Profit Laundering and Tax Evasion

Profit Laundering and Tax Evasion

The Dirty Little Secret of Financial Globalization

Harrington Sound, Bermuda (Johnny Peacock / Flickr)

The debate about cutting taxes for corporations and the wealthy is a false one. The issue is not whether transnational corporations and the very rich benefit from tax cuts, but that many of them walk away from all taxes. A General Accounting Office report found that between 1996 and 2000, 61 percent of all U.S. companies paid zero federal taxes. They accomplish this primarily through “profit laundering,” a phrase that ought to be on the lips of every social critic.

Massive profit laundering sucks resources out of the United States and other countries, beggars public programs, and lays waste the social contract on which taxation must be based: that everyone pays a fair amount. It hobbles legislators and officials who want to spend money on social programs but can’t dispute right-wing arguments that “there is no money.” There is no money because it’s been filched from public coffers with the help of the world’s big banks, investment companies, and offshore financial centers. The scam is accomplished via offshore shell companies and bank accounts, and it is happening on a global scale.

Figures on the amount of wealth offshore are hard to come by, as none of the international financial institutions has seen fit to lay out the global picture. In 1999, Merrill Lynch’s “World Wealth Report” estimated that one-third of the wealth of the world’s “high net worth individuals” (as banks like to call them), then $11 trillion, might be held offshore. In 2004, Merrill Lynch revised its wealth figure to $28.8 trillion, but it was no longer estimating how much of that was hidden in tax havens. As the percentage of wealth offshore has been growing, the number would likely be $10 or $12 trillion. Such an estimate was made by “The Global Wealth Report” for 2003 by the Boston Consulting Group (BCG). It estimated the total holdings of cash deposits and listed securities of high-net-worth individuals at $38 trillion and then broke that down by North America-$16.2 trillion, of which less than 10 percent was controlled offshore; Europe-$10.3 trillion of which between 20 percent to 30 percent was controlled offshore; Middle East and Asia-Pacific area-$10.2 trillion, with assets controlled offshore ranging from 10 percent (Japan) to 70 percent (ME); and Latin America-$1.3 trillion, of which more than 50 percent is held offshore.

How much of the money that moves around the world is offshore? The International Monetary Fund estimates that assets held in tax havens equal about 50 percent of total cross-border assets. And according to Merrill Lynch and BCG estimates, assets held in tax havens, beyond the reach of effective taxation, would equal one-third of total global gross domestic product, the value of goods and services, which in 2003 was $36.2 trillion.

IF THE U.S. government were able to collect these evaded taxes, they would fully fund every social program currently on the books. During the 1950s, U.S. corporations accounted for 28 percent of federal revenues. Now, corporations represent just 11 percent. If big corporations paid taxes of 35 percent on their U.S. profits, as the law requires, corporate income taxes in 2002 would have been $308 billion instead of an estimated $136 billion.

The reverberations of these losses extend to the states. The Multistate Tax Commission estimates that state governments lose as much as $12.4 billion a year to various forms of tax sheltering.

How It Works

This is how the international tax-evasion system works, both for corporations and for individuals. In both cases, the system is based on the seventy “offshore” centers-tax havens-where secret shell companies and bank accounts are used to carry out transactions that create paper profits and losses, and where the legerdemain is immune from the eyes of tax authorities and law enforcement. There are about three million shell companies. Offshore centers, with 1.2 percent of the world’s population, hold 31 percent of the assets and 26 percent of the stocks of American multinationals.

The offshore venues assess little or no taxes on foreign-owned shell companies. Some of these shells have no function other than to hold the assets of corporations or individuals. The offshore banks that handle the shell company money are not underground operations run by unknown shady characters. The banks’ managers may indeed be shady, but most of them work for subsidiaries of the multinationals-Citibank, Bank of New York, Credit Suisse, Barclays, Société Générale, Deutsche Bank, and others.

More than half of world trade is within corporations, not between them. And half the world’s trade goes through offshore centers, as corporations shift profits to where they can avoid taxes. Companies set up offshore “subsidiaries” that, on their books, perform functions that allow the firms to cut their taxes. The simplest ploy is the “sale” and “rental” back of a company’s logo or other intangible assets. Or money stashed in tax havens is “loaned” back to the U.S. company, which then deducts interest payments on its tax returns.

Even more important is transfer pricing: allocating profits for tax and other purposes among parts of a multinational corporate group. Offshore “trading” offices or companies handle imports and exports, buying a U.S. export from a company at a sharply reduced paper cost and selling it abroad for the real-world market value, so the exporting company makes no profit. That stays with the tax haven trading company. In the reverse, a company buys goods at a real price and “sells” to the U.S. firm at a grossly inflated one, so the U.S. firm has a huge cost to deduct when it uses the item in manufacture or resells it at a loss.

