Tax havens and tax administration

Red flag arrangements - beware

Below is a list of arrangements we have seen marketed that act like a red flag in attracting our attention.

If it sounds too good to be true …

There are some promoters of tax haven schemes and arrangements who set out to take advantage of unsophisticated investors. We are concerned about these investors being drawn into investments in tax haven entities, or into transactions through tax havens, with the promise of high tax-free returns from promoters. These investors run a high risk of losing their investment. The Australian Securities & Investments Commission (ASIC) provides warnings about this on their website at www.fido.asic.gov.au

If the arrangement or investment being considered sounds too enticing, remember the old adage, 'if it sounds too good to be true, it probably is'. Visit the Aggressive Tax Planning homepage for arrangement or investment warnings.

Make sure you get tax advice that is independent of the promoter or seek a private ruling from us if you encounter the 'red flag' marketing claims below.

Marketing claims: What you should be aware of

'This is a confidential arrangement for our select clients'

There are numerous variations on this theme but they all amount to the same thing - secrecy and concealment.

'Sign this confidentiality agreement - we don't want our competitors stealing our ideas'

A need for secrecy and concealment is a sure sign that something may be wrong. The real reason for secrecy is usually that the arrangement seeks to avoid or evade tax. It may even be a scam designed to steal your money. The promoter doesn't want us or ASIC to find out about it.

'There's no need to ask the ATO - we already have a ruling'

Get independent advice from a tax adviser who has no connection with the person promoting the arrangement. If the arrangement or investment is sound, why shouldn't it be subject to a second opinion? If the promoter claims to have an ATO ruling, first ask to see it and check our edited versions of written binding advice in the Register of Private Binding Rulings to ensure that we issued it. If we did, check whether its terms apply to you or to the particular arrangement being marketed.

The register contains responses to requests for written binding advice received from 1 April 2001 (except for GST-specific rulings, which date from 1 July 2000).

'Your money will be protected from Australian tax in an offshore tax haven'

'Protected' might sound like smart tax planning. What they really mean is 'hidden', which may entail tax evasion. Beware of offers to 'protect' your wealth using complex offshore business structures, nominee directors and other strategies that are designed to conceal.

Arrangements to hide income or assets are taken very seriously by the Commonwealth. Remember, regardless of what the promoter says, you will be held responsible for your tax obligations. Promoters who conduct your business may be recognised as your 'agent', and their actions and motives can be attributed to you.

'The ATO can't trace the money back to you'

An arrangement that distances you from your money usually involves giving someone else control over your money.

Don't deal with people or organisations you don't know. Tax haven entities are easily set up, but finding out who is actually behind the arrangement or structure is difficult. Once your money is sent to an offshore tax haven, it may be too late to get it back.

Anyway, it can be traced back to you. AUSTRAC tracks all international transactions in the financial system. You may be asked to explain your spending habits against your income flow. In reality, the promoter is hoping we won't look in your direction. The only way the account is tax-free is if you do not derive any benefit from it - and that does not make much sense.

'We'll put your money in a tax-free overseas account'

For Australian residents, interest from sources outside Australia (including a bank account or investment in a tax haven) is subject to Australian tax.

'Your funds will be managed by an international bank'

Don't be fooled by elaborate names. Titles like bank, international trust, fidelity, corporation or group don't mean anything by themselves. Banking licences are easy and cheap to obtain in many tax havens. Banking facilities and products offered in tax havens are often accompanied by high bank fees 'necessary to provide privacy'.

'You'll double your money in 90 days, tax-free'

Definitely too good to be true. We have seen a Panama-based corporation promoting returns of 0.5% daily, 5% weekly or 25% monthly through high-yield investment programs dealing in venture capital. Even if this extraordinary claim were true, it wouldn't be tax-free because Australian residents must account for their income from all sources, including overseas.

Real investments come with real risks. As a rule of thumb, the higher the potential return, the higher the risk.

'You pay invoices from offshore then borrow the money back. There's paperwork for everything so it's all legitimate - you can even claim tax deductions.'

There are a variety of 'round robin' or 'round tripping' financing arrangements, some of them very complex. Essentially they involve transactions in which money is moved to a supposedly unrelated offshore entity - for example, as a payment for consulting services or insurance - and returned in another form, such as a loan or refund. Tax deductions are sought in Australia.

Whatever the promoter might say, Australian tax law is clear: contrived arrangements such as this may be tax avoidance or tax evasion. We use a variety of methods, including sophisticated data matching, to identify such arrangements. Substantial penalties apply.

Case study: Failure to substantiate claims

AUSTRAC identified large transfers of funds from a Guernsey bank account to a taxpayer and his associates.

The taxpayer was not able to produce evidence to substantiate his claim that a large part of the funds originated from a substantial inheritance, nor could he provide bank statements and other information requested to substantiate his other claims. The funds were assessed as income and there were substantial penalties.

Case study: Employees and 'stichtings'

We examined a number of arrangements in which employees sought to avoid tax on employment-type income using structures known as 'stichtings'.

The employer would enter into an arrangement with an associated company, of which the employee was also a shareholder and/or director. Employment-type income, such as sign-on fees and bonuses, was directed to the stichting on behalf of the employee. The stichting was not created in a tax haven but the monies flowed through tax havens.

