A Fine Mess

by T. R. Reid

  The Panama Papers indicated that most of Mossack Fonseca’s client list came from Europe, Asia, and Africa; there were not many names from the United States in the leaked documents. Still, the Internal Revenue Service issued a warning to any Americans who might have tried to salt away money in foreign accounts to avoid paying tax. “People hiding assets offshore should recognize,” the IRS said, that such maneuvers were likely to be futile. “More than ever,” the agency added, “their best option remains to come forward voluntarily and participate in the IRS Offshore Voluntary Disclosure Program.” Naturally, the IRS has two different forms—Form 14437 and Form 14454—for Americans to use in revealing their offshore holdings. Just days after the first reports about the huge leak, the Justice Department announced that it had “opened a criminal investigation regarding matters to which the Panama Papers are relevant,” which seemed to indicate that the feds were going after Americans mentioned in the papers.

  When the story broke, the newspaper and broadcast accounts all referred to Mossack Fonseca as an “obscure” or “little-known” Panama law firm. And yet, the papers revealed, this unknown firm had more than fourteen thousand clients in more than a hundred countries, all of them willing to pay the Panama City lawyers hefty fees to salt their wealth away where nobody—and particularly no national tax agency—could track it.

  The venues for this hidden money were countries—sometimes tiny countries with a national population smaller than an American small town’s—that had written laws and regulations to permit people from any country to create corporations and/or set up bank accounts in complete secrecy. Such places are known in English as “tax havens.” The French call them paradis fiscaux, or financial paradises; in Spanish, it’s asilos de impuestos, asylums from taxation; the Italian term is rifugio fiscale, or fiscal refuge. Many of these refuges also happen to be sun-splashed tropical getaways, like Bermuda, the Cayman Islands, Panama, Belize, and Cyprus. That’s because tax evaders sometimes need to visit their money—it’s more private to go get the cash in person than to have the funds wired to your bank at home—and they like to take their families along for a beach vacation at the same time. Shady money is stashed in sunny places.

  Mossack Fonseca worked with several of these tax havens to conceal their clients’ funds. The Panama Papers showed precisely how this was done. In the early years—until the global crackdown on tax evasion began in the late 1990s—the firm sometimes just used the tried-and-true gambit of the numbered account at some international bank. The law firm would receive a large check from the client and deposit it in a bank in Switzerland, or Panama, or any other jurisdiction where secret bank accounts were legal. The bank’s records for that account would show only a number—ZU456238, or some such. Frequently, the bank itself didn’t know the identity of the depositor; only the law firm in Panama City had that information. Thus when the IRS or some other tax authority showed up at the bank with a warrant to search the accounts, the bank’s officers could honestly say that nobody had any idea who really owned the money deposited there. For this service, the banks took some heat from governments and international organizations. But they were making good money on the business, receiving large deposits on which they paid little or no interest, and charging fees along the way. As long as the law firm’s fees and the interest forgone cost less than the tax might have, the client was happy.

  But the law firm also developed more sophisticated ways to conceal money, and this became important in the twenty-first century as rich nations began working together to crack down on secret bank accounts. Mossack Fonseca became a global leader in the practice of creating so-called “shell corporations”—that is, a “business” that does no business. A client—or his banker—would come to the law firm with, say, $50 million that he didn’t want anybody to know about. The firm would then create a corporation with some anonymous name—something along the lines of “Panama 67453X,” or “BVI48484JK,” although some also took their names from characters or places in Star Wars or Game of Thrones—in a jurisdiction that was willing to issue a corporate license with no person’s name attached. The client would then use his $50 million to buy stock in the do-nothing corporation. The stock certificates would be payable to “Bearer”—that is, whoever owned them. No names required. The money that purchased these anonymous stock certificates would be deposited in a bank account under the corporation’s obscure name so that nobody could find it. Quite often, the bank would issue a Visa or Mastercard in the corporation’s name, which the wealthy client could use to buy goods and services in her home country.