Simon Pak of Penn State University and John Zdanowicz of Florida International University used aggregate customs data to examine the impact of over-invoiced imports and under-invoiced exports on U.S. federal income tax revenues for 2001. The findings were staggering. Would you buy plastic buckets from the Czech Republic for $973 each, tissues from China at $1,870 a pound, a cotton dishtowel from Pakistan for $154? U.S. companies, at least on paper, were getting very little for their exported products. If you were in business, would you sell bus and truck tires to Britain for $11.74 each, color video monitors to Pakistan for $21.90, and prefabricated buildings to Trinidad for $1.20 a unit? After all the deductions, the U.S. company has minimal profits. The offshore centers levy no taxes on “profits” claimed there. Comparing all the stated export and import prices to real-world prices, the professors figured the 2001 U.S. tax loss at $53.1 billion.

Companies using transfer pricing may file tax returns that show they are operating at a loss. What does Wall Street think? No problem: the United States allows companies to keep two sets of books, one for the Internal Revenue Service, the other for the Securities and Exchange Commission. The IRS sees a company deep in the hole, while stock buyers are pleased by profits that soar.

Transfer pricing is legal only if there is a true business purpose to the offshore entity. However, this rule is virtually never enforced, and account books in tax havens are off-limits to foreign tax and law enforcement investigators.

Offshore is also used to hide companies’ overall balance sheets so tax authorities can’t judge if their returns are valid. A Miami private investigator told me, “If I have a Colombian company that imports Mercedes trucks from Germany, the company ordering the trucks will be registered in the British Virgin Islands or Curaçao. The order will be made by the ‘Dewey, Cheathem and Howe Company’; no Colombian firm will handle invoices. Colombian tax authorities won’t know how much business they’re doing.”

The Bermuda Inversion

Since the late 1990s, some companies have been combining transfer pricing with the offshore transfer of their incorporations-especially to Bermuda. As non-U.S. companies, they have many more opportunities to avoid taxes by making deductible interest, management fees, or royalty payments to the new sheltered “foreign” parent. There was an outcry when Stanley Works announced it was moving its headquarters-on paper-from New Britain, Connecticut, to Bermuda and shifting its imaginary management to Barbados. (See Dissent, Spring 2003, “Offshore Banking: The Secret Threat to America,” by Lucy Komisar.) Though its building and staff would stay in Connecticut, where the company manufactured hammers and wrenches, it would no longer pay taxes on profits from “international trade.” It turns out that Stanley was planning to save on more than the taxes on business done outside the United States. With the help of its accountants, Stanley indicated in 2002 that even though it had paid $7 million U.S. tax on foreign income in 2001, the move would save at least $25 million in U.S. taxes, which suggests that Stanley was planning to cut taxes on U.S. profits by turning them into foreign profits. The immediate effect of the planned move would have been to increase the income of Stanley executives, who were already being paid millions. When the attorney general of Connecticut went to court, Stanley pulled back.

But others haven’t. Tyco moved its management from Exeter, N.H., to Bermuda, then set up more than 150 subsidiaries in Barbados, the Cayman Islands, Jersey, and other offshore havens. Many of the shell companies played accounting games to shield Tyco interest, dividends, royalties, and other income from United States taxes. In 2001, Tyco reported that although 65 percent of its revenues came from the United States, only 29 percent of its “income” did-a ploy that immediately erased 71 percent of its $36 billion profits from its U.S. tax statement.

“The whole business [of offshore companies] is a sham,” fumes New York District Attorney Robert Morgenthau. “The headquarters will be in a country where that company is not permitted to do business. They’re saying a company is managed in Barbados when there’s one meeting there a year. In the prospectus, they say legally controlled and managed in Barbados. If they took out the word ‘legally,’ it would be a fraud. But Barbadian law says it’s legal, so it’s legal.”

The AFL-CIO and several unions are supporting shareholder resolutions and legal actions against the Bermuda inversions. The AFL-CIO filed a brief endorsing a shareholders class action suit against Nabors Industries, a Houston-based operator of oil-drilling rigs. The Laborers International Union is also campaigning against Nabors. AFSCME, the public employees union, filed shareholder resolutions asking Tyco and Ingersoll-Rand, a New Jersey industrial manufacturer, to return their corporate registrations to the United States. UNITE HERE, the textile and hotel and restaurant workers union, is targeting Cooper Industries, an electricity company. The AFL-CIO wants global companies to be registered where they operate, which are jurisdictions with real taxes and real corporate governance, says Damon Silvers, AFL-CIO associate general counsel.

