Until a few years ago, a letterbox company or a numbered account in some tax haven was sufficient to hide money from the tax authorities and to avoid the taxation of capital income received on it.
In the last decade, policymakers have made these practices much more difficult. Starting in the early 2010s, the Organisation for Economic Co-operation and Development (OECD) has motivated many tax havens to exchange tax information with other countries. Nowadays, a considerable number of countries worldwide (automatically) exchange information of bank accounts held by non-residents in order to detect cross-border tax evasion. Tax information exchange mechanisms have become the main policy instrument to enforce the taxation of capital income across borders.
In response, tax evaders have to find new ways to hide their offshore holdings. In this light, some tax havens recently started to sell their citizenship via ‘citizenship-by-investment’ programs.
In our study, we provide indirect evidence that tax evaders indeed use citizenship-by-investment programs to escape international tax transparency measures and to hold billions of dollars undetected in offshore banks.
What are citizenship-by-investment programs?
By means of citizenship-by-investment (CBI) programs, private persons can obtain so-called ‘golden passports’ in exchange for a local investment or a fixed fee.
For example, the citizenship of some Caribbean islands, such as Dominica or St. Lucia, can be acquired for a US$100,000 donation to a governmental agency. The citizenships of European countries such as Malta or Cyprus are significantly more expensive.
Many customers of these citizenship programs come from China, Russia or the Middle East, interested in visa-free travel; or they want to be able to settle quickly in another country if the economic or political situation in their home country deteriorates.
However, a number of customers from Europe and North America use these programs to hide their offshore holdings from the tax authorities.
How can individuals use CBI programs to escape tax information exchange?
In most countries, individuals are supposed to pay capital income tax in their country of tax residence, which is unaffected by acquiring a new citizenship (assuming the individual does not actually relocate to their new homeland). Similarly, tax information exchange is based on tax residence, not on citizenship. Therefore, acquiring a new citizenship without moving to the new country does not affect the tax legally owed to an individual’s true country of residence.
It does, however, facilitate tax evasion by providing the individual with the means to circumvent tax information exchange. When opening a bank account, an individual can misuse residency supporting documents (such as passports) obtained via a CBI program to pretend tax residency in the CBI country. Therefore, the account information collected under the common reporting standard in the country where they invested will be falsely sent to the CBI jurisdiction.
Thus, CBI programs offer tax evaders a tool to undermine the due diligence procedures and to circumvent tax information reporting.
Are CBI programs actually used to escape information exchange?
In our study, we investigate this question using bilateral quarterly data on cross-border bank deposits from the Bank for International Settlements over the 2010-2018 period. This data set allows us to analyse the bilateral stocks of deposits held by residents from about 200 jurisdictions around the world in 30 major financial centers, including ten tax havens. For example, we can observe the deposits of Maltese residents held in Swiss bank accounts in the first quarter of 2018.
To test whether tax evaders use CBI programs to conceal their account ownership, we compare the development of bank deposits in tax havens and non-havens held through countries with CBI programs (Cyprus, Dominica, Grenada, Malta, St. Lucia and Vanuatu) against the development of bank deposits in tax havens and non-havens held through countries without CBI programs. In this analysis, we account for a number of other factors potentially affecting changes in cross-border capital flows. We consider only CBI programs classified as ‘high-risk’ programs by the OECD regarding their potential to be misused to escape information exchange. We note that Cyprus ended its program at the end of 2020.
We find that people from countries with CBI programs hold about 50% more money in tax haven accounts since the introduction or reform of these programs: the haven deposits increased significantly just after the programs had been put in place. This trend is only evident for countries with such programs: the deposits in tax haven accounts held by persons from other countries have tended to decline in recent years. We also do not observe an increase of bank deposits held in non-havens, neither for countries with nor for countries without CBI programs.
The most plausible explanation for these findings is that tax evaders use CBI programs to conceal their ownership of tax haven deposits from the tax authorities of their country of (tax) residence. In other words, the additional tax haven deposits are neither owned by the native citizens of CBI countries, nor by people who acquired a CBI country’s citizenship to actually live there. Rather, they belong to people who have acquired the new citizenship as a tool to circumvent tax information exchange.
The amount of money in tax havens belonging to residents from CBI countries increased by about US$9 billion in absolute terms; this is equivalent to about 25% of the aggregated GDP of these countries, or 0.66% of the total bank deposits of foreigners in tax havens. Note that our dataset includes only ten of the roughly 50 tax havens worldwide. In addition, our data does not include assets held in the CBI country, assets held through offshore intermediaries or assets other than money in foreign bank accounts. In this respect, the estimated amount of offshore holdings hidden by means of golden passports is likely a lower bound estimate.
What can be done to prevent CBI programs being used to escape information exchange?
From our perspective, it is essential that policymakers account for CBI opportunities when establishing or reforming tax information exchange mechanisms. The main challenge is to ensure that tax information is indeed exchanged with the true country of tax residence.
One option to address this challenge would be to conclude new information exchange agreements with the countries offering their citizenship for sale. They could be required to inform its new citizen’s country of origin when the citizenship is being granted and to pass on tax information to the tax authority of this country if the capital gains are not taxed locally.
A second option would be to require banks in tax havens to ask more questions when a customer wants to open an account with a CBI country’s passport, for example to ensure they require tax-residency supporting documents in addition to passports from such countries.
Principally, it would be helpful if passports obtained via a CBI program were specially marked, for example by a supplementary letter in the passport number.
The article is based on the paper, ‘Escaping the Exchange of Information: Tax Evasion via Citizenship-by-Investment’.
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