In a sensational combination of power, wealth, and financial secrecy, the now ubiquitous ‘Panama Papers’ revealed a treasure trove of previously inaccessible information about the opaque operations of offshore finance. The leak, divulged from the files of Panama City-based law firm Mossack Fonseca on 4 April, represents the world’s largest release of confidential documents to date, and has shed light on the rampant practice of ‘off-shoring:’ that is, moving an individual or corporation’s assets to an ‘overseas’ jurisdiction in order to take advantage of low tax rates and minimal operating costs.

Image courtesy of Thorgnyrthoroddsen, © 2016, some rights reserved.

Image courtesy of Thorgnyrthoroddsen, © 2016, some rights reserved.

Although there is nothing illegal per se about opening up an offshore bank account or creating a shell company, the legality of such actions invokes the source of the money and for what purpose the money will be used. However, despite its technical legality, the often opaque and anonymous nature of offshoring is thus an attractive business partner for a whole range of illicit activities, such as laundering corrupt money, tax evasion, and funding organised crime. In a further twist, many of those implicated by the released documents includes robust – albeit circumstantial – links to some of the world’s most prominent leaders, such as UK Prime Minister David Cameron, Russian President Vladimir Putin, Ukrainian President Petro Poroshenko, and ousted Icelandic Prime Minister Sigmunder David Gunnlaugsson, amongst dozens of other politicians and politically connected individuals. The Panama Papers highlight the governance issues that arise from establishing favorable tax schemes in various state and sub-state jurisdictions in combination with the persistent legal ambiguity regarding the money stored in offshore accounts, raising further ethical questions regarding the allegations that politicians are so closely connected to the use of offshore accounts. 

Broadly speaking, there are two dynamics at play in the world of offshore finance. One is the existence of countries offering low-to-zero tax rates, frequently referred to as offshore financial centres (OFCs) and ‘tax havens,’ and the common governance problems that arise from the policies enacted by such jurisdictions. The other is the process through which wealthy individuals and corporations set up tax vehicles and ‘shell companies’ – a company structure used exclusively to hold or pool the assets of other companies without owning any assets itself – in jurisdictions around the world that offer extremely favorable tax regimes. Indeed, there is a lack of transparency involving both dynamics, heightening the importance of the ‘Panama Papers’ in revealing the ethical problems behind the existence of tax havens and shell companies.   

Firstly, OFCs with deregulated business environments and low tax rates play the role of the ‘host’ in the complex global web of international finance, enticing high net-worth individuals (HNWIs), investment funds, multinational corporations, and other global financial players to establish a legal domicile. However, discrepancies between domestic regulatory regimes in different jurisdictions create distortions between tax regimes on a global scale. For example, distortions in global tax governance can arise when a number of jurisdictions deregulate their tax schemes and laws governing financial markets, which puts pressure on countries with a stricter code to deregulate in order to entice corporations and HNWIs to keep their money in that specific jurisdiction. Amongst pundits critical of deregulation, this phenomenon has been termed a ‘race to the bottom’ in that the competition between jurisdictions to retain their tax base prompts a competitive cycle of lowering tax rates and deregulating business practices. Transnational bodies, such as the Organization for Economic Co-Operation and Development (OECD) and the European Union (EU), have been tasked with overcoming the global ‘race to the bottom’ by creating a set of common regulatory standards for tax regimes; however, these organisations have a mixed record in creating a multilateral framework to enforce tax regulations. This is largely due to the fact that a state’s right to tax is closely tied to the notion of national sovereignty, which states have proven unwilling to sacrifice in order to create an international tax standard. Moreover, the OECD, which includes many of the the world’s developed economies that wield considerable influence over financial markets, has not come to a joint conclusion with non-OCED members and other OFCs to enforce existing regulations, allowing countries such as Panama to circumvent existing tax reporting standards. Indeed, streamlining international tax regulation between states is a problem which requires collective action through effective international institutions, which has been blocked by different states’ competing interests, leaving an opaque, badly-regulated international environment in which offshore finance can thrive. 

Consequentially, the lax regulatory regimes and the absence of a global consensus on governing tax-friendly jurisdictions has facilitated the process of conducting business in OFCs. In the case of Mossack Fonseca, the law firm acted as an intermediary in order to fulfill the demand of HWNIs and MNCs to establish legal domiciles in low-tax jurisdictions. The legal domicile would often take the form of a ‘shell company’ that does not own assets itself, but instead holds the assets of other companies and acts as a structure by which the majority owner can make strategic financial transactions. To this end, the owner of the shell company pays the comparatively low tax rate (often close to 0 per cent) on the income earned and can use the deregulated legal environment to remain anonymous. In return, Mossack Fonseca charges the client a yearly administration fee for setting up and maintaining the shell company. Although this process of setting up a shell company in an OFC is legal, the source and purpose of the money stored in OFCs can be illegal. For example, legitimate reasons for operating a shell company include using the company as a vehicle to diversify risk exposure by holding assets across several shell companies, pooling investors’ money, protecting intellectual property and trade secrets, insulating savings from an unstable economy, diversifying a business without affecting the core brand, and protecting the identity of the owner or brand of a company to avoid mis-valuation. On the other hand, illegal actions of using a shell company include evading taxes by falsifying income and storing it in an anonymous account, manipulating markets to sell a company at a profit, storing wealth earned from illicit activities; siphoning a country’s assets, circumventing a sanctions regime, and financing organised crime and terrorist groups.

Despite the broad legalities, the allegation of links between offshore accounts and high-ranking politicians adds a further suspicious wrinkle to proceedings and raises pressing ethical questions about the conduct of offshore finance. It ought to be noted that the most well-known politicians mentioned in the ‘Panama Papers’ were not implicated by name; rather they were circumstantially linked to offshore accounts held in the name of family members and close associates. In the case of Icelandic Prime Minister Sigmunder David Gunnlaugsson, Gunnlaugsson sold his 50 per cent share of an offshore company to his wife before becoming an MP in 2009, then later failed to disclose the interest when he became Prime Minister in 2013. The files further show that Ukrainian President Petro Poroshenko, one of Ukraine’s wealthiest individuals who made his fortune owning a confectionary conglomerate, created a offshore company through Mossack Fonseca to hold his business’ assets in 2014 in correlation to being sworn in as Ukraine’s president in the midst of the country’s conflict with pro-Russian rebels. Whilst both of these actions may be shrewd legal manoeuvers, it highlights the ethical doubts that emerge when politicians are acting in their own interest rather than that of the people they represent. Unlike individuals, who have a legal right to use offshore vehicles, democratically elected politicians shed their individual responsibilities once they are elected into power and carry the burden of being accountable for the interests of the public as a whole, and thus must be held to a higher ethical standard. However, politicians, their family members, and close associates owning stakes in offshore companies effectively sets two standards: that of the political elite, and that of the rest of the citizens, which only delegitimises their democratic mandate and undermines the population’s faith in the political system. Although offshore financial activity is legal, it is certainly a breach of ethics for elected officials, who are supposed to be acting in the best interests of their nation, rather than facing allegations of personally benefiting from money held in offshore accounts. The Panama Papers exposed ethical breaches by a handful of current political leaders, yet one crucial question remains: will the public pressure unleashed by the Panama Papers translate into enough political impetus to agree upon the stricter enforcement of international taxation standards?