Finding Individuals

Whereas public companies may leave a paper trail, it’s harder to track down offshore tax cheating by individuals. Success often depends on serendipity and clues turned up by other investigations. Nearly 3,400 of the people reporting incomes of $200,000 or more in 2001 claimed that they owed no U.S. income taxes, a rise of nearly 45 percent over 2000. But that is only a fraction of individual tax evaders. Most of them simply don’t report the bulk of their incomes; they use offshore shell companies as the owners of real estate, stocks, and companies. At least half the hedge funds, which cater to the mega-rich, are offshore, many in the Cayman Islands.

People open accounts with foreign brokers or set up foreign trusts and have the trustees buy the funds. To access cash, they use credit cards issued by the offshore banks or stock brokerages. They charge payments or withdraw money from U.S. ATMs and never have records on file in the United States. Some offshore credit cards have monthly charge limits as high as $1 million, not your normal “application-in-the-mail” plastic. The IRS says that as many as a million Americans may be paying their bills with credit or debit cards issued by offshore banks. Only a small number report their accounts, as required by law.

A few years ago, John M. Mathewson of San Antonio, Texas, accused by the Justice Department of money-laundering, made a plea bargain and turned over bank records that showed 1,500 tax-evading Americans with unreported accounts in his Guardian Bank and Trust Limited of the Cayman Islands. He admitted he was helping his clients evade taxes and that the other five hundred banks in the Caymans were doing the same, all helped by Cayman laws that strictly limited government and bank disclosure of bank records and personal information associated with depositors. The system, he said, was the basis of the Cayman financial industry. Depositors accessed their money easily through credit cards or anonymous wire transfers through the Guardian’s accounts in the Bank of New York, Credit Suisse, and other cooperative banks.


Beginning in 2002, the IRS has gone to court to get the major credit card companies to turn over accounts held by U.S. citizens in more than thirty offshore venues. But while that net may snare a lot of doctors and small businesspeople, it will miss the really rich, who run their money through offshore shell companies registered in the names of “nominees”-local lawyers and accountants. In a little reported but revealing (and honest) slip of the tongue, George W. Bush said in a campaign speech at the Northern Virginia Community College in Annandale last August, “On the subject of taxes, just remember when you talk about ‘we’re just going to run up the taxes on a certain number of people,’ first of all, real rich people figure out how to dodge taxes, and the small business owners end up paying a lot of the burden of this taxation.”

An inquiry by Senator Carl Levin in 2004 revealed that Riggs Bank in Washington, D.C., had helped ex-dictator Augusto Pinochet hide $8 million from Chile’s tax authorities. Until 1998, Riggs owned a share of Valmet, an Isle of Man operation that set up shell companies and accounts to hide and launder money for companies controlled by the oil mogul Mikhail Khodorkovsky, now in a Russian jail, and for Robert Brennan, the New Jersey penny stock fraudster now in U.S. federal prison.

The impact of all this tax cheating is enormous. It robs public treasuries and constitutes an assault on the country’s welfare and security. Health care, food programs, police and fire protection, educational opportunities, all are slashed and remain permanently out of reach because “there’s not enough money.”

Honest citizens pay extra every year to make up some of the difference. But you don’t hear them blaming corporations or rich tax cheats for the size of their own tax bills. You don’t hear domestic firms, which can’t match the prices of multinational transfer-pricing competitors, complain about the skewed playing field. The scams that corporations use to launder profits are not on the public agenda. And most people don’t understand how it is that rich individuals opt out of the tax system. Furthermore, corporate public relations has largely succeeded in convincing people that corporate tax “avoidance” is legitimate, that it’s okay for multimillion-dollar companies, run by executives who pay themselves seven- and eight-figure salaries, to pay as little in taxes as they can get away with, even down to zero.

The situation is worse in developing countries, which lose tax revenues greater than the $50 billion in annual aid flows, according to a report by Oxfam International. And when governments starved of taxes don’t have the money to finance decent public services, privatization and cuts in social programs are presented as the only solutions.

The Politics

In 1970, Congress, worried that rich Americans were evading taxes and that accounts were often linked to criminal activity, required taxpayers to report foreign bank accounts. But offshore secrecy made it easy for people to ignore the law. IRS inspectors tracking tax cheats were not allowed to see the accounts.

Beginning in the early 1980s, the issue of offshore tax havens was taken up in U.S. congressional hearings. However, except for a few years at the end of the Clinton administration, the American government’s prime interest has been not to do anything to impede the free flow of capital or decrease other countries’ reliance on the dollar. The Treasury Department wanted to “liberalize” financial flows, not regulate them.

