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RISKS AND RESTRICTIONS FOR THE INTERNATIONAL BUSINESS: BLACK AND GREY LISTS, STRENGHTHENING CONTROL

Facing the depth of the global economic crisis and reshaping of the world financial system a tighter control over cross-border capital flows gets a steady trend.

Below you can see a general review of the most significant restrictive measures, legal, financial   and political constraints, implemented at the international, national and corporate stages.

I. International vehicles for combating money-laundering and corruption        
The Organisation for Economic Co-operation and Development (OECD) and the Financial Action Task Force on Money Laundering (FATF)
are considered to be the main generators of such measures. Nowadays these institutions have developed an extensive set of rules and recommendations aimed at combating the legalisation of criminal incomes. Their gradual and consistent implementation into a national legislation will perspectively mean a global as well as binding action.

A. The Organisation for Economic Co-operation and Development (OECD)       
The OECD was founded in 1961 to “stimulate economic development and world trade”. It currently unites 36 mainly developed economies, and is considered to be a club of leading states, which establish the standards for the harmonization of tax legislation, data exchange, combating corruption, etc. In this regard the OECD is actually a major international provider and a moderator of financial transparency. Combating a wide range of financial crimes (money laundering, tax crimes, corruption, etc.) is one of the key activities of the OECD.

In order to uphold its responsibilities since 2013 the OECD has implemented the appropriate plan on combating the erosion of tax base and the withdrawal of profits from taxation (Action Plan on Base Erosion and Profit Shifting) or the BEPS Plan. The BEPS Plan focuses on situations of “double non-taxation” and schemes of artificial transfer of taxable profits from jurisdictions where such income is actually formed to other jurisdictions, which also contributes to the achievement of zero or low taxation (“aggressive tax planning” in OECD terms).

According to the OECD, the use of such schemes allows international companies to reduce taxation by 4-8.5%. As for the OECD and G20 countries, this is 4 to 10% of corporate taxes or $100-240 billion.

Actually, these are formally legitimate schemes that do not violate national legislation but appear to be undesirable to the tax authorities and the OECD.

The BEPS Plan is a package of 15 Actions (with brief explanations):

1. Address the tax challenges of the digital economy
Identify the main difficulties that the digital economy poses for the application of existing international tax rules and develop detailed options to address these difficulties, taking a holistic approach and considering both direct and indirect taxation.

2. Neutralise the effect of hybrid mismatch arrangement
Develop model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effect (e.g. double non-taxation, double deduction, long-term deferral) of hybrid instruments and entities.

3. Strengthen CFC rules
Develop recommendations regarding the design of controlled foreign companies (CFC) rules.

4. Limit base erosion via interest deductions and other financial payments
Develop recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense, for example through the use of related-party and third-party debt to achieve excessive interest deductions or to finance the production of exempt or deferred income, and other financial payments that are economically equivalent to interest payments.

5. Counter harmful tax practices more effectively, taking into account transparency and substance
Revamp the work on harmful tax practices with a priority on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring substantial activity for any preferential regime.

6. Prevent treaty abuse
Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances.

7. Prevent the artificial avoidance of PE status

Develop changes to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionaire arrangements and the specific activity exemptions.

8. Intangibles
Develop rules to prevent BEPS by moving intangibles among group members.

9. Risks and capital
Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members.

10. Other high-risk transactions
Develop rules to prevent BEPS by engaging in transactions which would not, or would only very rarely, occur between third parties.

11. Establish methodologies to collect and analyse data on BEPS and the actions to address it
Develop recommendations regarding indicators of the scale and economic impact of BEPS and ensure that tools are available to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS on an ongoing basis.

12. Require taxpayers to disclose their aggressive tax planning arrangements
Develop recommendations regarding the design of mandatory disclosure rules for aggressive or abusive transactions, arrangements, or structures, taking into consideration the administrative costs for tax administrations and businesses and drawing on experiences of the increasing number of countries that have such rules.

