Money laundering involves concealing the origins of illegally obtained funds through complex transactions that often span multiple jurisdictions. Such activities are therefore closely linked to income shifting.
Unsurprisingly, in a recently published study into Australian financial institutions, we find that firms exhibiting strength in money laundering governance are less likely to engage in income shifting arrangement. We estimate income shifting incentives can be reduced by some 15% in these entities.
Money laundering risks in the banking sector
In Australia, the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (AML/CTF Act 2006) helps corporations to identify, manage, and prevent money laundering risks.
A 2021 report by the Australian Transaction Reports and Analysis Centre (AUSTRAC) indicated that the Australian banking sector faces money laundering risks ranging from medium (foreign subsidiary banks and branches) to high (major banks). Despite advancements in money laundering governance within the Australian financial services industry, the report highlighted significant variability in governance effectiveness based on the global reach, customer base, and business nature of these entities. Recent breaches in Australia include Westpac Bank, Bell Financial Group, and Crown Casino, joining a list of global entities investigated for money laundering breaches such as Deutsche Bank, HSBC, PNB Paribus, and the Royal Bank of Scotland.
Within the Australian financial service sector, we assess the extent of money laundering governance of institutions using an index of attributes aligned with global anti-money laundering legislation. Effective money laundering governance includes controls for ‘know your customer’, governance structures addressing the source and integrity of capital flows, and audits certifying the effectiveness of policies, procedures, and training.
Income shifting
An entrenching practice of multinational corporations is to minimise their tax liabilities by exploiting differences in tax systems and rules across jurisdictions. Income shifting involves reallocating income across jurisdictions in ways that may not reflect the actual distribution of assets or operations. Besides facilitating tax avoidance, income shifting can be used to meet capital management objectives, providing working capital, and to meet regulatory requirements.
We measure the extent of income shifting incentives for an institution as the fractional reduction in the Australian statutory tax rate of 30% due to lower-weighted average foreign tax rates, divided by the Australian statutory tax rate.
We assess whether firms with weaker money laundering governance systems have a higher propensity to engage in income shifting. The Financial Action Task Force Global Network of which Australia is a member, highlights that firms with weaker money laundering governance in place risk facilitating other forms of transnational crime that could potentially include development of schemes or arrangements that involve income shifting or transfer pricing manipulation.
There may be a contagion effect with the likelihood of various forms of corporate misconduct. Financial entities may simultaneously derive taxation and financial benefits from income shifting and money laundering achieved through jurisdictional arbitrage across different governance, financial, legal, tax and regulatory environments.
Findings
Based on a sample of 164 publicly listed Australian financial firms from 2008 to 2018, we found that firms with weaker money laundering governance engage in significantly higher levels of income shifting. Conversely, firms with stronger money laundering governance are less likely to engage in such activities, as robust governance enhances financial transparency regarding funding sources, transfers, and usage.
Additionally, factors like tax haven use, lawsuits, and business risk can suppress the relationship between money laundering governance and income shifting. Overall, money laundering governance reduces income shifting incentives by approximately 15%.
While tax haven use is positively associated with income shifting, effective money laundering governance can mitigate these risks. Similarly, firms with strong money laundering governance can counteract the risks posed by high litigation and business risk.
We also adopted the methodology of Fatica and Gregori (2020) to develop a variable capturing firms’ profit-shifting incentives, calculated as the weighted average corporate tax rate differential between a subsidiary and all other affiliates within the corporate group. Our findings indicate that a greater multilateral tax differential increases profit-shifting incentives, but firms with robust money laundering governance systems can suppress these incentives.
Policy implications
These findings are valuable to financial services industry regulatory bodies in Australia and globally.
As highlighted by Unger et al. (2021), effective money laundering controls promote fairness, equity, and transparency in international capital and tax markets. Our study suggests that strong money laundering governance is crucial for enhancing economic stability by controlling capital sources and flows in financial markets.
Further, statutory reviews have determined that the current anti-money laundering regime is excessively complex, hindering regulated entities’ ability to understand and comply with their AML obligations. While full compliance may mitigate money laundering risks, this complexity can also obstruct legitimate income shifting activities aimed at achieving capital management objectives, which are not necessarily related to tax evasion.
It is a basic principle of English law that the Crown is not entitled to take the subject’s money, enter his property or view his private papers save by consent.
That consent may be given individually or in common, as when a law is passed by common consent granted in an Act of Parliament approved by the subjects’ representatives.
The abuse of writs of assistance by Crown officers was a major factor in the American Revolution and the Fourth Amendment of the United States Constitution accordingly restates the common law that:
“The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no Warrants shall issue, but upon probable cause, supported by Oath or affirmation, and particularly describing the place to be searched, and the persons or things to be seized.”
One of the first legal duties of a banker is to keep his customer’s affairs confidential and was one reason bank nationalization was opposed in 1948.
The AUSTRAC legislation goes against common law and contract law. Years ago, a senior official in Prime Minister and Cabinet remarked to me that “If the Australian people ever realised how much of their civil liberties they have lost in the name of the war against drugs they would vote to legalise them immediately.”
The level of mass intrusion into people’s private affairs granted by legislation these days would have been unthinkable in the Australia I grew up in. The idea that your bank was acting as a government informer would have reminded people of Germany in the 1930s when the Gestapo was plundering Jews and others. There was a reason for Jews getting Swiss bank accounts.
Anyone, especially any lawyer, who has ever witnessed the indignity of seeing junior ATO officers perving through a client’s bank accounts – and reaching the wrong conclusions to boot – has a revulsion to such inquisitions.
As a result, I personally have gone back to using cash as much as possible. NYBB – not your bloody business – is the good old fashioned Australian retort to any government agency wanting to see where I had lunch or a coffee etc etc without a proper warrant being sworn out.
Privacy is, after all, supposed to be human right.