  John Doe’s trove of “data” suggested that setting up such legal creations—they’re known as international business corporations, or IBCs—was an important line of business for Mossack Fonseca, and it clearly kept the lawyers busy. The Panama Papers indicated that the law firm created some 214,000 shell corporations—legal entities that had no employees, no officers, and no corporate activity except to serve as a clandestine repository for the money of wealthy tax dodgers. Sometimes, the firm put the money into “charities” or “foundations,” which can also be used to hide funds. The firm worked with more than five hundred banks around the world.

  This system required, of course, a legal jurisdiction that was willing to register a corporation or a foundation with no names attached. Mossack Fonseca’s lawyers particularly favored the British Virgin Islands, a Caribbean archipelago that is home to thirty-two thousand residents, several large banks, and hundreds of thousands of registered corporations. But there were many accommodating venues for shell corporations—particularly Switzerland, Luxembourg, Panama, Cyprus, and the Cayman Islands—which readily granted privacy in return for the incorporation fees and the banking business it generated. For that matter, the United States also served as a popular hiding place for money. In Delaware, Nevada, and South Dakota, it’s legal to start a corporation anonymously, and there’s no requirement that the new company transact any business.

  In Nevada, for example, a corporate license requires no person’s name; the state collects a “business license fee” of $500 per year, but this can be paid by a law firm or other go-between to preserve the privacy of the actual owner of the corporation. Generally, those who want to create a business in Nevada—legitimate or “shell”—hire a professional called a registered agent who files all the paperwork in return for a fee; the Nevada Registered Agent Association says this business supports a thousand jobs in the state. John Christensen, the British tax-reform advocate who tracks tax evasion around the world, told me that “the U.S. is a bitter adversary of tax-evasion schemes—when they take place in other countries. But, in fact, there’s a big neon sign in several of your states saying, ‘Open to tax cheats. Bring your money, and we won’t tell.’”

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  TWO WEEKS AFTER THE first media reports about the Panama Papers, representatives from forty nations gathered in Paris for an emergency meeting of an organization called JITSIC—the Joint International Tax Shelter Information and Collaboration Network. This international posse of tax officials had been working for more than a decade to crack down on tax-avoidance schemes like those set forth in the Panama documents. And JITSIC had made significant progress. All over the world, banks large and small had signed agreements promising to share information with tax authorities about their foreign customers and the money they had on deposit. But the Panama revelations suggested that international organizations like JITSIC still had a great deal of work to do.

  The driving force behind JITSIC, and the acknowledged leader of the international push to police tax dodgers, was the U.S. government. Although the law firm responsible for the Panama Papers drew only a small share of its clients from the United States, rich Americans had been actively hiding their money from the IRS for decades. When reporters at the Wall Street Journal analyzed IRS records in the fall of 2015, they estimated that Americans had more than ten thousand hidden accounts holding more than $10 billion in
just one country (Switzerland).2 The amount of tax that could be collected, if the IRS could reach the hidden American money in every tax haven, is hard to measure (the IRS declines to give a figure). But congressional sources have estimated that the lost revenue is greater than $40 billion per year.

  Motivated by numbers like that—the missing $40 billion could fund several entire federal agencies each year—Congress in 2010 enacted a tough new law forcing foreign banks, brokerages, and so on to report the names of all their American account holders and the amounts they had on deposit. The basic idea was to go after tax evaders by punishing the banks and law firms that kept their secrets. This statute, the Foreign Account Tax Compliance Act, or FATCA, has made a dramatic difference in the IRS’s ability to find hidden hoards of American money. Consequently, the acronym “FATCA” has become a hated term among the kinds of wealthy clients who turn to Mossack Fonseca and similar firms to help hide their money.

  Initially, the Obama administration sent out warnings to financial institutions around the world: if you help Americans hide their money to avoid taxation, you will be charged with a crime and liable to huge fines. For the first year or so after FATCA was enacted, this thinly veiled threat had only moderate impact. And then, in 2012, the Justice Department found a useful target and pounced. The U.S. attorney in Manhattan brought criminal charges against a Swiss bank—not just any bank, either, but Wegelin & Co., the oldest bank in Switzerland, with a proud pedigree of service to Swiss and foreign customers dating back 271 years (corporate slogan: “PrivatBankiers seit 1741”).

