How effective are tax information exchange treaties?

A parliamentary panel's recently tabled report in the Lok Sabha estimates that between 1980 and 2010, Non-Resident Indians (NRIs) held unaccounted-for wealth to the tune of $216.5-$490 billion. This issue is not India-specific. It plagues developing countries as well as developed countries across the world.

A major chunk of this wealth is stashed in tax havens that protect evaders with banking secrecy laws. To counter this, major economies have come together to force these havens to sign Tax Information Exchange Agreements (TIEA). A TIEA between, say, India and Mauritius allows Indian authorities to ask the authorities in Mauritius for information on bank accounts and other assets of a specific Indian in Mauritius. However, Indian authorities must have a documented reason to believe the person has committed tax evasion. In other words, TIEA does not allow roving inquiries.

Tax havens were first forced to sign TIEAs with G20 countries in the wake of the 2008 financial crisis. Over 3,000 treaties have been signed since then. However, it is not clear how effective such information exchange treaties are. A recent report by DIW Berlin shows that deposit of unaccounted monies in haven-based banks decreases whenever a new TIEA is signed but again increases after some time. The effect of TIEAs seems only temporary.

The report estimates that money moves out of banks in tax havens up to two quarters before a TIEA of the tax haven with a non-haven country comes into force, and persists for at least 20 quarters after the TIEA is signed. Tax evaders manage to adapt and money moves back in. The report concludes that the efficacy of information exchange treaties in subduing tax evasion is ‘still very doubtful’.

Information exchange treaties remain ineffective in the long run because of their many limitations. One simple way to dodge the treaty is to open bank accounts or shell companies in the name of a friend or relative. Panama paper leaks have revealed undisclosed wealth parked in the name of Russian President Vladimir Putin’s best friend, who is a cellist. The Football Leaks revealed unaccounted-for wealth formally belonging to Lionel Messi’s father. Roving inquiries cannot be made under TIEA; only information related to a specific person can be called for under TIEA. Such inquiries naturally miss out bank accounts maintained in name of a relative or friend.

A more complex strategy used to dodge TIEAs is creating complicated layers of companies across different tax havens so that it is difficult to reach the ultimate beneficiary. For example, consider an Indian citizen who opens a company C-A in tax haven A. C-A then incorporates a company C-B in tax haven B. C-B then becomes the owner of company C-D in tax haven D. India may not have TIEAs with all these tax havens. Even if India has TIEAs with all of these tax havens, it will take an excruciatingly long time to zero in on the owner of this wealth.

Another strategy used by tax evaders is to get second citizenship in a tax haven. For example, an Indian citizen may take up second citizenship of Saint Kitts & Nevis and not inform Indian authorities about it. Then they will open bank accounts in St Kitts & Nevis. TIEAs are applicable to accounts of foreigners, not citizens. As a result, their bank accounts remain fortified from TIEA inquiries of Indian authorities.

In 2014, the Organisation for Economic Cooperation and Development developed Common Reporting Standards (CRS) for automatic exchange of information between signatories of tax treaties. CRS is the second generation of the information exchange process that started with TIEAs. However, it is time to pause and evaluate the effectiveness of the treaties. If they are not effective, why?

CRS are an effort in the right direction, no doubt about it. They act as deterrents in some cases. In other cases, they increase the complexity and cost of evading taxes. But room remains to make CRS more comprehensive so as to plug the usual loopholes.