Since the 1998 publication of the OECD’s Harmful Tax Competition: An Emerging Global Issue (which Switzerland and Luxembourg foolishly did not veto), the OECD and its associates have been peddling the need for global information exchange on the intellectually meretricious argument that “residence” income taxation requires the identification worldwide of every person who is an “ultimate beneficial owner” of assets or income. This is the genesis of the war against trusts and the so-called Common Reporting Standard (CRS) compelling financial institutions to become State informers against their clients.
Wrong In Principle
Apart from the inherently obnoxious nature of what economist Adam Smith described as vexatious inquisitions of this kind, the OECD thesis suffers from some basic defects of logic.
The first defect is that income taxation is the only possible source of public revenue.
This is false, as the Physiocrats and Adam Smith pointed out over two centuries ago. All income resolves itself into the original factor incomes of the rent of land, the wages of labour, and the returns to physical capital. As they pinpointed, (and oil-rich states have demonstrated), it is perfectly possible for a nation state to derive an adequate public revenue from its land and other natural resources. For example, the land values of Paris, Berlin and London would vastly outweigh any paper “wealth” held in offshore financial centres. There is nothing to stop European countries returning to their original mediaeval revenue systems and requiring the holders of land to pay an appropriate annual rental rate to the Crown or State.
The second defect is that there is no reason for income tax to be “residence” based as opposed to “source” based.
Countries such as Malaysia and Singapore exempt foreign source income, as used to be the French and Latin practice. If foreign income and capital gains are not taxed, there is clearly no need for the reporting of overseas income or assets or “beneficial ownership” of foreign assets.
The third defect is that there is no logical reason for income tax to be “progressive” - a misnomer for a system of graduated increasing tax rates.
There can be a flat rate income tax system with a family-based subsistence exemption for resident taxpayers. This was actually the original income tax scheme devised by Pitt the Younger in 1798. As economists John Stuart Mill and John Ramsay McCulloch observed, once you abandon the idea of proportionality embodied in a uniform flat rate, you abandon a principle of equality before the law. From a social point of view, you are pandering to envy. From an economic point of view, what you are doing is substituting a tax upon persons according to their income rather than taxing income per se.
By contrast, it is relatively easy to administer a proportional income tax system with personal family-based exemptions. You simply collect at source and if a taxpayer wishes to claim a family-based exemption, he declares his income and lodges the appropriate claim for reduced assessment or withholding.
But for administrative purposes, who is the “ultimate beneficial owner” of income in the above cases is largely or completely irrelevant – it is all taxed at the same rate in the first instance. Thus, a simple source-based income tax system with a flat rate obviates the need to worry about who is the “ultimate beneficial owner” of the assets generating the income.
These are the OECD’s fundamental erroneous assumptions motivating the hunt for the “ultimate beneficial owner” in the ongoing war against trusts.
Impossible In Practice
However, tyrants and their sycophants are not usually persuaded by logic or argument but by resistance or impossibility. Here is where the CRS really starts to fall apart. It may be impossible to be sure as to who is the “ultimate beneficial owner”.
Most people, including economists and government policymakers, have a very simplistic idea of what ownership really is. In their heads, they think it is like owning a chair or having a bank account in one’s name and that, if the apparent owner is not the “real owner”, he must be able to tell them who the real owner is, or at least send them in the right direction to ask someone else.
However, as lawyers understand, property is a bundle of rights. There are many potential rights in a legal system which can affect the control, usage and disposal of assets and income, and which do not necessarily constitute “property”. There may be options, powers of veto, unexercised discretions, default beneficiaries liable to have their expectations defeated, et cetera, et cetera…
The Bureaucrats’ Response
Therefore, the Common Reporting Standard has had to attempt creating something unknown to the law - which is its own definition of “ultimate beneficial owner”.
The OECD ends up with the following sort of language in its Model Mandatory Disclosure Rules for CRS Avoidance Arrangements and Opaque Offshore Structures
“An Opaque Structure is a Structure for which it is reasonable to conclude that it is designed to have, marketed as having, or has the effect of allowing, a natural person to be a Beneficial Owner of a Passive Offshore Vehicle while not allowing the accurate determination of such person’s Beneficial Ownership or creating the appearance that such person is not a Beneficial Owner, including through:
(i) the use of nominee shareholders with undisclosed nominators.
(ii) the use of means of indirect control beyond formal ownership.
(iii) the use of Arrangements that provide a Reportable Taxpayer with access to assets
held by, or income derived from, the Structure without being identified as a Beneficial Owner of such Structure
the use of Legal Arrangements organised under the laws of a jurisdiction that do not require the trustees (or in case of a Legal Arrangement other than a trust, the persons in equivalent or similar positions as the trustee of a trust) to hold, or be able to obtain, adequate, accurate and current Beneficial Ownership information regarding the Legal Arrangement;
where it is reasonable to conclude that the Structure is designed to have, marketed as having, or has the effect of allowing a natural person to be a Beneficial Owner of a Passive Offshore Vehicle while not allowing the accurate determination of such person’s Beneficial Ownership or creating the appearance that such person is not a Beneficial Owner.”
