Cyprus Exposes Perils Of Overseas Tax Havens
Russian deposits amount to $19 billion, of which more than half may be lost.
Published: April 17, 2013 (Issue # 1755)
Since 2007, confidence in the international banking system has been shaken by a succession of high-profile financial crises, all of which have taken their toll on the world’s economies. The recent collapse of the banking sector in Cyprus is of particular relevance to Russia, which continues to grapple with the challenges of developing an efficient and reliable banking sector while dissuading its rich from stashing their assets abroad.
The Cypriot crisis has made headline news in Russia. According to the International Monetary Fund the island has received a third of all outward investment from Russia in recent years. Account holders are reported to include Rosneft and the banks Sberbank and VTB. Russian deposits amount to $19 billion, of which more than half may be lost.
It is well-documented that many of Russia’s wealthier citizens prefer to keep their assets overseas. Since 2008, more than $350 billion is reported to have fled the country, including over $56 billion last year alone. Two thirds of this sum is thought to have been illegally-earned. According to Global Financial Integrity (a Washington-based research and advocacy organization), illicit offshore flows of money are so great that they raise “serious questions about the economic and political stability of the nation.” The head of RCB, Sergei Ignatyev, blamed “one well-organized group” for half of the outflow.
In his state-of-the-nation address in December 2012, Vladimir Putin called for a crackdown on the use of offshore tax havens, and in February this year he introduced a draft law to bar senior officials from holding foreign bank accounts.
Last week the International Consortium of Investigative Journalists (ICIJ), a network of journalists from around the world, started releasing the results of a 15-month investigation into tax havens and offshore banking.
Among the prominent Russian figures it names is Olga Shuvalova, wife of the deputy prime minister, listed as a shareholder in Severin Enterprises Inc., registered in the British Virgin Islands. Valery Golubev, deputy chair of the management committee of Gazprom is another, together with Boris Paikin, general director of Gazprom Sotsinvest, both shareholders in Sander International, also registered in the British Virgin Islands. Paikin’s company has been involved in the construction of St Petersburg’s new football stadium, whose cost is projected at $1.1 billion, as well as the Olympic ski resort in Sochi. Further revelations are expected.
Russia is not alone in taking steps to tackle the problem of tax havens. It appears that governments around the world are beginning to intensify their scrutiny of the use of tax havens and offshore banking to shelter wealth.
In 2009, the U.S. Internal Revenue Service (IRS) won a three-year battle with United Bank of Switzerland (UBS), forcing the disclosure to American tax investigators of 4,450 accounts, representing $18 billion.
And last Friday, Switzerland conceded a tax evasion treaty to Germany, which is keen to investigate tax evasion by German citizens hiding their wealth in Swiss banks — a move which could bring $13 billion in lost tax revenues next year.
Meanwhile, on Sunday, Luxembourg’s finance minister, Luc Frieden, was quoted by the German newspaper Frankfurter Allgemeine Sonntagszeitung, to be ready to open Luxembourg’s secretive banking sector to greater transparency. Frieden said that he wanted “to strengthen cooperation with foreign tax authorities.”
While European governments have been hiking tax rates in response to the financial crisis, Russia has maintained a low flat rate of 13 per cent. However, even this is resented by many of its citizens, who believe their contributions will be misappropriated by corrupt administrators. A senior manager with a St. Petersburg bank, who wanted to remain anonymous, told the St Petersburg Times that tax avoidance is a major driver of capital flight.
The low income tax is compensated for by high payroll taxes. Consequently, the practice of paying minimum wages topped up with cash is widespread. The shadow economy is thought to represent a third of the total economy, and cash transactions over a quarter. This compares with less than ten per cent in OECD countries as a whole.
In Russia, which resumed commercial banking only in 1991, the key issue is an absence of trust. A generation of Russians owes its distrust of the banking system to the default of August 1998, when many saw their life savings wiped out in the space of days as the ruble crashed.
In the new century, the banks have focused on rebuilding the retail banking sector. In the last five years the number of people using debit and credit cards has shot up dramatically and mortgages are now a standard financial product. Despite the reduction in the number of private banks at the end of the 1990s, the Association of Russian Banks lists over 700 members. However, many Russians still display a reluctance to keep their assets in the country’s banks.
An efficient banking sector is vital for the Russian economy. Money that is sent abroad, or kept under mattresses, cannot be lent as capital. The less capital available, the more expensive it becomes and the less entrepreneurial activity occurs. Putin is right to be concerned. The solution will be difficult — everything in banking ultimately boils down to trust, or failing that, an effective legal system.