The Model Mandatory Disclosure Rules (‘AEOI PHASE 3’) Briefing Series: PART IV

By Rodrigo Zepeda, CEO, Storm-7 Consulting

GLOBAL AND NATIONAL ESTIMATES OF TAX EVASION

The most recent estimates of the cost of global tax evasion to governments around the world is nearly $500 billion (£408 billion) – around $312 billion (£254.68 billion) is lost because of tax abuse by multinational corporations, and around $171 billion (£139.58 billion) is lost via individual tax evasion (Global Tax Justice 2020; McGoey 2021). Let us put these losses in context within the United Kingdom (UK). For the 2021/2022 tax year, the UK Government raised over £915 billion in tax receipts (UK Parliament 2022).

HM Revenue & Customs (HMRC) published revised annual estimates of the national ‘tax gap’ that presently exists (Seeley 2021, p. 5). The tax gap is the difference between tax that is collected and that which is theoretically due to the UK Government (Seeley 2021, p. 5). For the UK, this was put at £35 billion for the 2019/2020 tax year, which represents approximately 5.3% of total national tax liabilities (Seeley 2021, p. 5). This 2019/2020 figure incorporated the estimated loss from tax avoidance, which was put at £1.5 billion, and the estimated loss from tax evasion which was put at £5.5 billion (Seeley 2021, p. 5).

For the 2018 to 2019 tax year, it cost £4 billion to run HMRC (HM Revenue & Customs 2019). This means that the UK Government essentially loses more money from annual tax evasion than it costs to run the entire Government tax service. Now let us take a look at how this situation might potentially change in the future in the UK under new and enhanced regulatory ‘Automatic Exchange of Information’ (AEOI) frameworks. We will start by analysing the new approach to preventing tax evasion within firms introduced in the UK.

CORPORATE OFFENCE OF FAILURE TO PREVENT FACILITATION OF TAX EVASION

In the UK, the Criminal Finances Act 2017 (c.22) (CFA 2017) was enacted on 27 April 2017. PART 3 of the CFA 2017 covers the corporate offence of failure to prevent facilitation of tax evasion, which is a strict liability criminal offence. The Act governs any ‘relevant body’ (B) which includes a body corporate (company) or a partnership (CFA 2017, s. 44(2)). The Act provides that B will be guilty of a criminal offence if a person commits a ‘UK tax facilitation offence’ when acting in the capacity of a person associated with B (CFA 2017, s. 45(1)).

A person can be associated with B if that person is B’s employee (acting in the capacity of employee); if that person acts as B’s agent (acting in the capacity of agent); or if that person is someone who performs services for, or on behalf of B (acting in the capacity of a person performing such services) (CFA 2017, ss. 44(4)(a)-(c)). This covers inter alia business partners, contractors, distributors, sub-contractors, subsidiaries, and other related entities. A UK tax facilitation offence covers:

(1) being knowingly concerned in, or taking steps with a view to, another person’s fraudulent tax evasion;

(2) aiding, abetting, counselling, or procuring commission of a ‘UK tax evasion offence’; and

(3) taking part in the commission of an offence which consists of being knowingly concerned in, or in taking steps with a view to, fraudulent tax evasion (CFA 2017, ss. 45(5)(a)-(c)).

A UK tax evasion offence consists of an offence of cheating the public revenue, or any other UK offence which consists of being knowingly concerned in, or in taking steps with a view to, fraudulent tax evasion (CFA 2017, s. 45(4)(a)-(b)). In short, this means that all covered firms will be criminally liable in situations where they fail to prevent those who act for, or on their behalf, from criminally facilitating tax evasion (HMRC 2017, p. 3). Where a covered firm fails to prevent a person associated with the firm from criminally facilitating the evasion of tax, whether tax is owed in the UK or abroad, a criminal offence will have been committed (HMRC 2017, p. 3).

The three-stage test applied to a tax evasion facilitation offence is proof of: (1) criminal tax evasion by a taxpayer; (2) criminal facilitation by an associated person within B; and (3) B’s failure to prevent its representative from committing the criminal facilitation act (HMRC 2017, p. 6). A professional (e.g., accountant, banker, lawyer) must deliberately and dishonestly facilitate the commission of revenue fraud by a client (HMRC 2017, p. 8). The fact that such persons were instructed to undertake such practices by the firm is no defence.

Corporate Offence Defence

It is important to note that covered firms may be able to rely on a statutory defence, if B can prove that when the UK tax evasion facilitation offence was committed:

(1) B had in place such prevention procedures as it was reasonable in all circumstances to expect B to have in place; or

(2) it was not reasonable in all the circumstances to expect B to have any prevention procedures in place (CFA 2017, ss. 45(2)(a)-(b)).

