Capital flight from developing countries of the South. Credit: Tax Justice Network

By Emilio Godoy
MEXICO CITY, Jul 4 2014 (IPS)

The U.S. Foreign Account Tax Compliance Act is unlikely to contribute much to combating persistent tax evasion in Latin America, which will require more national and multilateral instruments, experts say.

FATCA, as it is better known, was approved in March 2010 and finally came into force on Jul. 1 after a number of delays. It is a reciprocal agreement, which means that other countries may learn which of their citizens have accounts in the United States.

The law requires governments and financial institutions worldwide to report to the Internal Revenue Service (IRS) financial information about U.S. citizens who are resident or have assets abroad.

“The limiting factor for developing countries is that it is bilateral. Mexico, for example, would benefit from receiving information about its residents who have accounts in the United States, but these residents may also have accounts in other jurisdictions,” analyst Andrés Knobel of the London-based Tax Justice Network told IPS.

Knobel and other experts consulted by IPS say that tax evasion and avoidance have reached such proportions that firm national policies and multilateral instruments will be needed to combat them. FATCA could coexist with and support these.

Knobel also complained that, although there is reciprocity between the U.S and its partners, the exchange is unequal.

The U.S.  “demands more information from its partners but gives less. The information is supposed to be for tax purposes, but the authorities decide what they use it for,” he said.

Under FATCA, banks, investments funds and other financial institutions must identify U.S. citizens’ accounts abroad and notify the IRS of their account numbers, balances, names, addresses and U.S. identification numbers.

The law covers investments greater than 50,000 dollars. Institutions that fail to comply risk the withholding of 30 percent of any payments originating in or passing through U.S. territory.

The IRS has registered over 77,000 institutions worldwide out of a total of between 200,000 and 400,000 that should adhere to FATCA. In Latin America 3,800 institutions have come to an agreement with the IRS so far, while 800 have not.

The U.S. has signed bilateral agreements with over 70 countries, in two categories.

The first requires financial institutions to report information about U.S. citizens to their national tax authority, which is to advise the IRS. The second calls for the financial agency to report the information directly to the IRS.

“FATCA has potential for preventing tax evasion, but better mechanisms are needed to process the information quickly and take action as a result,” academic Benito Rivera, of the Faculty of Higher Studies at the National Autonomous University of Mexico, told IPS.

“Agreements have been signed, but fiscal paradises have not been touched, although some transactions have been identified,” he said.

In its report on Tax Administration 2013, the Organisation for Economic Cooperation and Development (OECD) said that in Chile, taxpayers’ fiscal debt had increased continuously between 2005 and 2011.

Average growth during this period was 13 percent. The country has a tax burden of nearly 20 percent of GDP.

Mexico, with a tax burden of 18 percent, had similar growth figures, although data since 2010 are lacking. This is also the case with Brazil, which has a tax burden of 32 percent, and Colombia, with 17 percent.

In Argentina the tax burden has fallen by 48 percent, although the level of tax debt is still high. Its present tax burden is 33 percent.

The OECD estimates that at least 500,000 individuals in Latin America have a combined fortune of seven trillion dollars, with no certainty that they are paying appropriate taxes.

The Economic Commission for Latin American and the Caribbean (ECLAC) puts income tax evasion at nearly 50 percent in Argentina, 47 percent in Chile, 64 percent in Ecuador and 42 percent in Mexico.

The International Monetary Fund (IMF) has also warned of tax avoidance and evasion by means of “financial engineering.”

In the document “Spillovers in International Corporate Taxation,” published in May, the IMF indicates that foreign direct investment (FDI) that leaves Brazil turns up in known fiscal paradises like the Cayman Islands, the British Virgin Islands, the Bahamas, the Netherlands and Luxemburg.

In another example, it says that FDI arriving in El Salvador comes from countries like Panama and the Cayman Islands.

“With FATCA, more information will be available, but there will be loopholes for rich companies and individuals to avoid the exchange of their information,” Knobel said.

He recalled that “for a long time, organisations have been asking for automatic information exchange. We asked for public registers of final beneficiaries, the real owners of any financial activity that takes place.”

The U.S.-Mexico FATCA agreement, signed in November 2012, shows the disparity in the information provided. Mexico is required to report the total amount of interest, dividends and other income generated and paid by the account assets, as well as total income from sales of possessions that are recorded in the account.

But the U.S. will only inform Mexico of the total amount of interest paid on a deposit account, dividends or any other source of income.

In the case of Chile, the national tax authority must ask U.S. account holders for their tax identification number and written consent. It must report annually to the IRS the number and balance of non-consenting accounts.

Under the agreement, the U.S. “shall cooperate with Chile to respond to requests to collect and exchange information on accounts held in U.S. financial institutions by residents of Chile.”

There are at least 60 tax havens in the world, including U.S. territories like the northeastern state of Delaware, which has big tax discounts. For this reason, Washington has negotiated favourable bilateral agreements.

The Tax Justice Network’s 2013 Financial Secrecy Index ranks the U.S. in sixth position, behind Switzerland, Luxemburg and Hong Kong, among others. In Latin America, only Panama is placed among the top 20.

In February, the U.S. Senate’s Committee on Homeland Security and Government Affairs criticised the FATCA in its report “Offshore Tax Evasion: The Effort to Collect Unpaid Taxes on Billions in Hidden Offshore Accounts.”

