NAME : ANKIT LAHOTI
ROLL NO. : 282
ROOM NO. : 12
SUBJECT : FMO & FMA
COLLEGE : ST. XAVIER’S COLLEGE
TAX HAVENS
A tax haven is a state or a country or territory where certain taxes are levied at a low rate or
not at all. Individuals and/or corporate entities can find it attractive to move themselves to
areas with reduced or nil taxation levels. This creates a situation of tax competition among
governments. Different jurisdictions tend to be havens for different types of taxes, and for
different categories of people and/or companies. There are several definitions of tax
havens. The Economist have suggested that any country which modifies its tax laws to attract
foreign capital could be considered a tax haven. According to other definitions, the central
feature of a haven is that its laws and other measures can be used to evade or avoid the tax
laws or regulations of other jurisdictions. In its December 2008 report on the use of tax havens
by American corporations, the U.S. Government Accountability Office was unable to find a
satisfactory definition of a tax haven but regarded the following characteristics as indicative
of a tax haven:
1. nil or nominal taxes;
2. lack of effective exchange of tax information with foreign tax authorities;
3. lack of transparency in the operation of legislative, legal or administrative provisions;
4. no requirement for a substantive local presence; and
5. self-promotion as an offshore financial center.
MONEY LAUNDERING
Money laundering is the practice of engaging in a series of financial transactions to conceal the
ownership, source, control or destination of illegally gained money. Ultimately, it is the process
by which the proceeds of crime are made to appear to have a legitimate origin. The crime
proceeds involved can be generated by any number of criminal acts, including drug dealing,
corruption, accounting and other types of fraud, and tax evasion. The methods by which money
may be laundered are varied and can range in sophistication from simple to complex.
Many regulatory and governmental authorities quote estimates each year for the amount of
money laundered, either worldwide or within their national economy. In 1996 the International
Monetary Fund estimated that two to five percent of the worldwide global economy involved
laundered money. However, the FATF, an intergovernmental body set up to combat money
laundering, admitted that "overall it is absolutely impossible to produce a reliable estimate of
the amount of money laundered and therefore the FATF does not publish any figures in this
regard." Academic commentators have likewise been unable to estimate the volume of money
with any degree of assurance. Regardless of the difficulty in measurement, the amount of
money laundered each year is in the billions and poses a significant policy concern for
governments. As a result, governments and international bodies have undertaken efforts to
deter, prevent and apprehend money launderers. Financial institutions have likewise undertaken
efforts to prevent and detect transactions involving dirty money, both as a result of
government requirements and to avoid the reputational risk involved.
METHODS
Money laundering often occurs in three steps: first, cash is introduced into the financial system
by some means (“placement”), the second involves carrying out complex financial transactions in
order to camouflage the illegal source (“layering”), and the final step entails acquiring wealth
generated from the transactions of the illicit funds (“integration”). Some of these steps may be
omitted, depending on the circumstances; for example, non-cash proceeds that are already in
the financial system would have no need for placement. Money laundering takes several
different forms although most methods can be categorized into one of a few types. These
include "bank methods, smurfing, [also known as structuring], currency exchanges, and double-
invoicing."
Structuring: Often known as "smurfing," it is a method of placement by which cash is
broken into smaller deposits of money, used to defeat suspicion of money laundering and to
avoid anti-money laundering reporting requirements. A sub-component of this is to use
smaller amounts of cash to purchase bearer instruments, such as money orders, and then
ultimately deposit those, again in small amounts.
Bulk cash smuggling: Physically smuggling cash to another jurisdiction, where it will
deposited in a financial institution, such as an offshore bank, with greater bank secrecy or
less rigorous money laundering enforcement.
Cash-intensive businesses: A business typically involved in receiving cash will use its
accounts to deposit both legitimate and criminally derived cash, claiming all of it as
legitimate earnings. Often, the business will have no legitimate activity.
Trade-based laundering: Under- or over-valuing invoices in order to disguise the
movement of money.
Shell companies and trusts: Trusts and shell companies disguise the true owner of
money. Trusts and corporate vehicles, depending on the jurisdiction, need not disclose its
true, beneficial, owner.
Bank capture: Money launderers or criminals buy a controlling interest in a bank,
preferably in a jurisdiction with weak money laundering controls, and then move money
through the bank without scrutiny.
Casinos: An individual will walk in to a casino with cash and buy chips, play for a while and
then cash in his chips, for which he will be issued a check. The money launderer will then be
able to deposit the check into his bank, and claim it as gambling winnings.
Real estate: Real estate may be purchased with illegal proceeds, then sold. The proceeds
from the sale appear to outsiders to be legitimate income. Alternatively, the price of the
property is manipulated; the seller will agree to a contract that under-represents the value
of the property, and will receive criminal proceeds to make up the difference.
Terrorist Financing: Technically not money laundering at all; while money laundering
typically involves disguising the source of the money, which is illegal, terrorist financing
concerns itself with the disguising the destination of the money, which is illegal.