13. Re-examine transfer pricing documentation
Develop rules regarding transfer pricing documentation to enhance transparency for tax administration, taking into consideration the compliance costs for business.

14. Make dispute resolution mechanisms more effective
Develop solutions to address obstacles that prevent countries from solving treaty-related disputes under MAP, including the absence of arbitration provisions in most treaties and the fact that access to MAP and arbitration may be denied in certain cases.

15. Develop a multilateral instrument
Analyse the tax and public international law issues related to the development of a multilateral instrument to enable jurisdictions that wish to do so to implement measures developed in the course of the work on BEPS and amend bilateral tax treaties.
A detailed analysis of 15 Actions is set out here.

Thus, the BEPS Plan is an attempt to unify a number of principles of tax legislation at the global level and to establish new “rules of the game”, significantly reducing the possibilities of international tax planning.

Whereas a vast number of countries that are not members of the OECD and the G20 (“inclusive group”) has pledged to follow a “minimum BEPS standard”, in prospect it will have a global coverage. In practice, this means that as 15 BEPS Actions are implemented, most of the traditional schemes previously used by foreign taxpayers for international tax optimisation become illegal. Growing information transparency also dramatically increases the ability of tax authorities to expose illegal schemes.

In addition to the BEPS Plan the OECD introduced the requirement of Automatic Exchange of Financial Account Information in Tax Matters (Common Reporting Standard, CRS as a tool).

Unlike the transfer of information on request, in this case the competent authorities provide for the transfer of data not on individuals, but of information arrays on non- residents served by the financial institutions of a participating country. Meanwhile, the amount of information to be exchanged is strictly defined by the CRS and will not be total. Although in practice it is already proved to be an effective tool.

To provide the international legal framework for the automatic exchange of CRS information (AEOI), in October 2014, the Multilateral Competent Agreement (MCAA) was  signed  by a total of 61 jurisdictions. It sets a standard  and an efficient  mechanism  to  facilitate  the  AEOI  and  avoids  the  need  for  several authority bilateral agreements to be concluded.

To the present, the OECD has significantly experienced in the BEPS Plan implementation.

A number of certain cases dealt with the Chinese tax authorities are presented below.

In August 2018, the Wujing district tax office of Jiangsu province State Tax Bureau denied dividend withholding tax (WHT) relief to a Hong Kong (HK) company. The latter was established by an American company as a holding company for a Chinese firm in Changzhou (Jiangsu). This company, in turn, owned the assets of another Chinese company and received dividends from it. Having noted that the HK company operated out of a 100 square metre warehouse in HK New Territories, while having insignificant salary costs as well as huge dividends from a Chinese company, the provincial tax authorities have established an exchange of information with the HK tax authorities. Given the HK company's lack of any economic activity and its being used by a Changzhou firm only for tax optimisation  purposes,  the  latter  was  forced  to  pay  income   tax   in   full (RMB 1.5 million or $215,000).

In June 2018, the Wuxing district tax office of Huzhou (Zhejiang province) denied dividend WHT relief (according to the China-Singapore double taxation agreement, DTA) to a Singapore company, which held 80% of the Huzhou company. It turned out that before lodging the DTA relief forms and documentation with tax office in August 2016, the company announced its liquidation in June 2016. During that period its financial statements recorded substantial intangible assets. The dividend payment to the Chinese firm in respect of which the DTA relief was claimed mainly comprised the consideration received for the sale of these assets. Having recognised the scheme as an attempt to evade taxes, the Wuxing district tax authorities obliged the Huzhou company to pay supplementary WHT RMB 1.8 million.

These cases highlight the effectiveness of the national measures taken for the BEPS Plan and AEO compliance and also a wide range of instruments used (in China – Golden Tax III system, taxpayer credit rating, “web crawler” software, international information exchange, pooling of data with other governmental authorities, etc.).

