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Tax havens and the money laundering phenomenon.


Under the current conditions of internalization of all aspects of the economic activities, the methods and techniques of fiscal optimization - particularly those used within fiscal paradises and by off-shore companies - have become a hot topic generating contradictory opinions. The manipulation of the fiscal regulations within the legal frame may provide the "parent" companies with either an "additional" profit (sometimes called "illegitimate") or an illicit international transfer of capitals "clothed" in a legal appearance.


Within the present international context, the rising of the off-shore industry is favored by the trend regarding the investment planning. It is specific to the multinational corporations that prefer to penetrate a new market using off-shore companies in order to minimize the risks with no regard to their nature.

On the other hand, by using fiscal paradises the multinational corporations enforce an efficient fiscal management that covers both the repatriation of the dividends in foreign currency and the control transfer over the confidentiality of the shareholders, managers and operations.

The identification of the "perfect" fiscal paradise has been a very interesting issue among the theoreticians and practitioners in the field. It is obvious that there is no universally valid quantitative and qualitative hierarchical system of the fiscal paradises. A certain fiscal paradise becomes most desirable depending on the profile of the user and the goals of the latter.

If we take into account whether the would-be user of the fiscal paradise is a natural person or a legal person, the principality of Monaco is the "perfect host" from the point of view of the income taxation of the natural persons (except for the French citizens). The principality is not as friendly in regard to the income taxation of corporations. The Island of Jersey is on the opposite side: the non-resident corporations, in exchange of a 300 British pounds annual subscription, are not under the obligation of keeping accounting books or filing tax returns, but natural persons must pay 20% of their revenue in taxes. Other fiscal paradises favorable to the legal persons are Bahrain and Guernsey (they do not tax the non-resident companies) and Bahamas, c and Cayman, all three stipulating that the non-resident corporations must carry out transactions outside the fiscal paradises in question.

The choice of investing in a fiscal paradise rests on the basic motivation of minimizing the fiscal burden to the highest extent. The investment option in a fiscal paradise is based on an economic efficiency calculus named in the speciality literature "option pricing". It refers to the total material profit obtained as a result of the activities of avoiding taxation by using the fiscal paradises. The social and political stability and the existence of banking, transportation and communication facilities are also important. The costs incurred by the setting up a company and the yearly total of the tax forfeitures and last but not least, some guarantees that allow the transfer and repatriation of the profits and capitals are also essential factors in the process of choosing a fiscal paradise.

The goal of the fiscal fraudsters is to transfer the revenues of the company generating them to the final beneficiary with as little expenses as possible. They aim at building a chain made up of several "links" (named in the speciality literature as "screen companies") that act within the whole circuit and must optimize the total of the transfer prices incurred by the operations in question. The calculus is based on the national fiscal legislations, the existence of the double taxation treaties, the extent to which the fiscal control is enforced in the targeted countries etc.

The ingenuity of these fraudsters has limits only in theory. Many times they find themselves one step ahead the national and international agencies responsible for identification and sanctioning the cross border fiscal evasion. These criminal organizations may use simultaneously a number of tax havens, depending on the advantages offered by each of them, in order to keep the strictest confidentiality about the identity of the beneficiaries and profits.

We take the following example to illustrate those outlined above: for the purpose of avoiding paying taxes and hiding the real circuit of goods and money, a "white collar" representative that owns a company registered for VAT purposes in an UE state (Romania for example) undertakes the following operations:

Sets up an off-shore international business company in Panama or Singapore - tax havens where product manufacturing is very profitable due to the low production costs;

Opens an account for this off-shore with a "captive" bank in Bermudas or the Isle of Man - places acknowledged for being attractive from the point of view of the banking operations;

Sets up an off-shore trust in Cyprus - a tax heaven in the EU. Cyprus has one of the lowest normal VAT quotas in the EU and the lowest level of taxation levied on EU companies;

The off-shore company in Cyprus opens a bank account in Cyprus and another one with a "captive" bank in Bermudas or the Isle of Man;

The products made in Panama or Singapore are initially exported with an already increased price to Cyprus where the customs import formalities are fulfilled. The goods enter the EU territory;

The goods are delivered inside the EU from Cyprus to Romania.