HAWALA SYSTEM
Since the September 11, 2001, terrorist attacks on the United States, public interest in
informal systems of transferring money around the world, particularly the hawala system, has
increased. The reason is the hawala system's alleged role in financing illegal and terrorist
activities, along with its traditional role of transferring money between individuals and families,
often in different countries. Against this background, governments and international bodies
have tried to develop a better understanding of these systems, assess their economic and
regulatory implications, and design the most appropriate approach for dealing with them.
Informal funds transfer (IFT) systems are in use in many regions for transferring funds, both
domestically and internationally. The hawala system is one of the IFT systems that exist under
different names in various regions of the world. It is important, however, to distinguish the
hawala system from the term hawala, which means "transfer" or "wire" in Arabic banking jargon.
The hawala system refers to an informal channel for transferring funds from one location to
another through service providers—known as hawaladars—regardless of the nature of the
transaction and the countries involved. While hawala transactions are mostly initiated by
emigrant workers living in a developed country, the hawala system can also be used to send
funds from a developing country, even though the purpose of the funds transfer is usually
different (see box).
How does the system work?
An initial transaction can be a remittance from a customer (CA) from country A, or a payment
arising from some prior obligation, to another customer (CB) in country B. A hawaladar from
country A (HA) receives funds in one currency from CA and, in return, gives CA a code for
authentication purposes. He then instructs his country B correspondent (HB) to deliver an
equivalent amount in the local currency to a designated beneficiary (CB), who needs to disclose
the code to receive the funds. HA can be remunerated by charging a fee or through an exchange
rate spread. After the remittance, HA has a liability to HB, and the settlement of their
positions is made by various means, either financial or goods and services. Their positions can
also be transferred to other intermediaries, who can assume and consolidate the initial positions
and settle at wholesale or multilateral levels.
The settlement of the liability position of HA vis-à-vis HB that was created by the initial
transaction can be done through imports of goods or "reverse hawala." A reverse hawala
transaction is often used for investment purposes or to cover travel, medical, or education
expenses from a developing country. In a country subject to foreign exchange and capital
controls, a customer (XB) interested in transferring funds abroad for, in this case, university
tuition fees, provides local currency to HB and requests that the equivalent amount be made
available to the customer's son (XA) in another country (A). Customers are not aware if the
transaction they initiate is a hawala or a reverse hawala transaction. HB may use HA directly if
funds are needed by XB in country A or indirectly by asking him to use another correspondent in
another country, where funds are expected to be delivered. A reverse hawala transaction does
not necessarily imply that the settlement transaction has to involve the same hawaladars; it
could involve other hawaladars and be tied to a different transaction. Therefore, it can be
simple or complex. Furthermore, the settlement can also take place through import transactions.
For instance, HA would settle his debt by financing exports to country B, where HB could be the
importer or an intermediary.
Why hawala developed
In earlier times, IFT systems were used for trade financing. They were created because of the
dangers of traveling with gold and other forms of payment on routes beset with bandits. Local
systems were widely used in China and other parts of East Asia and continue to be in use there.
They go under various names—Fei-Ch'ien (China), Padala (Philippines), Hundi (India), Hui Kuan
(Hong Kong), and Phei Kwan (Thailand). The hawala (or hundi) system now enjoys widespread use
but is historically associated with South Asia and the Middle East. At present, its primary users
are members of expatriate communities who migrated to Europe, the Persian Gulf region, and
North America and send remittances to their relatives on the Indian subcontinent, East Asia,
Africa, Eastern Europe, and elsewhere. These emigrant workers have reinvigorated the
system's role and importance. While hawala is used for the legitimate transfer of funds, its
anonymity and minimal documentation have also made it vulnerable to abuse by individuals and
groups transferring funds to finance illegal activities.
Economic and cultural factors explain the attractiveness of the hawala system. It is less
expensive, swifter, more reliable, more convenient, and less bureaucratic than the formal
financial sector. Hawaldars charge fees or sometimes use the exchange rate spread to generate
income. The fees charged by hawaladars on the transfer of funds are lower than those charged
by banks and other remitting companies, thanks mainly to minimal overhead expenses and the
absence of regulatory costs to the hawaladars, who often operate other small businesses. To
encourage foreign exchange transfers through their system, hawaladars sometimes exempt
expatriates from paying fees. In contrast, they reportedly charge higher fees to those who use
the system to avoid exchange, capital, or administrative controls. These higher fees often cover
all the expenses of the hawaladars.
The system is swifter than formal financial transfer systems partly because of the lack of
bureaucracy and the simplicity of its operating mechanism; instructions are given to
correspondents by phone, facsimile, or e-mail; and funds are often delivered door to door within
24 hours by a correspondent who has quick access to villages even in remote areas. The minimal
documentation and accounting requirements, the simple management, and the lack of
bureaucratic procedures help reduce the time needed for transfer operations.