The OECD intends to move forward in ensuring of the countries` CRS compliance. In November 2018, an updated OECD report on obtaining citizenship/residence by investment (CBI/RBI) schemes (“golden visa”, “investor visa”) was introduced. The Report states that such schemes potentially endanger the proper operation of the CRS due diligence procedures.

B. The Financial Actions Task Force on Money Laundering (FATF)
The Financial Actions Task Force on Money Laundering (FATF) is a key institution in developing and implementing the international standards (“the safeguard” and the arbitrator) in anti- money laundering and combating the financing of terrorism (AML/CFT), as well as other threats to the integrity of the international financial system.

FATF was established at the 1989 G7 summit and its Secretariat is housed at the OECD headquarters in Paris. However, FATF is independent and not included in OECD or other international organisation framework.
Its main objectives and operating principles are set out here.

The FATF 40 Recommendations are recognised as an international standard for AML/CFT and the proliferation of weapons of mass destruction. It is also  obligatory  for  implementation  for  all  UN  Member  States  (UN  Security Council Resolution 1617/2005).

Below is the summary of recommendations (as amended in 2012):

Recommendation 1 requires the identification and assessment of money laundering and terrorist financing risks to the country and appropriate steps should be taken in this direction (risk-based approach).

Recommendation 3 requires countries to criminalise money laundering on the basis of the Vienna Convention and the Palermo Convention and apply the crime of money laundering to all serious offences, with a view to including the widest range of predicate offences.

Recommendation 4 requires countries to adopt measures similar to those set forth in the Vienna Convention, the Palermo Convention, and the Terrorist Financing Convention, including legislative measures, to enable their competent authorities to freeze or seize and confiscate property laundered, proceeds from, or instrumentalities used in money laundering or predicate offences ... and more.

For better understanding of their essence, in 2013 a new methodology for assessing technical compliance with FATF Recommendations and the effectiveness of national AML/CFT systems was approved.

The most practical significance for international business might have the publication since 2000 (and updated thrice a year) of the black and grey lists, including countries that have significant deficiencies throughout AML/CFT control framework.

The FATF black list now includes Iran and North Korea. The grey list includes “high-risk and other monitored jurisdictions”. As of October 2018, 11 jurisdictions are on the list: Bahamas, Botswana, Ethiopia, Ghana, Pakistan, Serbia, Syria, Trinidad and Tobago, Sri Lanka, Tunisia and Yemen.

These FATF lists, as well as the similar OECD list of Uncooperative Tax Havens are directly related to the banking system and international trade. Any payments in favour of a receiver in the listed country are seen with suspicion, so it is strongly recommended to take particular care when conducting business with customers in these jurisdictions. In practice, financial institutions often refuse to make transactions with customers from these countries in order to avoid problems with supervisory bodies.

II. National measures in anti-money laundering and combating the financing of terrorism (AML/CFT)
The pioneers and “engines” of building a global system of control over international financial flows are first of all, the United States and, to a large extent, the United Kingdom.

In most cases the US efforts laid ground for developing the international AML/CFT legislation.

A. The US Office of Foreign Assets Control (OFAC)
OFAC as part of the Department of the Treasury (DoT) plays a key role in performing sanctions regimes.

The parent department, DoT is in fact a financial superagency with extremely broad powers in the fiscal, customs, supervisory areas (Internal Revenue Service, Customs Service, Office of the Comptroller of the Currency, Financial Crimes Enforcement Network, Office of Foreign Assets Control, etc.).

Initiating in 1970s to build a system of control over cross-border financial flows with the regulation of the domestic banking sector (the Bank Secrecy Act, BSA of 1970 and the Money Laundering Control Act of 1986), in early 2000s, the United States created the basis for the extraterritorial jurisdiction in this area.

The founding document is the USA PATRIOT Act 2001, which granted unprecedented   powers to law enforcement agencies in gathering “foreign intelligence information” from US and non-US citizens. Its constituent part is the International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001. Although replaced in 2015 by the USA Freedom Act, which limited the powers of intelligence services in public and everyday life, the USA PATRIOT Act laid the ground for building a global system of control over international finances. It focused primarily on identifying suspicious transactions, on elaborating principles of customer verification, prohibition on operations with foreign “shell banks” and empowering certain government agencies (seizure and arrest of funds in interbank accounts, forfeiture of property, etc.).

