Transparency triumph amid legal crackdown on money laundering

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Real estate is a known method for money-laundering. The basic principle behind this offence which is punishable by law is to “clean” illegally gained proceeds (e.g. from terrorism, corruption, etc.) by reinvesting it into legitimate assets, thus giving it the appearance of legally obtained funds. Money laundering disguises the real source of income using documentary proof which is either forged or belonging to third parties. Offshore financial services and banking systems often serve this purpose.

In recent years, many international organisations have taken steps to fight money laundering and tax avoidance. Because real estate is a magnet for dirty money, for a property deal to go smoothly, it is important to understand the recent fundamental changes to money laundering laws in the EU and internationally.

OECD initiatives

In 2014, the Organization for Economic Cooperation and Development (OECD) introduced a number of initiatives to improve transparency and tackle tax avoidance. The Base Erosion and Profit Shifting (BEPS) Action Plan sets out 15 key items of international tax rules to be addressed in 2014–2015. Seven of them were already implemented in 2014:

Tackle money laundering in the digital economy (e-commerce, marketing, online banking).
Coordinate cross-border corporate taxation to stop companies from deducting expenses and avoiding taxes by manipulating tax regulations in two separate states.
Tackle harmful tax practices.
Prevent double taxation treaty abuse like tax evasion. Companies must disclose information on their income, profits, pricing policies and assets in all tax jurisdictions they do business in. Data is becoming available to tax authorities in relevant countries.
Ensure pricing compliance with market levels for transfer pricing to stop corporations from flouting pricing rules and declaring income in tax jurisdictions different from their place of operations.
Improve tax administration transparency by introducing a three-tiered approach to accounting for international corporations.
Ensure rapid implementation of the BEPS Action Plan via the creation of a multilateral document.

Actions planned and pursued in 2015 include reinforcing Controlled Foreign Corporations (CFC) tax regimes, making tax evasion increasingly difficult for businesses creating affiliated companies in tax havens. Other suggested CFC innovations include:

unifying the definition of “Controlled Foreign Corporation”;
clarifying the definition of “control” over CFCs;
resolving disagreements over the definition of CFC “earnings”;
updating regulations on double taxation prevention and elimination.

The OECD is also developing additional measures and control instruments:

Preventing corporate profit erosion through interest deduction and other financial schemes. Some companies use complicated financing structures with the interest on borrowed funds to reduce their tax base, while interest income on the borrowed funds is declared in offshore jurisdictions. The OECD plans to establish rules preventing these schemes.
Preventing artificial avoidance of permanent establishment (PE) status. Currently, a state is not entitled to charge tax on a foreign company’s profit when the company is not permanently established on the territory. The OECD suggests redefining PE so as to eliminate double non-taxation. The OECD also aims to target the “commissionaire arrangement”, artificial avoidance of PE by companies using their own name to sell good of foreign companies on their behalf so as to evade taxes on profits as the company selling the goods does not own them. In these schemes, companies only pay tax on the sales commission.
Ensuring transfer pricing rules are in line with real value creation. In some cases, major corporate groups manipulate existing transfer pricing rules in order to declare income in a jurisdiction other than that of business operations. For example, structuring a business so that taxable income is paid in the country of production and there are little sales. According to current transfer pricing rules, all the other earnings can be declared in other countries where corporate group members are located so it can be beneficial to declare income in countries with mild tax regimes.
Establishing rules to tackle tax evasion and profit shifting by means of transfer pricing.
Establishing tools to collect and analyse data on BEPS and actions to address misconduct.
Requiring taxpayers to disclose aggressive tax arrangements by regulating information disclosure on certain types of schemes with deadlines punishable by non-compliance penalties.
Improving cross-border dispute resolution within the context of double taxation agreements.

Know Your Customer procedures

Most banks in the world are committed to the “know your customer” (KYC) principle. This mitigates risks of engaging in transactions linked to money laundering or financing terrorism by investigating the origin of funds.

