Paradise Papers: Is Offshore Investment in Tax Havens Illegal?

New leak includes details of offshore investments from around the world, but they may not all be illegal.

On 5 November 2017, the International Consortium of Investigative Journalists (ICIJ) began revealing the results of an investigation into the widespread use of offshore investments in tax havens by individuals and corporations. The investigation is founded on information leaked from two offshore law firms as well as information available from company registries.

The ICIJ has partnered with various news organisations around the world, including The Indian Express in India, to release the documents, termed ‘Paradise Papers,’ and publish the results of the investigations, especially in relation to what they reveal about political figures.

At least 714 Indian nationals are named in these papers, including Minister for Civil Aviation Jayant Sinha, BJP MP RK Sinha, former UPA ministers P Chidambaram and Sachin Pilot, and lobbyist Niira Radia.

But why is this such a big deal? Is it illegal to invest in offshore entities? Or is it perfectly okay to have investments in ‘tax havens’?

Why Do People Invest in Offshore Entities?

Investing in offshore entities has come to be viewed as an intrinsically ‘wrong’ activity in public perception over the years. This is understandable given the average person’s exposure to the world of offshore entities is through news stories or movies/serials, in which they have been used to spin webs of secrecy over a company’s activities. This, in turn, is used to facilitate money laundering, tax evasion, and fraud.

However, it is tax planning, not tax evasion, that is the primary reason for investments in offshore entities. It is perfectly legal to plan your finances to ensure that you pay the least amount of tax required, as long as you don’t break the law while doing so. Tax planning looks at all the legitimate means one might have to save on paying tax, and uses those to reduce your tax bill.

The majority of us look at purely domestic ways of saving tax – by claiming relevant deductions – but there are also other options to do so, including investing in offshore entities.

Several countries around the world have very low or nil income tax and corporate tax rates. If there is a double tax agreement between the country where you’re from and a country where you’re investing, you can avail the lower rate of tax on income you show arising in that country. This is where the offshore investments come into play.

Of course, such a system can be manipulated by those with a lot of money and some very creative lawyers and accountants. As a result, countries (including India) tend to have strict regulations on offshore investment, to try and keep this in check, and it is only by following these regulations that a person can invest in an offshore entity.

Also Read: Indian Media Houses Find a Spot in the Paradise Papers Leak

Can Indians Invest in Offshore Entities?

Indian individuals and corporate entities can invest outside India, provided they comply with relevant legal norms. Investments made outside India are governed by the Foreign Exchange Management Act 1999 (FEMA), as well as more specific regulations under this Act formulated by the Reserve Bank of India (RBI).

The most important of these regulations are the TIFS Regulations – the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations 2004 . The TIFS Regulations prescribe the scheme for Overseas Direct Investment (ODI), ie, how Indian persons resident in India can invest in foreign countries.

Under the TIFS Regulations, there are two routes of investment – the Automatic Route and the Approval Route. If your investment is eligible for the Automatic Route, you just need to make your investment through an authorised bank, and don’t need to go to the RBI. If your investment is not eligible for the Automatic Route, then you need to go for the Approval Route, which means you need to get prior permission from the RBI.

Getting special permissions from the RBI is a long and complex process, and is not something most people would want to do, especially since getting approval is not easy.

To qualify for the Automatic Route, the total financial commitment to the foreign investment must not exceed 400 percent of the Indian party’s net worth (as per their last audited accounts), and the investment must not be in a prohibited industry, such as buying and selling real estate, or financial services. If the value of the investment is less than US$ 1 billion, in such circumstances, an Indian party can invest in an offshore entity relatively easily. Yes, it will need to disclose the investment, and yes, it will need to make some additional regulatory filings, but otherwise, such investments are completely legitimate.

An additional point to note is that most offshore investments are not made in one’s individual capacity, but through a corporate vehicle, normally a limited company. This is because doing so limits liability, and also because there are additional restrictions on how much money an individual can send abroad.

Under the Liberalised Remittance Scheme (LRS), an individual, even if below the age of 18, can send up to US$ 250,000 outside India in a single year, without requiring prior approval.

To send more, RBI approval would be required, which, as mentioned earlier, is not easy to obtain. While family members can pool their LRS amount together, this may still often be short of the level of investment generally at play, meaning investment through a corporate vehicle makes more sense.

Also Read: Multi-Agency Group on Panama Papers Leak to Probe Paradise Papers

Can Indians Make Investments in 'Tax Havens'?

There are no specific restrictions on investments by Indians into the countries (or jurisdictions) generally considered ‘tax havens’, such as Bermuda, Jersey, Guernsey, the Cayman Islands, and Mauritius, to name a few.

As long as FEMA and the other RBI regulations discussed above are complied with, and appropriate tax arrangements are made, there is nothing wrong with investing in these countries.

This is not to say that there are no countries into which investments by Indians are restricted. Any investment into Pakistan requires prior approval of the RBI, regardless of the amount of investment. Investment into Nepal can only take place in Indian rupees and no other currency; and investment into Bhutan is only allowed in Indian rupees and freely convertible currencies.