Prevention procedures is defined to mean procedures designed to prevent persons that act in the capacity of a person associated with B, from committing UK tax evasion facilitation offences (CFA 2017, s. 45(3)). Firms are required to follow official UK Government guidance about preventing facilitation of tax evasion offences published by the Chancellor of the Exchequer in 2017 (Tax Evasion Prevention Guidance 2017) (CFA 2017, s. 47).

So, if a client of a firm (taxpayer) commits criminal tax evasion, and someone at the firm criminally facilitated this offence, the firm itself will be criminally prosecuted if it failed to prevent its employee/contractor (representative) from committing the criminal facilitation act. However, if the firm puts in place effective prevention procedures, then even though such procedures may not have actually prevented the crime from taking place, they may still be sufficient to provide the firm with a statutory defence. If a firm does not put in place any prevention procedures, there is effectively no way it can rely on any statutory defence.

STRATEGIC ANALYSIS OF AEOI PHASE 3

In Part I of this Blog Series, we saw that 'Automatic Exchange of Information' (AEOI) Phase 1 commenced with the introduction of the ‘Foreign Account Tax Compliance Act’ (FATCA) in the United States (US) in 2010 (U.S. Department of the Treasury). AEOI Phase 2 commenced with the introduction of the ‘Common Reporting Standard’ (CRS) in 2014. The ‘Model Mandatory Disclosure Rules for CRS Avoidance Arrangements and Opaque Offshore Structures’ (MMD Rules) were published on 9 March 2018.

The implementation of the MMD Rules in the UK via ‘The International Tax Enforcement (Disclosable Arrangements) Regulations 2022’ (SI 2022 No.) (DR 2022) scheduled for some time in 2022, will introduce AEOI Phase 3 in the UK. The likelihood is that during the next five years (i.e., 2023 to 2027) more CRS partner jurisdictions around the world will transpose the MMD Rules into domestic legislation, thereby facilitating AEOI with respect to information required to be disclosed under the MMD Rules. Overall, it can be deduced there will likely be a change in approach and focus for both covered firms and domestic tax authorities (DTAs), with the onset of AEOI Phase 3.

The focus for covered firms under AEOI Phases 1 and 2 was all about becoming FATCA/CRS compliant, and reporting accounts and information to DTAs. Even though the whole point of FATCA/CRS is to counter criminal tax evasion, the focus for firms seemed to be on reporting information not on identifying and preventing a criminal offence. It is true that firms can be fined and even criminally prosecuted under CRS frameworks, however this has not generally widely occurred. Two of the main reasons behind this are data and efficiency. Despite the huge amounts of AEOI data that DTAs will exchange, they still need to invest heavily in technology and manpower to be able to effectively analyse and utilise such data.

Given the short operational time frame of AEOI Phase 2, many DTAs will likely have not yet fully implemented ‘advanced analytical technologies and methodologies’ (AATMs) to exchanged AEOI data. AATMs include application and use of inter alia artificial intelligence, algorithms, machine learning, Big Data analytics, and predictive analytics (Alm 2021; Aparicio 2017; Dean 2017; Tropina 2017). Consequently, as a result, they may not yet be in a position to be able to fully leverage this data to implement efficient tax evasion investigations and prosecutions, i.e., larger volumes of investigations based on convincing data evidence resulting in a higher probability of conviction.

Nevertheless, this prevailing position is set to potentially change under AEOI Phase 3. Over the next five to ten years, more and more DTAs will fully implement AATMs to exchanged AEOI data, and their operational insights will increase and expand. At the same time, more and more DTAs will implement the MMRs nationally. As more and more MMD Rules AEOI data is exchanged, DTAs will be able to better understand and target global tax evasion strategies at a much more granular level. Timely reporting of ‘Arrangements’ and ‘Structures’ under the MMD Rules, will enable DTAs to intervene at an earlier stage within the tax evasion life cycle (OECD 2021, p. 39).

The MMD Rules may also have a disruptive effect on professional (tax evasion) enablers, who will have to actively contemplate their actions owing to MMD Rules reporting, and they may be deterred from pursuing illegal arrangements (OECD 2021, p. 39). A failure to report under the MMD Rules can result in criminal or civil actions and large financial penalties, and MMD Rules reporting may also deter clients (i.e., Arrangements/Structures must be reported to the DTA) (OECD 2021, p. 39). Overall, this means data and efficiency challenges will likely finally be directly addressed by many more DTAs around the world.