In addition to economic factors, kinship, ethnic ties, and personal relations between hawaladars
and expatriate workers make this system convenient and easy to use. The flexible hours and
proximity of hawaladars are appreciated by expatriate communities. To accommodate their
clients, hawaladars may instruct their counterparts to deliver funds to beneficiaries before
expatriate workers make payments. Moreover, cultural considerations encourage expatriate
workers to remit funds through the hawala system, and such considerations also apply to family
members in the home country. Many expatriate communities are exclusively male, because wives
and other family members remain in the home country, where family traditions prevail. These
traditions may require family members, especially women, to maintain minimal contacts with the
outside world. A trusted hawaladar, known in the village and aware of the social codes, would be
an acceptable intermediary, protecting women from having direct dealings with banks and other
agents. Thus, a system based on national, ethnic, and village solidarity depends more on absolute
trust between the participants than on legal documents.
On the receiving side, repressive financial policies and inefficient banking institutions, which
have often lacked interest in the remittance business, have contributed to the development of
IFT systems. In addition to overly restrictive economic policies, unstable political situations
have offered fertile ground for the development of the hawala and other informal systems.
Most IFT systems have prospered in areas characterized by unsophisticated official systems
and during times of instability. They continue to develop in regions where financial development
has been slow or repressed. Overall, financial development tends to check the spread of
informal fund transfer systems, even though they exist in financially mature countries as well.
Economic implications
Despite its informality, the hawala system has direct and indirect macroeconomic implications—
for financial activity as well as for fiscal performance. One aspect is its potential impact on the
monetary accounts of countries on either end of the hawala transaction. Because these
transactions are not reflected in official statistics, the remittance of funds from one country
to another is not recorded as an increase in the recipient country's foreign assets or in the
remitting country's liabilities, unlike funds transferred through the formal sector. As a
consequence, value changes hands, but broad money is unaltered. However, hawala transactions
may affect the composition of broad money in a recipient country. In the remittance business,
such transactions are conducted mainly in cash, even though hawaladars may use the banking
system for other purposes. Individuals from developing countries who transfer funds abroad
through the hawala system for investment or other purposes are usually members of wealthy
groups. They supply local hawaladars with cash by making withdrawals from their bank accounts.
As a consequence, hawala-type transactions tend to increase the amount of cash in circulation.
Furthermore, IFT systems have fiscal implications for both remitting and receiving countries
because no direct or indirect tax is paid on hawala transactions. The negative impact on
government revenue applies equally to both legitimate and illegitimate activities that involve the
hawala system.
Hawala transactions cannot be reliably quantified because records are virtually inaccessible,
especially for statistical or balance of payments purposes. This holds true for both the
remitting and, especially, the receiving sides of the transactions. Hawala transactions from
developing countries are sometimes driven by capital flight motivations; they may also be driven
by a desire to circumvent exchange control regulations and the like, leaving no traceable
records. Nevertheless, the authorities of some countries have sporadically made estimates of
hawala activity based on their expatriate populations and balance of payments data. In any case,
all crude estimates should take into account both hawala and reverse hawala transactions (see
box) as well as transactions driven by illicit activities. Although it would be impossible to provide
a precise figure, the amounts involved in hawala transactions are likely to entail billions of
dollars.
Difficulties for regulators
There is also a consensus that, in the wake of heightened international efforts to combat money
laundering and terrorist financing, more should be done to keep an eye on IFT systems to avoid
their misuse by illicit groups. Policymakers believe that the potential anonymity afforded by
these systems presents risks of money laundering and terrorist financing that need to be
addressed. Yet selecting the appropriate regulatory and supervisory response requires a
realistic and practical assessment and an understanding of the specific country environment in
which the IFT dealers operate.
Regulation of IFT systems in various jurisdictions will be a complex endeavor. The variety of
legal systems and economic circumstances across countries make a uniform approach technically
and legally impractical. In a number of countries, the hawala system is prohibited. Any attempt
to regulate this system in these countries would, therefore, be at odds with existing laws and
regulations and would be seen as legitimizing parallel foreign exchange operations and capital
flight.
Where IFT regulations are conceivable, there is agreement that overregulation and coercive
measures will not be effective because they might push IFT businesses, including legitimate
ones, further underground. The purpose of any approach is not to eliminate these systems but
to avoid their misuse. Against this background, policymakers tend to favor two options, which
are already in force in some countries: registration or licensing of IFT systems.
While these measures could deter illegal activities, they will not, in isolation, succeed in
reducing the attractiveness of the hawala system. As a matter of fact, as long as there are
reasons for people to prefer such systems, they will continue to exist and even expand. If the
formal banking sector intends to compete with the informal remittance business, it should focus
on improving the quality of its service and reducing the fees charged. Therefore, a longer-term
and sustained effort should be aimed at modernizing and liberalizing the formal financial sector,
with a view to addressing its inefficiencies and weaknesses.
