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Panama Papers: A Lawyer’s Perspective

Panama Papers

Recently a lot of ink has been spilled about a leak of confidential papers from the massive law firm Mossak Fonseca, also known as the Panama Papers (or #PanamaPapers). Unfortunately like most things media, the reaction seems to be extremely misplaced. In this article I hope to convey a lawyer’s understanding of shell companies and anonymous LLC’s so that you can better understand the news.

The Media Reaction

I just finished reading an article on CNN entitled, Panama Papers and America’s Problem by Matthew Gardner. Matthew Gardner is the executive director of The Institute on Taxation and Economic Policy, an arm of Citizens for Tax Justice, a public interest research and advocacy organization focusing on tax policies and their impact. Read more about this organization at Wikipedia.

The overall thesis of Mr. Gardner’s article is this: “Congress [should] immediately pass the ‘bipartisan’ Incorporation Transparency and Law Enforcement Assistance Act, which would make information on shell corporation ownership available to tax administrators and law enforcement.

We agree that tax fraud and money laundering are very bad. The Panama Papers show a prime example of this. Unfortunately, he really doesn’t understand how corporations work.

How Corporations Actually Work

As the founder for Law 4 Small Business, I have setup countless anonymous LLC’s because New Mexico is one of the more favorable states to file a domestic anonymous LLC in the United States.

First and foremost, please note that the entities set up by Mossak Fonseca and the corporate options available in the US are not the same.

My explanation rebutting Mr. Gardner’s thesis relies on the arcane process of how corporations and LLC’s are formed and maintained. It seems the media and political cycle hate diving into details, especially if they represent an inconvenient obstacle achieving their goals. In this case, details are everything.

Corporations and LLC’s are entities created under state law in the United States. Each state has its own laws regarding such entities. There are often significant differences from one state to the next. In general, such entities have one or more owners and can be public or private.

  • A public company is what you typically think of when you think of companies whose stock you can purchase in a stock market. They are heavily regulated and governed by numerous governmental agencies (at the state level and the federal level). Public companies can have millions of owners.
  • A company with very few owners is generally considered a “closely held corporation” or a private company.

And, companies can own other companies. This means that the aforementioned owners of a company can be other companies.

In the United States, C-Corporations and LLC’s can be owned by US citizens, foreign nationals and other companies. S-Corporations have limitations on ownership, so that companies and foreign nationals are not permitted to have an ownership interest in S-Corporations.

The states enable companies to be formed by statute. States keep track of companies at the highest level by the “formation documents” (i.e. Articles of Incorporation or Articles of Organization) and corporate reports (depending on the type of entity). Unlike a DMV or MVD, where the state keeps track of the ownership information of each and every titled vehicle, no state keeps track of the ownership information of companies over time with any degree of rigor. At most, a state may request ownership information at the time of formation, or at the most with annual or bi-annually with reports. Even then, such information is never validated or verified — and asking a state to do such validation or verification would be very difficult in the extreme.

What LLC’s and Corporations Actually Do

Now that you have a brief understanding of entity formation in the United States, I need to briefly discuss their day-to-day functions.

What LLC’s and Corporations Do

  • Help the owner maintain privacy and security. There are many legitimate reasons for wanting to prevent just anyone from looking up who “owns” a corporation. We’ve handled plenty of cases where an anonymous LLC has helped the owner avoid an abusive ex-spouse, disgruntled tenants and unfair competition.
  • Ensure liability falls to the LLC or corporation itself, not the owners or their family.
  • Allow a company to have multiple owners and successors.

What LLC’s and Corporations CANNOT Do

  • Avoid Taxes. Anonymous LLC’s in the US still require a FEIN from the IRS if they are to move money around and/or have a bank account. The IRS requires a “responsible party,” which must have a valid FEIN, ITN or SSN. The IRS can trace anonymous shell companies, and the IRS can be subpoenaed by law enforcement. Second, any company, including anonymous LLC’s, can be sued, taken to court or the subject of a criminal investigation. Discovery rules permit obtaining ownership information, and if an owner of an anonymous shell company ignores the lawsuit, they risk a default judgement or worse.
  • Conduct illegal activity.

Why the Proposed Changes Will Not Work

Mr. Gardner advocates that we should jump on the bandwagon with our friends in “the United Kingdom and France, and create a public registry of the owners of every corporation.” I mean, who doesn’t want to stop tax dodgers and cheats? Wouldn’t a public registry make it impossible for people to dodge taxes and commit tax fraud?

No. These proposed changes spurred on by the Panama Papers are flashy and reactionary at best. They will not work for a variety of reasons:

  • Tax Fraud Will Still Occur. Just look at Enron misleading investors with shell companies (that were fully disclosed as being owned by Enron). Enron was not an issue related to anonymous shell corporations or anonymous LLC’s. Tax frauds will still lie, create duplicate books, hide profits or losses, and the millions of other things that tax fraudsters do. A database of ownership information won’t change the situation even a little bit.
  • It’s Impractical. Mr. Gardner implies that the states who do expose ownership information of companies are actually exposing accurate information. This is debatable at best. Most information about company ownership is horribly out of date in most state’s registries. It’s impractical to enforce accurate information and there are many ways to defeat the release of accurate ownership information.
  • Unreasonably Expensive. Who is responsible for keeping this proposed “database” up-to-date? It’s very difficult to maintain accurate ownership information. It can change quickly. It can change without the knowledge of a company (especially publicly traded companies). It can change for many reasons outside the control of a company. To force accurate, and verifiable, registration of ownership information is a Sisyphiusian task.
  • True Anonymity in the United States is a Myth. Anonymous shell companies simply means members of the public cannot look up ownership information. Such information is still known to the IRS, as well as the legal process.

In Conclusion … Don’t Fall For It

It’s tempting to react to the news of the Panama Papers. Don’t fall for it. In the United States, we have many safeguards to prevent truly “anonymous shell corporations,” and the anonymous LLC’s you read about in the US are simply not the same animal as used by the firm Mossack Fonseca to hid or obfuscate its clients.

Law 4 Small Business. A little law now can save a lot later.

A Slingshot company.

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