Panama Papers: the thin line between the law and morality

“This intermingling of religious, moral and legal precepts was typical of early society. But now these precepts have been severed. This severance has gone much too far. They say law governs one’s dealing with one’s fellows religion concerns one’s dealings with God, but the two quite separate. Likewise they say the law has nothing to do with morality. It lays down rigid rules, which must be obeyed without questioning whether they are right or wrong. Its function is to keep order, not to do justice.

               The severance has, I think, gone too far. Although religion, law and morals can be separated, they are nevertheless still very much dependent on each other. Without religion there can be no morality, and without morality there can be no law”

Lord Denning

There are always debacles on whether there is a separation of what is legal and what is morally right. The debacle continues with the expose of 11.5 million of documents leaked to German newspaper Suddeutsche Zeitung. Due to the overwhelming of documents, International Consortium of Investigative Journalist (“ICIJ”) was roped in to review volumes of documents. The expose of documents was later dubbed as Panama Papers.

It is investigative journalism at its best. The result shows offshores holdings of politicians and public officials or person connected with them like the president of Azerbaijan, Russia, Prime Minister of Iceland, the son of the Malaysian Prime Minister, royalty like the King of Saudi Arabia, Mexican drug lords, terrorist like Hezbollah, dictator government like Syria, and rogue nation like North Korea. It is unthinkable that we can lump all these people together in one sentence due to what they have in common.

Legal institutions like the banks support these offshore holdings. Banks such as Deutsche Bank, HSBC, Societe Generale, Credit Suise, UBS, and Commerzbank had they name all over the documents. Respected professions like bankers, lawyers, and accountants are at the center of this system. However, the main actor in this issue is a Panama law firm Mossack Fonseca (“MossFon”). Hence, the expose was later dubbed as “Panama Papers”, attributing to the country where the legal firm situated.

The documents span for more than 40 years from 1977 to 2015 of MossFon’s creation of more than 214, 488 offshore entities. The firm specialized in creating shell companies in tax haven jurisdictions such as British Virgin Island, Samoa, and Panama. The firm creates layers and labyrinth of corporate structure that makes it difficult to know who are the beneficial owners of these shell companies.

Shell companies basically companies without active business operations and office.

How do you buy the shell companies?

You can buy them from any offshore service provider. Like a normal company, shell company can open a bank account which enables them to receive and transfer money.

The process to buy shell company from offshore service providers takes less than 10 minutes. Here are the steps:-

1.     Choose shell company that you like.

2.    Choose the name and tax havens jurisdictions such as Panama, Cayman Island, Samoa, Seychelles, Labuan or British Virgin Island.

3.     Appoint nominee director.

4.     Give a copy of your identification documents.

5.     Open a bank account.

In tax haven jurisdiction, to be anonymous is perfectly legal. Features of tax haven are basically low or no inheritance/income tax. Basically creating a tax shelter to the offshore company. Secondly, tax haven promise financial secrecy. The whole legal ecosystem of the tax haven is to keep confidentiality. In fact it is an offence for the law firms/ incorporation agents to disclose the identity of the beneficial owners. 

We may not have to look far to see an example of tax haven jurisdiction. We have our own version of tax haven in a form of Labuan, an island in the South China Sea off the coast of Sabah. Labuan was established as an International Offshore Financial Centre (IOFC) in 1990.

Offshore companies kept the confidentiality of the beneficial owners through the following mechanism:

Nominee Directors

You can put in a number of people to be the nominee director of your offshore company. You can choose to be the director of the company but it will compromise the confidentiality. Maybe you want to ask confidentiality from what?

Well, confidentiality protects you from personal taxation from your home country, protect your assets from litigations, and enable dealings between your offshores company and your domestic companies or with the government, and also for general secrecy purposes. To ensure high level of confidentiality, the nominee director needs to play an active role in the administration of the offshore company. The beneficial owner can control the action of the nominee director by having a system of communication and reporting line between the former and the latter.

Nominee shareholders

The beneficial owner may transfer the shares to various nominees. By having nominee shareholders sign a Declaration of Trust it will be easy for the beneficial owner to establish that they are the owner of the offshore company.

Azerbaijan's Ilham Aliyev case 

To show the labyrinth of corporate structure to preserve the confidentiality of the beneficial owner, we can look at the case that involve the President of Azerbaijan, Ilham Aliyev. The following flowchart is taken from ICIJ website.

Fazil Mammadov the Tax Minister of Azerbaijan created Ata Holdings, a consortium that deals with banking, telecommunications, mining, and Oil&Gas business.  In 2014 corporate filing shows that this conglomerate held over $490 million in assets. Mammadov had created offshore company FM Management Holding Group S.A with stand in directors supplied by MossFon, hence concealing his involvement in this company.

As you can see from the flowchart, there are three layers of corporate structure that was created by MossFon:

UF Universe Foundation which control FM Management, a Panama company set up by Mammadov, which have shares in Financial Management Holding Limited, a UK based company. The foundation and FM Management was closed in 2007 but later reactivated in 2014.

Recent records shows that Hughson Management Inc. holds 51% of Ata Holding Azerbaijan.  Record shows that the directors of the company are Arzu and Leyla, daughters of the Azerbaijan President, Ilham Aliyev.

Law v Morality

Labuan came to light when one of 1MDB entity, 1MDB Energy Ltd was incorporated in Labuan while another 1MDB entity was incorporated in British Virginia Islands. The crux of the argument is that there nothing illegal to open an offshore company in tax haven jurisdictions. Commenting on the legality of the tax haven jurisdictions, Communication Minister Salleh Said Keruak had this to say:

“…if placing money in tax havens were a crime, then Labuan, the brain child of Tun Dr. Mahathir Mohamad would need to be closed down”.

Technically it is a correct statement. Nobody is questioning the legality of the tax haven jurisdictions. However, people are questioning the morality of the tax haven jurisdictions. Laws that created the tax havens ensure it legal status, functioned to keep the tax havens’ in order. However, just because it was made legal, it does not necessarily deliver justice.

The secrecy that is the crux of the tax havens nurtures a perfect environment for money laundering, corruptions, and tax evasions.

Panama Papers shows that MossFon had created 123 companies in Nevada, United States of America that was used by cronies from Argentina to hide million of dollars stolen from government contracts.

Complex corporate structures combined with the confidentiality of the identity of the beneficial owners of these offshore companies make it hard for the tax collectors to trace the flow of the money.

Why is it morally wrong?

While the average rakyat and small companies are subject to local tax laws, the rich and big corporations can hide their profits offshores. Hence, the nation is built based on the sweat of the average rakyat. It seems that there are two sets of law for the rich and the poor. It is a contradiction in terms when the law says that every one is equal before the law but at the same the law give an unfair advantage to the rich and in power.

While small businesses are subject to good corporate governance such as transparency, big corporations may hide behind confidentiality laws in tax haven jurisdictions. It is morally right when a government backed investment company incorporated in tax haven jurisdiction, hence not subject to local tax regime.

The government come up with the tax laws that all of us need to pay. It is an offense for a normal rakyat and business not to pay tax. Then, is it morally right for the government’s investment company incorporated in tax haven’s jurisdictions hence avoiding paying tax?

It is a constant collision between the 1% and the 99%, those few who have millions against millions of just tried to make it.

When the law was used to hide it may be legally right but does not necessarily morally right. I guess that the debacle of the demarcation of law and morality will be prolonged without any hope of solutions.