Previously posted on GenFKD.
The Panama Papers bring a lot more to light than just hidden money and global corruption. The episode shows that when you increase the price of something, people will either buy less of it or find a way to get it cheaper — an important lesson to remember when discussing tax havens.
The Panama Papers
For those reading the news for the first time, no, Panama Papers are not high-quality rolling papers. There were a few, or 11.2 million, leaked documents, that showed the world where big names (and some pretty dark names) store their big money from the public eye.
The Panama Papers, (given the GenFKD breakdown here), come from a tiny Panamanian law firm, Mossack Fonseca, MosFon for short. These are the go-to guys for making money act like ninja smoke and they do it by creating offshore shelter accounts that mask the wealth and identity of the anyone wanting to be “off the record.”
Offshore shell companies, MosFon’s specialty, are used for international mergers (like the Allergan-Pfizer deal we’ll get into in a little bit), bankruptcies, wealth restructuring, confidentiality and protecting intellectual property (like trademarks, patents, and copyrights).
They can also be used to launder money made from illicit activities linked to sex and drug trafficking, shady banking by politicians, and straight-up thievery. However, most of these services are used to get out of paying too much in taxes.
The law firm claims that there is no foul play here, however the papers seem to show otherwise. The majority of the documents are legal transactions, but there are a bunch that can lead the world to believe that these guys are a couple rotten businessmen.
Shellin’ your cheddar before they take it
However, shell companies have a very legitimate use in particular circumstances, as Margaret Peters, Yale Political Scientist, told Vox, “In authoritarian countries, yeah.”
This reality is backed up when browsing through the nationalities of some of the individuals taking advantage of this service, with countries like Georgia, Iraq, Jordan, Qatar, Sudan, Saudi Arabia, the United Arab Emirates, Ukraine, Azerbaijan, Syria, Egypt, Pakistan, Ghana, Morocco, the Palestinian Authority, Cambodia, and Kazakhstan all appearing on the list.
These are countries that can easily extract or freeze bank accounts whenever the regime gets the urge. So, putting your money in some kind of tax haven or shell company is more than reasonable.
29 percent of the active companies repped by MosFon are from China, a country where having too much wealth risks being taken away or used against the individual. Nine of the power families in China, including relatives of Premier Xi Jinping, have shell companies with MosFon. However, it has been kept under wraps in the motherland through censorship of the media and web in order to protect a propagandized anti-corruption drive that Xi is using to consolidate control.
So not only can they take your money, but they can use your money against you! Shellin’ up doesn’t sound like such a bad idea now, does it?
“What’s your tax rate?” “Too high.”
Other than calling out Vlad and a slew of other high-character guys — like Hosni Mubarak, Muammar Gaddafi, and Bashar al-Assad — for good ole fashioned corruption, it goes to show that if you try and take the arm, you get the finger. In other words, if the tax rate is too high, humans will do anything they can to keep their wealth hidden from those taxes.
In Spain, we see a personal income tax rate of 46 percent which was down from a whopping 52 percent from 2012 to 2014. Spain whacks companies with a 28 percent corporate rate, and a combined rate of 36.25 percent between employees and companies to cover social security, or welfare programs.
Of course, Leo Messi would store his money elsewhere! At a salary of around $52 million, he would pay close to $24 million in personal income tax at the current rate. Add the other $22 million from international endorsements, that’s another $10 million taken out of the paycheck to pay the Spanish government. Like Messi and co., most would have given them the finger and put their overseas earnings in a shell company or found another route to avoid paying so much in taxes.
Here is a list of other countries, in which the big names that do business with MosFon reside in, and their tax rates.
At those rates, it is no surprise that the wealthy would want to hide their earnings from the tax collector.
Obama plays “Inversion Diversion”
Shell companies and offshore trusts may be a useful tool for keeping the tax bill on fleek for many individuals, but another popular method are corporate inversions. Remember when Burger King merged with Tim Horton’s, the Canadian coffee and donuts chain? Well, in 2014, this inversion was projected to save BK $275 million in taxes. Having it your way is not just for whopper lovers, but for the shareholders as well!
In order to merge with another company overseas and put all the finances under one roof with one tax bill, the size of the company overseas has to be at least 60 percent of the company in the states, according to some previous inversion regulations. This makes it tough for big corporations to just swallow up tiny little organizations and easily avoid the looming tax bill from the IRS.
So, to get around that, smaller U.S. companies have merged with smaller companies overseas, and then merged again, and again, and again. Each time, complying with the rules, but getting larger with each inversion.
Recently, the Obama administration has been trying to address this blatant method of lowering the tax bill for big companies by throwing in some extra regulatory measures in their proposed Business Tax Reform initiative.
Without getting too into the weeds, these measures include several conditions, but one of importance is that it would limit inversions by disregarding foreign parent stock attributable to certain prior inversions of acquisitions of U.S. companies. This means that you can’t avoid taxes if you merge with a company overseas that has been previously merged with another U.S. company.
Why are you stealing my Viagra?
Although the administration won’t directly admit it, these new added regulations were aimed particularly at alleged serial inverters as evidenced by the fact that the rules give no value to deals within the last three years. The Pfizer/Activis/Allergan “threesome that wasn’t” gives us a clear view towards the impacts of these rules.
Pfizer, the Connecticut-based pharmaceutical company and manufacturer of Viagra, wanted to combine forces with Allergan,Plc, a smaller drug company in Dublin responsible for manufacturing Botox. Allergan had recently been bought by a different U.S. pharma company, Actavis, which, despite technically being the “buyer” in the merger, adopted Allergan’s name and headquarters as its own.
Why would Actavis take Allergan’s name and headquarters? Because the corporate tax rate in Ireland is effectively 12.5 percent compared to the 39 percent in the United States.
Since Actavis’ acquisition and personality takeover of Allergan happened within the last three years, February 2015 to be exact, the Pfizer-Allergan merger fell through as soon as the anti-inversion caveats surfaced. And just like that, the largest corporate inversion worth $152 billion, that would have saved Pfizer $1 billion in taxes per year, was dead.
Now, this isn’t technically an example of the use of a “shell company,” but it goes to show that the tax game is an expensive one to be played, but one that will go on. It’s back to the books for Pfizer to find another loophole in the easy-read tax code.
The Panama Papers have brought light to how people hide illicitly made funds from the almighty Big Brother. Its effects though, are a dual-edged sword. On one hand, it protects hard-earned money from being taken through burdensome tax policies, authoritarian rulers and corrupt business deals.
On the other hand, developing nations miss out on billions of dollars in tax revenue that can help alleviate poverty, provide for education, and infrastructure development. At this level however, many of these developing countries are burdened by inefficient institutions and systematic corruption that make people want to duck out on their taxes in the first place.
No matter how it’s applied, taxation will always be avoided in some capacity. The good thing about tax shelters, be it shell companies or corporate inversions, is that they add efficiency to the global economy by acting as an escape valve for confiscatory practices of oppressive governments and they help keep tax rates at digestible levels.
Governments need to reflect on their own systems instead of using the episode as a moral finger-pointing session.