The United States of Sanctions
The Use and Abuse of Economic Coercion
The Panama Papers—the 11.5 million leaked documents that detail more than 214,000 offshore companies listed by the Panamanian corporate service provider Mossack Fonseca—have shed new light on how wealthy individuals, including public officials, hide their money from public scrutiny.
But Panama’s history as a tax haven is quite old. It goes all the way back to 1919 when, as a young nation, it was looking for economic opportunities and began allowing foreign ships to register in its country and sail under the Panamanian flag. This helped companies such as Standard Oil dodge U.S. taxes and regulations, such as the Seaman’s Act, which provided certain rights for sailors and safety standards for the boats. Offshore financing followed in 1927, when Wall Street, searching for ways to avoid taxes, helped Panama craft lax company incorporation laws that enabled foreign investors to set up anonymous tax exempt corporations.
Still, it wasn’t until the 1970s that offshoring really took off in a big way. As the OPEC oil embargo caused oil prices to skyrocket, the shipping industry was hit hard. A slump in shipping meant that Panama needed to broaden its scope and attractiveness to foreign investors beyond hiring out “flags of convenience” for foreign ships. During the 70s, Panama officially adopted what has now become the standard tax haven model based on a process known as “ring-fencing,” which involves exempting foreign investors and their international business companies from taxes, enforcing strict banking secrecy laws, and offering competitive incorporation laws. The revised legislation led foreign investors to flock to Panama and there, the financial services sector boomed.
As a sign of how successful Panama has been as an offshore jurisdiction, it now has 370,000 international business companies, the third largest number in the world after the British Virgin Islands and Hong Kong. The Panamanian banking system is also the largest in Central America with consolidated assets of more than three times Panama’s GDP and a financial sector that makes up about eight percent of GDP. This makes the size of the financial sector in Panama exceed those in large developed countries like Italy, Japan, and the United States. Ronan Palan estimates that the majority of the money that flows through Panama originates in the United States, making Panama the largest U.S.-influenced tax haven in the world.
What sets Panama apart from other tax havens is that it specializes in creating offshore foundations. More generally, a foundation, which is tax exempt, has a board of directors, and unlike a company, it does not have shareholders. It may have beneficiaries, for either charitable or non-charitable purposes, depending on its location. In Panama, no approval is needed to create a foundation and unlike in Western countries, the foundation faces few requirements as to what it must list publicly (usually just the foundation’s name, its objective, and provisions concerning how it is to be “wound up” if say, it is dissolved). Details about the beneficiaries and the operation of the foundation are not made public.
To enforce privacy and secrecy, Panama has set up stringent laws to protect the anonymity of offshore trusts and foundations. For example, violation of laws of confidentiality can result in imprisonment for up to six months and fines of up to $50,000. All those involved in the formation of a trust or foundation in Panama (including lawyers, foundation members, agents, and bankers) who fail to adhere to these laws face criminal penalties.
Perhaps not surprisingly given its regulations, Panama is considered a haven for money launderers. The U.S. Internal Revenue Service has found that of all the criminal activities they uncovered from 1978 to 1983 related to moving drug trafficking money, 28 percent of the cases involved Panama. As scholar Jeffrey Robinson wrote in a study, “the free trade zone (of Panama) is the black hole through which Panama has become one of the filthiest money laundering sinks in the world.” This is because Panama has exempted the Colón Free Trade Zone, which sits near the Atlantic opening of the Panama Canal and specializes in trading precious metals and stones, from any anti-money laundering laws. This was a conscious decision to make the zone more attractive to all types of businesses. However, the zone has become a money laundering hotspot for terrorists and Colombian drug smugglers.
In 2014, however, the International Monetary Fund began paying attention to the problem. In an investigation of Panama’s compliance with the IMF’s Anti-Money Laundering and Combating the Financing of Terrorism provisions, the fund concluded that “Panama is vulnerable to money laundering from a number of sources including drug trafficking and other predicate crimes committed abroad such as fraud, financial, and tax crimes.” The IMF report also acknowledged that in spite of Panama having criminalized money laundering, enforcement against such activities was poor and where there was legislation, there were also substantial loopholes. So far, there are few signs that Panama has made any effective efforts to rectify the shortcomings pointed out by the IMF.
The biggest loopholes are, of course, Panama’s strict banking secrecy laws, which were purposely designed to protect offshore bank account holders. Panamanian banks are prohibited from disclosing information regarding offshore bank accounts, which is classified as confidential. Information may be given out in cases of criminal investigations, however, if the proper court order has been issued. Failure to comply with these laws can result in fines of up to $100,000.
Panama also grants its international business companies, which are essentially shell companies, some of the highest levels of privacy in the world. As a tax haven, Panama does not require that the names of the shareholders be registered as public information nor does it require offshore companies to file annual financial reports with the relevant tax authorities. The IMF has also found that the regulatory frameworks for the capital markets and insurance sectors in Panama remain underdeveloped, meaning that oversight and enforcement are lacking.
Not everyone, though, agrees with IMF’s assessment. As journalist Nicholas Shaxson has argued, the real problem is that Panama has yet to sign tax treaties with foreign countries that would facilitate cooperation on tax issues, and Panama, in contrast to almost all other locales that are considered tax havens, has refused to sign tax information exchange treaties. This is a clear signal to foreign investors that Panama maintains a high level of secrecy and that they can trust their wealth to stay safe there from prying eyes. Panama has also failed to pass currency exchange control laws, which means currencies can flow in and out of Panama without oversight. It makes it easy for offshore companies to move funds freely across countries, but a side effect is that such freedom makes it difficult to enforce international money laundering provisions such as suspicious transaction reporting.
Another aspect that attracts wealthy foreigners to Panama is the opportunity it offers to invest in the bearer shares of offshore companies. These shares, unlike traditional stocks, do not require registration and can therefore be owned and transferred anonymously. They are widespread in Panama, although they are largely banned in the developed world because they disguise the stocks’ chain of ownership over time and can be easily used for money laundering. There has been an attempt to crack down on them in Panama as well. As of August 2015, anyone in possession of Panamaian bearer shares is required to designate an authorized custodian (a lawyer, law firm, bank, or trust company in Panama) who will then receive a custody certificate in return. The new rule still protects the privacy of the shareholders, however, and so it is not clear how successful it will be in tackling crime related to anonymouse stocks. Further, it is an ominous sign that both existing and new firms can still use bearer shares.
The Panama Papers have exposed another practice widespread in many tax havens that is used to disguise the wealthy or corrupt. People in Panama “rent” their names for use as a director of a shell company in order to hide the true ownership, even though these name renters have little to no knowledge of what the companies do. The leaks reveal that some Panamanians have rented out their names to thousands of companies. In fact, the Norwegian bank DNB used only three Panamanians to serve as fronts for 4,000 companies.
It is not yet clear what the consequences of the Panama leaks will be. They may certainly damage Panama’s business model and that of other tax havens, but the irony of Panama is this: all these tax evasion laws apply only to foreign companies and persons. They are actually off limits to Panamanians, unlike in the United States where places such as Delaware, Nevada, South Dakota, and Wyoming allow Americans to hide their wealth onshore. And so the real question at hand is whether the world will continue putting up with practices that are so harmful, that tax havens themselves have banned their use among their own people.