KINIGUIDE | Asset protection, financial privacy or tax evasion?

·12-min read
KINIGUIDE | Asset protection, financial privacy or tax evasion?
KINIGUIDE | Asset protection, financial privacy or tax evasion?

KINIGUIDE | When we hear about offshore trusts and tax havens, images from Hollywood films come to mind, depicting the super-rich or mega-corporations secretly moving their wealth to countries with little or no taxation and evade paying them at home.

Countries in the Caribbean such as the British Virgin Islands, the Cayman Islands, and the Bahamas are frequently depicted as "tax havens".

While the reality may not be quite as dramatic as what Hollywood makes it to be, the global offshore financial industry allows individuals and corporations to take advantage of the best possible financial regulations and tax regimes, costing governments billions in lost tax revenue.

This guide is written as a companion piece for Malaysiakini's series on the Pandora Papers.

READ MORE: How Daim, M'sia's uber-rich use S'pore to store money offshore

The Pandora Papers is an investigation by the biggest journalist collaboration in history into millions of records exposing tax haven secrecy, following an anonymous 2.94 terabyte info dump to Investigative Consortium of Investigative Journalists (ICIJ) and its partners, including Malaysiakini.

The files are from 14 offshore service providers that set up and manage shell companies and trusts in tax havens around the globe.

With this guide, Malaysiakini gives an overview of offshore trust companies and tax havens.

What is a tax haven?

There are several definitions of what makes a country a tax haven.

The term generally refers to countries or jurisdictions (such as the Channel Islands of Jersey and Guernsey) with low or no corporate taxes, and allow non-residents or citizens to easily set up businesses there.

Most tax havens usually have strong privacy regulations about companies, trusts and their owners, making it difficult for the public to obtain information about them.

What is an offshore trust?

A trust is a fiduciary relationship where one party gives another party (whether an individual, financial institution, law firm etc.) the right to hold property or assets.

The party setting up the trust is known as the settlor, and the party given the rights to manage the property or assets is called the trustee. The trustee holds the trust for the beneficiary's benefit, who can be the settlor or another third party.

Among the reasons trusts are created are privacy, protecting property and assets and tax management.

An offshore trust is a trust established outside of the settlor's country of origin, such as when a Malaysian creates a trust in the Bahamas. A trust is usually formed by setting up a private limited company in the desired country.

The choice of the country would generally be one with low tax rates and stringent privacy laws to preserve confidentiality.

Why hold assets offshore?

There are several advantages for the creation of an offshore trust versus an onshore one. However, a trust is not the only vehicle possible to take advantage of a tax haven.

Below are some of the advantages:

a) Privacy

Firstly, an offshore trust is not subject to the laws of the creator's country of origin. This allows for more confidentiality and privacy of the properties and assets placed in the trust.

John Doe from country X has established a trust in country Y. If anyone else, including the authorities of X, want to obtain information on the trust, an application must be made to the authorities in Y. The authorities in Y will determine if the request will be granted.

Usually, if there is evidence that John is involved in illegal or fraudulent activities, the request to access information on the trust will be granted.

b) Asset protection

Secondly, there is the matter of asset protection, especially if the party setting up the offshore trust fears situations such as political instability. The assets are protected by the laws of the trust's jurisdiction.

While this is so where financial assets are concerned, obvious problems may arise in the case of real property and other tangible possessions held under an offshore trust but physically located in other jurisdictions.

This also applies if a person is involved in an acrimonious divorce, for example. In theory, the person's assets placed in a trust are protected from the divorce settlement.

Recent cases in Hong Kong, the United States and Australia have proven that the asset protection conveyed by trusts depends on the terms and conditions of the trusts and the involvement of the couple in the trust.

However, proceedings are also needed in the trust's legal jurisdiction to access its assets. In John Doe's case, in country Y.