Once arrived in Romania the products are delivered on the domestic market in complying with the regulations regarding the registration of the financial and fiscal operations of the Romanian company including those regarding the intra-community acquisitions of goods (application of the reverse charge mechanism, filling out the Form 300 - "VAT Expenses Deduct Statement", Form 390 "Recapitulative Statement" and VAT of 24%).

The Cypriot trust transfers the money in its account opened with the "captive" bank in either Bermudas or the Isle of Man, account that belongs to the manufacturing company located in either Panama or Singapore.

According to the mechanism previously described, some of the advantages of the conjugated use of the fiscal paradises are:

The products are manufactured at low cost in Panama or Singapore and the profit returns to the manufacturer that benefited from a very favorable taxation;

The company gains also from manipulating the VAT quota differences between Cyprus and Romania as a result of the intra-community delivery / acquisition;

The final beneficiary of the money cannot be practically identified;

The Romanian company is above any suspicion because it carries out intra-community transactions that are registered with the accounting books, files the tax forms pertaining to the transactions and pays the incurred taxes (it is obvious that the financial burden in Romania is very light due to the described mechanism). Even the payments are made to banks within the EU.

The mechanism is very simplified for the theoretical purpose of this paper, but in reality is very complex. For example, after the intra-community acquisition from Cyprus and its registration with the fiscal authorities, in compliance with the legal norms and procedures, the Romanian company adds a very low mark-up and simulates retail sales (by using electronic cashiers) to individual persons that cannot be later identified because there is no law requiring this. In fact, the goods involved are sold on the "black market" at prices much higher than those in the accounting books, but much lower than their market price.

Because the speciality literature allocates vast spaces for presenting the various tax heavens, we will approach an atypical fiscal paradise which is New Zealand. An independent, stable and safe state from every point of view, New Zealand does not represent a tax haven according to the classical definition of the term. The fiscal legislation of this country stipulates a total tax exemption for the companies that have at least one shareholder resident in the country (a natural or legal person) and undertake commercial operations outside the borders. In this case only a compulsory annual tax is levied. These companies are incorporated as joint stock companies and the shares are registered (those transferrable being not allowed). If the real shareholder wants to withhold his true identity, he can designate another shareholder to act on his behalf, the relationship between the two being regulated by a "Declaration of Trust". In this way the registered shareholder gives up all his prerogatives as a shareholder in favor of the other shareholder.

The company registration procedures in New Zealand take a relatively short time (about 10 days) and are not expensive, depending on the company type (with or without a nominated board director). There are no requirements regarding a minimal capital stock, the accounting and financial procedures or the convening terms of the shareholders general assembly.


The general globalization trend has lead not only to the globalization of the economic activities, but also to the rise of the organized crime in the business area, the money laundering becoming the terminal point of the economic and financial criminality. The basic procedure of money laundering aims at dispersing the origins of the profits fraudulently gained for the purpose of creating an appearance of legality of the sums involved, sums that are to be reintroduced later on into the legitimate economy. This phenomenon is facilitated by legal imperfections and especially by the institutional malfunctions within the agencies and bodies created for combating it. The more extended the phenomenon, the deeper the authority crisis of the government bodies.

Any economic activity, be it legal or illegal, is evaluated by taking into account its efficiency. The efficiency of the money laundering is illustrated by the ability of the criminal organizations to "recycle" the profits gained from fiscal evasion, corruption, forgery, fraudulent bankruptcy etc. The success rate of the criminal economic activities depends on the obscure and semi-clandestine recycling character of the illicitly achieved funds.

