Panama Papers explained: They went looking for secrecy and an identity mask

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Why float a foreign company, why go all the way to Panama to register it?

The two big draws that offshore entities in jurisdictions such as British Virgin Islands, Bahamas, Seychelles and more specifically Panama, offer are: secrecy of information relating to the ultimate beneficiary owner and zero tax on income generated.

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In fact, in Panama, individuals can ask for bearer shares, where the owner’s name is not mentioned anywhere. Besides, it costs little or nothing to set up an entity abroad. The Registered Agent charges a few hundred dollars to incorporate an entity. It doesn’t take much time to incorporate one either. Companies are available off-the-shelf and can be registered in a couple of days.

Will regulators be interested in this information? How does it affect NRIs?

Non-disclosure of an overseas asset (in this case the company acquired or floated) will be of interest to authorities and regulators here. Floating these companies and depending on the reason for which they are put to use, could also violate, individually or jointly, the Foreign Exchange Management Act, the Prevention of Money Laundering Act, the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, the Prevention of Corruption Act and the Income-Tax Act. NRIs do not have to report their offshore entities to Indian authorities. But any income earned by them in India has to be filed with regulators in the country.

What’s the kind of secrecy that the Panama agent offered?

The offshore entity need not appoint natural persons as directors or have individuals as shareholders. The Registered Agent, Mossack Fonseca in this case, offers its own executives to serve as shareholders or directors. Sometimes, an intermediary law firm or a bank acts as a director or a nominee shareholder. So the real beneficiary remains hidden.

The registered agent provides an official overseas address, a mail box, etc, none of which traces back the entity to the beneficial owner. In many cases, the shareholding of these entities is vested in a Panamanian Trust or Foundation. The Foundation further masks beneficial ownership. A professional trustee is often the nominee shareholder of the Foundation. The beneficiaries of the Foundation’s assets are mentioned in the Regulations, and these Regulations do not form part of the Public Deed executed by the trustee.

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Couldn’t those in the list argue that when they set up these companies, FERA was a draconian law and they had to do this to go around it?

Foreign Exchange Regulation Act severely restricted even current account transactions, forget those on capital account. Since India’s foreign exchange holdings were low or inadequate in the 1980s and 1990s, the law was aimed at preventing an outflow of foreign exchange.

In those days of controls, many secretly opened Swiss bank accounts and offshore entities by sending money abroad through hawala. It was to these offshore accounts that money flowed in several cases of over invoicing or under-invoicing of trade transactions. But progressively, after liberalisation in 1991, and with an improvement in macro economic indicators, FERA was replaced with FEMA in 1999.

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And as India’s foreign exchange reserves rose and topped $100 billion in 2004, in January 2004, RBI allowed companies to invest up to 100 per cent of their net worth (now it’s 400 per cent of net worth) abroad by doing away with the $100 million cap and started its experiment with limited capital account convertibility by introducing the Liberalised Remittance Scheme (LRS) in February 2004 which permitted resident individuals to remit up to $25,000 a year.

This was increased in phases to $200,000 by September 2007, but was reduced to $75,000 in August 2013 to arrest a sharp slide in rupee. The LRS limit was subsequently increased again in phases and now stands at $250,000 a year. This means, an Indian resident individual can invest $250,000 abroad in buying shares or property or gift or donate to anyone living abroad up to this limit every year.

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But RBI’s intent and internal understanding in opening the LRS windows was to allow resident individuals in the spirit of liberalisation to diversify their assets, promote trade and boost exports and earnings, but not to let them set up companies, which could be put to misuse.

Are regulators, RBI and Income Tax authorities, aware of these firms?

There are many who have set up companies dating back to the pre-2004 period when the LRS was not even announced. So, they are clearly outliers.

Then there are individuals who have taken an interpretation of the LRS to mean that offshore entities can be set up. The LRS did allow for buying shares, but did not specifically allow incorporation of companies by individuals abroad going by a clarification in the RBI FAQs of September 17, 2010.

On August 5, 2013, the RBI allowed resident Indians to invest directly in joint ventures and overseas subsidiaries through the LRS route too.

So, technically, those individuals who had set up companies overseas prior to August 2013 would have violated the rules on LRS. In certain cases, there has been a compounding of payment of fines by individuals after the LRS violations came to the notice of the RBI or were disclosed by individuals themselves. In some other cases relating to the pre-2013 period, individuals who set up companies abroad using the LRS facility were directed by the RBI to divest their holdings or unwind their operations.

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Before 2013, many chartered accountants took a technical view and advised individuals that acquiring companies was not the same as setting up companies, and facilitated buying companies off-the-shelf made available by the likes of Mossack Fonseca.

While some have declared all this to Income Tax authorities, many others have refrained from doing so fearing the current adverse environment where any irregularity can be seen as tax evasion or attempt to stash black money.

So what’s the next step once these names are out?

For the Reserve Bank of India, this issue has been work-in-progress. It will have to take a call whether they can allow compounding (recognising that an individual has erred bona fide and regularising the investment in the offshore entity post facto by imposing a penalty) or insist that individuals wind up these investments made prior to August 2013. The Income Tax department will have to probe if there has been ‘round tripping’ of funds i.e. routing of funds invested in offshore entities back to India, and where required, refer the cases to the Enforcement Directorate. It will also have to see if the offshore entities have declared all their incomes and assets to the Income Tax department.

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What’s the relevance of The Panama Papers to the black money debate?

Offshore entities can be and have been used by individuals to remit funds abroad. Globally, they carry a reputation of being vehicles set up by individuals and corporations to evade or avoid tax. Companies call this tax planning, the tax man sees it as tax avoidance. With coordinated moves by G-20 countries to introduce stringent anti-money laundering measures, as part of a global crackdown on tax avoidance, there is rising international scrutiny over such jurisdictions and giant company incorporators such as Mossack Fonseca which facilitate setting up of offshore entities.

Searching 36,957 Needles In An 11-million Haystack

Given the humongous 2.6 tera byte dump size of Project Prometheus — as the investigation was aptly named — the task was cut out for the team. Tracing Indians in the database comprising over 11 million files and 2,14,488 offshore entities was akin to searching for a needle in a haystack. And all the giga bytes did not come in one go, forcing us to what management experts call ‘fix the aircraft while it flies’. In all, the dump finally threw up 36,957 India-related files. Online tools were created to unravel complex web-like linkages between individuals and multiple entities. Internal mails of Mossack Fonseca and legal incorporation documents attached in these revealed not only addresses and passports of individuals, but in some cases also their source of wealth and the intent in setting up offshore entities.