The Panama Papers have caused quite a stir around the world in recent weeks. Now that the initial storm has subsided, it is time for a factual categorisation of the accusations that were made after publication.
The Panama Papers reveal that the law firm Mossa Fonzecka set up so-called letterbox companies for its clients in Panama City on a large scale. It is now suspected that clients used the letterbox companies for dubious purposes such as tax evasion, money laundering and hiding state assets (keyword oligarchs). Internationally active companies and private individuals came under scrutiny. Not only journalists but also tax investigators and public prosecutors in the countries concerned will thoroughly analyse the business relationships uncovered. Unsurprisingly, two raids have now taken place at the offices of the Mossa Fonzecka law firm. Whether the allegations of illegal behaviour are justified in detail, however, will only become clear after the documents have been thoroughly analysed.
What is asset protection?
The term asset protection is often used in connection with letterbox companies, as letterbox companies are frequently used for this purpose. In the public perception, the term now seems to be synonymous with the illegal hiding of assets and tax evasion. But what is really behind it?
Asset protection means nothing more than the protection of assets. Private individuals and companies want to prevent economic ties from becoming visible to everyone and third parties from gaining unauthorised access to assets or filing claims. So-called letterbox companies are suitable for this purpose for three reasons: they are easy to set up, do not require any staff apart from a managing director and, depending on where they are set up, there is no register in which the shareholders are published for everyone to see. In contrast, the shareholders of German GmbHs can be easily identified via the publicly accessible commercial register. Nevertheless, it is a fully-fledged company that may have assets such as real estate, shares in other companies, bank accounts or shares in investment funds. Many countries provide the legal framework for such companies, for example states in the USA such as Delaware.
Asset protection = criminal offence?
Anonymisation is then used to generate the accusation that letterbox companies are only used by people who have something to hide. Companies and private individuals are accused of hiding profits or shifting them to tax havens, concealing black funds, penalising creditors and money laundering. Private individuals must also ask themselves whether they are hiding money from their family, in particular from their spouse or children, in order to evade claims for maintenance, equalisation of gains or inheritance claims.
The automatic conclusion from anonymisation to criminal activity is wrong for two reasons: Firstly, there are many legal and legitimate purposes from the field of asset protection to use letterbox companies. Secondly, no one can evade the tax authorities, their creditors and the legitimate claims of their family by simply using a letterbox company.
Private individuals and companies that utilise asset protection must operate within the framework of the applicable laws: By simply using a letterbox company, you cannot evade the relevant authorities such as the tax authorities and capital market supervisory authorities, anti-money laundering laws, your creditors or even the justified claims of your family. Dr Thomas Elser and Dr Frank Thiede recently explained that letterbox companies do not provide German taxpayers with any tax advantages in their article "The letterbox company from a German tax perspective" in the Stock exchange newspaper.
Legal and legitimate purposes of asset protection
Wealthy private individuals use the option of anonymisation so that the general public does not find out about the size and structure of their assets. It is true that information about accounts and custody accounts is not accessible to the general public due to banking secrecy. However, the situation is completely different for shareholdings in companies: Limited partnerships (KGs, GmbH & Co. KGs) and GmbHs, for example, must publish their shareholders in the commercial register. In addition, all corporations and other large companies must publish their annual financial statements in the Federal Gazette. In combination with the information from the commercial register, this information enables the expert reader to assess the assets. In a less secure environment, such information can pose a security risk, especially for minors and people who are still inexperienced in business.
People who are in the public eye are not recognisable as investors to outsiders, which can have tangible financial benefits. A price premium for celebrities or recognisably wealthy individuals when purchasing high-priced properties is not uncommon.
The pooling of family assets with the help of such special purpose vehicles is also popular. A family office enables efficient management, as not every family member has to make every single investment decision themselves. Family offices are interesting clients for asset managers and banks due to the volume of assets they manage - they generally receive better support than a family member on their own. This serves not least to provide financial security for children and spouses. Family members can invest jointly in company shareholdings via letterbox companies and acquire strategically important share packages without their involvement becoming generally known. Investments can also be structured entirely according to individual wishes and needs.
Legal and tax consequences
Anonymity for the general public does not mean anonymity for the business partner! According to the current standards for combating money laundering, banks, insurance companies and financial services institutions, among others, must record who the beneficial owner is in accordance with the "know your customer" principle, in other words, who the shareholder of a letterbox company is. These obligations also apply to trustees and service providers who set up companies - and therefore to the service providers who set up and manage letterbox companies. At EU level, the requirements have been harmonised by the Fourth Money Laundering Directive recently tightened.
Strategic investments that are aimed at relevant minority shareholdings or even majority shareholdings may have to be reported or publicised to the responsible supervisory authorities.
It also makes no sense to hide money from the family in order to withhold equalisation of gains from the less wealthy spouse in the event of a divorce, for example, or to cheat children who are supposedly unworthy of inheritance. The claims continue to exist - if necessary, the defrauded family members can sue for information.
If letterbox companies receive capital income in the form of interest or dividends, this is attributed to the shareholder resident in Germany under German tax law, i.e. it must be taxed in Germany. If shares in letterbox companies are transferred to spouses or children in the event of inheritance, the assets are subject to German inheritance tax. A gift of shares is also subject to tax in Germany. If the taxpayer fails to declare these transactions, they are committing tax evasion.
In the case of foreign matters, which also include investments in foreign companies, taxpayers are also subject to increased duties of disclosure. For example, if the tax office discovers that the declared capital income has suddenly fallen sharply or other indications emerge that suggest income has been concealed, it will ask the taxpayer to provide a detailed statement. The tax office can receive information, for example, via control notifications from foreign tax authorities - Germany has a data exchange network with many countries outside the EU. If the tax office is not convinced by the information provided by the taxpayer, it can estimate the income - at the taxpayer's expense. The threat of criminal liability combined with the international exchange of data and the right to estimate income is an effective means of exerting pressure.
Conclusion
Does the equation asset protection = criminal offence apply? The clear answer is no.
Does the equation asset protection = morally reprehensible apply? Quite clearly: no.
Is the use of letterbox companies for asset protection illegal or illegitimate? No.
It is up to each person to keep their financial circumstances secret from the eyes of the general public within the framework of the law. A letterbox company is an instrument for this purpose. Such a special purpose vehicle does not provide anonymity vis-à-vis the tax authorities and the financial supervisory authorities. It does not protect against money laundering laws and the legitimate claims of children and spouses. Therefore, neither the objective of asset protection nor the use of letterbox companies is illegal or illegitimate per se.
Inga Zillmer is a lawyer at TAXGATE, a tax law firm specialising in transactions, investments and tax compliance.