Conceptually, the money laundering phenomenon is structured on three fundamental steps:

1. The cash placement takes place either by couriers or by the financial and banking system. Taking into account the space localization, the location where the money is to be placed is generally close to the place where the initial illegal activity that generated the "dirty money" was undertaken. In their pursue of a consistent client portfolio and a larger market share, the banks often act superficially, breaking their own internal regulations or those enforced by the central bank and involuntarily become a part in the "dirty money" laundering. On the other hand, the "captive" banks in the tax heavens are often aware of their own complicity.

2. Stratification implies the undertaking of a string of successive transactions and operations, apparently not inter-connected, having as a goal the cover up of the money provenance. In this way an aura of legitimacy is created for the illegally obtained funds. These funds are transferred within such multi-layer structures from the legitimate economy to its "grey" areas.

3. Integration - the last step of the money laundering phenomenon. It implies the transit of the money through the "grey" area of the economy and its reappearance into the legitimate economy (usually into that of a respectable and stable sate). The amounts are in this way "whitened" or "recycled" by using loans or donations or by paying for certain services or goods that have never been rendered or delivered.

In some circumstances, in order to confuse the investigators, the "white collar" criminals reverse the succession and the trend of the money laundering classical steps. The best moments for taking advantage on the placement of the "black" money in investments are the periods of economic recession when an acute lack of liquidities exists. On the contrary, during periods of economic boom, some funds volatilize (being hidden from taxation) only to be used later on in difficult economic times (evidently after being previously recycled).

The money laundering typology is practically a pattern that combines various creative methods, techniques and instruments that cannot be detected due to the lack of analysis of the indirect indicators. Using illegal income is by far a difficult undertaking and therefore the financial criminals must create increasingly complicated money laundering typologies depending on the opportunities identified by them at a certain time. These typologies are becoming more and more difficult to trace by the financial investigators. For example, Rodriguez Gacha, one of the heads of the Columbian cartel, laundered about 130 million USD using the bank accounts of 82 companies set up in 16 countries in Central and South America, the Caribbean Islands, Asia and Europe.

Some widely used typologies of money laundering are:

1. Laundering of the "black" money gained by oil and alcohol producers that do not declare and pay the due excise duties.

A company that produces or trades goods that are taxable with excise duties may gain illegally important amounts by not paying the excise duties. The fiscal evasion in this case takes place as follows: a product subject to excise duty, once outside the tax warehouse, appears in the documents as a product which is not taxable with excise duties or as one which is taxable with a low excise duty. Later on the same company gets a bank loan for investing in the tourism industry. It buys a hotel with restaurant and a high efficiency is simulated by using the income registered with the electronic cashiers. This income is not real, but allows the loan to be paid back and provides additional money. This additional money represents in fact not the income generated by the tourism business, but the legal facade of the "black" money gained as a result of the fiscal evasion connected to the products taxable with excise duties.

2. Laundering of the "black" money gained through criminal activities such as corruption, drug trafficking, prostitution, card cloning etc.

Money laundering through real estate market is the classical example. It is one of the most widely used method because of the numerous flaws of this sector (it is impossible to monitor the price fluctuations and, implicitly, to assess the "real" price). The flaws allow the hiding of the real provenance of the funds involved in the transaction and the identity of the real beneficiary of the transaction. From the operational point of view, the criminal modus operandi is made up of several "layers", two of them being essential:

a) The real estate price manipulation method that can operate in two ways: either the property price is under-evaluated at the moment of purchase or it is supra-evaluated at the later moment of resale. Evidently the difference between the price in the contract and the one paid/gained in reality represents the mean by which the money gained through illegal activities are accounted for.

b) The mortgage loan method generally resembles the previously described method with one mention: simultaneously with the real estate property acquisition the buyer engages a mortgage loan in order to account for the purchase price. Particular cases within this method are represented by the "loans back" and by the "back to back" loans.

Another example:

Three individual persons (A, B and C) - Romanian residents - receive over a short period of time important amounts in their bank accounts opened with a Romanian commercial bank. These sums are "wages" sent from a Spanish resident company. The three persons use the amounts in question for purchasing real estate properties.