In the late 1990s, the Organization for Economic Cooperation and Development worked out a policy for dealing with tax havens. It said it would take “defensive measures” against jurisdictions that had no or only nominal tax rates, that engaged in “ring fencing” (giving tax preferences only to foreigners who don’t do business there), and that lacked transparency and allowed no effective exchange of information.

But then George W. Bush came to power. At the G-7 finance ministers meeting in February 2001, Treasury Secretary Paul O’Neill expressed concerns that the OECD was trying to dictate other countries’ tax rates. In May of that year, he said that the OECD demands were “too broad” and withdrew U.S. support. Some tax havens pulled back from negotiating with the OECD.

At the end of the Clinton administration, the IRS proposed requiring U.S. banks to report the interest they pay to foreign depositors. The goal was not only to curb tax cheating by foreigners in their home countries but also evasion by Americans pretending to be foreigners. After Bush was elected, his brother Jeb, governor of Florida, wrote O’Neill warning that adoption of the Clinton proposal “could trigger a massive withdrawal of [nonresident alien] deposits in U.S. banks.” The American Bankers Association predicted “serious economic harm” to the United States.

The United States already shares such bank information with Canada. Elise Bean, Democratic staff director of the U.S. Senate Permanent Subcommittee on Investigations, said, “There was a scream and a holler especially from banks with Latin American money that if we report it to the home countries, everybody’s going to leave.” Indeed, the tax cheats and drug traffickers and other criminals might leave. So the plan was slashed to include only a small number of mostly European countries. Countries with major tax evasion problems, including Russia, Mexico, other Latin-American and third world nations, were exempted.

After the events of September 11, 2001, anti-money-laundering measures were included in Title 3 of the Patriot Act. But multinational banks and brokerages, which make big commissions on offshore accounts and stock trades, intervened to water down the bill. In a letter to Paul Sarbanes, chair of the Senate Committee on Banking, Housing, and Urban Affairs, Financial Services Roundtable president Steve Bartlett expressed the financial industries’ support for cutting a provision that would have made tax evasion or fraud against a foreign government a money-laundering offense because the United States “should not prevent foreign citizens from seeking a safe haven in America for their assets.” Although Bartlett worried that citizens of countries with repressive governments would not be able to hide their money in the United States, cutting the amendment also meant that banks did not lose tax-evading accounts.

The Patriot Act requires the identification of customers of securities firms, which doesn’t mean much unless that includes the names of beneficial [real] owners of offshore corporations. As Jack Blum, an expert on the offshore system who ran the Senate investigations on BCG and Iran/contra, told me, “Treasury was hammered to death by the securities industry, and that will not be required under customer identification. It should be there.” Now terrorists, drug traffickers, and tax cheats can trade in stocks through U.S. brokerages undetected.

Adding insult to injury, the Bush 2004 tax bill gave a one-year “tax holiday” to corporations that brought back to the United States the money they had been stashing offshore to evade taxes. Instead of penalizing these profits-launderers by banning their offshore scams and demanding full tax payments, the government said that they could pay taxes on claimed offshore income at lower rates than if they had reported it as U.S. profits. Republicans blocked moves to make Bermuda inversions illegal or even to ban such tax evaders from federal contracts. Last year, Congress passed largely ineffective provisions that apply only to companies that inverted after March 4, 2003, a date intended to protect the big-name companies that have already inverted. Hilary Cain, Ways & Means counsel for Representative Lloyd Doggett, said, “The provisions are estimated to raise a pathetic $830 million over ten years, a drop in the bucket when it comes to the amount of revenue that is probably being lost to these inverted companies.”

This shift in the tax burden has occurred without public debate and with the cooperation of both Republicans and Democrats on the Senate Finance Committee and House Ways and Means Committee. The few legislators fighting offshore tax evasion-led by Senators Carl Levin and Byron Dorgan and Representative Lloyd Doggett-are stymied, because they don’t have active support from civil society. Progressives should be organizing such support. In 2003, a network of political action and development groups, most of them European, founded the Tax Justice Network ( to raise the tax evasion issue internationally. In the United States, such groups as Citizens for Tax Justice and Citizen Works are working on tax issues, but they must be joined by others. Globalized greed threatens the well-being of us all.

Since the summer, the federal government has cut back funding for dozens of Superfund sites eligible for cleanup money, ordered reduced aid to millions of college students, slashed money for housing and community development by a third, and announced cuts in food stamps and in health projects aimed at diseases related to poverty. Taxes don’t have to be raised to pay for these programs, they just have to be collected.

