The Sink: Crime, Terror, and Dirty Money in the Offshore World Paperback - 2004

Excerpt

.On a blustery Friday morning, March 13, 1931, a panel of twenty-three random citizens who’d never met before sat down on hard wooden chairs in a dingy, windowless room of the ancient federal courthouse in downtown Chicago and, with the door guarded by armed U.S. Marshals, listened to United States attorney George E.Q. Johnson – a tall, thin, stern man wearing gold­rimmed glasses – as he asked them to formally inculpate the most notorious gangster in the country for failing to pay $32,488.81 in income tax seven years earlier.

After several days of hearing evidence, the men and women of this grand jury returned an indictment that, the judge ordered, would be kept secret until further investigations were completed concerning Alphonse Capone’s subsequent tax years 1925 to 1929. The same group met again on June 5 to return a second indictment, charging Capone with twenty-two counts of tax evasion totalling over $200,000. The following week, they indicted him again, along with sixty­eight members of his gang, this time on five thousand violations of the Volstead Act – the law that created Prohibition by banning the manufacture, transportation, and sale of beverages containing more than 0.5 per cent alcohol.

Facing a possible thirty­four years behind bars – for running a $2.5­million-a-year industry that was built on illegal booze, gambling, prostitution, and five hundred murders – Capone agreed to plead guilty in exchange for a short sentence. Johnson was willing to discuss it for several reasons: he was concerned with potential jury tampering; recognized the real possibility that witnesses might wind up dead; and feared that defence lawyers might successfully argue that the statute of limitations had run out on some of the charges. So after lengthy negotiations with Capone’s attorneys, Johnson recommended a custodial sentence of two to five years. Believing it was a done deal, Capone started bragging that he’d be out in under thirty months. That incensed the judge, who accepted Capone’s guilty plea but then handed down eleven years. Furious, Capone reneged on his plea and decided to take his chances with a jury. The trial ­didn’t last long and on Saturday, October 17, he was found guilty on some, but not all, of the tax-evasion charges. The judge accepted the jury’s decision and gave Capone eleven years anyway.

Watching this from the sidelines, a twenty­nine-year­old New York bootlegger named Meyer Lansky couldn’t believe that, where G-men with guns had failed, accountants with pencils had succeeded.

Capone’s dim-witted brother Ralph – a.k.a. “Bottles” Capone – suffered a similar fate. The way Lansky viewed life, that should have been warning enough. Capone’s lieutenants, Frank Nitti and Jake Guzik, were also charged with tax evasion. Ironically, four decades later, Lansky himself would have to face those charges. But now, in 1931 – the same year that gambling was relegalized in the State of Nevada – Lansky was shocked that Capone had fallen for “the rum-runner’s myth.”

Throughout Prohibition, bootleggers had convinced themselves that because booze was illegal, the money they made on it was not taxable. The same false impression was shared by gamblers taking illegal bets on horse racing. “The income tax law is a lot of bunk,” Capone had insisted. “The government can’t collect legal taxes from illegal money.”

Lansky, aghast at how easily Capone’s world had crumbled, was determined not to fall into that same wide trap. At first glance, he was staring at a no-win situation. Pay taxes and you admit your guilt. Don’t pay taxes and you get done like Capone. Eventually, though, he realized there was a third possibility. The Internal Revenue Service (irs) could only make a tax-evasion case if they could find the money. If the Feds couldn’t find the money, he reasoned, then the money was, by default, not taxable. With this as his premise, he turned to the one place where secrecy was already a business – Switzerland.

Long before Holocaust money needed a place to hide, or James Bond gave secret Swiss banking a patina of cinema glitz, the gnomes of Zurich were selling stealth. Several banks offered anonymous banking to clients during the French Revolution. By the end of the nineteenth century, all of them were offering numbered accounts. But it took New Jersey, Delaware, and Great Britain to help the Swiss find their niche.

Facing a budgetary crisis in the mid-1880s, the governor of New Jersey passed a law permitting businesses located across the Hudson River in New York to incorporate in his state. For a small fee, New York businesses could pretend to be New Jersey businesses, which would save them from paying New York’s higher taxes. Based on New Jersey’s success, Delaware went one step further. Towards the end of the 1890s, that state offered incorporation to anyone looking to avoid taxes anywhere. Today, Delaware is America’s foremost offshore centre.

The tax advantages built into a registered company somewhere else were further enhanced by British case law. Judges ruled that a company was resident for tax purposes in the jurisdiction where it was controlled. If the management was in Britain and the factory was in Germany, then the company was British. By that same principle, a company doing business in the U.K. was not subject to British tax as long as the business was entirely “controlled from outside” the U.K. To define that term, judges asked several questions: Where do the directors permanently reside? Where is the seal of the company? Where are the minutes of the meetings kept? Where are the books of accounts and transfer kept? And where are transfers approved?

As long as the answers to all those questions was “someplace besides Britain,” the company was deemed to be non­resident for U.K. tax purposes. The significance of the ruling is that it applied to the entire British Empire, which opened the door for Bermuda and the Bahamas to sell companies resident in their jurisdiction but controlled from elsewhere and, therefore, not subject to tax in Bermuda or the Bahamas.

The Swiss got into the game when they realized they could use dummy companies to create a second barrier of secrecy. Lawyers formed shell companies for clients whose names never appeared on the incorporation documents. A numbered account was opened by the lawyer in the name of the shell, and those few bankers who knew about the shell’s account never know who the beneficial owner was. Only the lawyer knew, and he could not be forced to reveal his client’s name because it was protected by attorney-client privilege. The Swiss also allowed the shares of one dummy corporation to be held by a second shell.

In 1934, the Swiss added another ingredient, making it a criminal offence for anyone working in a bank to reveal any details whatsoever of any account, creating a system that was, in those days, impregnable.

Because there was money to be made in this, Liechtenstein invented trusts that were even more secret than anything the Swiss had for sale. Luxembourg went one better. Where Swiss banking rules dictated that two senior executives in each bank needed to know a client’s identity, the Luxembourgois limited that to one. Not to be left out, the Austrians decided that no one in any bank needed to know anyone.


From the Hardcover edition.