The report criticised the thresholds for reporting accounts, the failure to aggregate data from different institutions and potential tax evasion through offshore shell companies.

The law will not solve the problem of reporting information; its regulations have created a number of loopholes, the report says.

“It will take a few years for it to meet its goals. It would be desirable for the competent authorities to meet regularly to analyse procedures and speed of action,” Rivera said.

Earlier this month, Reuters revealed that a special division within the U.S. Drug Enforcement Administration (DEA) has been using intelligence intercepts, wiretaps, informants and a mass database of telephone records to secretly identify targets for drug enforcement actions.

In the wake of these revelations, a former prosecutor tells IPS he believes he and his colleagues may have been unwitting pawns in the federal government’s effort to deceive defendants and the court system, thereby violating citizens’ constitutional rights.“This is changing the rules of the game so they can conceal the source and use tainted information." -- former prosecutor Patrick Nightingale

“None of us had any idea whatsoever there was a secret DEA programme that instructed DEA agents to conceal the source,” Patrick Nightingale, a former prosecutor for Allegheny County, Pennsylvania, and a member of Law Enforcement Against Prohibition, told IPS.

“My oath as an attorney and as a prosecutor was as an officer of the constitution, and not to win at all costs. This [programme] is a win at all costs mentality: whether it’s constitutional or not we’re going to use it and we can conceal it,” he said.

Called the Special Operations Division (SOD), it is comprised of some two dozen federal agencies, including the Federal Bureau of Investigation, Central Intelligence Agency, National Security Agency (NSA), Internal Revenue Service (IRS), and the Department of Homeland Security.

Everything about the SOD is secret, including the size of its budget and the location of its offices.

Reuters has also identified the IRS as a recipient of the information, pointing to a former IRS training manual that referenced the SOD programme.

As a routine practice, the SOD secretly provides the information to local authorities across the U.S., allowing them to start investigations against U.S. citizens under false pretenses, in a practice known as “parallel construction”.

For example, under parallel construction, local law enforcement will be instructed to find a reason to stop a particular vehicle – for example, through a routine traffic stop – and then once the drugs are found, the government will falsely state the drugs were found in the traffic stop.

The IRS training document details how government officials are instructed to conceal – from prosecutors, defence attorneys, and even the courts – the methods by which a suspected drug criminal is identified and then targeted for apprehension.

“Special Operations Division has the ability to collect, collate, analyze, evaluate, and disseminate information and intelligence derived from worldwide multi-agency sources, including classified projects,” the 2005 and 2006 IRS training manual says, according to Reuters.

“SOD converts extremely sensitive information into usable leads and tips which are then passed to the field offices for real-time enforcement activity against major international drug trafficking organizations,” the document states.

The Electronic Frontier Foundation (EFF), a group that defends free speech and privacy issues, calls it “intelligence laundering“.

Since the revelations on Aug. 5, the Justice Department has said it is reviewing the programme, according to reports. But such a review does not address the constitutional violations that appear to have already occurred.

“Our criminal justice system is based on the presumption of innocence and our constitution demands fair play in criminal proceedings. It demands that prosecutors reveal to the defence both the good and the bad,” Nightingale said.

“If the source of this information is so sensitive that a law enforcement agency is told to keep the information from its own team [including federal and local prosecutors] because it knows members of its team are required to divulge it to the other side [the defence], then it’s a problem,” he said.

Nightingale told IPS he had no awareness of the programme as a prosecutor, even though he worked on many cases where he sought court approval for a Title 3 wiretap based on certain evidence. Now he does not know – nor does he have any way of knowing – how many of those cases originated from a secret SOD tip.

“This is changing the rules of the game so they can conceal the source and use tainted information, depriving… defence attorneys and defendants from being able to have a fair trial as defined by the Constitution,” he said.

Hanni Fakhoury, a staff attorney with EFF, told IPS, “The NSA data is being gathered on purpose, and then directed to a different purpose.” He said the information being gathered by the NSA “should” be something that the FISA Court has been approving, although there is no way to know.

“Those orders have a broad scope. The orders aren’t public, there isn’t insight into what the orders look like, or how the court operates really,” Fakhoury said.

“The big concern is they’re not being forthright about the fact that they’re using the information directed toward a purpose not related to national security, and they’re not telling the court or the defendants the true source of that information.

“It’s yet more proof what is being said publicly [by the NSA] is not all entirely accurate,” he said. “It’s another reason why we have to very carefully scrutinise the government’s justification for these types of programmes.”

Fakhouri says the SOD programme is unconstitutional because of the Fifth and Sixth Amendments combined.

Full and fair disclosure is enshrined in the U.S. Constitution as part of the Sixth Amendment, which states, “In all criminal prosecutions, the accused shall enjoy the right… to be informed of the nature and cause of the accusation.”

The Fifth Amendment provides, “No person shall be… deprived of life, liberty, or property, without due process of law.”

The revelations also raise the possibility that individuals who have been convicted over the last 20 years on drug charges, or perhaps IRS-related charges, will challenge those convictions in court on the basis that secret evidence may have been used in the investigative process.

“I think we’re going to see a lot of those types of arguments. How successful those will be – will be a tough sell. I think it will be an interesting thing to watch,” Fakhoury said.