Financial Crime Compliance
Subject Matter Enthusiast
Sachin Shah is a CAMS accredited financial crime compliance professional and has 19 years of experience in the financial services industry having exposure in India, Middle East and APAC region. He is a subject matter enthusiast and has interest in the field of financial crime compliance and is passionate about writing on current trends and issues in the worlds of financial crime compliance.
Globally, over the past two decades, there has been increasing sensitivity around tax evasion and facilitation thereof by financial institutions (FIs). This eventually led to the categorization of tax evasion as a money laundering predicate offense by the Financial Action Task Force (FATF) in 2012. Tax evasion is an illegal action in which a person or entity deliberately avoids paying a true tax liability by concealment or misrepresentation of beneficial ownership of assets, income and gains, or otherwise fraudulent conduct, designed to divert money from the public revenue.
Before we dig deeper into the topic of tax evasion it is imperative to understand that other forms of tax evasion such as tax planning, avoidance and non-compliance falling short of criminal liability are different domains and can’t be treated as equivalent of tax evasion. Tax planning involves organizing one’s affairs in the most tax efficient manner within the intent of the law and, typically, with an honest belief that it is a legal method of reducing a tax liability. Tax avoidance refers to conduct that, while still within the letter of the law, generally involves the deliberate exploitation of weaknesses in the tax system.
Those caught evading taxes are generally subject to criminal charges and substantial penalties.
Now, more than ever, the need for increased transparency, inter-agency co-operation, and international collaboration is undeniable and duly recognized. The fight against tax crime is being actively pursued by governments around the world. Jurisdictions have comprehensive laws that criminalize tax offences, and the ability to apply strong penalties, including lengthy prison sentences, substantial fines, asset forfeiture and a range of alternative sanctions. Jurisdictions generally have a wide range of investigative and enforcement powers as well as access to relevant data and intelligence. In addition jurisdictions are increasingly taking a strategic approach to addressing tax offences, which includes targeting key risks and leveraging tools for co-operation with other law enforcement agencies, both domestically and internationally. At the same time, tax crime investigations are also been increasingly undertaken with greater efficiency and fewer resources.
Many financial integrity NGOs estimate that roughly USD 1 trillion flows illegally out of developing countries annually due to crime, corruption and tax evasion.
In recent years, tax evasion, and the facilitation thereof, have gained greater global prominence from tax authorities, regulators and the public. This increase in prominence has led to FIs seeking to enhance their focus on their customers’ tax affairs, as well as conduct by persons acting on the FIs’ behalf that may constitute the facilitation of tax evasion. The Government appears to be giving serious thought to the idea that tax evasion must be declared a criminal offence with all the attendant consequences.
For example, in the US, tax evasion is considered a criminal offence which can lead to penalty or imprisonment, or both.
Section 7201 of the IRS Code prescribes a fine of not more than USD 1,00,000 or imprisonment for not more than 5 years or both, for tax evasion. The annual tax evasion in the US is estimated at USD 100 billion. Hence for a country like the US, such global guidance will assist them in leveraging their existing framework and making it more robust and effective. On the other hand for countries like India where tax administration is notoriously known to be slack and there is a lot of political interference, such global guidance will help in devising a country level strategy to tackle tax evasion as predicate offense.
Similarly many more jurisdictions have introduced legal and regulatory changes to put this requirement into effect and have mandated that FIs incorporate tax evasion controls in their anti-money laundering (AML) framework. International financial centers have been extremely sensitive to being perceived as tax havens. Regulators in such centers have mandated their FIs to ensure robust tax evasion related controls so that the jurisdiction is not exposed to reputational risk. Concurrently, due to severe enforcement actions, FIs are expected to drastically strengthen their AML controls framework. Lack of appropriate tax evasion controls would obviously tantamount to inadequate AML controls.
Challenges Faced by FIs
While tax evasion facilitation risk is distinct from the underlying predicate offence i.e.not governed by money laundering regulations), AML controls and procedures play an important role in the identification of tax evasion facilitation and it may, therefore, be fitting to consider both in tandem. Furthermore, in order to ensure compliance with all applicable laws and regulations, FIs may need to consider developing an overarching approach that is organizationally broader than the AML framework. This approach may entail recognizing, leveraging and enhancing existing controls across the organization (predominantly AML, tax and conduct-related controls) and appropriately deploying specialist resources (e.g. in-house tax experts) to support the implementation and on-going maintenance of such a Programme. However, there are several challenges faced by FIs across the globe to design an effective compliance framework to detect and deter the tax evasion. Few of these challenges are explained as below
Risk assessment – One of the biggest challenges is the inadequate risk assessment. Even though adequate and effective risk assessment is an industry-wide issue, however FI who already have embedded the enterprise risk assessment in their compliance framework, they still are not able to demonstrate that they have assessed and understood the potential risk and exposure they face in relation to money laundering in the form of tax evasion, and the facilitation thereof. Either the risk assessment undertaken don’t cover tax evasion related risks with sufficient granularity or the scale and detail of methodologies used to assess the risk are not proportionate to the level of risk and nature of the business.
Policy and Procedures – Existing financial crime compliance, conduct and tax (including tax transparency regimes) procedures and controls are not in order to address the risks of customer tax evasion, and the facilitation thereof. Though the senior management is aware of the impending compliance and reputational risks, there is still a lack of executional commitment to detect and prevent tax evasion. The top to bottom approach is restricted only to paper and there are several operational challenges in the execution of policy and procedures.