The first question a lawyer asks, when looking at this fine game of bureaucratic hypothesising, is “Well so what? What if the person is not a Beneficial Owner anyway?”
The bureaucrats have thought of that. We are then treated to the following novel “definition” of Beneficial Ownership -
“Beneficial Ownership” or “Beneficial Owner” shall be interpreted in a manner consistent with the latest Financial Action Task Force Recommendations and shall include any natural person who exercises control over a Legal Person or Legal Arrangement. In the case of a trust, such term means any settlor, trustee, protector (if any), beneficiary or class of beneficiaries and any other natural person exercising ultimate effective control over the trust, and in the case of a Legal Arrangement other than a trust, such term means persons in equivalent or similar positions.”
The diligent legal reader mutters to himself “Well, that may involve a cast of thousands” and then refers for enlightenment to the Financial Action Tax Force (FATF) Recommendations and reads:
“Beneficial owner refers to the natural person(s) who ultimately (footnote 54) owns or controls a customer (footnote 55) and/or the natural person on whose behalf a transaction is being conducted. It also includes those persons who exercise ultimate effective control over a legal person or arrangement.
Footnote 54 unhelpfully states “Reference to “ultimately owns or controls” and “ultimate effective control” refer to situations in which ownership/control is exercised through a chain of ownership or by means of control other than direct control.”
Footnote 55 states “This definition should also apply to beneficial owner of a beneficiary under a life or other investment linked insurance policy”.
From a precise legal point of view, all this is simply gobbledygook. What do you do with a trust with large classes of beneficiaries including default charitable beneficiaries which are not persons, but purposes? What does “effective control” mean when no one person has effective control?
Even if you define “effective control”, of what use is it to the practical administration of an income tax when the controller is not the recipient of the income and has not made up his mind as to who shall have the income or what shall be done with it?
One can, for example, think of a mixed charitable and non-charitable purpose trust or company being established to promote the study of the writings of the Physiocrats, Adam Smith, Henry George and others as to the merits of raising of public revenue from land values alone as a morally and economically superior alternative to any need for taxation. Such a mixed charity could also have as potential beneficiaries all present or past officers of treasuries and tax authorities, lawyers, accountants, businessmen, politicians or academics throughout the world seeking such a better alternative to unjust and oppressive contemporary tax regimes. Deserving taxpayers may also be beneficiaries. The study of taxation is a valid charitable object and there are jurisdictions where such a wide range of additional potential private beneficiaries would be valid.
So, what does the trustee of such a worthy mixed charity report? That many present and past tax collectors and taxpayers are potentially involved as possible beneficiaries of a charitable company or trust? The reality is that such an entity has no real ultimate beneficial owner. Other examples can be imagined.
The basic fallacy into which the OECD has fallen is that income must have a beneficial owner before it is actually income to anyone and that the mere control of assets or income is ownership. If that were true, Finance Ministers would be getting very large personal tax assessments indeed.
What the OECD has embarked upon is fundamentally a legally futile attempt to equate ownership and actual derivation of income with direct or indirect control or influence over the disposition of assets or income.
The driving OECD idea is that tax bureaucracies must know everything about everybody in order to administer an income tax. That becomes a never-ending quest for the mythical quark. The hunting of information becomes a great, job-creating object in itself, with no real relevance to the business of collecting an income tax. A vast financial cost is being imposed upon financial institutions and their customers, as well as the wider community, of dubious relevance to income tax collection. The result is massive violations of personal financial privacy which may, in some instances, leave customers of financial institutions and their families dangerously exposed to violence, kidnapping or other crimes.
“Go back, wrong way” is the best advice to be given to governments foolish enough to follow this OECD hunt for the quark. However, the prospect of that happening in any brief time is best expressed by my adaption of Adam Smith’s remarks on restoration of free trade:
“To expect, indeed, that the freedom from intrusion should ever be entirely restored …. is as absurd as to expect that an Oceana or Utopia should ever be established … Not only the prejudices of the public, but what is much more unconquerable, the private interests of many individuals, irresistibly oppose it. …. This OECD tax-gatherers’ monopoly has so much increased the number of some particular tribes of them, that, like an overgrown standing army, they have become formidable to the government, and upon many occasions intimidate the legislature.”
Dr Terry Dwyer
Dr Terry Dwyer B.A. (Hons), B.Ec. (Hons) (Sydney) M.A., Ph.D. (Harvard), Dip. Law (Sydney) Principal at Dwyer Lawyers in Australia, specialising in taxation, trusts, wills and estates. Formerly: Senior Adviser, Taxation, Commonwealth Treasury and Prime Minister’s Department, Senior Economist, Economic Planning Advisory Council, Private Secretary, Senator Brian Harradine.