There is a possibility that the courts where a trust is located may disagree with the judicial decision of the divorce, especially if the countries have no bilateral or multilateral treaties in place. The onus here could then be upon the individual concerned and not the foreign authority to comply.

c) Favourable tax laws

One of the key reasons for an offshore trust is to take advantage of favourable tax laws. Some countries offer low or even no tax rates on income earned by trusts.

A simple comparison of the Malaysian corporate tax rate of 24 percent would be with those in Singapore and Hong Kong, where it is 17 percent and 16.5 percent, respectively.

This is seen as an aspect of tax management or optimisation by wealthy individuals with income generated in foreign businesses or investments.

For example, a Malaysian entrepreneur, Jimmy Private, owns or invests in many businesses overseas. He can make use of differing tax regulations to maximise profits.

Through the use of a services company in Singapore (such as Trident Trust, Asiaciti etc.), Jimmy Private sets up an offshore trust, ABC Private Ltd, incorporated in the Cayman Islands.

Jimmy Private operates a company in Hong Kong that manages business in several countries in Southeast Asia, such as Thailand and the Philippines. Profits from these countries (after being taxed) are remitted to Hong Kong and then to ABC Private Ltd in the Caymans.

Under Hong Kong's tax regulations, there is zero tax if a company's profits are from operations outside of the island. Using the same example, if the profits are first sent to Malaysia, a corporate tax up to a maximum of 24 percent would have been applied.

It must be noted that Malaysia follows the "territorial scope" of tax under which only income derived from Malaysia would be subject to tax locally. Any income earned overseas would be exempt even if remitted into Malaysia; the principle applies to both companies and individuals, resident or non-resident.

The exceptions to this treatment are banks, insurance companies, and sea and air undertakings, which are taxed on a world basis.

Nevertheless, the reverse could apply. If a company's control and management are in Malaysia, the income it earns abroad may be deemed to have been derived from Malaysia and thus liable here. The alternative could be to set up a subsidiary in the country of operations where any repatriation of profits to Malaysia would fall outside the ambit of tax.

Tax rates are not the only reason one would set up a company offshore. Other advantages like investment incentives and the general business climate in the country selected may be other factors.

However, this is less likely the case in the examples provided in the Pandora Papers, where the businesses do not actually operate in the Caribbean jurisdictions they are registered in.

(Note that the above is a simplified example of how a person can benefit from different tax regimes. This is not intended to provide advice on actual taxation.)

Is it illegal to use tax havens, have offshore trusts or hold assets overseas?

Holding assets overseas or having offshore companies, trusts or accounts in another country is not illegal.

There are laws and regulations on trusts, including due diligence by the financial institutions setting up a trust to ensure laws concerning illegal financial activities are not breached.

However, in some instances, the practice has been linked to tax evasion or tax avoidance or an attempt to maintain secrecy for nefarious reasons.

According to tax experts consulted by Malaysiakini, if they are used for illegal means, by the time illegal funds reach an offshore trust, the money would have gone through processes where their origins are disguised, thus making them seem legitimate.

This is to avoid scrutiny from increasing tightening global financial laws and improved monitoring due to better technology used by authorities.

The tax experts conceded that there are still ways and loopholes that can be exploited to use trusts to evade taxes.

If it is not illegal, then why is Malaysiakini reporting on it?

Some may argue that this is a breach of privacy.

By the same token, it is also not illegal for companies to burn forests in order to clear land for oil palm plantations. But journalists can reveal who is doing it and how extensive the problem is, so the public and policymakers can be informed on the matter.

When it comes to tax havens and offshore trusts, the issue is a loss in government revenue for the state - revenue that could be used for the public good.

According to the International Monetary Fund, tax havens collectively cost governments between US$500 billion (RM2.08 trillion) to US$600 billion (RM2.5 trillion) a year in lost tax revenue.

How do you set up an offshore trust?

The setup is fairly straightforward - a person can engage a corporate services company locally or in another country, such as Hong Kong and Singapore being two favourites in the region.

The person then states their intention to set up a trust or company in an offshore jurisdiction, and the company handles all the paperwork.