There are still instances where AML/CTF policy and procedures don’t state explicitly that tax evasion is a predicate offence to money laundering. In addition, the procedures also lack guidance for supporting staff so as to be enable them to identify FI-specified indicators of tax evasion.
Customer Due Diligence (CDD) and Red flags FIs should be sensitive to risk indicators and/or red flags that may suggest an increased risk of tax evasion. Following a risk -based approach to the extent practicable or considered appropriate, they should have a mechanism in place to identify and document the relevant red flags / risk indicators. However, a lot of FIs are struggling to synchronize their CDD related controls to carve out, define and document the red flags / risk indicators related to tax evasion.
For example, the policies and procedures related to obtaining information on Source of Wealth (SoW) and Source of Funds (SoF) at the time of customer on-boarding are not granular on the SoW/SoF corroboration. There are several instances where the required SoW/SoF corroboration is not assessed appropriately and hence the required red-flags cannot be triggered. Similarly assessment of the commercial rationale for complex or opaque structures is another challenge where the policy is silent on the action required for a specific instance of red flags / indicators observed.
Monitoring and Screening – One of the key pillars of any compliance framework is the monitoring and screening process and Fis’ existing Financial Crime Compliance (FCC) monitoring framework will play a part in mitigating customer tax evasion risks too. However the biggest challenge is either FIs don’t have adequate monitoring and screening process in-terms of automated solution or if they have, the required tax evasion related rules and thresholds are not defined in the monitoring and screening systems. Another challenge mentioned in the recent guidance by The Wolfsberg Group is that that there is an opportunity for national governments to aid in the efforts to prevent tax evasion by publishing or permitting access to information on prosecutions and settlements for tax evasion by both individuals and companies. This would allow FIs to identify potentially undetected accounts which would be of direct interest to the relevant tax authorities.
Training and Development – The other challenge is the inclusion of specific material relating to tax evasion risks, as well as seeking out the appropriate escalation channels (e.g. whistleblowing procedures) in the mandatory trainings imparted to all the staff on fighting financial crime. Also there are no targeted tailored training on risk indicators and/or red flags and common tax evasion typologies for the staff working in areas identified by the FI as high risk.
Specialist Resources in Compliance Team – Although tax evasion and money laundering are operationally distinct processes, they share similar sophisticated obfuscation techniques and the success of each crime depends on the ability to hide the financial trail of the income. Hence it is very imperative for the FIs to ensure that they have specialist in-house resources in their transaction monitoring team who not only are AML experts but also understand the tax evasion related red-flags and co-relate them with the money laundering offence. Unfortunately this is not the general practice followed by the FIs and in the industry at large and hence we have lack of such specialist resources to support the implementation and on-going maintenance of such tax evasion cum AML programme.
Tackling Tax Evasion Crime – A Three Layered Approach
Since the last few decades, the fight against tax crime is being actively pursued by governments around the world. Jurisdictions have comprehensive laws that criminalize tax offences, and the ability to apply strong penalties, including lengthy prison sentences, substantial fines, asset forfeiture and a range of alternative sanctions. There is an increasingly coordinated and collaborative approach followed by governments and regulators across the globe. Jurisdictions now generally have a wide range of investigative and enforcement powers as well as access to relevant data and intelligence.
Although jurisdictions are taking a strategic approach to addressing tax offences, which includes targeting key risks and leveraging the tools for co-operation with other law enforcement agencies, both domestically and internationally. However there is lot to be done and a three pronged approach will be the right strategy to deter, detect and report the tax evasion related crime. This three pronged approach includes a coordinated approach between Governments (including government bodies/FIUs), industry bodies and associations and the FIs. If all these three stakeholders follow a collaborative approach it will surely have a positive impact on the efforts to curb the menace of tax evasion crime. This approach is aptly covered by OECD in their publication of the ten global principles to fight tax crime.
If all these three stakeholders (Governments, industry bodies and associations and the FIs) follow a collaborative approach it will surely have a positive impact on the efforts to curb the menace of tax evasion crime.
Considering the same guidance in-light of the challenges mentioned in above paragraphs, following actionable is expected by each of the stakeholders:
- Ensure tax offence is criminalized
- Provide investigative and enforcement powers to LEAs
- Promoting inter-governmental coordination and executing IGAs with other jurisdictions
- Creating an effective framework for domestic inter-agency co-operation
- Promoting assisting the regulator for international co-operation mechanism
- Support and promote domestic and international inter agency cooperation
- Assist the government and the regulator in devising an effective strategy for addressing tax crimes
- Framing industry approach note on the collaborative approach for the FIs to fight the tax crimes
- Embedding tax evasion related risk in the enterprise wide risk assessment
- Having robust policy and procedures giving clear direction to the organization and the stakeholders on their roles and responsibilities in tacking tax evasion related instances/transactions.
- Effective CDD framework to detect the tax evasion related red flags at the initial stage of on-boarding itself so as to avoid the bad guys to enter the financial system and use it for tax evasion.
- Tone from the top for effective monitoring and screening systems
- Pro-active approach and the required budgetary support to recruit specialist resources within the respective departments.
- Having a robust and targeted training and development program targeted to tax crime for the staff
- Creating a robust governance and assurance framework.
We need to take a serious view of tax evasion and declare it as a criminal offence. This will require rewriting the law and strengthening the tax administration. This is an opportune time since the public mood is now seriously against all forms of tax evasion. This can be achieved by having a pro-active and supportive government and regulatory vision and strategy which will holistically cover the financial services industry and which will finally benefit each of the FI to tackle the challenges in fighting the tax evasion crime.