Panama Papers: How does off-shore tax avoidance work?

More than 11 million documents accuse former and current heads of state of tax evasion, avoiding sanctions and money laundering (AFP/Getty Images)

Millions of confidential documents have been leaked from one of the world’s most secretive law firms, exposing how the rich and powerful have hidden their money.

Dictators and other heads of state have been accused of laundering money, avoiding sanctions and evading tax, according to the unprecedented cache of papers that show the inner workings of the law firm Mossack Fonseca, which is based in Panama.

But how doest tax avoidance work ?

1) An individual or company transfers assets or cash to the nominal ownership of an offshore company, with the transaction facilitated by a law firm such as Mossack Fonseca.

2) The offshore company is registered in a tax haven regime such as the British Virgin Islands, which doesn’t disclose who the beneficial owner is and which doesn’t co-operate with other tax authorities. So the owner of the assets can avoid national taxes in their resident country – whether income tax, capital gains, or corporation tax – which might otherwise be due.

This is purely an accounting issue. The individual doesn’t move to live in the tax haven. And the company’s employees can be based anywhere in the world. Going offshore be used to hide the proceeds of a crime from the legal authorities.

3) To access the money, the offshore company could lend money with a zero interest rate to a company based in the home country of the individual which is also ultimately owned or controlled by the individual or company that is avoiding tax. This individual or company can then extract cash from the recipient company while paying minimal tax.