Thursday, 11 August 2016

‘White Papers’ from Panama Part - II



‘White Papers’ from Panama Part - II


Challenge before those who have vested interest in tax havens




For the bankers keeping secret funds in safe custody, for the law firms facilitating creation of shell companies and transfer of funds and for the beneficiaries of these services, the leakage of 2.1 million Panama Papers is a much bigger setback than the leakage of secret accounts of a few hundred persons kept by the HSBC bank in Switzerland a couple of years back. Because of its strategic location and American backing, Panama was supposed to be the most secure tax heaven, especially for the Americans. Undisturbed trade through Panama Canal is crucial to the western countries, especially  the USA. The treaty signed by Obama in 2011 insulates Panama from any crackdown by the US. They must not have imagined that one day they would face such a problem. It would be highly simplistic to believe that even leakage of such magnitude would change the heart of tax evaders and other criminals and put an end to their illegal activities. Their real worry must be  ‘how there has been such a massive leakage and how to protect their interest in future’.  

Despite all precautions there is always the danger of theft. The secret documents can be saved from thieves only when kept in a tamper-proof safe. The lock should be so strong  that it can neither be opened with another key nor can be broken with any hammer. Such a ‘lock’ is provided by encryption technology. Today anyone who has access can read the leaked Panama Papers because there are plain texts. Visualise the scenario had these documents been encrypted. The experts would have been struggling to decrypt which is not an easy task. The use of encryption is becoming quite common. According to a recent news in a Delhi paper, with a new feature added by WhatsApp, everything done on the app – chats, calls, videos – are secured with strong end-to-end encryption. No one who intercepts any communication during transmission can decode it. Theoretically it is possible to develop algorithmic equations that can provide encryptions that cannot be decoded even by the most experienced experts of the NASA working on supercomputers. According to an article I read recently ‘to break a 1620 bit key, one would need a computer with 120 Terabytes of memory and the memory requirement virtually rules out cracking methods.’ 

  I would not be surprised if the use of encryption technology to keep the ill-gotten money hidden becomes common. Like China, Russia and USA, Panama is also not a signatory to the OECD convention. As long as Panama serves US interest by agreeing to abide by FATCA, there is little possibility of its being forced to sign the OECD convention nor can it be forced not to use encryption technology.

Even if there are restrictions on the use of higher forms of encryptions, enforcement would not be easy. For example, in India the Department of Telecom norm of 2007 does  not permit private service providers to use encryption stronger than 40-bits. Only some banks have been allowed to use encryption of up to 128-bits. However, WhatsApp is using 256-bit encryption without any objection being raised so far.

 The rapidly growing use of Bitcoin (digital currency) provides another opportunity. The RBI and investigating agencies like the ED and Income Tax Department have cautioned the government that Bitcoins can be used to transfer black money anywhere in the world without leaving its ‘footprints’ behind.

Another possibility is to develop new tax havens to store encrypted data. The need is so pressing that if one tax haven goes, new ones will emerge to fill the void. It will take time before investigating agencies become aware of such tax havens and magnitude of operations. According to the Financial Transparency Coalition, an organisation focusing on accountability and transparency, some British business concerns are planning to develop Kenya as a tax haven.

 Incidentally, the list of 15 big tax havens includes Germany, Japan and the USA.

Meanwhile the ‘tax havens’ have taken an important measure to protect their ‘honour’. They do not want to be called ‘tax havens’. In other words they do not want a tattoo on their arm or back that ‘I am a crook’. The Government of India has accepted their demand.


Challenges before income tax authorities




The flow of information as a result of FATCA and international convention would start within a year or so. But availability of information is one thing, successful use of information is quite different. The tax authorities in several countries must be struggling with millions of documents leaked from Panama. They may not have adequate resources to process volumes of data flowing every year from hundreds of sources. Considered very powerful,  the IRS (Internal Revenue Service) of the USA has often complained that it does not have the requisite resources to investigate serious economic crimes being committed in Panama. The agency has even complained of shortage of funds to investigate  cases of ‘transfer pricing’ abuse – a technique used by US companies to sell their own products to the foreign subsidiaries at unbelievable prices in order to reduce tax liabilities. The New York Times has also  warned that the US IRS will not be able to take the  workload.




Our own IRS (Indian Revenue Service) is much less equipped. Panamanian law firm Mossac  Foseca and persons like Amitabh Bachchan linked with that firm have been under the investigation of the income department for nearly nine years, without any visible result. There is no public knowledge about the reasons: lack of expertise, lack of manpower, or external pressure or a combination of all these.

The task of our IRS will become very challenging once information about secret funds is encrypted. I had flagged this issue 25 years ago when I was heading the Organisation & Management Directorate of the income tax Department. After discussions with a Delhi IIT professor who had been given an encrypted document and two years of time by the Government of India to decrypt, I had prepared a paper on the challenge ahead and had suggested need for proactive measures. The paper was submitted to the Central Board of Direct Taxes where it was simply ignored by the computer illiterate member dealing investigations. The National Academy of Direct Taxes at Nagpur has a computer centre to train the IRS officers in the use of information technology.  My impression is that the computer centre has no arrangements to prepare the officers to deal with the challenge posed by encryption technology.  It is high time, the government gives serious consideration to this problem.

It is a common experience that law breakers are often ahead of law enforcers.

To give due credit, I understand that the IRS officers are trying to understand the use and misuse of Bitcoins.

The bottom line is that the process to achieve universal transparency will be slow and painful. As long as the rich and powerful are able to hide their money, ordinary taxpayers like us will have to bear extra burden to meet the growing government expenses and the main sources of information from tax havens will be whistleblowers.

Devendra Narain

April 25, 2016


‘White Papers’ from Panama, Part - I was uploaded yesterday.

Link: http://naraindevendra.blogspot.com/2016/08/who-really-governs-india-part-i.html

If you like the article, please share with your friends.