Trust advisors from the services company will speak with the person to determine which country will be the best country for the trust based on the individual's financial needs.

Based on incorporation documents and correspondence sighted by Malaysiakini, individuals intending to set up an offshore trust need only to show proof of identity and residence, declare in a form where the source of funding for assets, complete other simple paperwork, pay a small sum of up to several hundred US dollars to set up offshore entities.

There is also an annual fee to keep the firm active and maintain its accounts.

Do service providers check to ensure that applicants are not attempting fraudulent activities?

Corporate services firms are obliged to conduct due diligence, among others, checking if the applicant is a politically exposed person (PEP) or on any terrorism or wanted list. Singapore, for example, requires service providers to declare if their clients are PEPs.

They need to then file a series of paperwork for the offshore jurisdiction, and the offshore company is born.

Other due diligence conducted includes checking if taxes had already been paid on the funds transferred in the originating country.

In 2020, Asiaciti Trust Singapore was fined S$1.1 million (RM3.38 million) for breaching Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) regulations.

It is unknown how often corporate services firms are audited by the Monetary Authority of Singapore (MAS).

MAS did not respond directly when asked how many financial services companies such as Portculis Group and Trident Trust have been audited and what the findings were.

Instead, a spokesperson said Singapore does not tolerate abuse of its financial system for illicit activities, and it has a robust system to detect abuse, money laundering and tax evasion.

"MAS will not hesitate to take regulatory and enforcement action against individuals and entities, regardless of nationality, if they have breached the laws and regulations administered by MAS."

Can individuals completely hide their assets in offshore accounts?

In recent years, especially in the wake of the Panama Paper leaks in 2016, the assumed "advantage of secrecy" is starting to change with more countries taking a stronger stand against fraudulent financial activities such as tax evasion, money laundering and financing criminal organisations.

Global organisations such as the G7's Financial Action Taskforce have taken on a more active role in combatting money laundering and financing of terrorism.

In Malaysia, new reporting guidelines from Bank Negara concerning anti-money laundering and countering financial terrorism activities came into effect on Jan 1, 2020.

In addition, Malaysia is part of the Automatic Exchange of Information (AEoI) arrangement involving more than 130 countries. Under this facility, member countries transmit information to other relevant countries on offshore accounts held by individuals and companies.

Accordingly, there is also no such thing as perfect confidentiality. Even the once secretive Swiss private banks are releasing client information to investigating authorities. Authorities can request information about a trust from the country where it is based if the requesting authority has proof that the trust was involved in illegal or fraudulent activities.

Do Malaysian owners of offshore trusts or accounts need to declare them to the Inland Revenue Board?

Tax experts told Malaysiakini that there is no need to inform the IRB if it is an offshore trust.

However, an individual is under the obligation to ensure that whatever the applicable taxes (if any) on the funds moved into the offshore accounts and trusts have been paid.

Generally, through the AEoI, the tax authorities will come to know of such accounts soon enough and the person will, of course, be asked to explain the sources of income for these funds.

They could be from income already taxed in Malaysia or amounts not liable, for example, gains from the disposal of investments.

There is also no requirement to inform IRB on the money transferred into the trust.

Malaysiakini reported that Malaysian high-net individuals are using Singapore to set up offshore trusts. Is Singapore an offshore tax paradise?

According to a report from the University of Amsterdam's Corpnet research group in 2017, Singapore is not a traditional tax haven per se.

Rather it is among the top five countries in the world for channelling funds to countries with low (or even no) tax regimes such Luxembourg, Cyprus and Jersey (an island in the British Channel) as well the Caribbean such as the British Virgin Islands, Bermuda and the Bahamas.

It is not usually the final destination of the assets because it does not provide an attractive tax and asset protection package like some Caribbean nations.

However, many of the specialist financial institutions and advisors that help set up offshore trusts are based in Singapore.

This KiniGuide, compiled by ANDY HEONG, is part of Malaysiakini’s coverage of the Pandora Papers, with the ICIJ and other partners worldwide.

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