In What Circumstances Would Offshore Investments Violate the Law?

Failure to comply with FEMA and its related regulations does not give rise to criminal liability. However, there are heavy penalties and fines for contravention of them, and the contravener’s money can be confiscated.

The listing of Amitabh Bachchan in the Paradise Papers offers an interesting example of how this aspect of the law could be violated. Bachchan is listed as a shareholder in 2002 of a company incorporated in Bermuda – before the introduction of the LRS. At that time, individuals could not make investments like purchasing shares abroad without getting RBI approval, and failure to do so would attract the relevant penalty. As a result, even if the amount invested by him was a very small figure, he would have still needed to apply to the RBI for permission. As he has not responded to The Indian Express’ questions, we are not sure whether or not this was the case.

Another example of falling foul of FEMA and its related regulations is if the entity in which the investment is made diversifies its activities to start doing something for which ODI is prohibited – any information about diversification is required to be intimated to the RBI, even if this weren’t the case.

There are three other ways in which offshore investments could fall foul of the law.

1. First, if the tax requirements under the Income Tax Act 1961 relating to these were not fulfilled: This could happen in several ways. India does not have comprehensive double tax arrangements with all offshore jurisdictions. This could lead to tax liabilities in India (provided there was a way to make the income in that offshore jurisdiction taxable in India). In addition, it is essential to disclose any foreign financial assets, even if they are not taxable in India, in a schedule in your tax returns. Another potential tax issue could arise if a complex offshore investment structure was used to obscure the actual value of sales of shares – as tax is payable on certain such sales, fudging the sale price could affect the tax payable. Any of the discrepancies mentioned above could lead to cases by the Enforcement Directorate (ED).
2. Secondly, If the offshore investments were involved in any money laundering activities: The Prevention of Money Laundering Act 2002 covers certain cross-border transactions, for instance, if an offshore company is used to launder money from, say, sale of illegal drugs, and part of the money laundered is transferred back to India. Or, if money from sale of illegal drugs were to be transferred to a foreign subsidiary. In such cases, the CBI could come knocking on your door.
3. Thirdly, if some other regulatory disclosure requirements are not fulfilled in relation to the offshore investments: Examples of mistakes in this regard include not providing details of an offshore subsidiary in accounts filed with the Registrar of Companies, or failing to disclose shareholdings in an offshore investment in an affidavit when standing for elections as an MP. Depending on the relevant regulation, these could be civil or criminal offences – concealing information in an election affidavit, for instance, is a criminal offence under Section 125A of The Representation of the People Act 1951.

Also Read: As Paradise Leak Rages, What Have Agencies Done on Panama so Far?

So Have the Indian Persons Listed in the Paradise Papers Done Anything Illegal?

The fact of the matter is that at this point in time, we do not know whether or not the Indian individuals or companies listed in the Paradise Papers have done anything wrong by law. The Indian Express has done some digging into the Indian names on the list, but their findings don’t seem to indicate any illegalities as such.

Having said that, this information could end up providing the impetus to investigate some of these persons, during the course of which wrongdoings may be found. As with the Panama Papers, we can probably expect the ED to send notices to the persons named in the Paradise Papers, asking them to clarify certain issues relating to their offshore investments, and depending on their responses, it may decide to investigate further.

Also Read: The Players in Paradise Papers: Who Are the People Named and Why?

It is worth mentioning at this point that even though offshore investments are not illegal as the law stands (or as it stood when the investments referred to in the Paradise Papers were made), this does not mean that there doesn’t need to be a conversation around whether such investment is right or wrong.

Revelations like the Paradise Papers indicate just how widespread the usage of offshoring is, and the extent to which money is moved out of jurisdictions where it could be taxed and used for public benefit, which can seem unfair. The extent of offshoring also raises concerns about whether compliance requirements have been met when it comes to these investments, and given our experience with the financial services industry, it’s perfectly valid to be concerned that everything has not been above board.

Again, moral and ethical qualms do not equate to unlawful conduct. But that may not be the case for long.

Concerns over offshoring have been at the centre of international tax policy discussions for several years now, most notably as part of the OECD’s Base Erosion and Profit Shifting (BEPS) programme, which is trying to make it tougher to shift profits between different jurisdictions to reduce tax liabilities. Another measure that has been gaining traction globally is the imposition of General Anti-Avoidance Rules (GAAR), under which any measures taken purely with a view to avoid tax in a particular jurisdiction may be invalidated.

India has been heavily involved in BEPS, and introduced GAAR from 1 April 2017. This should mean that at least some of the offshoring measures described in the Paradise Papers, while previously legal, will no longer be so. India also recently amended its rules on determining tax residency – under the new Place of Effective Management rules, even offshore companies may be found to be tax resident in India, and have to pay taxes they previously didn’t have to.

At the end of the day, the Paradise Papers may not disclose any actual illegality by anyone. But if we are careful to not read more into them than necessary, and use the information we gain from them to make necessary reforms, they will have provided a valuable service.