheme (15% for
-received by a company nonfiler)
-Received by Individual or AOP
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5 Other corporate and non-corporate 12.5%
shareholders: 20%
-Filer
-Non-Filer
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As per the treaty between UAE and Pakistan, the rate of advance tax to be deducted from payment to a non-resident beneficial owner of shares shall not exceed 10%. In such a case, there is a straight prima facie saving of 10% tax on dividend. Since the ultimate beneficial owner of United Pak Ltd is the Pakistani resident person, however, on paper United Arabs LLC is the beneficial owner. This sophisticated layering results in loss of revenue to exchequer as explained above.
To go one step further, in case the United Pak Ltd is a 100% owned subsidiary of United Arabs LLC (being a filer) and a group return is filed, no tax shall be deducted by former while making payment of dividend to later as per clause 11B, part IV, second schedule of ITO. Furthermore, such dividend shall be exempt in the hands of United Arabs LLC as per clause 103A, part I of Second Schedule to ITO. Once again, due to such a sophisticated layering, the high net worth Pakistani resident is not only able to park his wealth to offshore, but he is also able to do it without paying a single rupee as taxes.
Secondly, there come the persons who remit capital out of Pakistan in the guise of commission to offshore companies which may be held by, and in the name of, their associated persons, however, in their books in Pakistan they do not disclose the fact that the remittances on account of commission are made to related parties. For example, AB Exporters remit amounts from Pakistan to an offshore company, AB Agency, on account of commission in line with allowed limits as prescribed under section 32 of Foreign Exchange Regulation Act, 1947 ("FERA") (ie, 7% for textile made ups, sports goods, etc and 6% for other goods). Although AB agency is a sister concern of AB Exporters, the same may not be declared by AB Exporters as such. This means that, on one hand, AB Exporters are involved in placement (ie first stage in money laundering) of dirty money, and on the other hand, this act also comes under misdeclaration/non-declaration of assets which is against the provisions of section 116 of ITO as explained above and also in violation of FERA due to misdeclaration.
Lastly, some Pakistani non-residents have also made investments in Pakistan through their offshore companies who earn dividend on such investments which is remitted back to their offshore companies. However, such Pakistanis, being non-resident, are not required to declare any of their assets and their investments through offshore companies are completely legal; in fact, their investments contribute to the Federal Reserves.
These offshore companies are created on behalf of high net worth business individuals, politicians, sportspersons and artists by and on advice of internationally affiliated advisory firms (out of which mostly are accounting firms). These advisory firms show these high net worth individuals the way to route, hide, re-route and protect their ill gotten or untaxed moneys taking advantage of their international presence. To curb such practices, firms involved in such advisory roles should also be penalised along with the persons involved as these are the root cause of such money laundering. In a recent seminar subsequent to signing of OECD convention by Pakistan, an esteemed speaker also raise the same point and suggested that the personal wealth management departments of accounting firms should be curtailed due to the foregoing reasons.
Furthermore, these advises are given under the guise of provisions of duly amended Protection of Economic Reform Regulations ("Reform Act"). Section 4 of the Reform Act provides freedom to bring, hold, sell and take out foreign currency and also provides that no one shall be required to make a foreign currency declaration nor shall anyone be questioned with regard to same. Section 5 of the Reform Act provides immunity to foreign currency accounts against any inquiry from Income Tax Department or any other taxation authority as to the source of financing of the foreign currency accounts. Moreover, section 9 of the Reform Act ensures secrecy of bona fide banking transactions. However, these advices ignore judgements 2000 SCMR 814 and 2006 SCMR 1609 of Supreme Court of Pakistan which has discussed the provisions of sections 4, 5 and 9 of Reform Act and held that nothing that is contained in Protection of Economic Reforms Act, 1992 provides blanket protection regarding criminal acts and liabilities. It means that the inquiries with respect to financing of offshore companies may be made under section 94 of the Criminal Procedure Code, 1898, subject to prior permission in writing of a Session Judge or High Court, as the case may be, as provided in section 94.
Another reason is lack of enabling environment in Pakistan for these individuals. For example, incentives/tax credits available in Income Tax Ordinance, 2001 (ITO), for establishment of a new undertaking or investment in assets of existing entity, are ambiguous and does not clarify the scope of such credits (eg, whether minimum taxes and/or alternate corporate taxes are also covered or not). If the scope of such credits is reduced after the announcement and investment by the taxpayer, the credit no longer retains the utility and becomes impotent due to compulsory payment of taxes such as ACT and minimum taxes. Inconsistent policies, like these, discourage the potential investors to invest in Pakistan causing exploration of other alternatives.