In the UK, there has been a significant and widespread move towards increasing responsibility and accountability within authorised firms under the new ‘Senior Managers and Certification Regime’ (SMCR) (Financial Conduct Authority 2015). There is a much greater focus on strengthening culture, governance, and accountability within firms, and addressing and mitigating potential conduct risk concerns. This ties in with firms tackling the prevention of criminal facilitation of tax evasion by implementing effective tax evasion prevention procedures internally.

It therefore makes complete sense for firms to seek to integrate all these new regulatory obligations with existing know your client (KYC), anti-money laundering (AML), and FATCA/CRS identification and due diligence procedures over time. This can provide a holistic and much more cost-effective approach to financial crime (money laundering, tax evasion) risk management. Indeed, the risk-based approach (RBA) to AML (FATF 2014) is fully consistent with the Guiding Principle of ‘proportionality of risk-based prevention procedures’ set out in the Tax Evasion Prevention Guidance 2017:

“Reasonable procedures for a relevant body to adopt to prevent persons acting in the capacity of a person associated with it from criminally facilitating tax evasion will be proportionate to the risk the relevant body faces of persons associated with it committing tax evasion facilitation offences. This will depend on the nature, scale and complexity of the relevant body’s activities.” (HMRC 2017, p. 21). 

In fact, the whole approach adopted in the Tax Evasion Prevention Guidance 2017 seems to essentially mimic the approach taken to assessing and addressing internal firm AML frameworks. Under AEOI Phase 3, over time there will ultimately be effective AEOI on a mass scale across DTAs globally, not only covering CRS tax information, but also MMD Rules tax information. DTAs will have fully implemented AATMs to exchanged AEOI data, and they will be able to effectively and efficiently leverage operational insights with respect to identification of tax evasion strategies and practices.

DTAs will have increased investigatory powers, more streamlined workflows, and greater levels of cooperation between other DTAs worldwide. In the UK, the likelihood is that HMRC will seek to implement more aggressive tax evasion investigation strategies based on a range of new criminal offences under the DR 2022/MMD Rules and the CFA 2017. There would seem to be an increased emphasis on regulatory and tax investigations lined up in the future, along with industry updating of internal firm risk management frameworks owing to new CFA 2017 obligations with respect to tax evasion prevention procedures.

This will be bolstered by the growing focus and importance of addressing conduct risk in firms. Such tax evasion prevention procedures will not only provide covered firms with a statutory defence, but the DR 2022 confirm that HMRC will also take into account any reasonable procedures a person has put in place to ensure reporting, when determining whether or not a person has a reasonable excuse under the DR 2022, or when determining the amount of any penalty incurred (HMRC 2021, p. 17).

So, implementing effective tax evasion prevention procedures internally within firms can be considered as a risk mitigation tool with respect to DR 2022 obligations. Consequently, it is the cumulative effect of all these developments that will occur over time, in tandem with the global implementation of the MMD Rules, that will very likely catalyse a new change in approach throughout AEOI Phase 3.

That is, an approach which was based purely on reporting information under AEOI Phases 1 and 2, will now change to one that places much more emphasis on regulatory investigations and interventions aided by exchanged AEOI data and DTA AATMs; implementation of tax evasion risk prevention and management strategies for firms; and more widespread monitoring and addressing of tax evasion conduct risks for firms. The interaction of all these processes in the UK, can help to illustrate what changes firms in other CRS partner jurisdictions around the world will likely face over the next 10 years.

The problem for firms is the deeply interconnected nature of the onshore and offshore global banking systems. If an offshore firm is now investigated under the DR 2022/MMD Rules, this may then reveal dozens of clients that may be subsequently prosecuted for substantive tax evasion offences. The presence of these clients at other firms may then trigger additional investigations by DTAs, i.e., daisy chain causal effects are triggered that may negatively impact firms resulting in materialisation of reputational risks. In reality, it is these global financial interconnections that may be very difficult for firms to identify and address.

In the UK, the unofficial soft quantitative targets for AEOI Phase 3 have been set, these are £5.5 billion in tax evasion funds that HMRC is seeking to claw back, and £1.5 billion in tax avoidance funds that HMRC will be seeking to minimise. In light of the massive financial losses incurred in the UK because of the combined tripple whammy effects of the BREXIT economic fallout, the COVID-19 pandemic, and the Russia-Ukraine War, it makes complete sense for HMRC to currently adopt much more aggressive tax recovery strategies. If successful in mitigating these figures, the UK Government could set a precedent that would surely be followed by many more DTAs around the world over the next five years.