Another giant trove of data was leaked about the ways that the wealthy are able to hide their money, both from the public eye and from investigators. Around six and a half million documents, three million images, a million emails, and half a million spreadsheets were recently leaked. The more than 600 journalists in 117 countries have been trawling through the files from 14 sources for months. The data was obtained by the International Consortium of Investigative Journalists (ICIJ) in Washington DC, which has been working with more than 140 media organizations on what is the biggest ever global investigation. This comes 5 years after a similar leak called the Panama Papers which sparked calls to change the way that many countries report corporate ownership.
One of the most shocking things about this leak is that a new preferred jurisdiction has emerged for the world’s tax dodgers. While the U.S. has been one of the most vocal countries in the fight to change global reporting standards, one of the newest playgrounds for corporate gamesmanship is one of its least populous states, South Dakota. There has always been a so-called race to the bottom when it comes to tax law. Not only is wealth constantly looking for favorable tax rates, it is also searching for places where it can be hidden behind shell corporations and trusts. Places that make themselves attractive, low-risk places to park money can benefit from the swell of economic activity that comes from doing so.
Switzerland was the first country to use this strategy. At the end of the nineteenth century most European countries were undergoing social upheaval and governmental transitions. This understandably worried the aristocracy. The Swiss capitalized on this anxiety by developing banking laws that promised anonymity to the owners of certain types of bank accounts, creating the world’s first well-known modern tax shelter. After World War II this practice came under scrutiny as it became a vehicle for hiding assets by Nazis fleeing prosecution. American threatened sanctions and the Swiss eventually changed their laws to allow investigators access to their once-secret records.
It was at this time that almost every Caribbean island nation saw the opportunity to become financial hubs similar to Switzerland. As their economies struggled to find industry outside of agriculture it seemed like an easy alternative. Many failed in their attempt but a few succeeded, most notably The British Virgin Islands and The Cayman Islands. Both of these countries are still used to this day as tax shelters.
It wasn’t until about ten years ago that South Dakota emerged as a popular place to hide money. It should be noted that South Dakota is not the first U.S. state to do so, Nevada and Delaware have long been places where incorporation is cheap, taxes are low, and transparency is hard to come by. What separated South Dakota, and what made it so attractive to the ultra-wealthy, is the state’s ban on “rules of perpetuity.” Most places don’t allow what are called dynasty trusts, which can exist in perpetuity as a way for wealth to be passed from one generation to another. This seemingly inconsequential law (the entire code is only thirteen words long) along with the fact that the state doesn’t have income, capital gain, estate, or inheritance tax has made it a great place to set up shell accounts that are the vehicle of choice for clandestine cash.
Putting the money in a shell account is only half of the strategy. The other important step is to invest it. The Pandora Papers have also put a spotlight on what the world’s wealthiest do with their money once it is in these secretive trusts. It turns out that real estate, particularly in high-demand, stable markets like London, New York, and California is one of the assets of choice. And why wouldn’t it be? Money in the bank is nice but you can’t throw a lavish dinner party for your ultra-wealthy friends with it.
There are also very few barriers to entry when it comes to buying property in America, as long as you have the money to do so. In 1980 Congress passed The Foreign Investment in Real Property Tax Act (FIRPTA) due to concerns about a trend of foreign buyers buying up farmland at the time. But this tax regulation only affects foriegn sellers and most of the people using shell accounts seem like they have little intention to sell what they have gone through so lengths to buy.
It should be said that much of what was uncovered in the Pandora Papers is not illegal. Sure, hiding wealth begs the question of why but these loopholes are bound to be exploited by the army of lawyers, accountants, and financial advisors’ tasks with finding ways to save their clients from paying taxes. What these leaks have done, though, is expose that these loopholes exist, often right under our noses. Limiting the methods for tax evasion is a bit like playing Whac-A-Mole, (is that still a thing?) new jurisdictions that prospect investors of shell companies pop up all the time. What might happen instead is that popular real estate markets for foreign investors might start requiring more disclosures on where the money for a property comes from. It might be difficult to stop all shell corporations from existing, but limiting where they can invest with impunity is certainly doable. We are in for a change in global tax law and real estate is right in the middle of the conversation.