After a careful analysis, the following conclusions are reached:

The natural persons A, B and C are not educated, do not speak any foreign language and did not travel abroad recently;

The Spanish firm has never undertaken any economic activities in Romania. In its country of origin (Spain) it appears to be a "phantom" company - it does not have employees and does not submit tax forms;

The natural person D, next-of-kin to the natural person B, has a power of attorney for the bank accounts of the Spanish firm. Firstly, he makes cash deposits in these accounts and secondly, he transfers the same sums into the Romanian bank accounts of the natural persons A, B and C;

The natural person D is caught in the act by the Spanish authorities while cloning the cards of several Spanish residents.

After a thorough investigation, the following conclusion has been reached: the money sent to and used by the individual persons A, B and C in Romania has as a source the criminal activity (card cloning) undertaken by the individual D in Spain.

There is confusion between the notions of "black money" ("dirty money") and "hot money" ("hot capital"). The "black money" implies a fraudulent provenance (as outlined above), while the "hot money" implies those financial resources that supposedly have a legitimate provenance (even simulated) and later on are destined to finance the "underground" activities.


According to Directive 2005/60/EC of the European Parliament and of the Council of 26 October 2005 on the prevention of the use of the financial system for the purpose of money laundering and terrorist financing, the following conduct, when committed intentionally, shall be regarded as money laundering:

* the conversion or transfer of property, knowing that such property is derived from criminal activity or from an act of participation in such activity, for the purpose of concealing or disguising the illicit origin of the property or of assisting any person who is involved in the commission of such activity to evade the legal consequences of his action;

* the concealment or disguise of the true nature, source, location, disposition, movement, rights with respect to, or ownership of property, knowing that such property is derived from criminal activity or from an act of participation in such activity;

* the acquisition, possession or use of property, knowing, at the time of receipt, that such property was derived from criminal activity or from an act of participation in such activity;

* participation in association to commit, attempts to commit and aiding, abetting, facilitating and counseling the commission of any of the actions mentioned in the foregoing points.

In the Romanian legislation the law that incriminates the money laundering is Law No. 656/2002 on prevention and sanctioning money laundering, as well as for setting up some measures for prevention and combating terrorism financing including the provisions of the Emergency Government Ordinance No. 26/2010. Some practical and relevant aspects of this law are outlined below:

According to Law 656/2002, article 23, para. (1), the following deeds represent offences of money laundering and are punished with prison from 3 to 12 years:

The conversion or transfer of property, knowing that such property is derived from criminal activity, for the purpose of concealing or disguising the illicit origin of property or of assisting any person who is involved in the committing of such activity to evade the prosecution, trial and punishment execution;

a) The concealment or disguise of the true nature, source, location,

b) disposition, movement, rights with respect to or ownership of property, knowing that such property is derived from criminal activity;

c) The acquisition, possession or use of property, knowing, that such property is derived from any criminal activity.

Several exceptions of unconstitutionality of this law article have been invoked, basically motivated by the fact that the right of not being judged and sentenced twice is violated. In every case the Constitutional Court rejected the exception of unconstitutionality, last time by Decision No. 299/2010.

According to art. (3) par. (6), the persons provided in the art. 8 or the persons designated accordingly to the article 14 par. (1) shall report to the National Office for Prevention and Control of Money Laundering within 10 working days, the carrying out of the operations with sums in cash, in RON or foreign currency, whose minimum threshold represents the equivalent in RON of 15,000 EUR, no matter if the transaction is performed through one or more operations that seem to be linked to each other (operations that seem to be linked to each other means the transactions afferent to a single transaction, developed from a single commercial contract or from an agreement of any nature between the same parties, whose value is fragmented in portions smaller than 15.000 EURO or equivalent RON, when these operations are carried out during the same banking day for the purpose of avoiding legal requirements).

In the case of this article the exception of unconstitutionality was evoked because the mandatory reporting eliminates the contractual liberty of the parts, infringes the authenticity of the property rights and, on the same time, gives an illicit character. By Decision No. 626/2009 of the Constitutional Court this exception of unconstitutionality was rejected also.