A policy program to end the offshore tax evasion system would include the following:

  • Corporations should be taxed according to where they operate: where workers exist and real value is added, not where they carry out paper transactions or where they file corporate registrations.
  • There should be an international agreement to tax multinational corporations on a unitary basis, with subsidiaries’ profits computed as part of the whole.
  • Transfer pricing and intra-company transactions, such as loans and rental of logos, aimed at reducing taxes should be made illegal.
  • There should be one set of books for the SEC and the IRS, not two.
  • Banks and brokerages should be required to obtain the names of real beneficial owners, who are persons, not shell companies or straw figures.
  • Banks and companies that wish to do business in the United States should be required to practice full company and account ownership transparency and cooperate with American law enforcement.
  • U.S. law should include domestic and foreign tax evasion as a predicate crime for money laundering.
  • On a global level, there should be automatic information exchange between countries’ tax agencies.
  • Corporate executives and their lawyers and accountants should be liable for criminal penalties-mandatory jail terms-for profit laundering and tax evasion.
  • Companies that proclaim adherence to corporate social responsibility should commit to rejection of transfer pricing and other tax evasion schemes.
  • A corporation’s payment of fair taxes and its rejection of tax evasion should be a condition for approval by socially responsible investment funds.

Both we and our elected officials must find a way to put these proposals before the U.S. public in a comprehensive and comprehensible way. If we don’t, the money will never be available to enrich society as a whole.

Lucy Komisar, a New York journalist, is writing a book about the offshore bank and corporate secrecy system. She is a member of the steering committee of the Tax Justice Network.

Sources consulted for this article:

Washington, D.C.: General Accounting Office, “Comparison of Reported Tax Liabilities of Foreign- and US-Controlled Corporations 1996-2000,” February 2004.

“Corporate Tax Sheltering and the Impact on State Corporate Income Tax Revenue Collections,” July 15, 2003.

“U.S. Trade with the World: An Estimate of 2001 Lost U.S. Federal Income Tax Revenues Due to Over-Invoiced Imports and Under-Invoiced Exports,” Oct. 31, 2002,

Merrill Lynch’s “World Wealth Report,” 2004.

IMF paper Offshore Financial Centers June 23, 2000.

IMF September 2004 World Economic Outlook

Mark Lopatin, “Tax avoiders rob wealth of nations,” the London Observer, November 17, 2002.

“Calif. Opens Attack on Illegal Tax Shelters/ With Revenue Down, Other States May Use Campaign as a Model,” by Jonathan Weisman, Washington Post, December 4, 2003.

“Tax Havens: releasing the hidden billions for poverty eradication,” June 2000.

“U.S. Trade with the World: an Estimate of 2001 lost U.S. Federal Income Tax Revenues Due to Over-invoiced Imports and Under-invoiced Exports,” by Simon J. Pak and John S. Zdanowicz, Florida International University, Oct 31, 2002.

“Money Laundering and Tax Havens: The Hidden Billions for Development,” Report of a Conference organized by the Friedrich-Ebert-Stiftung, July 8-9, 2002, New York.

“The Taxonomist: The Tax Cheaters’ Lobby, How the banking industry and the right foment tax evasion,” by Robert S. McIntyre, American Prospect, November 18, 2002.

“Uncle Sam Gets Shorted By the Bermuda Bye-Bye,” by Allan Sloan, Washington Post,
July 5, 2002.

“The Tax Games Tyco Played.” by William C. Symonds, with Geri Smith, Businessweek, July 1, 2002.

Speech by New York district attorney Robert Morgenthau at the Brookings Institution, Washington D.C. June 5, 2002.

Damon Silvers, AFL-CIO associate general counsel, interview with the author, December 12, 2002.

“Federal Court Approves Service of IRS Summons on Mastercard,” press release from U.S. Department of Justice, August 22, 2002.

“Private Banking and Money Laundering: A Case Study of Opportunities and Vulnerabilities,” Minority Staff of the U.S. Senate Permanent Subcommittee on Investigations, February 5, 2001.

“Shell Games: Brash Russian Banker And His Deals Are Key To Laundering Probe-Mr. Kagalovsky’s Menatep Set Up Offshore Firms Alleged to Skim Millions-Cashing In on the Isle,” by Andrew Higgins, Alan S. Cullison, Michael Allen, and Paul Beckett, Wall Street Journal, August 26, 1999.

Elise Bean, speech at “Dirty Money and National Security,” conference sponsored by the Brookings Institution, Washington D.C., September 10, 2003.

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