  The Swiss government issued an angry protest, and the bank itself, noting that it had no American branches, said it was outside the jurisdiction of U.S. criminal law. But Wegelin had several hundred U.S. depositors, whose secret accounts totaled some $1.2 billion that the bank had not reported. Testimony indicated Swiss bankers used all sorts of euphemisms to conceal what they were doing; when a U.S. customer wanted to withdraw some money, for example, she would ask the bank to “send me a postcard” or “download some tunes.” A federal judge agreed that all this constituted a crime under FATCA, and the penalties were harsh. The bank paid a fine of $22 million, plus another $20 million representing the amount of U.S. tax that would have been collected if the IRS had known about the hidden money, plus a forfeiture of an additional $15.8 million representing the fees Wegelin had earned from its American customers. On top of that, the Justice Department seized $16 million that the firm had on deposit in a bank in the United States.

  With its assets depleted, its age-old reputation for secrecy destroyed, and depositors fleeing, Wegelin & Co. went out of business. Some 245 of its American customers ended up paying $13 million in back taxes and penalties. On the steps of the courthouse, the U.S. attorney Preet Bharara issued a blunt warning to other foreign banks and to the American depositors who used them for tax evasion. “Wegelin has now paid a steep price for aiding and abetting tax fraud that should be heeded by other banks, bankers, and advisers who engage in the same conduct,” he said. “U.S. taxpayers with undeclared accounts—wherever those accounts may be—should know that their bank may be next, and they should pay what they owe the IRS before we come find them.”

  And with that, the walls of secret banking started tumbling down. The United States indicted dozens of bankers, lawyers, and advisers in Switzerland for FATCA violations. By mid-2016, more than fifty Swiss banks had reached settlements with the Justice Department, agreeing to reveal the names of all American customers and to pay hefty fines for their secret deposits. The investigation caught more than fifty-four thousand U.S. taxpayers who had hidden money in Swiss banks, and it collected over $8 billion in back taxes and penalties from those would-be evaders. The biggest catch of all was the Swiss financial giant Credit Suisse, which pleaded guilty to criminal charges under FATCA in 2014 and paid a whopping $2.6 billion fine. Emboldened by the U.S. action, France, Germany, and other rich countries enacted their own versions of FATCA and went after banks in all the major tax havens. Under the auspices of the aforementioned JITSIC, countries beyond the United States and Europe joined the global war against tax havens; ninety-six nations signed on to an automated system of information sharing that would alert the tax authorities whenever their nationals deposited money in a bank overseas. Under intense pressure, some of the most recalcitrant champions of bank secrecy, including Cyprus, Luxembourg, Switzerland, the Bahamas, and the Cayman Islands, weakened their financial secrecy laws.

  One major holdout was Panama, where the government recognized the work of the Mossack Fonseca firm and its affiliated banks as a significant portion of the national economy. The nation had entered into some bilateral agreements on financial data but did not join the JITSIC information-sharing system. But the storm of attention and criticism that followed the leak of the Panama Papers may have changed the country’s stance. A week after the first news stories appeared, the Panamanian president, Juan Carlos Varela, announced the appointment of a national commission that was ordered to “strengthen the transparency of the financial and legal systems.” The nation’s cabinet chief announced that Panama no longer felt the need to stay outside the global system of banking transparency.

  What was not transparent was the real identity of “John Doe,” the source of the biggest global leak in journalistic history. Most observers guessed that the leaker of the Panama Papers was an embittered former (or, maybe, current) employee of the Mossack Fonseca firm. When Obermayer, the German reporter who received that first cryptic e-mail, asked his source why he was providing the flood of documents, the response seemed angry: “I want to make these crimes public.” John Doe never asked for financial compensation, Obermayer said, and never tried to dictate what the newspapers would report. “My life is in danger,” Mr. Doe told the newspaper. “No meetings, ever. The choice of stories is up to you.” The law firm insisted that it had never done anything illegal and demanded a government investigation of the leaker who had hacked into the firm’s records. But the government of Panama, facing a national embarrassment surrounding its eponymous “Papers,” had more serious issues to worry about than the identity of John Doe.