In fact, the bulk of these measures has put an end to offshore banking business in usual sense.

Along with sanctions against entire jurisdictions, OFAC also implements a sanctions regime against certain individuals and entities. Among them are the Specially Designated Nationals and Blocked Persons List (SDN List) with a selection  by country and  specific  sanction  programmes.  Also  highlighted is a Sectoral Sanctions Identities List (SSI List), adopted in pursuance of the US President Executive Order 13662 in March 2014 against Russia in connection with the Ukrainian crisis.

OFAC also allows to seek special permission to review the reasons for listing and possible de-listing, although, in practice it is a rather complicated procedure. In the United States, a significant number of law firms are ready to assist in releasing blocked funds due to sanction violation issues.

B. The Financial Crimes Enforcement Network (FinCEN)
The FinCEN acts as a financial intelligence agency of the United States (since 2001, a department within the US Treasury), its responsibility covers a wide range of tasks to protect the US financial system, fight money laundering and the financing of terrorism, weapons of mass destruction (WMD), etc.

The FinCEN list is similar to the FATF list, actually determining its contents, and American banks use both documents. The close relationship between the two agencies may be confirmed by Advisory on the Financial Action Task Force-Identified Jurisdictions with Anti-Money Laundering and Combatting the Financing of Terrorism Deficiencies.

FinCEN activity is shown in the case of the Bank of Dandong (China) which has been accused in and sanctioned for dealing with North Korea.

Based on the ban imposed in November 2016 on American financial institutions to open or have correspondent accounts for North Korean banks (or on their behalf), in November 2017 FinCEN introduced the similar measures against the Bank of Dandong.

The Bank of Dandong was suspected of being used by North Korea (through state-controlled financial institutions and shell companies) “as a channel for illegal international financial transactions that could contribute to WMD and ballistic missile activities”.

In order to improve the AML/CFT compliance the FinCEN has also issued the Advisory on North Korea`s use of the International Financial System to evade sanctions, launder funds and finance WMD programmes.

C. The U.S. Securities and Exchange Commission (SEC)
Along with the Department of Justice and the Federal Bureau of Investigations, the Commission has broad powers in fighting corruption.

The SEC is one of the key government agencies responsible for implementation and monitoring compliance of Foreign Corrupt Practices Act (FCPA).

In 1997 FCPA served as a basis for the development of the OECD Convention on combating bribery of foreign public officials in international business transactions and the United Kingdom Bribery Act 2010.

The latter has a broader scope that goes beyond the national borders and applies to any entities that have any relation to the company including associates.

D. Britain`s and EU AML/CFT efforts
The UK enforcement agencies and courts activities in AML/CFT are based on Anti-Terrorism, Crime and Security Act 2001 and Criminal Finances Act 2017 (CFA).  The latter represents the largest overhaul of the UK’s anti-money laundering regime in more than a decade and the largest expansion of corporate criminal liability since the Bribery Act 2010.

Its implementation is ensured by two key tools – “unexplained wealth order” and “interim freezing order”. They require to explain the sources of the acquisition of an asset (real estate, jewellery, cars, etc.) worth more than £100,000. If they seem to be suspicious the real estate or other property might be subject to arrest.

The CFA enactment opened a legal possibility to block bank accounts and forfeit properties belonging to foreign businessmen and public officials.

A month after it entered into force in February 2017, CFA was applied in practice.
In March 2017 the assets of “an overseas oligarch”, including “£22m of property” have been frozen in an assault on unexplained wealth.

As the British authorities say, the main reason of that is “rather loyal UK legislation” and “questionable assets are already being targeted”.

Considerable powers are also vested in the UK Serious Fraud Office (SFO). SFO is allowed to conduct criminal investigations and it actively cooperates with commercial firms. Many of their cases are described on the SFO website.

