A Study of How Money Laundering is Related with Evading Tax and Tax Havens

Tax evasions and Money Laundering have always been perceived and widely believed to be the demise of all economies. Tax havens on the other hand are considered by many as tax shelters for tax evaders and money launderers. Despite the fact that money laundering and tax evasion are categorized as different crimes, the two are closely related and linked together. Money launderers aim to transform illegally earned income into legal income while tax evaders seek to hide income, whether legally or illegally earned, from detection a collection by the relevant tax authorities (Spreutels and Grijseels, 2000). In sustaining these activities the launderers and evaders tactically depend on offshore financial centers and tax heavens as they offer high level of secrecy and guarantee of anonymity. Therefore, there exists a significant interlinking relation among the three. This research explores the relations between money laundering, tax evasion and tax heaven. The paper seeks to establish clearly the inter-link between the two offences and the contributions by tax heavens.

To evaluate and fathom the link between money laundering and tax evasion requires a basic understanding of the activities involved. Money laundering as Tavares notes:

“… is a criminal offence aimed at presenting wealth of illicit origin or the portion of wealth that has been illegally acquired or concealed from the purview of tax and other authorities, as legitimate, through the use of methods that obscure the identity of the ultimate beneficiary and the source of the ill-gotten profits.” (Tavares, 2013)

Money laundering may occur in a number of ways and is thought to have originated when the mafia owned Laundromats in the United States of America. According to Ansia Storm (2014), Laundromats were originally legitimate business holdings that were used by the mafia to legitimize sums of money from the then illegal businesses such as extortion, gambling, bootleg liquor and prostitution. The process involved the cooperation of illegal gains with cash gains from the Laundromats business. This was made possible by the fact that Laundromats were a cash deposit business. Conviction of Al Capone for tax evasion may have been the spark leading to the trigger of getting money laundering business off the ground (Dadoo, 2012; Krishna, 2008; as quoted by Storm, 2014).

This is a possible link between the two. The translation leads to the entailing details of tax evasion. Tracing the details of the Al Capone case, a lot is revealed on the matter. When the federal government found no evidence against Capone and the murders that occurred during his tenure as the mafia boss, they sought to attack him with a two-pronged plan. The federal government collected the evidence of prohibition law violation and those of not paying taxes on his income. Later on Capone was found guilty on five accounts of tax evasion charges. From this Meyer Lansky, the then mob’s accountant, feared a similar fate and sought to find better ways to launder money and evade taxes. “Lansky discovered the benefits of numbered Swiss bank accounts,” tax heavens, “starting the culture of money laundering” (Krishna, 2008; Dadoo, 2012 as quoted by Storm, 2014).

According to the United Nations Office on Drugs and Crime (UNODC) estimates, 2-5% of global gross domestic product (GDP) is laundered in a year (UNODC, “Money-Laundering and Globalization,” 2012). This interprets to a minimum loss of approximately $800 billion. The underlying question raised is if the illegality of these money is addressed then for the perpetrators to conceal identity they would have to apply mechanism that shield them from paying taxes. Alternatively the money is hidden and save in offshore financial institutions and tax heavens like the Swiss bank. This goes to shore that for one crime to level up another one has to lend a hand. This amounts are too large to be successfully laundered without detection and for such reason tax evasion comes in.

In light to this, it is essential that we establish a common definition of tax evasion for purposes of our critic and for scholarly discussions. Tax evasion is defined as an illegal practice where one engages in an intentional avoidance to submit or pay the appropriate tax liability. Tax evasion sums up and qualifies as a crime as it involves a violation of the law and causes an injury to the public. The injury caused to the public is substantial and occurs when a government is faced with the lack of funds to improve efficiency and facilitate government responsibility the public is injured (Storm, 2014). The activities surrounding the act of tax evasion range from the failure or rather the refusal to file a tax return to lying on one’s tax returns. The crime of tax return closely associated with the illegality of money laundering and use of tax heavens is that of failure to declare the full extent of one’s income. This would cover the declaration of offshore bank accounts and foreign income. This traits can potentially amount to the act of money laundering and conceal identity of beneficiary.

Storm (2014) idealizes that, pointing out the essential activities of tax evasion that have close relation to money laundering practices strengthens the established proof that the link between money laundering and taxation exists.

Having in mind the detail definitions and explanations of the two crimes, money laundering and tax evasion, can be analyzed to pick out the common ground between the two acts. Storm’s evaluation identifies a number of factors that stand as commonalities between the two. To begin with is the standard legality fact that both the acts are unlawful and both involve the violation of laws. Storm notes that the activities are acts of deliberation to mean that individuals engage in the activities intentionally (2014). Furthermore, the both of these practices conceal and disguise the money received in each (p.4). In addition to the analytical argument, Storm (2014) points that, “it was necessarily to analyze the definition of tax evasion in terms of a crime because it has frequently been argued that the proceeds of tax evasions are different to the proceeds of conservative criminality.”