  11.

  SIMPLIFY, SIMPLIFY

  Every once in a while, the members of the U.S. Congress get mad at the Internal Revenue Service. Reacting to some bureaucratic bungle, real or imagined, the senators and representatives launch a round of angry speeches in their respective chambers. Then they order IRS officials to appear at a hearing before one of the congressional oversight committees—a session that is generally marked by scorching rhetoric, hostile questions, and furious accusations, as long as the TV cameras are on. Finally, the members put out a fiery report denouncing the tax code and the IRS staffers who administer it. Then they move on to the next target.

  There’s a strong kill-the-messenger flavor to these periodic outbursts of manufactured rage. Members of Congress love to harangue the IRS bureaucrats about lengthy tax forms and unfair rules and complex instructions—but of course the IRS isn’t responsible for the length, the fairness, or the complexity of our tax code. It is Congress that writes the tax laws. It’s Congress that adds hundreds of new exemptions, allowances, credits, and calculations to the tax code every year. It was Congress that decided to give the IRS responsibility for managing the health insurance subsidies flowing to millions of Americans under the Affordable Care Act (ObamaCare)—and then cut the agency’s staff after assigning it this major new task. It was Congress that assigned to the IRS the management of the earned income tax credit (EITC), which has become one of the nation’s largest support programs for low-income Americans. It was Congress that crafted the much-hated alternative minimum tax, which spawned whole new dimensions of complexity, and hours of additional work, for millions of families. And yet congressmen and senators can’t seem to resist pointing angry fingers at the IRS, as if somebody else had created the legislative monster that is the U.S. tax code.

  This form of pol
itical showmanship reached its zenith in the spring of 2016, when a group of Republican backbenchers mounted a quixotic effort to impeach the commissioner of the IRS, John Koskinen. This idea—the first time Congress had ever tried such a thing—was doomed from the start, because the leadership in both houses opposed it, viewing the whole exercise as an empty gesture. But the critics were determined to proceed, in large part because Koskinen—who came out of retirement in his seventies to run the agency and thus had no fear of snippy young congressmen—had never treated the august members of Congress with the respect and deference they had come to expect from bureaucrats. Indeed, Koskinen generally displayed thinly veiled contempt for committee members when he was hauled into a congressional hearing. Whenever the members starting griping about the complexity of the tax system, Koskinen would shake his head and steer the complaint right back at them. “I didn’t write the tax laws, Congressman,” he would say. “You did that.” When Congress scheduled a hearing in mid-2016 on the impeachment resolutions, Koskinen rather blatantly thumbed his nose: the IRS sent word that the commissioner was too busy to make the one-and-a-half-mile ride to Capitol Hill to testify. The impeachment resolutions didn’t come to a vote in either chamber.

  Generally, a congressional inquisition of the IRS leads to nothing more than a fleeting moment on the evening news and a committee report that is put on a shelf and forgotten. But occasionally, this burst of congressional rancor prompts new legislation designed to deal with whatever problem sparked the anger in the first place. One such moment came in 1998, following a series of heated congressional hearings on the way IRS agents were treating (and sometimes mistreating) taxpayers who had run afoul of the code. The result was the IRS Restructuring and Reform Act of 1998, a voluminous and hugely complex new law, which included the laughable “anti-complexity clause”—that is, Section 7803(c)(2)(B)(ii)(IX). Another part of that same law—to wit, Section 7803(c)(I)(B)(i)—created a new office within the Internal Revenue Service, to be known as the Office of the Taxpayer Advocate. The national taxpayer advocate was based on a position found in the national tax agencies of several foreign countries: the ombudsman. The taxpayer advocate’s main job is to be a helping hand for harried taxpayers facing an audit or a penalty fee or a levy from the IRS. This ombudsman is to work within the IRS but not under the control of the commissioner; the advocate is appointed by the secretary of the Treasury to an unlimited term and can be removed only by the secretary. Congress did not stint on resources, either; the taxpayer advocate has a staff of two thousand people, with offices in every state, who are empowered to jump in whenever a taxpayer complains of being mistreated.