The Double Blind Crime

Vasily Hudiakov (A skirmish with smugglers from Finland at the Russian border, 1853)

The IMF & The Pakistan Tax Net

Ever since the Pakistan Budget was announced in June this year, Finance Minister Ishaq Dar has been complaining about how the international community is criticising his generosity in financing military counter-terrorism operations (that haven't actually succeeded in improving Pakistan's economy & are rumored to be the reason behind the nation's embarrassing removal from the United Nations Human Rights Council). He is convinced that his detractors could be silenced if the citizenry could just cut down on their daily expenses some more & contribute more taxes to his cause...or something like that.

To complicate matters further, he recently had a series of meetings with the International Monetary Fund (IMF) in Dubai & returned convinced that they agree with his interpretation of the situation. He claimed that they had "demanded" an increase in taxes on the people of Pakistan in return for a loan they would extend for development projects. Most citizens were left wondering that, if they were being taxed to finance development, why was Mr. Dar troubling the IMF for a loan? Wouldn't the tax revenue itself suffice? Anyway, maybe this is just the way an accountant goes about matters. Who knows?

IMF Country Director Harold Finger held a press conference in Islamabad, too. But it wasn't particularly informative. Either he was only addressing Mr. Dar in his statements, or the media has provided an atrociously truncated version of his message. I, for one, am quite certain that it is the latter explanation. The representative of such a venerable institution would not yammer in public like a confused pigeon! Mr. Dar claimed that Mr. Finger instructed him to widen the tax net, which he refused to do. Then Mr. Dar went on to add that he thought a better approach would be to reshuffle the officials responsible for various aspects of Pakistan's fiscal policy. Which posed another question: If there is no legal evidence of dereliction of duty on the part of any official, how does a game of Musical Chairs constitute a solution to the challenge?

Anyway, this question can only be answered by authorities like the Pakistan Finance Ministry or the IMF. The really interesting question is how can one tell if a criminal enterprise is covering its illicit activities by pretending to be a tax-evading (but otherwise legitimate) enterprise?

"Tax Avoidance" Versus "Tax Evasion"

For a start, it is important to have a very clear understanding of the difference between "tax avoidance" & "tax evasion". According to Wikipedia, the definitions of the two concepts are as follows:

Tax avoidance is the legal usage of the tax regime in a single territory to one's own advantage to reduce the amount of tax that is payable by means that are within the law. Tax sheltering is very similar, although unlike tax avoidance, tax sheltering is not necessarily legal. Tax havens are jurisdictions which facilitate reduced taxes.

Tax mitigation, "tax aggressive", "aggressive tax avoidance" or "tax neutral" schemes generally refer to multi-territory schemes that fall into the grey area between commonplace & well-accepted tax avoidance (such as purchasing municipal bonds in the United States) & evasion, but are widely viewed as unethical, especially if they are involved in profit-shifting from high-tax to low-tax territories & territories recognised as tax havens. Since 1995, trillions of dollars have been transferred from OECD & developing countries into tax havens using these schemes.

Laws known as General Anti-Avoidance Rule (GAAR) statutes, which prohibit "tax aggressive" avoidance, have been passed in several developed countries including Canada, Australia, New Zealand, South Africa, Norway, Hong Kong & the United Kingdom. In addition, judicial doctrines have accomplished a similar purpose, notably in the United States through the "business purpose" & "economic substance" doctrines established in Gregory v Helvering & in the UK through the Ramsay case. Though the specifics may vary according to jurisdiction, these rules invalidate tax avoidance which is technically legal but not for a business purpose or in violation of the spirit of the tax code. Related terms for tax avoidance include tax planning & tax sheltering.

The term avoidance has also been used in the tax regulations of some jurisdictions to distinguish tax avoidance foreseen by the legislators from tax avoidance which exploits loopholes in the law such as like-kind exchanges. The United States Supreme Court has stated that "The legal right of an individual to decrease the amount of what would otherwise be his taxes or altogether avoid them, by means which the law permits, cannot be doubted."

Tax evasion is the illegal evasion of taxes by individuals, corporations, & trusts. Tax evasion often entails taxpayers deliberately misrepresenting the true state of their affairs to the tax authorities to reduce their tax liability & includes dishonest tax reporting, such as declaring less income, profits or gains than the amounts actually earned, or overstating deductions.

Tax evasion is an activity commonly associated with the informal economy. One measure of the extent of tax evasion (the "tax gap") is the amount of unreported income, which is the difference between the amount of income that should be reported to the tax authorities & the actual amount reported.

Catching A Fox

Former British drug lord Michael Forwell's criminal career, eventual capture, sentencing & life after, is a very interesting & educational lesson in how a "professional" criminal enterprise can be carried out. If the media is to be believed, the mistake that led to his downfall was his attempt to ship a 72-ton cargo of narcotics aboard his ship, the Encounter Bay, in a single trip, which proved the straw that broke the camel's back.

However, that error doesn't nullify the value of his business model. He ran a series of perfectly legitimate businesses all over the world, some examples of which were his bar in the red-light district of Bangkok, his seafood import-export business in Singapore & his shipping company in the United Kingdom; he even briefly laundered money through a Formula One team he launched! The thing about all these businesses was that they actually turned a profit - the only anomaly was that, unlike the conventional tax fraudster, he over-stated the value of the profits produced by his legitimate investments.

While ordinary law-abiding citizens may or may not have paid attention to the adventures of Mr. Forwell, the international criminal community definitely must have. Which means they have taken a lesson from his decline; as a result, they will do their best (or worst) not to commit the mistake of aiming too high. Instead of a single big score, they will run several small enterprises none of which would individually qualify as headline material (or put a significant dent in the major shareholders' investment) if exposed.

The Post-Forwell Fox Hunt

Here is a (more-or-less) imaginary scenario to illustrate the point:

A criminal cartel - let us call it "A" - has come upon a large & valuable collection of immovable assets through illegal means. "A" wishes to diversify; taking a lesson from Mr. Forwell, it opens a series of small-scale meth labs that double as brothels all over several cities. It hires petty criminals, not as individuals but as families, to run these businesses; the advantage of this approach is that the same parties can cook meth & (since it is a multi-generational group) can service any & all needs of the brothel clientèle at the same time.

The meth production can be covered with an excuse such as herbal treatments & the customers (whether for drugs or sex) can be passed off as "visiting relatives & friends". As to the question of legal cover, the enterprise is made to look like a tax-evading herbal clinic or printing press. That way, if exposure does take place, the blame for negligence can be placed on the tax authorities instead of the law enforcement agencies.

But no matter how many "SMEs" any criminal syndicate runs, there will always be just one wellspring from which the major portion of the investment will come - or which will provide a golden parachute if the other investments crash & burn. This asset will also be illegal, but it will have been acquired from a party who, the criminal syndicate are certain, will never have the motive or means to demand it back in an effective or noticeable manner. And that particular asset will be the one that the syndicate guards most fiercely because it will be the foundation upon which the entire organization has been built & without which the whole edifice will come crashing down. Further linking this example with Michael Forwell's story, it is the syndicate's "Encounter Bay".

Therefore, in the post-Forwell underworld, the best way to track down organized crime cartels, is to find that one asset that the cartel is most protective of & make every aspect of its financial record public knowledge. A group is best understood by understanding the asset it values most. After all, 99% of the time, you can find a person's identification information in his wallet.