«Delaware» Crackdown: All Bark and No Bite?

The U.S. has used judicial might to successfully pursue offshore tax cheats all over the world. A little-noticed new rule introduced by Barack Obama’s administration gets tough on U.S. states such as Delaware and Nevada, which are notorious for murky shelters often used for illicit purposes. But there is a catch.

U.S. officials have spent years trying to catch what the Internal Revenue Service (IRS) estimates to be $458 billion in tax income that is lost every year from people hiding their money in offshore accounts.

Switzerland, formerly home to iron-clad banking secrecy laws which protect clients, has long been a willing enabler to tax cheats, providing offshore accounts and until recently refusing to cooperate with foreign partners on rooting out untaxed funds.

U.S. Not Innocent

That all changed after massive U.S.-led international pressure on Switzerland which in sum led the country to effectively abandon banking secrecy and to sign up to agreements designed to share data on clients by 2019.

Switzerland has been a prominent target of American officials, but transparency proponents have long pointed out that the U.S. itself is hardly innocent of the crimes that it accuses others of: the U.S. wealthy have also long made use of opaque entities set up in states such as Delaware or Nevada to shield their assets from scrutiny.

Hiding in Plain Sight

A veritable competition among states has fed this frenzy to cater to the 1 percent – hiding in plaint sight at home, instead of offshore such as Switzerland or the Caymans.

Much like the Swiss system of cantonal autonomy in tax matters, U.S. tax code leans heavily on states’ right to decide in tax matters with little interference from federal authorities.

That was all meant to change in May, when U.S. Treasury officials rolled out a rule which will require banks to identify the owners behind holdings by name.

Obama and Lew Team Up

The so-called customer due diligence or CDD final rule, in the works for 14 years and finally issued one month after the Panama Papers were leaked in April, forms the fifth pillar of a series of U.S. measures to crack down on tax cheating and fraud.

“Building on years of important work with stakeholders, the actions we are finalizing today mark a significant step forward to increase transparency and to prevent abusive conduct within the financial system,” Jack Lew, Treasury Secretary under Barack Obama, said in May.

Terrorism Financing, Drug War

For the U.S., anonymity and offshore centers are no longer purely an issue of lost tax dollars. The specter of terrorism financing and a raging opioid epidemic in many U.S. cities have added another, more pressing dimension to the debate over money havens.

But back to the CDD rules, which means the wealthy can no longer hide in anonymity behind a smokescreen. Or does it?

Delaware Smokescreens

The disconnect between Lew’s vow to crack down on offshore wrong-doing and the reality of CDD final rule is huge: beneficial owners will indeed be required to be disclosed, but the definition of owner is flexible enough to allow a lawyer, advisor or another nominee to be named as the owner.

This means those wishing to stay anonymous in Delaware, Nevada, South Dakota or other states offering shelters can do so – entirely legally. In short, the U.S. rules fail before they start, and underpin firms such as Mossack Fonseca, who cater to these companies by lending their names to corporate registries.

UBS Pushing for Tougher Rules

Efforts to build a central register for beneficial owners are one example: a bill currently in Congress seeks to get rid of anonymous shell companies, which is meant to fight money-laundering and terrorist financing.

A lobby or 24 top commercial banks in the U.S. – including Switzerland’s UBS –  back the bill, and have urged Congress to go further. In a letter sent to congressional leaders last week, the banks urge lawmakers to effectively toughen the bill by making data collected on beneficial owners accessible to other financial institutions.

In the aftermath of CDD final rule, Obama’s administration has effectively thrown the ball back to Congress. Like many political efforts in the U.S., a push to crack down on money havens inside the U.S. is hampered by federal efforts vs those of states as well as the division of responsibilities among countless agencies who don’t always communicate with each other.

Fatca, DTA Efforts Founder

Lew also urged Congress to commit to reciprocating, or responding in kind, with U.S. Fatca requirements, which came into effect two years ago. The Foreign Account Tax Compliance Act (Fatca) requires foreign banks and other financial institutions to divulge information to U.S. officials about Americans’ accounts worth more than $50,000.

He also tried to nudge along a dormant approval process for a series of bilateral tax treaties currently pending in the Senate, including one with Switzerland, which has been blocked by Kentucky Senator Rand Paul for years now.

Perhaps predictably, neither of the efforts have made any headway since the CDD final rule was issued.