Easy availability of routing money through informal channels have also enabled and encouraged these individual to invest hugely in real estate in Middle Easter countries.
Way forward
To curb money laundering, tax evasion and smuggling of capital out of Pakistan, Individuals should be incentivize through an ad hoc scheme until, the consistent policies are formulated, to provide a vent through which the suffocation of taxpayers is released. Although Pakistan, on September 14, 2016, signed the OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters, a bare reading of the convention reveals that the benefits of information availability and administrative support will be restrained by various limits as prescribed in the Convention (section 21 read with section 14), therefore, any such measure to trace back the individual and corporations involved in money laundering, assets parking and/or tax evasion through OECD convention will not get the desired results.
Currently, introduction of a scheme to bring the undeclared assets into the economy is inevitable. Examples of India and Indonesia may be suitable to refer here.
Indian model An Income Declaration Scheme was launched in India on June 01, 2016. Under the scheme, those who had evaded taxes were given the opportunity to avoid punishment by paying tax, penalty and cess totalling 45 percent of the undisclosed income. The payments have to be made in three instalments of 25%, 25% and 50% by November, 2016; March, 2017 and September, 2017; respectively. Up to October 01, 2016, 64,275 declarants have declared approximately USD 97.5 billion. The Indian Government has promised to maintain secrecy of declarants without any question on the source of income. The scheme is expected to get approximately USD 44.8 billion as tax revenue from scheme.
Indonesian model Indonesia also introduced a tax amnesty scheme recently. The amnesty collected USD 7.45 billion during first phase of the scheme which expired on September 30, 2016. Around 366,757 taxpayers signed up for the first phase of the scheme declaring approximately USD 277 billion. The penalty rates are as follows:
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Clearance Levy Rates
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Declaration filing date Onshore assets declared and Offshore assets declared
Offshore assets declared and but not repatriated
repatriated
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1 July, 2016 to 2% (if repatriated by 4%
30 September, 2016 31 December, 2016)
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1 October, 2016 to 3% (if repatriated by 6%
31 December, 2016 31 December, 2016)
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1 January, 2017 to 5% (if repatriated by 10%
31 March, 2017 31 March, 2017)
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Proposed Pakistani model
Pakistan can also benefit by introducing a scheme on similar lines to bring concocter money into the documented economy. The scheme may be inspired by the Indonesian model as follows:
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Clearance Levy Rates
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Phases Declaration filing date Onshore assets declared Offshore assets declared
and Offshore assets but not repatriated
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declared and repatriated
I 1 January, 2017 to 5% (if repatriated by 10%
3l March, 2017 30 June, 2017)
II 1 April, 2017 to 7% (if repatriated by 14%
3O June, 2017 30 June, 2017)
III 1 July, 2017 to 10% (if repatriated by 20%
30 September, 2017 30 September, 2017)
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The above proposed scheme will inject a fresh blood in the documented economy not only in the year of its implementation (due to repatriation of assets) but also for coming years as the income generated each year on assets declared will be charged to tax and will add to the reserves (even if repatriation is not opted).
The above scheme is inevitable as under the prevailing impotent Income Tax Ordinance, 2001 (ITO), general information about a taxpayer cannot be sought by the commissioner and/or any competitive authority, in author's humble opinion. Section 176 of ITO deals with the notice to obtain information or evidence. It provides that information to be obtained must be specified by the commissioner in the notice. Section 144 of the Repealed Ordinance (corresponding to section 176 of ITO) had a quite wider language. Even then, it was always understood that the information required would be specific. Notices issued to individuals specially carrying caveats like "or any similar undisclosed transactions or investments", etc, would not be legally tenable in author's humble opinion. Supreme Court of Pakistan in their judgement 2005 PTD 1933 also held that every word used by the legislature must be given its true meaning. Therefore, the word "specified" used in subsection (1) of section 176 of ITO must also be given its true meaning and, therefore, any general information sought would not stand any legality.
Moreover, even in case the information sought is specified in the notice, no order of assessment can be passed on account of a transaction which pertains to prior periods of more than 5 years. A penalty equal to the amount of tax evaded is provided under clauses (12) of subsection (1) of section 182 of ITO. This penalty will also be ineffective as the assessment order for levying tax evaded would be out of scope being pertaining to a period older than five years, in author's humble opinion.
Furthermore, in addition to the scheme, a cap should be introduced to remit moneys outside Pakistan as available in India, ie, amounts to be remitted outside India are restricted up to USD 500,000 in a financial year. Moreover, 100% penalties may be imposed on transfer of moneys through informal channels.
(The views expressed in this article are not necessarily those of the newspaper)
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