Piercing the Veil of Secrecy: Securing Effective Exchange of Information to Remedy the Harmful Effects of Tax Havens

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ABSTRACT

The enforcement of tax laws abroad has long posed problems for authorities. However, that enforcement becomes increasingly more problematic when the information necessary for proper enforcement is located within an impenetrable system whose sole purpose is to protect that information from tax authorities in other countries. Although much effort has been expended to remedy the harmful effects of tax havens, few strategies have succeeded. But with the prospects of a record federal deficit and an ever-increasing tax gap, U.S. authorities have begun to look for new ways to strengthen the enforcement of U.S. tax laws abroad. The most prominent of these proposals is the Stop Tax Haven Abuse Act, which invokes the use of a presumption strategy to remedy the lack of information problem. Nevertheless, this Act will most likely fall short of successful regulation. Most importantly, the Act represents a one-sided attempt to regulate a problem that is truly international. Moreover, even if the Act passes, it will provide the Internal Revenue Service few new tools to assist with the collection of taxes. Another issue with the proposed Act is that it invokes a presumption strategy, which may be viewed as an easy runaround for the lack of an automatic exchange provision in the bilateral agreements that currently control the exchange of tax information with foreign authorities. This Note summarizes and analyzes the current regulatory framework and proposes a strategy for the unification of existing regulatory regimes to provide a more effective system for combating the harmful effects of tax havens.

TABLE OF CONTENTS

I.   INTRODUCTION

II.  TAX HAVENS AND THE HARM THEY CREATE
     A. What Is a "Tax Haven"?
        1. The OECD Definition
        2. Other Characteristics of a Tax Haven
        3. The Veil of Secrecy
     B. Methods of Tax Evasion
        1. Individual Tax Evasion
        2. Corporate Tax Evasion
     C. What Are the Harmful Effects of Tax
        Havens?
        1. Loss of Tax Revenue
        2. Fraud and Other Abusive Practices

III. REGULATION OF TAX HAVENS: NATIONAL AND
     INTERNATIONAL APPROACHES
     A. Regulatory Framework in the United States
        1. Bilateral Agreements
        2. The Stop Tax Haven Abuse Act
           a. The Use of Presumptions to
              Circumvent the "Veil of Secrecy"
           b. Codification of the Economic
              Substance Doctrine
           c. Expanding the IRS's Toolbox
           d. Criticisms of the Stop Tax Haven
              Abuse Act
     B. International Regulation
        1. OECD
        2. The European Union
        3. G-20 Countries
        4. The Financial Stability Forum and the
           Financial Action Task Force

IV. CREATING A COMPREHENSIVE SOLUTION TO
EFFECTIVELY REMEDY THE LACK OF INFORMATION
EXCHANGE
     A. Multinational Approach
     B. Updating the Tax Information Exchange
        Agreements to Respond to Past Failures
     C. Creating a Comprehensive Approach for
        Regulating Tax Havens

V. CONCLUSION

I. INTRODUCTION

Commentators have long viewed tax havens as a type of "necessary evil" that facilitate tax competition among nations, leading to increased mobility and efficiency in international capital markets. (1) But in light of the recent economic downturn, many are starting to question whether tax havens should be subject to a stricter regulatory scheme because the harmful consequences significantly outweigh any benefits the tax havens might produce. (2) While tax havens claim to offer potential investors financial privacy, limited regulation, and low tax rates, these jurisdictions have also become sanctuaries for tax evasion, financial fraud, and money laundering. (3)

The issue of tax havens is not solely one of promoting financial integrity and stability, but also one of balancing the federal budget. Facing a record deficit of $1. …