Following a four year investigation, in January of 2017 the SFO and Rolls- Royce PLC entered into a Deferred Prosecution Agreement (DPA).

The charges against the company included falsifying accounts to hide the illegal use of local middlemen, attempting to thwart investigations into corruption, and paying tens of millions in bribes to win engine and other contracts in Indonesia, Thailand, China and Russia. It had been lasting for 30 years in seven jurisdictions and involving three business sectors.

The DPA involves payments of about £497m (comprising disgorgement of profits of £258m and a financial penalty of £239m) plus interest.
The investigation into the conduct of individuals continues.

The European Union has also developed an extensive regulatory framework.

It is based on the Fourth Directive or Directive 2015/849 of 25 June 2015 (“On the prevention of the use of the financial system for the purposes of money laundering or terrorist financing”). The Directive is a follow-up to earlier documents in AML/CFT.

III. Banks and financial institutions in AML/CFT
The largest banks, on one hand, being controlled by the relevant international structures, on the other hand, represent one of the key links in the global framework of control over the financial flows.

The establishment of a system of combating money laundering in the private  banking  sector  was  initialled  in  2000  when  a  group  of  13  major transnational banks (Banco Santander, Bank of America, Bank of Tokyo-Mitsubishi-UFJ Ltd, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan Chase, Societe Generale, Standard Chartered Bank and UBS) set out the Wolfsberg principles (the Wolfsberg Group Principles).

The Wolfsberg group focuses primarily on producing principles and standards to promote best practices and improve the overall effectiveness of the financial crime compliance regime.

While developing standards of the financial services industry, the Wolfsberg group implements a policy of transparency, including KYC (Know Your Customer, alternatively Know Your Client), Integrity Check and other compliance processes based on financial crime risk management.

In fact, with absence of legal force, the principles are a public obligation of participating banks to “follow certain ethical rules” and they build an appropriate global environment for all banking institutions. For instance, one of the tools is a Correspondent Banking Due Diligence Questionnaire (CBDDQ).

The careful multi-level of customer verification by transnational banks and financial companies includes a set of basic procedures, first of all  “Know Your Client”  (KYC), and identifying Politically Exposed Persons (PEP), i.e. individuals who are or have been entrusted  with   prominent public functions domestically or by a foreign country, as well as members of their families.

Adding to PEP list means enormous difficulties for a certain person, relating his daily business (opening bank accounts, making a loan, selling shares, etc.), serious reputation damage, together with disregard for the presumption of innocence.

In practice, it is common to be falsely referred to PEPs, and in order to resolve the situation it is necessary to follow “the same ridiculous and dishonest procedures as the basic criteria to put someone on the list”.

Furthermore, in order to make the procedure more clear and comprehensible, the World Bank published the Guidance on preventive measures for the banking sector relating Politically Exposed Persons.

In addition, in large banks there is a Customer Identification Programme (CIP), put into effect under the USA PATRIOT Act.

IV. Strengthening control over the offshore jurisdictions
In the situation of the deepening global financial crisis, as well as the fight against terrorism, offshore jurisdictions are under the spotlight of the world financial institutions.

While focused only on their regulation and control until the beginning of the 2000s, later the policy towards offshore companies has been changed into tough opposition to their illegal use.

In 1980, the Basel Committee initiated the establishment of the Offshore Banking Supervision Group (OBSG), which was renamed in 2011 into the Group of International Finance Centre Supervisors. It is aimed at the global cooperation in developing and implementing the international standards of cross- border banking supervision.

In early 2000s, the United States publicly announced the start of the fighting offshore jurisdictions. The turning point was considered to be the adoption of Foreign Account Tax Compliance Act (FATCA) in 2010, its main purpose was to prevent American citizens abroad from using banks and other financial institutions to avoid taxation on their income and assets. FATCA required all foreign financial institutions to search their records for customers referred to the United States and to report the assets and identities of such persons to the US Department of the Treasury. It was a law of extraterritorial effect.

