Taxation to Protect Bona Fide Diamond Businesses: on Tax Inspectors Becoming Compliance Officers

Finance and Trade
28/09/2016 12:26

By Chaim Even-Zohar. Reprinted from Diamond Intelligence Briefs by special arrangement. Click here to read the first article. 

A fiscally attractive diamond-trading environment may inadvertently invite abuses and entice undesirable criminal elements. If that were to happen, this would compromise the integrity and transparency of the Belgian diamond industry. By removing the link between the tax return filed and the actual financial reports, unscrupulous players might be able to do the following: establish diamond companies to which they would transfer enormous amounts of funds, file a tax return, pay a symbolic 2.1% or less. They may thus be able to launder dirty money.

The Belgian government has quite openly expressed its concerns – and has devoted considerable thoughts regarding steps that need to be taken to avoid this abyss. In the documentation presented to the European Commission in the approval process of the Carat Tax, it is repeatedly stressed that “the stated purpose of the Diamond Regime is to reduce the possibility of tax fraud in the sector and to ensure a predictable tax environment and legal certainty for diamond traders.”  The concerns about “fraud” were mentioned before the “certainty for diamond traders.”

The documents stress that “by applying a fixed percentage of GPM [gross profit margin], the tax inspection difficulty related to the assessment of the amount of the cost of sales would be avoided while addressing the fraud issue.”  The Diamond Regime therefore removes the possibility to manipulate and frees the tax inspector from having to check the value of the inventory.

The assumption is that the overwhelming majority of the diamond trade operates in good faith; the tax inspectors can (and should) direct their efforts to the elimination and prevention of fraud. Though none of this will really affect the diamantaires, it should be understood that this is an integral part of the Belgian government’s intentions.

The Need to Eliminate Any Possible Fraudulent Activity

One of the rarely mentioned reasons that Belgium’s current Fiscal Plan needed to be changed is that it hampered the government’s ability to filter out “real fraud.” Under the present laws, diamond wholesale traders are subject to the regular income tax rules applicable to professional income earned by individuals or companies. There have never been specific accounting rules or requirements that apply to diamond traders. Yes, since the 1990’s there has been a specifically-designed inspection technique (so-called “Fiscal Plan”). However, this had to do with the way the books were audited without specifically changing laws.

The Fiscal Plan that has been in force until now sets “acceptable” gross- and net-margin minimums and is applied in situations where it is not possible to carry out the standard invoicing and inventory auditing techniques. The Belgian government has now admitted that the Fiscal Plan is not only cumbersome for the tax administration, but it is also inefficient to combat fraud.

The way that the technique worked is that the tax inspector “rejected” the books of the diamantaire – which then became the starting point of lengthy litigation. This scenario will not happen again, as there won’t be arguments about inventories, etc. The tax inspector now has time to concentrate on – and identify – the few possible rotten apples, if there still are some.

Following in the Footsteps of the Banks

In a truly unprecedented (and highly laudable) manner, the Belgian government opted to adopt a mechanism akin to the AML/CFT compliance risk assessment methods followed by the banks. Financial institutions are obligated to file suspicious activities reports if the client behaves in a suspicious manner.

Banks know that suspicious activities may involve several factors. On their own, these activities may seem insignificant. However, when analyzed, they may raise suspicion that they involve proceeds of crime or funds related or linked to money laundering or terrorism financing, or they may be used for such purposes. Banks want to understand the purposes and nature of the transactions of a client. The Belgian tax inspectors will now follow a similar model for their diamond clients. They will want “to know their clients.”

The new law introduces a unique and intentionally vague concept of “genuine and habitual” trade. This gives the tax inspectors considerable freedom to identify and examine the activities of a suspected “pseudo” diamond company serving as a front for laundering or other illegal activities. It is assumed that this will only be the case in very exceptional instances; the burden of proof that a company is involved in laundering falls wholly on the tax inspector.

As we stressed before, participation in the Carat Tax Regime is mandatory for all registered diamond traders in Belgium. The tax inspectors have no authority to deviate from the rules or exempt any trader who sells from his own inventory. There is one exception: If a company is “suspicious” – and the Tax Inspector can prove the irregular conduct – the diamond company will become like any other company, and will pay the regular income taxes as applicable in the Belgian fiscal regime. This, of course, is in addition to other sanctions applying to those who violate the criminal laws of the land.

Indicators of Suspicious Companies

The publicly available documentation gives a few examples of elements that the Tax Inspectors may consider. It is understandable that not all of these indicators would be shared with the public – one doesn’t tip off possible launderers. But warning the industry about “abuses” of the Carat Tax Regime is imperative – it’s an inherent part of the system. Knowing this may discourage those few who were hoping that they could use the system for less than honorable purposes.

These elements which may serve as red-flag signals for the tax administration include the following:
Trades conducted by a non-bourse member
Trades that take place with unconventional diamond trade centers
Financing by banks that are not generally known to be active in, focused on the diamond trade or to have particular expertise in the diamond trade
Traders that do not comply with regulations with respect to inventory reporting, AML-compliance, etc.
Recently established diamond traders with large turnover, with or without large margins, without an immediate logical explanation
Margins on individual trades which are clearly excessive in light of the respective goods and transaction, particularly when realized by a trader without “track record” on the market.

The government knows very well that a bona fide experienced diamantaire may be able to produce in certain times huge margins – but that’s fine. In fact, the more the better! Belgium’s tax administration fully appreciates that the context in which a diamond company conducts transactions must be a significant factor in assessing suspicion. This will vary from business to business and from one company to another.

The government and its tax administration will evaluate transactions in terms of what seems appropriate and within normal practices in the diamond trade. Or, maybe, this should be said differently: The Carat Tax will enable the normal, time-honored trade practices to become the New Normal for Belgium’s government and tax authorities. Let’s be honest about it all: The Carat Tax isn’t about the behavior of the industry – but rather about the way the government and Parliament views and governs the industry.

We have said it before: the sooner the better. 