All over Europe account holders are asked to prove the origin of their funds or the account will be frozen. This requirement comes from the 1993 Spanish Law on Prevention of Money Laundering (Normativa de prevención del blanqueo de capitales) which obliged all EU citizens, foreign nationals, residents and non-residents to disclose all personal data from their residence permit to bank account details every two years. Similar procedures apply in other EU states and it’s not uncommon to face some challenges with local banking regulations. For instance, a Tranio client‘s property purchase in France was blocked for three months while the bank verified the origin of the funds before accepting to open the account necessary to make the payment.

The British way

The United Kingdom is very popular among money launderers, but tough legislation has been passed to tackle the practice.

There are 1.5M trust companies in the UK used for tax mitigation and inheritance procedures. According to Transparency International, approximately 37,000 properties in London belong to offshore companies registered in the British Virgin Islands, Guernsey, Jersey, the Isle of Man and other tax havens.

There are five anti-money laundering and counter-terrorism financing acts in effect including the Terrorism Act 2000, the Anti-Terrorism, Crime and Security Act 2001, the Proceeds of Crime Act 2002, the Serious Organised Crime and Police Act 2005, and the Money Laundering Regulations 2007. According to the Proceeds of Crime Act 2002, money laundering offences carry a maximum penalty of 14 years in prison and a fine decided by the court. All bank and investment company employees must report suspicious transactions or face a fine and up to seven years in prison. If a company director fails to set up a procedure for tracking suspicious transactions, they risk two years in prison and a fine.

Unlike other jurisdictions, the British list of money laundering-related crimes includes less serious violations too. There are no monetary limits. Financial transactions with no typical traits of money laundering may be considered money laundering in the UK. It is not possible to open an account in one day here as the mandatory background checks may take up to one week. If money is transferred from abroad, its owner has to confirm its origin by providing translated and notarised tax documents, property sale agreements, etc.

If a bank is approached by a millionaire or a high-risk client, managers can initiate other due diligence procedures requiring additional documents. According to Financial Action Task Force standards, clients considered high-risk include politicians, officials, top-ranking military men, senior executives of government-owned companies as well as their immediate family members and close associates.

Banks which do not conduct the necessary checks risk both their reputations and their money. For example, in August 2014, the US fined the British bank Standard Chartered for pursuing “suspicious transactions” with Iranian clients.

New EU measures

Transparency is increasing thanks to new rules including EU directives and the European Foreign Account Taxation Act which are set to change the stage for business owners around the world.

The EU introduced three anti-money laundering directives in 1991, 2001 and 2005. According to the most recent, banks, real estate agents and companies can be investigated for any amount exceeding €15,000. On 16 December 2014, the European Parliament and the EU Council of Ministers ratified the 4th Anti-Money Laundering Directive, AMLD IV. New provisions will establish the Central Register of Beneficial Owners and a risk-based approach to monitor all financial operations like transactions and opening accounts.

Starting in 2017, EU member states must create central registers containing detailed information on beneficial owners of companies, trust companies, and other structures registered in European jurisdictions including names, birthdates, nationalities, and places of permanent residence. The information will be made available to financial services, banks, and other organisations. Even investigative journalists will be entitled to partial access after proving their “legitimate interest”. According to EU observer, an online newspaper reporting on the European Union, Germany, Spain, and Poland oppose public access to the register, while the UK, Denmark, the Netherlands, and France plan to make their registers open to the general public.

The European FATCA

Another new development is the European equivalent of the US Foreign Account Tax Compliance Act (FATCA). Banks that fail to report tax payers will be banned from operations in the European Union, including opening accounts in EU banks. 28 EU members have already agreed on the regulation which will be applied within the Convention on Mutual Administrative Assistance in Tax Matters, signed by more than 80 states that are members of the Council of Europe and the OECD. Other states which comply with the European FATCA are tax havens like the Cayman Islands, Guernsey, Jersey, the Isle of Man and Sark.

In brief…

Global and regional transparency and disclosure are on the rise, targeting both individuals and companies engaging in tax evasion. Prospective investors and businesses should pay particular attention to the management of their funds as well as money laundering acts in the countries they operate in or plan to.

Yulia Kozhevnikova, Tranio