These arrangements sought to reduce the tax payable in Australia by claiming a deduction for the amount paid to the stichting and/or failing to declare the employment income. The offshore funds were later accessed in a number of ways, including loans, payments to credit cards or channelling funds to an associated entity in Australia. In one case, funds remitted back to an associate in Australia were used to purchase substantial assets. We issued amended tax assessments and imposed substantial penalties.

Case study: Accessing profits of a tax haven entity

The taxpayer, then a non-resident, conducted an overseas business venture. The venture was sold and the proceeds were directed to an international business company in a tax haven.

The taxpayer controlled the international business company. The taxpayer's ownership of the company was disguised by using offshore nominee companies provided by an international promoter.

On his return to Australia, the taxpayer, now a resident, tried to remain outside the tax system. Our action resulted in the taxpayer lodging tax returns and paying back taxes.

The international business company acquired properties in Australia and some years later transferred one of the properties to the taxpayer at cost. In effect, some of the gains of the international business company - that is, the amount representing the increased value of the property - were distributed to the taxpayer when the property was transferred to him at cost.

This was deemed to be a distribution benefit received by the taxpayer and assessments were issued with interest and penalties.

Case study: Tax haven structures created when taxpayers were non-residents

Sometimes taxpayers create structures such as trusts, foundations or anstalts in tax havens at a time when they are not Australian residents, or even contemplating a move to Australia. These structures are expensive to set up and maintain over time. When the taxpayer moves to Australia, we need to examine the key features of their offshore entity and determine the tax consequences for the period after the taxpayer becomes an Australian resident. The question of control is often an important factor in determining the tax implications of offshore structures.

In one case, the circumstances required the unwinding of the tax haven structure. The taxpayer and tax adviser cooperated with us to determine the correct tax consequences. We issued amended tax assessments with interest and with penalties; the latter were reduced due to the taxpayer's cooperation.

In another case, a taxpayer making a voluntary disclosure of his offshore foundation decided that he would wind up the structure and move the assets to Australia. Reduced penalties will apply where a voluntary disclosure is made.

Profits derived by these types of offshore foundations may be attributable and taxed in Australia once the person has become a resident here.

Case study: Diversion of sales proceeds

An Australian company was identified as remitting funds to a Vanuatu company. The Australian company indicated that the funds had been received in error from other overseas companies and were therefore redirected to the Vanuatu company.

Analysis of AUSTRAC information showed money was being transferred from Vanuatu to the personal account of the director of the Australian company. The director claimed to be a non-resident.

Assessments were raised both on the company to include the omitted sales income and on the director. Substantial penalties of over 50% of the tax avoided were applied in this case.

Case study: Diversion of income offshore

In response to a letter from us about funds sent offshore, a taxpayer indicated that monies sent to Vanuatu represented the net proceeds of stock options, which the taxpayer had received from an employee stock option plan. These funds were deposited into a Vanuatu bank account. The taxpayer was assessed on the profit and interest earned on the bank account with interest and penalties applied.

Case study: False names

A taxpayer was a shareholder and director of a manufacturing company based in Australia. The taxpayer created a number of trusts and bank accounts in Vanuatu and then used false names at Australian banks to send funds offshore. Funds from the trust in Vanuatu were then repatriated in a purportedly non-taxable form direct to investments in Australia, for or on behalf of the taxpayer.

Analysis of AUSTRAC information did not show the taxpayer's name, but the regularity and size of the dealings recorded by AUSTRAC raised the suspicions of our analyst. Further investigation linked the dealings to the taxpayer.

The source of the funds being sent offshore was cash from the taxpayer's business.

The preliminary analysis revealed serious concerns about the taxpayer's course of conduct, and this resulted in an unannounced visit to the taxpayer to obtain access to documents and records. We determined that part of the arrangement was a sham and there was also undeclared income. Assessments were raised, including substantial penalties. The case may also result in the taxpayer being prosecuted.

Case study: Offshore superannuation funds or trusts

We have identified cases where taxpayers have been involved in establishing what are claimed to be offshore superannuation funds and where funds (including employment income) may have been diverted to the structure. We examine these arrangements to ensure the structure is a genuine superannuation fund and not a trust to which the transferor trust regime or other anti-tax-deferral provisions may apply.

In one case, the taxpayer who was the member and beneficiary of the 'superannuation fund' in a tax haven did not know who his purported offshore employer was. We are continuing our enquiries.

Case study: Annuity arrangement

The Administrative Appeals Tribunal (AAT) considered a case involving an annuity arrangement using Vanuatu, in which a taxpayer claimed deductions for interest (Hickman v. Federal Commissioner of Taxation (2005) AATA 339).

In essence, the taxpayer borrowed 100% of the annuity sum from a Vanuatu financier and claimed interest deductions each year on interest paid to an associate in Vanuatu. If the scheme had run its course, interest would have been payable for about 20 years, with an annuity becoming payable after 29 years (2028) for a period of 15 years (until 2043).

The annuitant had no guarantee that the payments would ever be made and was not asked for security for the loan.

The Tribunal held that the investor did not commit any of his own money and that the annuity and loan agreements were shams. Accordingly, the tax assessment which disallowed the claim for interest was confirmed. In this case we applied a significant penalty and it was affirmed by the AAT.