In one perspective the position is that in a tax evasion scenario, the generated income or profit was legal and therefore the non-payment of subsequent tax on those profits could not be equated to those of a criminal activity. On the other hand, although the underlying conduct is legal, the retention of money that should be paid over as tax is the actual criminal conduct (Oliver, 2002, p.57 as quoted by Storm, 2014, p.20). Furthermore, the argument can be interpreted in the direction hat where tax evasion is identified there is no automatic indication of money laundering. Despite this, it has also been argued that whenever money is laundered the perception is that chances of tax evasion stand at 100%.

The critical examination of the existing link leads to the basic question of why criminals launder money. Scholars and researchers a like reason out that, criminals tend to launder money for purposes of concealing the beneficiary identity and to hide wealth, in hiding wealth one aims to avoid tax submission and increase in profits. In the South African income tax act No. 58 of 1962, an individual is required to pay taxes on their earnings regardless of the earnings origin. This translates that even the illegal earning like those of laundering and drug money should be stated in the South African revenue services.

The existing links can further be pointed out by outlining the consequences that exists for both crimes. Storm elaborates and details the consequences as:

“Money laundering undermines financial systems by expanding the segment of a country’s economic activity that is derived from sources …falling outside of a country’s rules and regulations regarding commerce. Secondly, it promotes crime because it enables criminals to use and deploy illegal funds effectively. Lastly, the most important consequence is that money laundering reduces revenue and control by diminishing government tax revenue and weakening government control over the economy” (Storm, 2014, p.21).

These consequences reveal the extent of the link between the two crimes and the similarities in the consequences. The role of illicit financial flows to the existence of money laundering and aid of tax evasion is also a critic of an existing link between the two. According to Renner (2012), the inter-border exchange of money that is illegally acquired transferred or put to use adds up to the flow of illicit funds. Therefore, from this analysis, tax evasion and money laundering fit in the criterion of illicit financial flows. The global growth in the flow of illicit finances depicts a rise in criminal activities including laundering and tax evasion. According to the primary findings of the Global Financial Integrity report on the illicit financial flows (2012), money laundering and tax evasion have been group together under illicit financial flows. Hence putting perspective to the existing relation.

Money launderers and tax evaders have been found to operate with the aid of banking institutions and financial centers upholding the bank secrecy. Detective Des Bray of the commercial and electronic crime branch is quoted as saying:

“What is being increasingly identified is the infiltration of criminal identities into otherwise legitimate business interests. None of these people could get away with it a lot of what they were doing if it wasn’t for lawyers, accountants, financial advisors and the like, knowingly assisting them to launder and hide assets.”

This indicates the link between money laundering, tax evasion, financial centers and tax heavens. The strict bank secrecy rules have facilitated the success of tax evasion and money laundering a like. This makes it difficult for the tax authorities to track one’ capital income (Storm, 2014). According to a research quoting He, it was discovered that, banking institution were specifically preferred for money laundering and found to be a popular channel for its convenient transfer of funds across the international markets (He, 2010). The secrecy existing in the financial centers make them vulnerable to money laundering and tax evasion. An example examined by (O’Toole, 2012), it involved three Zurich-based bankers who allegedly helped more than 100 clients between 2005 and 2010 to hide approximately 1.2 billion from the internal revenue service. Offshore tax evasions have complicated the fight against illicit flow of finances and facilitated the ease with which money is laundered. As Owen explains:

“Offshore tax evasion is not about small islands that do not impose income taxes: it is about all the countries [for example Liechtenstein], that lack transparency and that are not prepared to cooperate to counter tax abuse. These practices make it difficult for other countries [for example USA] to enforce their own tax laws” (Owen, 2007).

“Small islands” as Owen points out can be interpreted to refer to tax heavens. According to Rider (2009), the international press jointly puts tax havens and offshore financial centers, and focuses on their facilitation of money laundering, tax evasion and other financial related crimes. Storm emphasizes regarding that the most common place used to launder cash in an aim to evade tax is at an offshore financial account or a tax haven (as quoted by Storm, 2014). Christensen (2011, p.1) describes a tax haven as, “an autonomous or semi-autonomous jurisdiction offering a combination of lax legislation, low or zero taxation on income and capital of non-residents, secrecy facilities for banking or corporate ownership, and absence of effective information exchange with the authorities of third party countries.” The considerable relation that tax evasion and money laundering is aided by the use of sophisticated offshore structures using secret jurisdictions.

The legal provisions against money laundering have excluded tax evasion. In the recent years, international bodies and national governments have sought to overturn this position considering the entanglement of criminal activities and use of tactical schemes to hide and launder money. Many have acknowledge that money laundering is entangled with all types of crimes including tax evasion. As evidenced by the various criticism examined above shows that, tax havens facilitate the crimes and form operational bases for taking advantage of the loops in the legislations. The link between tax havens and tax evasion lies in the housing or rather what can be describe as an environment in which the practice of laundering and evasion is encourage and enabled. Tax evasion, money laundering and tax havens are related because they all aid some form of criminal activity, they cause injury to the public, and all fall under a common discussion of illicit financial flows