The entities which must report the aforementioned transactions are enumerated in article 8 of Law No. 656/2006:

a) Credit institution and branches in Romania of the foreign credit institutions;

b) Financial institutions, as well as branches in Romania of the foreign financial institutions;

c) Private pension funds administrators, in their own behalf and for the private pension funds they manage, marketing agents authorized for the system of private pensions;

d) Casinos;

e)Auditors, natural and legal persons providing tax and accounting consultancy;

f) Public notaries, lawyers and other persons exercising independent legal profession, when they assist in planning or executing transactions for their customers concerning the purchase or sale of immovable assets, shares or interests or good will elements, managing of financial instruments or other assets of customers, opening or management of bank, savings, accounts or of financial instruments, organization of contributions necessary for the creation, operation, or management of a company, creation, operation, or management of companies, undertakings for collective investments in transferable securities, other trust activities or when they act on behalf of and their clients in any financial or real estate transactions;

g) Persons, other than those mentioned in para (e) or (f), providing services for companies or other entities;

h) Persons with attributions in the privatization process;

i) Real estate agents;

j) Associations and foundations;

k) Other natural or legal persons that trade goods and/or services, provided that the operations are based on cash transactions, in RON or foreign currency whose minimum value represents the equivalent in RON of 15000 EUR, indifferent if the transaction is performed through one or several linked operations.

According to article 14 para. (1), the legal persons provided for in the Art. 8 shall design one or several persons with responsibilities in applying the present law, whose names shall be communicated to the National Office for Prevention and Control of Money Laundering, together with the nature and the limits of the mentioned responsibilities.

(1) The persons referred to in the article 8 (a)-(d), (g)-(j), as well as the leading structures of the independent legal professions mentioned by article 8 (e) and (f) shall designate one or several persons with responsibilities in applying the present law, whose names shall be communicated to the National Office for Prevention and Control of Money Laundering, together with the nature and the limits of the mentioned responsibilities, and shall establish adequate policies and procedures on customer due diligence, reporting, secondary and operative record keeping, internal control, risk assessment and management, compliance and communication management, in order to prevent and stop money laundering and terrorism financing operations, ensuring the proper training of the employees. Credit institutions and financial institutions are obliged to designate a compliance officer, subordinated to the executive body, who coordinates the implementation of the internal policies and procedures, for the application of the present law.

Article 22 par.. 1 (b) and par. (2) stipulates that the failure to comply with the obligations previously outlined shall be deemed as contravention punishable by a fine ranging from 15 000 RON to 50 000 RON. By Decision No. 1162/2008 the exceptions of unconstitutionality evoked in connection with article 14 par. (1) and article 22 par. (1) (b), par. (2) of Law No. 656/2002 with its subsequent amendments have been rejected by the Constitutional Court.


Due to the exhaustive character of the subject we do not claim that this paper has touched all the aspects of the money laundering. We have tried to approach the subject from an useful point of view. Taking into consideration the still existent flaws in the national and EU legislation we can conclude that the cross-border fiscal evasion can be fought only by bettering the legal frame, identifying its vulnerable spots and accelerating the reactions of the authorities in charge with combating this phenomenon.


European Parliament, European Council (2005). "Directive 2005/60/EC on the prevention of the use of the financial system for the purpose of money laundering and terrorist financing", Official Journal of the European Union L 309/15, November 25.

Mihu, St. (2008). The Fiscal Policy. Constanta: Europolis.

Patroi, D. (2007). Fiscal Evasion between the Permissive Side, the Infringement Aspect and the Criminal Character. Bucharest: Economica.

Romanian Parliament (2002). Law no.656/2002 for preventing and sanctioning money laundering, Official Gazette of Romania no. 395 of December 12.


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Author:Mihu, Stefan
Publication:Economics, Management, and Financial Markets
Article Type:Report
Geographic Code:4EXRO
Date:Dec 1, 2012
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