A study on Money laundering and tax evasion risks in free ports provides an insight into the money laundering, tax evasion and tax avoidance risks connected with free zones, particularly those that function as (semi-) permanent storage for high-value goods, often referred to as ‘free ports’.

Conducted at the request of the European Parliament’s Special Committee on Financial Crimes, Tax Evasion and Tax Avoidance (TAX3) the study follows up on concerns about free zones expressed in recent resolutions by the European Parliament. The study is based on an analysis of relevant legislation, academic literature, annual and special reports by authorities, think-tanks and operators in the art business, articles in the media, interviews with experts at European level and at the OECD and a case study of the legal and supervisory framework at ‘Le Freeport’ in Luxembourg.

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Free ports are conducive to secrecy. In their preferential treatment, they resemble offshore financial centres, offering both high security and discretion and allowing transactions to be made without attracting the attention of regulators and direct tax authorities.

Goods sold in free ports often works of art or antiques, are not subject to value-added tax. No withholding tax is collected on capital gains or inheritance, though sellers may need to report to the tax authority in the country where they are tax resident.

The high level of monetary transactions, the unfamiliarity of enforcement agencies with values and the portable nature of art itself all contribute to making the art market a suitable vehicle for illegal activity. As art is still one of the few unregulated markets, it can be a means of tax evasion and capital flight, and a case can be made for regulating the market for investment art.

As of 10 January 2020, free port operators as well as other actors in the arts market, such as auction houses or galleries, will become obliged non-financial entities under the EU’s AMLD5. This means they will become AML gatekeepers as they will have to report suspicious transactions to FIUs and have to carry out client due diligence research in order to identify the beneficial owner of the stored goods.

Proceeds of sales of art or the possession of substitute goods such as art, antiques or jewellery do not fall within the categories for automatic exchange of information between tax authorities under DAC1. As free port operators are not financial institutions, they are not obliged to provide bulk data regarding their clients to tax authorities under the FATCA, CRS or DAC1 and therefore the exchange of such information between tax authorities is likely to be limited.

Access to these UBO records held by obliged non-financial entities is available to the AML supervisor only for supervision purposes. Direct tax authorities are not allowed to ‘fish’ in these data, but they can have access ‘upon request’since the entry into force of DAC5 on 1 January 2018. However, given that the identities of beneficial owners in free ports, but also in customs warehouses, are ‘unknown unknowns’ to these authorities, they will need to have a prior suspicion in order to substantiate such a request. In this context, the likelihood of a ‘spontaneous exchange’ or ‘exchange upon request’ with other direct tax authorities is small.

Tax fraud and tax evasion have been considered predicate offences for money laundering since the entry into force of AMLD4 in June 2017.

The effects of this remain to be seen as it is almost impossible for a free port operator to establish whether a client who has sold or inherited a piece of ‘investment art’ should have declared capital gains or inheritance or establish if this client actually did make a declaration to the direct tax authorities in the country of tax residence.

The UCC allows for significant flexibility as to who presents the goods upon entry and it does not require the holder of the procedure or of the authorisation to provide customs with information about the UBO. For the moment it can be anyone, as far as the UCC is concerned.

Currently, apart from Luxembourg, there is not one country in the world that has made free port operators subject to AML legislation. As UBO data are not required it is relatively simple to hide the UBO’s identity behind another layer of secrecy, which can be an offshore firm, a trust or foundation, a lawyer or a gallery, or a combination of these.

The UCC provides the legal basis for (indirect) tax deferral as it allows for the permanent storage of goods under a free port or customs warehousing procedure. The fact that investment goods in such  Money laundering and tax evasion risks in free ports facilities can be sold tax-free implies, if they are sold, that indirect taxes have in effect been avoided by the seller.

The wording in the AMLD5 is not consistent with that of the UCC. Firstly, ‘free ports’ are not recognised as such in the UCC, but are formally considered as any other ‘free zone’. This might lead to confusion regarding the scope of the AMLD5.

The AMLD5 (Article 2(3)j) explicitly refers to persons ‘storing, trading or acting as intermediaries in the trade of works of art when this is carried out by free ports’. Given that free ports fall under the so called ‘free zone procedure’ in the UCC, which is almost on the same legal footing as the UCC’s ‘customs warehousing procedure’, it opens the discussion as to whether ‘customs warehouses’ or ‘bonded warehouses’ also fall within the scope of the directive.

Bringing operators such as auction houses and dealers under AMLD5 will pose challenges for them, but also for supervisors. The future success of AMLD5 in the arts market depends on the willingness of these new obliged entities to report suspicions to FIUs and on the deterrent effect of future supervision and possible sanctions. The poor implementation of the AMLD3 by financial institutions throughout Europe and the failing AML supervision of the financial sector, revealed by the Panama Papers and many other leaks and ongoing scandals in the banking sector, may be taken as a warning.

Luxembourg is the only country to have put licensed free port operators on the same footing as non-financial obliged AML entities – almost five years ahead of its obligation to do so. Freeport operators lost clients after the AML legislation entered unilaterally into force in Luxembourg in 2015 and they had to carry out customer due diligence (CDD). Some existing clients refused to provide information concerning beneficial ownership of the goods and took their business elsewhere. It also became much more difficult for operators to bring new clients on board as a result of this clampdown on secrecy. Owners can no longer use offshore companies, trusts, their lawyers, nominees or galleries to shield their ownership of goods in the Luxembourg free port from AMLauthorities, and for some this appears to be a problem.

Despite the strict AML regime in Luxembourg – and as of 2020 throughout the EU – the success of the AML framework will depend heavily on the good faith of obliged entities and their willingness to act as AML gatekeepers by reporting suspicions. Even after the entry into force of AMLD5, the likelihood of exchange of information between tax authorities is low as a consequence of limited access to AML data kept by non-financial obliged entities.

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http://www.europarl.europa.eu/cmsdata/155721/EPRS_STUD_627114_Money%20laundering-FINAL.pdf