The scope of FATCA non-compliance sanctions varies from withholding a 30% penalty tax on transactions of a non-participating institution, suspension/closure of correspondent accounts to problems with subsequent opening of accounts in other banks, damage to the business reputation of the financial institution, etc.

The FATCA application can be confirmed by practices of certain countries, such as Singapore, India, South Africa, or large multinational companies  and banks (HSBC, Credit Suisse, etc.). In the United Kingdom, the Dependencies and Overseas Territories a British analogue of FATCA, UK FATCA, determines the exchange of tax information and its regulations. The extraterritorial US AML jurisdiction is also confirmed by recent cases related with the US law enforcement authorities, which reveal complicated fraud and corruption schemes, in particular, in Venezuela.

In November 2018, the former Chavez-era Minister of Finance E. Cedeno and businessman C. Belisario were accused and sentenced to imprisonment for the organisation and use of money-laundering schemes. At the same time, the US Department of Justice actively uses anti-money laundering laws in case of inability to act directly under the Foreign Corruption Act (FCPA).

V. How to check your business partner/customer via databases, online services
For business, checking itself, its partners and customers on various databases, mostly of limited access, can be of huge interest.

The following online services should be mentioned first.

World-Check (Thomson Reuters) professional database, containing profiles of more than 3 million individuals and companies worldwide. It is considered to be the pre-eminent global watchlist available today of PEP, officially sanctioned individuals and “persons of special interest” (i.e. high profile people which are not on an official list but reported in publicly available sources of being accused or convicted of serious crimes).

However, some false claims have been recorded in World-Check.

In 2017, the service acknowledged that the Palestine Solidarity Campaign (PSC) should never have been on the database and, moreover, not have been associated with terrorism and have not presented any financial risks. As a result, The PSC and World-Check have reached an agreement to address the harm to the reputation of the PSC and its chair and to resolve the matters between them.

In a similar case with Finsbury Park Mosque in 2017 it was claimed about its false association with terrorism related activity. World-Check was forced to pay compensation and make an official apology.

NameScan is an online AML/CFT compliance service, which provides scanning services against lists of PEPs (plus their Relatives and Closes Associates), sanctioned individuals and organisations, persons of special interest and special interest entities. NameScan has two types of data available, both of which provide a global coverage.

The service is based in Australia and mostly utilises Thomson Reuters World-Check database. It provides information on more than 3 million total profiles.

Kompany Integrated service provides access to more than 100 million companies in more than 150 countries and jurisdictions, as well as to the data of commercial registers of companies in more than 60 countries (Business Concierge Service). The system allows for a wide range of checks: from PEPs and sanctions/checklists of various international organisations, countries and agencies to information from the media (since the 1900s).

Lexis Nexis service by RELX Group provides access to multi-industry databases of legal and business information, including in the field of risk management (Company Dossier, Encyclopaedia of Forms and Precedents, Total Patent, etc.). It is considered the world's largest online library of legal, business and archival information.

Furthermore, on the United Kingdom Home Office website a basic check of individuals is available. It includes, for instance, criminal record disclosure (for those who live or work in the country). This check is provided on the databases of Disclosure and Barring Service (DBS), part of the Home Office.
 
VI. Conclusion
For today, the growing pressure of various international institutions setting the “global rules of the game”, as well as the increased attention to business from various supervisory and regulatory bodies, both nationally and internationally, are hardly questionable.

The new rules are majorly triggered by ongoing trends, particularly the restriction of access to international financial markets, a set of measures aimed to enhance the transparency of corporate and banking institutions (banking secrecy reducing, expanding the international tax and financial exchange, etc.), reducing the attractiveness of offshore jurisdictions, finally, excessive bureaucratization of governmental agencies and corporations.

The situation suggests that in future these trends will only gain strength.

In a rapidly changing environment, businesses have to consider the ever- increasing tax, financial, and far more importantly, reputational risks, and build an efficient development strategy.
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